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Auto Focus

By Melissa Anderson
Vice President, IRN Inc.
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The U.S. auto market has performed very well for most of the last 20 years, helped by macroeconomic conditions and non-economic factors such as the automakers’ practice of using incentives to prop up demand to justify running assembly plants. In 2008-2009, the industry got a jolt in the form of a 42-percent drop in a two-year time frame. Long-time industry participants know that the auto industry is a cyclical business and that we were overdue for a correction, but for many Americans, the recent recession caused a harsh realization that the assumption of rising prosperity is not a sure bet. The economic crisis, and the debate about how to fix it raised a host of questions about what we really know about the future and forecasting.

The answer is “not much,” if you ask 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 concept that connects the recession and Taleb is his exploration of the human tendency to: a) overestimate our ability to predict and b) underestimate the role of randomness. A simple analogy illustrates a common flaw in forecasting, e.g. in using models that rely heavily on patterns in historical data, such as automotive sales. Taleb writes:

‘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. … 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. He says, “We humans are the victims of an asymmetry in the perception of random events. We attribute our successes to our skills, and our failures to external events outside our control, namely to randomness.” His book constructs such an elegant dissection of the performance of “experts,” if you were a forecaster with low self-esteem, you might really be demoralized. (Fortunately, I don’t know any forecasters with low self-esteem.)

The fact is, we have to rely on what we can do to make sense of our environment and to make any decisions at all about how to proceed. Taleb doesn’t necessarily disagree, but he 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 risk and even benefit from them. The Black Swan describes the strategy Taleb used as a trader to maximize the likelihood of actually profiting from ‘Black Swans,’ those events that are outside the realm of regular expectations, carry an extreme impact, and seem, in retrospect, to have been predictable. (Read the book.)

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. In the recent downturn, 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). In IRN’s 2009 supplier survey, 26 percent of respondents expected that at least half of their cost improvements would be permanent even when production returned to more normal levels.

Suppliers need to develop cost structures and organizational designs that can cope with a much more volatile external marketplace. We have been advising companies to spend less time on trying to accurately predict the future and more time on preparing their organization to make ongoing calibrations based on market requirements. The market is improving, but the best suppliers learned lessons during the past two years of misery that they will not soon forget.

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