Friday, April 15, 2011

Black Swan Events

It seems like everywhere I turn I'm being compared with my peers based on the bell curve. I've been graded against it in school and stuff like promotions and raises are commonly granted based on how I perform in comparison with other people. You know the curve I'm talking about, the one shaped like a bell, where you cluster most of the people together in the middle - the C students, then a small clump at the top, another small clump on the bottom. Does this even make sense? Is this how life works? Should a company any company make employee evaluations in this way? Should our schools operate in that way? Do I want my children graded this way?

I think the reason the bell curve has caught on is because in many aspects of our day to day lives it seems to work pretty well. You can get away, mostly, grouping people in a bell shaped curve, where most people are average, a few are below average and a few are above average. But it's rare to impossible to diverge too far from the mean.

There's a lot of reason this approach is favored. For one, it reduces complexity. If you're a teacher (or a parent), you can easily assess how your child is doing in her class by looking at a letter grade, and these grades really mean something when you know they have been applied based on a bell curve. The problem is there are people who clearly don't fit. They either fall so far to right of the curve, they completely off of it. So, not only are super-super stars rare, if you believe the Gaussian curve, they don't exist.

So, how do you account for the super-extraordinary student? You can't give him an A. Well, they are either moved up a grade (or two or three) or they are pushed out of the educational system completely. In the business world, they quit your company and create their own, or if they don't, they will achieve all star status, but will be hopelessly underpaid and probably under-utlized.

Because most of us have grown up in a culture of bell curves, it's only natural that large companies use this same technique to determine raises, promotions, and in the time of hardship, who to lay off.

Why am I focused so much on the bell curve? Well, because I recently finished the book The Black Swan by Nassim Nicholas Taleb who talks about the bell curve in the most disparaging way possible.

The main thesis of the book is that everything that truly matters in our society happens because of events that are both unpredictable and revolutionary. One single stock market crash can wipe out the gradual, predictable gains made over the course of 20 years. A major earthquake in Japan can destroy entire communities that took decades to build. A single event on 9/11/2001, can destroy our economy, turn the airline industry upside down, and bog our country down into two wars. In fact war itself is a black swan. So many times they seem to come out of nowhere, devastating nations for decades.

These are disruptive events and are extremely difficult to predict. Technology is an industry ripe with black swans. Cisco, eBay, Google all were black swan events. Rising out of the dust to produce companies that changed everything. But as soon as these companies got big, they also became predictable. The truly important events, largely in all cases, happened the day these companies were founded. Everything since has been only to leverage their initial idea.

But are people as easy to classify as the bell curve suggests? I would make the argument that the whole notion of the bell curve is flawed. We use it because it works most of the time, but mainly because it makes our lives simple. An individual person is just that, an individual, with built in strengths and weaknesses, but also with a unique set of experiences and opinions and points of view. One of the reasons we are so surprised by black swan events is because a really good idea can germinate just about from anywhere. So much of what happens in society occur through a series of well-timed accidents. The right person was in the right place thinking the right thoughts having the right skills at the right time. So much of all of this is just luck, coming from a circumstantial sequence of events.

Skill matters, though. If you aren't prepared for the unpredictable, it will either bury your or pass you by. How do you prepare? In the words of Taleb, how do you turn black swans grey?

I think we need to break out of the bell curve way of thinking. Every single person has the potential, if given the opportunity and training, to produce black swan events.

Here is one suggestion taking directly from the book:

"The strategy for the discoverers and entrepreneurs is to rely less on top-down planning and focus on maximum tinkering and recognizing opportunities when they present themselves. So I disagree with the followers of Marx and those of Adam Smith: the reason free markets work is because they allow people to be lucky, thanks to aggressive trial and error, not by giving rewards or 'incentives' for skill. The strategy is, then, to tinker as much as possible and try to collect as many Black Swan opportunities as you can."

If we, as a country, want to continue to develop as a nation of innovators, there has to be room to do exactly this. It has to be open to all and widely encouraged and openly supported. The more people excluded, due to lack of opportunity or education, the more we narrow opportunities to benefit from positive black swan events.

At the end of the day, none of us in reality falls within the Gaussian curve. It's a massive over-simplification of how individuals behave and how the world works. It's possible to force the real world into a theoretical model and to pretend things work that way - until you're hit by a black swan event, of course.

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