Spend Matters welcomes this guest post from Sachin Yadav, of GEP.
Nassim Nicholas Taleb isn’t the nicest guy around, but he is exceptionally brilliant in provoking your thought process. His new book, “Antifragile: Things That Gain from Disorder,” is intended to answer the questions raised in “The Black Swan” (another brilliant book), in which the world revolves around disastrous and unpredictable events called Black Swans. So, what can we learn from Black Swan events from a procurement standpoint? Surprisingly a lot, as it turns out.
Taleb describes a “Black Swan” as an event with the following features:
- It is an outlier to the “statistically normal” range
- It has an extreme impact on all participants
- In spite of its outlier status, basic human nature results in us making up explanations for its occurrence after the fact, thereby making it explainable and predictable
As procurement professionals, our job is not to just to minimize costs but to “manage risk” as well. I am using the term “manage” because statistically, we can never reduce risk to zero, and even if we can, the costs for doing so would be prohibitive. Effective management of risk was likely a differentiating factor between the firms that survived the 2008 economic crisis and those that didn’t.
As procurement professionals, rather than wishing that the markets and technology will somehow become less volatile, we should focus on learning from shocks to the system that come our way and eliminating organizational fragility preemptively. The internet revolutionized global business; then, social media revolutionized the internet; and now, smartphones have revolutionized social media. These events are all 1) outliers to the statistically normal range of innovation, 2) have had extreme impacts on consumers and companies, and 3) are now being rationalized as part of the norm — they are all Black Swan events that bankrupted some companies and made billions for others.
This raises the question of what the impact will be for the next Black Swan event:
- How will driverless cars and trucks impact your firm logistics and travel costs?
- How will virtual reality impact air travel?
- How will gene editing techniques impact the healthcare industry?
- How might a trade war crash prices of a commodity such as oil?
Antifragility directs one to benefit from the unpredictable rather than try to prevent it. It means a strategy where you find risk and replace it with antifragility before a shock occurs, so that when it does, you can effectively benefit from it and thus, can move ahead of the competition. So first, let’s talk about how one can manage Black Swan events in the Procurement world:
- Force majeure clauses: These clauses will cover a company from natural calamities and other unpredictable events like fire, strikes, civil war, etc.
- Penalty clauses/pricing commitments/volume commitments: These clauses will force suppliers to adhere to commitments in all conditions, and so, it effectively safeguards the company’s interests as compared with your competitors.
- First mover advantage: Being the first mover in a market or industry can lead to significant market dominance and higher profitability over time if the company can capture the benefits of being first. Basically, there are three benefits of moving first: leadership in technology, control of resources and higher buyer-switching costs. If effectively captured, these benefits can imbibe antifragility into the first mover that will ultimately help it grow during crises.
- Patents: In case a company chooses to take the risk of moving to next-generation technology, how will it make sure that the firm’s innovation is protected? One can also think about exclusivity contracts with technology suppliers to maintain competitive advantage (e.g., the AT&T and Apple contract). Automobile companies also tend to use exclusive contracts with their suppliers to build market share.
- Managing supply risk: Effective supplier relationship management is a cornerstone of supply risk management. Antifragility hedging techniques can be used to benefit from Black Swan events like buying options for low probability events (oil options for 2017 at $200 per barrel).
While it is impossible for a company to position itself to benefit from all risks, these techniques can at least reframe one’s thought about a category as it relates to an entire organization. Living in a world where the only constant is change, it’s not a bad idea that we aim not only to endure the changes that affect us, but to prosper from them.
For more interesting thinking on procurement, visit the GEP Knowledge Bank.