Monday, 7 July 2014

Risk vs Uncertainty and How to Make Better Predictions

Predicting the company's future has never been trickier than today. In the age of accelerating changes, even the most comprehensive annual reports could be misleading and cannot serve their purpose.

We can make predictions more reliable by understanding the difference between risk and uncertainty. Companies that are able to make this distinction usually perform better than others. In practical terms, they are more capable of narrowing the gap between plans and reality and can tolerate uncertainty with greater ease. 

'Risk means that the probabilities are known. Uncertainty means that the probabilities are unknown.
On the basis of risk, you can decide whether or not to take a gamble. In the realm of uncertainty, though, it’s much harder to make decisions. The terms risk and uncertainty are as frequently mixed up as cappuccino and latte macchiato – with much graver consequences. You can make calculations with risk, but not with uncertainty. The 300-year-old science of risk is called statistics. A host of professors deal with it, but not a single textbook exists on the subject of uncertainty. Because of this, we try to squeeze ambiguity into risk categories, but it doesn't really fit.' 
'This confusion contributed to the chaos of the financial crisis in 2008.’    
(‘The art of Thinking Clearly’, Rolf Dobelly)

Even if we learn how to differentiate between risk and uncertainty we still need to transform this understanding into practical decisions. To do that, we need to acknowledge the existence of self-induced uncertainties and learn how to 'read' them. Operational disruptions could be a good starting point as a measure of airline ability to cope with unknown. Being able to grasp even a bit of this knowledge can sometimes make the difference between business survival and demise. This is at the core of my work.