Black Dragons are Black Swans with Chinese characteristics. Nassim Nicholas Taleb popularized the concept of the Black Swan in his book of the same name. Black Swans are highly improbable events that have consequences in proportion only to the improbability of their occuring at all: the more improbable, the more consequential. The recent meltdown of the global financial system is a Black Swan: the highly improbable events leading up to and coincident in the cascade of failures was a phenomenon few in the world expected. Black Dragons are equally improbable, but have the distinct fingerprints of the Chinese culture, psyche and system of governance all over them. The Blizzard of 2008 in Central and South China in combination with coal and electricity price controls, weakening export markets and hyper-inflated costs for inputs spawned just such a Black Dragon. Strict controls on the media during the run-up to the Olympics in combination with corporate and government collusion gave birth to the Dairy Scandal in 2008. Indeed, it could be said that 2008 was more the Year of the Black Dragon for China than the Year of the Rat.

The outbreak of Swine Flu in April 2008 led expat friends who were around during SARS to reminecse one evening at a local Suzhou pub about the impact SARS had on their operations. “Oh yeah,” one British engineer said, “it was great. No visits from the home office. No Vice Presidents or technicians or Inspectors to hand-hold while they were in China.”

“There was no production,” another friend chimed in. He was a production manager for a large Danish company. “There was nothing to do for weeks,” he said.

“So what did you do during the time?” I asked them.

“We drank beer!” one of the fellows laughed. The others heartily joined in the camaraderie, taking sips from their own glasses of beer. Of course, this is the last thing any headquarters would want to hear from its staff about its far-flung investment in China.

I had come to China on a project just one week after SARS had run its course and the WHO gave its all-clear that China was SARS-free. For nearly two months during the crisis, according to Chinese and Western business owners, business transactions in China had nearly ground to a halt as the government fought to isolate and then eradicate the virus.

The important thing to realize about Black Swans – and their Chinese cousins, Black Dragons – is that they are very difficult to predict, especially with traditional statistical and risk measurement methods. Black Swans and Black Dragons are exotic creatures: they live outside the narrow window of our Bell Curve view of the world and every once in a while, when the incidental becomes the co-incidental they swoop in through the portal of our perception to shake up our world view. So how do Western  companies invested in China keep on the lookout for Black Dragons that may affect their businesses, and how can they protect themselves?

There are indicators that can give companies some idea of the direction, intensity and increased probability of the improbable happening in China. One indicator is the extent to which the government blacks out news about certain incidents: there seems to be an inverse-proportion relationship between the degree to which information is obscured in China and the corresponding impact of the issue on society. For instance, reports of children poisoned by milk powder had been reported (and subsequently squelched) in local papers a full nine months before the full scale of the tragedy exploded onto the scene. Another indicator seems to be a direct correlation between the extent to which the government works to divert the attention of domestic media reports and the severity of Black Swans; that is, an extreme disconnect between local media coverage and international coverage. Coverage of the Tibetan protests in 2008 is a case in point, wherein the dischord between state-controlled and international channels was so great that government relations and business was disrupted between China and the EU – France, especially.

Other barometers for on-coming Black Dragons include hyper-inflated commodity prices and unemployment rates (especially that of university graduates) within the context of seasonal adjustments, especially around holidays and commemorative dates in China (like Spring Festival and the anniversary of the Tiananmen Square protests). Chinese emotions and government watchfulness (read: censorship) tends to run high during these times, opening the window for a confluence of events to blow through society.

But what about the Black Dragons that seem to materialize out of nowhere, like the earthquake in Sichuan province in the Spring of 2008, or the spy plane incident of 2001 in which an American aircraft had to take to Hainan Island after a collision with a Chinese fighter plane? Unfortunately, there is no rational way to predict such occurences. However, decision makers can become more sensitive to the possibility of Black Dragons by referring to the current narratives that explain the occurence of nonlinear events in a more digestable, more acceptable linear fashion. For instance, an increasing number of clashes between Chinese and American naval vessels off the coast of Hainan Island has increased the volatility of the flashpoint the South China Sea has always presented to international relations. The Sichuan earthquake exposed the likelihood of additional substandard construction techniques and materials in earthquake zones that may affect operations in the region.

Very few Western companies with which I am familiar in China have contingency plans and budgets to deal with Black Dragon events. SARS saw the mass evacuation of expats and their families at enormous cost to companies, not to mention the damage done to balance sheets by operations that had to be taken out of production. Companies also need to consider local and expat staff that may be personally caught up in Black Dragon events. In the event of death or dismemberment, companies in China are responsible for compensating the Chinese families of the staff affected – even if the company was not at all responsible for the event.

Of course, a common sense approach to meeting the challenges the occurrence of the highly improbable event presents companies is to keep a cash reserve or line of credit that addresses the consequences of just such catastrophes. Also, as morbid as it may sound, providing staff training in self-supporting emergency services such as evacuation procedures and CPR techniques will reduce the risk of tragedy to employees on the job. The Chengdu-based Bookworm book shop went one better and coordinated emergency supplies and volunteers to help the victims of the Sichuan earthquake last year.

The New Zealand company Fonterra could easily have been swallowed up by the most dramatic scandal in China in 2008: melamine-tainted milk powder products. Fonterra had a 45% stake in a joint venture with Shijiazhuang-based Sanlu, the third largest dairy producer in China. When the story finally broke in September 2008 that Sanlu and other Chinese dairies had known about the poisoned milk and its effects on infants, Fonterra could say it had been the one that had been pushing Sanlu and local authorities to publicly recall the bad product. It took the New Zealand government to directly contact the Chinese central government to finally reveal the cover-up. Though Sanlu is effectively being remade and the central government has acquired the assets of the joint venture (some of which Fonterra may be re-purchasing), Fonterra has gone on to act on its promises to help Chinese citizens the best it could under the difficult circumstances. For instance, Fonterra is making donations to a foundation to support construction of maternal and infant hubs in rural communities. Now, the company is on track to treble its dairy exports to China to about 160,000 tonnes this financial year, because Chinese have lost a great deal of faith in local dairy products.

In other words, it sometimes pays to stick your head in the dragon.

Next installment: Why the World Should Care About China’s Black Dragons

Read the Black Dragon series from the beginning:

The Black Swans of China

Thar Be Black Dragons in China