The Knight of Uncertainty

No, not the Sir Lancelot sort of knight, but Frank Knight, a University of Chicago economist.

He’s most famous for drawing a distinction between risk and uncertainty. I know those sound like much the same thing, but in reality they’re not.

Risk involves having a large data set with a strong track record of known outcomes, such that you can use statistical modelling to make reasonably reliable decisions about future events.

Life insurance, for example, is about managing risk. If you’re a 45 year old, female non-smoker a life insurance company will write a policy in full knowledge of the likelihood of that policy ever having to pay out, and price it accordingly.

With the benefit of hindsight, might that be the wrong judgement for a specific individual? Almost certainly. And some will be wildly out – the unfortunate lady who steps in front of a bus tomorrow or the fortunate one who reaches 120 unscathed.

But on average, across a large enough group of people, statistics kicks in and the average lifespan of a 45 year old, female non-smoker will be reliable enough for you to price life insurance policies and make a profit.

Uncertainty is something entirely different.

That’s where we have no signposts to make statistically reliable decisions. No data. We might not even be able to imagine what the range of potential outcomes might be.

By way of example, imagine someone in 1998 asking you to guess which woman would have the largest Twitter following in 2020.

Back then, Twitter wasn’t even a thing. In fact the internet was barely a thing. And you’d have no way of knowing what the next 20 years might bring…smartphones were almost a decade away, back in 1998, as was Twitter itself and 4G mobile data.

Since I know you’re dying to find out, Taylor Swift is the woman with the most Twitter followers at the time of writing. She was 9 years old in 1998.

The reason this is important is that in business, you need to understand whether you’re managing risk…like a life insurance company using historic data and high-powered statistics to make a fairly safe bet about someone’s remaining lifespan…or uncertainty, like picking out the 9-year old Taylor Swift as the woman with the most Twitter followers 22 years later.

Of course, now you know the answer, it’s not surprising that one of the world’s foremost female music artists has more Twitter followers than any other woman. But it wasn’t obvious 22 years ago and no matter how much data you crunched back then, you’d never have got the right answer.

Why does this matter?

When you’re planning for uncertain future events bear in mind that more data almost certainly won’t get you a better answer.

The key to handling uncertain future events is to be as light on your toes as possible, and have as many options as possible, together with having the authority to make decisions as events unfold.

If there’s one thing we’ve learned from 2020, it’s that most companies thought they were managing risk, insurance company-style.

In reality, they were managing uncertainty. And by and large doing a poor job of it, because they’d developed rigid systems and processes based on their belief that the world was inherently predictable and plannable.

Coronavirus as such would have been just as hard to predict as 9-year old Taylor Swift’s future stardom.

But “bad things happening which sideswipe the economy” is a remarkably frequent event. And you don’t need to know exactly what’s going to happen to prepare for adversity. It’s just that very few businesses do.

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