Gut Feel

McLeod Governance lives near a Mercedes dealership (and for the astute reader … yes also near a McDonald’s with a police only parking sign!).

At this Mercedes dealership they have been maintaining for the last couple of weeks a countdown clock for how many cars they can sell within a specified period of time.

To the best of McLeod Governance’s albeit limited abilities, it appears that the countdown clock is part of a marketing campaign to show that Mercedes are somehow (don’t ask us how – for that is definitely way beyond our cognitive abilities!!) immune from the global financial crisis.

Perhaps we have, all this time, misunderstood the Mercedes value proposition, but McLeod Governance always viewed this brand as a luxury good where there was flexible demand dependant upon the prevailing economic circumstances.

Lo and behold it turns out that Mercedes are actually a necessity and demand for them actually increases in times of once every 80 years economic uncertainty brought on by the Global Financial Crisis. (The sign at the dealership would suggest that they are offloading more than a car a day!).

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This brings us to the concept of outliers.

In statistics, an outlier is an observation that is numerically distant from the rest of the data.

They can occur by chance in any distribution, but they are often indicative either of measurement error or that the population has a heavy-tailed distribution.

McLeod Governance is probably not inventing a new economic concept when it observes that the Mercedes sales data is an outlier to most other pieces of economic data currently being published.

Which brings us to what it is that we – as people interested in outliers (well you were up to this point!!!) – should indeed do when confronted with one.

In the first instance an outlier demands examination.

Why is it an outlier and what is causing the variation from the norm.

This is the reasonable, sound and sensible approach.

The second approach – and the one that many people often miss in their analysis of risk distributions – is, is the outlier the warning sign of an underlying trend?

It is this latter use of outliers that is often overlooked.

What if the sale of Mercedes was actually disproportionately related to the current health of the economy?

What would you do with that information.

This brings us to today’s McLeod Governance sermon – we see outliers in our work environments every day and, whilst we acknowledge them, we very rarely do anything with the information that the outliers contain.

For each circumstance there will be a different outlier so the challenge – and the profit – lies in identifying which ones are false positives and which ones are prophets.

The difference between the two will define the risk environment that you operate it.

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