Knowns and unknowns
All planning requires us to peer into the future as far as we can, and based on what we see and our forecasts we devise plans. However, there is a huge range in what we are capable of foreseeing and with what reliability. It is useful to divide future events into three classes, as did Donald Rumsfeld, the former US Secretary of Defense. He was derided at the time but – at least in this matter – he made perfect logical sense, though somewhat clumsily expressed:
‘There are known knowns; there are things we know we know. We also know there are known unknowns; that is to say, we know there are some things we do not know. But there are also unknown unknowns – the ones we don't know we don't know.’
• The known knowns – for example, an organisation might know that its drug patents will expire in three years, or that it will be relocating in six months. These events are relatively easy for planners to handle and to build into budgets and objectives.
• The known unknowns – for example, an organisation might know that its competitors are going to launch an important new product but it is not sure exactly what the characteristics of that product will be. (Think of the launch of the Apple iPad: everyone knew something was coming, but no one outside Apple knew any details.) Or, organisations might know that interest rates will rise but are not sure when or by how much. These types of unknown can be handled by making estimates and possibly by assigning probabilities to the various outcomes. Decision trees, expected values, and sensitivity analysis are all very useful techniques.
• The unknown unknowns – do you know when there will be a powerful earthquake that flattens the city of London? (Of course, by definition, we don’t know if there will ever be one.) In 2007, no one knew, or suspected, that Lehman Brothers would fail. Unknown unknowns cannot be planned for, but organisations should assume that they will happen and should therefore build into their plans robustness to protect themselves against negative events and an ability to exploit positive ones.
These unknown unknowns are by far the most difficult to manage. They are sometimes termed ‘black swan events’ (1) because before black swans were discovered in Australia, no one could imagine the existence of a swan that wasn’t white. Black swan theory was developed by Nassim Taleb to explain:
• the huge impact of unpredictable, rare events that are outside our normal experience and without historical precedent
• the non-computability of the effect of these rare events because there is no data on which to base calculations
• the psychological bias that blinds us to the possibility and impact of rare events. We tend to assume that things (such as property price increases) will continue in a predictable way.
The phrase ‘black swan event’ is therefore used as a metaphor for the frailty and limitation of any system of thought and planning: bounded rationality. This means that we cannot know all-important factors that will affect the future (and, anyhow, do not have time to evaluate them). We are, in practice, likely to suffer from bounded rationality even with the known knowns because of imperfect research or pressure of time. However, in a period of turbulence, more events will be in the last two categories and this makes planning more difficult. So how should organisations respond to the threat of unknowns while still trying to move forward in terms of gaining competitive advantage?