Managing uncertainty

The growth rate in North American light vehicle sales is expected to slow between 0.5% to 1% a year for the next 5 to 7 years. That is a conservative, stable pace after a strong recovery in the auto industry following the economic downturn of 2008 to 2009. The industry got quite a jolt then in the form of a 42% drop in production. The economic crisis and the resulting scramble of companies to adapt raised questions about what we really know about the future and forecasting.

The answer would probably be “not much,” if you asked Nassim Nicholas Taleb, former Wall Street trader, mathematical finance scholar, and author of several books including his 2007 work “The Black Swan: The Impact of the Highly Improbable” (Random House: New York). The author explores the human tendency to both overestimate our ability to predict and to underestimate the role of randomness. An analogy from the book illustrates a common flaw in forecasting – using models that rely heavily on patterns in historical data, such as automotive sales.

“Consider a turkey that is fed every day. Every single feeding will firm up the bird’s belief that it is the general rule of life to be fed every day by friendly members of the human race.” Taleb writes. “On the afternoon of the Wednesday before Thanksgiving, something unexpected will happen to the turkey. It will incur a revision of belief.… What can a turkey learn about what is in store for it tomorrow from the events of yesterday? A lot, perhaps, but certainly a little less than it thinks, and it is just that ‘little less’ that may make all the difference.”

Taleb describes many characteristics of the human psyche that lead us to flawed expectations and conclusions: a tendency to look only for corroboration of what we already believe, to force a logical explanation onto any sequence of facts, and to underestimate uncertainty. Companies have to try to make sense of their environment in order to make decisions about how to proceed, but Taleb would prefer that we be more realistic about our ignorance.

Be aware of the full range of possible outcomes; don’t forget there are outliers. Rely on informed risk-taking; distinguish between facts and claims of expertise where none is possible. Favor clinical knowledge over theories, experimentation over anecdotes. Taleb suggests that by being receptive to the possibility of big, bad events, one can figure out how to minimize risks and even benefit from them.

Relative to the automotive industry, Taleb’s message of being prepared for a wide range of outcomes is consistent with what many component suppliers learned the hard way during the recession. Many companies were successful in reducing their cost structure to a point of profitability at North American light vehicle production levels of 10 million units or less (previously, 14 million vehicles might have been considered an appropriate breakeven level). They worked hard to retain cost improvements even as production returned to more typical levels.

Suppliers need to develop cost structures and organizational designs that can cope with a volatile external marketplace. We have long advised companies to spend less time on trying to accurately predict the future and more time preparing their organization to make continuous calibrations based on market requirements. The market has improved, but the best suppliers learned lessons during those years of misery that they will not soon forget.

Melissa Anderson Consulting LLC
mandersonconsultingllc@gmail.com

About the author: Melissa Anderson, owner of Melissa Anderson Consulting LLC, has consulted with automotive suppliers extensively since 1986.