Is that a black swan lurking just around the corner, ready to sow chaos and devastation? Or is it a false alarm?
Black swan is the term popularized by the writer Nicholas Nassim Taleb for a seemingly unpredictable surprise with extreme consequences. Many people apply the term to the housing and financial crash of 20072009. But the term should not be restricted to global crises. Black swan surprises can impact individual sectors or companies, even when the rest of the market is calm.
The real problem with black swans is that, while they may seem obvious in hindsight, they are anything but beforehand. Corporate executives (and risk managers) need a system to help them make decisions before the black swan has arrived, at which point it may be too late to take action.
And it had better be a pretty good system, because the consequences are severe: Fail to act and the company could be destroyed. But an executive who jumps at shadows may miss out on the opportunity to invest and grow.
Once a black swan has arrived, there may be little time to react--it might even be too late. But just because a black swan might be flapping around somewhere off in the distance--that doesn't mean it's time to run for the bunkers. What would help is an early warning system that separates potential risk from imminent danger.
This early warning system should have three components. The first component is a process for identifying potential risks. It's fine if this process is largely intuitive. After all, most executives understand the risks unique to their business. Start by writing them down. Then open the newspaper. What macro risk factors are people debating? Add them to the list.
Back in 2007, there was a huge debate about the housing market. With hindsight, we now know that most people were too optimistic, and only a few foresaw just how bad things would get. But housing market risk wasn't a secret. Everyone was talking about it. And therefore it should have been on every executive's list of potential risks.
Today, a list of macro risk factors might include economic growth in China, the ongoing debt crisis in Europe and political uncertainty surrounding the United States budget deficit.
The second component of an effective early warning system is a list of key risk indicators, i.e., data points that measure the company-specific and macro risks on the list.
For example, in 2007 key risk indicators for the housing market could have included home sales or home price appreciation, which are...