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The Halo Effect - Phil Rosenzweig

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Praise for

The Halo Effect

One of the Best Business Books of 2007

Financial Times and The Wall Street Journal

Annual Accenture Award for Best Article of the Year: Misunderstanding the Nature of Company Performance: The Halo Effect and Other Business Delusions

California Management Review, summer 2007

I was taken by this book. It destroys myths concerning the attribution of success in the management literature using potent empirical arguments. It should stand as one of the most important management books of all time, and an antidote to these bestselling books by gurus presenting false patterns and naive arguments.

—Nassim Nicholas Taleb, author of The Black Swan

"In The Halo Effect, Phil Rosenzweig has done us all a great service by speaking the unspeakable. His iconoclastic analysis is a very welcome antidote to the kind of superficial, formulaic, and dumbeddown matter that seems to be the current stock in trade of many popular business books. It’s the right book at the right time."

—John R. Kimberly, Henry Bower Professor of Entrepreneurial Studies, The Wharton School, University of Pennsylvania

Business books all too rarely combine real-world savvy with scientific rigor. Rosenzweig’s book is an outstanding exception—it’s a superb work and long overdue.

—Philip E. Tetlock, Lorraine Tyson Mitchell Chair II in Leadership and Communication, Haas School of Business, University of California, Berkeley

Rosenzweig doesn’t only poke fun at the mass of bad writing and bad science in the management world. He explains why it is so bad—and how you can learn from it despite the efforts of the authors.

—John Kay, Financial Times columnist and author of Everlasting Light Bulbs: How Economics Illuminates the World

He writes with a relaxed sense of mastery, uses simple but compelling examples, is rigorous without being pedantic, and bends over backward to be fair to the so-called experts he demolishes.

The Conference Board

A trenchant view of business and business advice.

The Wall Street Journal

This is a fascinating, tightly argued book that challenges much of what we know about business, prodding us to view the research findings with more skepticism. It is an appeal to the mind, rather than a practical handbook for managers, but it does help us evaluate the foundation for the new (and old) ideas we hear.

Globe and Mail (Toronto)

A dismantling of much business writing, which finds that the advice peddled in countless best-selling business books may be much less useful than it appears . . . A thorough, occasionally devastating, de-boning of a clutch of business books and popular business reporting.

The Guardian

Rosenzweig offers a telling indictment of the superficiality of much management literature, and a critique of the many studies that claim to illuminate the source of high performance through the experience of successful companies.

—John Kay, Management Today

"[A] feisty and entertaining new book [that shows how] problems of research methodology and corrupt data bedevil much management literature, turning it into reassuring parables rather than reliable guidance based on empirical evidence . . . has the temerity to name names . . . gives a seeing-to to Jim Collins and Jerry Porras’s Built to Last and Collins’s Good to Great, perhaps the most influential management volumes of recent years."

—Simon Caulkin, The Observer

A refreshing corrective.

—Simon Hoggart, The Guardian

Makes sturdy sense.

The Economist

[Rosenzweig] deserves acclaim for this brave, provocative piece of work . . . He has thrown down a serious challenge to his business school peers and the business media as well.

The Financial Times

A masterly exposé of many myths and sloppy thinking in management. If you want to avoid the next dumb fad, and, in Kipling’s famous line, ‘keep your head when all about you are losing theirs,’ this is an essential primer.

—Professor Andrew Campbell, Ashridge Business School, and author of The Growth Gamble

A brilliant and sobering book.

—Vuyo Jack, Business Report (South Africa)

To my parents,

Mark and Janine Rosenzweig

Contents

Preface (2014)

Preface

Chapter One: How Little We Know

Why do some companies prosper while others fail? Despite great amounts of research, there’s much we don’t know. While some studies of company performance meet the standard of science, many are better described as pseudoscience—they follow the form of science but are better described as stories.

Chapter Two: The Story of Cisco

Cisco Systems surged in the late 1990s with a brilliant strategy, a laserlike focus on its customers, and a masterful skill for acquisitions. When the bubble burst, Cisco was said to have bungled its strategy, neglected its customers, and made reckless acquisitions. History was rewritten in light of diminished performance.

Chapter Three: Up and Down with ABB

While times were good, ABB was a New Age wonder with a great corporate culture, a futuristic organization, and a hero at the helm. When it collapsed, ABB was remembered as having a complacent culture, a chaotic organization, and an arrogant leader. ABB hadn’t changed much—the difference was mainly in the eye of the beholder.

Chapter Four: Halos All Around Us

A central problem that clouds so much of our thinking about business is The Halo Effect. Many things we commonly believe lead to company performance—corporate culture, leadership, and more—are often simply attributions based on company performance.

Chapter Five: Research to the Rescue?

Can academic research about company performance overcome the Halo Effect? Only if it measures independent variables in a way that’s truly independent of performance. Even then, many studies have other flaws, including The Delusion of Correlation and Causality and The Delusion of Single Explanations.

Chapter Six: Searching for Stars, Finding Halos

Examining two well-known bestsellers, In Search of Excellence and Built to Last, we find strong evidence of the Halo Effect as well as other errors such as The Delusion of Connecting the Winning Dots, The Delusion of Rigorous Research, and The Delusion of Lasting Success.

Chapter Seven: Delusions Piled High and Deep

Subsequent studies, including Good to Great, tried to be even more elaborate and ambitious but reveal still more mistakes in their thinking about company performance, including The Delusion of Absolute Performance, The Delusion of the Wrong End of the Stick, and The Delusion of Organizational Physics.

Chapter Eight: Stories, Science, and the Schizophrenic Tour de Force

Many popular business books are deeply flawed as science, but are appealing because they work well as stories. They inspire and comfort their readers. Yet they also focus attention on the wrong priorities and sometimes lead managers in dangerous directions.

Chapter Nine: The Mother of All Business Questions, Take Two

So what does lead to high performance? One approach looks at just two elements: strategic choice and execution. Yet both are full of uncertainty, which explains why company performance can never be guaranteed and why efforts to isolate the secrets of success will always come up short.

Chapter Ten: Managing Without Coconut Headsets

How can managers press onward without delusions? Consider a few managers who set aside wishful thinking and guide their companies with wisdom and clarity, recognizing the uncertain nature of business performance and working to improve their probability of success.

Chapter Eleven: Greed and the Great Recession

The Great Recession lent itself to a satisfying explanation: greed. Although it seems easy to detect greed after the fact—whether on Wall Street, or at Toyota, or in the BP oil spill—it’s much harder to spot in advance. When greed is inferred whenever something goes wrong, it’s just another example of the Halo Effect.

Chapter Twelve: Back to the Present

Checking up on our cast of characters, we see how the fortunes of Intel, Logitech, and Robert Rubin have varied over the past years, while Apple Inc. shimmers under a dazzling Halo, unprecedented but likely unsustainable. Meanwhile, Lego engineers an impressive turnaround and reminds us of the drivers of high performance: sound strategic choice and rigorous execution.

Appendix

About Phil Rosenzweig

Notes

Bibliography

Acknowledgments

Index

The Halo Effect and Eight Other Business Delusions

Delusion One: The Halo Effect

The tendency to look at a company’s overall performance and make attributions about its culture, leadership, values, and more. In fact, many things we commonly claim drive company performance are simply attributions based on prior performance.

Delusion Two: The Delusion of Correlation and Causality

Two things may be correlated, but we may not know which one causes which. Does employee satisfaction lead to high performance? The evidence suggests it’s mainly the other way around—company success has a stronger impact on employee satisfaction.

Delusion Three: The Delusion of Single Explanations

Many studies show that a particular factor—strong company culture or customer focus or great leadership—leads to improved performance. But since many of these factors are highly correlated, the effect of each one is usually less than suggested.

Delusion Four: The Delusion of Connecting the Winning Dots

If we pick a number of successful companies and search for what they have in common, we’ll never isolate the reasons for their success, because we have no way of comparing them with less successful companies.

Delusion Five: The Delusion of Rigorous Research

If the data aren’t of good quality, it doesn’t matter how much we have gathered or how sophisticated our research methods appear to be.

Delusion Six: The Delusion of Lasting Success

Almost all high-performing companies regress over time. The promise of a blueprint for lasting success is attractive but not realistic.

Delusion Seven: The Delusion of Absolute Performance

Company performance is relative, not absolute. A company can improve and fall further behind its rivals at the same time.

Delusion Eight: The Delusion of the Wrong End of the Stick

It may be true that successful companies often pursued a highly focused strategy, but that doesn’t mean highly focused strategies often lead to success.

Delusion Nine: The Delusion of Organizational Physics

Company performance doesn’t obey immutable laws of nature and can’t be predicted with the accuracy of science—despite our desire for certainty and order.

Preface (2014)

In the years since The Halo Effect was first published, a great many things have changed. Even so, the subject of this book—the delusions and errors that pervade the business world and that lead us to misunderstand the nature of company performance—is as timely as ever. Maybe more so.

As John Kay observed in the Financial Times: The power of the halo effect means that when things are going well praise spills over to every aspect of performance, but also that when the wheel of fortune spins, the reappraisal is equally extensive. Our search for excessively simple explanations, our desire to find great men and excellent companies, gets in the way of the complex truth.

The Halo Effect was well-received by managers in a wide number of fields, ranging from value investing to safety engineering, from lean manufacturing to risk analysis, and from auditing to pharmaceutical research. What do these fields have in common? In every one, there’s a need to draw sound conclusions from valid data. It was also appreciated by academics, who used it to help students think critically about company performance and to conduct sound research.

I was gratified that The Halo Effect also struck a chord with readers in many countries. Although my examples were mostly American, the ideas resonated around the world. Three countries deserve special mention: the United Kingdom, China, and India.

For the UK edition, I was asked to find evidence of the Halo Effect among British companies. I didn’t have to look far. In 2005, Marks & Spencer, Britian’s most famous retailer, ranked a mediocre 127th out of 220 companies in a survey of most admired British companies conducted by Management Today. But then, as CEO Stuart Rose’s strategy took hold, performance began to improve. By 2007, Marks & Spencer was in first place, lauded as Britain’s Most Admired Company. Not only did it receive the highest score overall, Marks & Sparks (as the British call it) was rated best in five out of nine categories: quality of goods and services, quality of marketing, use of corporate assets, value as a long-term investment, and ability to attract, develop, and retain talent. It also ranked among the top three on each of the remaining four categories: quality of management (second), financial soundness (second), community and environmental responsibility (second), and capacity to innovate (third). In not one of Management Today’s nine categories did it finish out of the top three.

Can it be that Marks & Spencer ranked near the top in every one of nine different categories? It seems too good to be true—and sadly, it is. Marks & Spencer’s success in the Management Today survey is a good example of the central phenomenon described in these pages. When it posted strong sales and profits, Marks & Spencer enjoyed a Halo whose aura extended to just about everything it did. Impressed by its strong performance, observers inferred that Marks & Spencer must be innovative, that it must have great management, that its marketing must be brilliant, and so on. For all the claims of rigorous research, and for all the thousands of managers that it surveyed, Management Today relied on no objective measures of these categories. It only asked for perceptions, which almost inevitably are strongly shaped by financial performance.

Not surprisingly, when Marks & Spencer’s performance faltered the next year, it quickly fell out of the top tier on almost every one of these same measures. Without objective measures and valid data, the survey turns out to be little more than a feel-good story masquerading as scientific research. Of course, most readers are impressed by large sample size and apparently precise statistics—Marks & Spencer’s winning score was 76.33, calculated to two decimal points—and can’t spot what’s wrong. They’re taken in by what I call the Delusion of Rigorous Research—the fifth delusion described in these pages. Wise readers should not be fooled. They should be aware that a study like this may ask about nine categories, but in reality taps one basic perception, which it then expresses nine different ways—an entirely different matter!

A continent away, in China, the Halo Effect is also thriving. One of my Chinese colleagues regaled me with stories of huge praise that was heaped upon successful companies during years of meteoric growth, only to be followed with merciless fury when the performance of those companies faltered. Reputations were exaggerated on the upside and then destroyed with equal passion.

The most illuminating response to The Halo Effect came from India, where I was contacted by ICICI Bank, the county’s largest private bank. ICICI Bank had grown tremendously over the previous decade, leading to many complimentary articles in the business press. Journalists in India, like their cousins the world over, were quick to lavish praise. A few of the bank’s executives had the good sense to be concerned. As one of them explained to me: We don’t mind if others put a halo on us, but we never want to be fooled by our success. We need to understand what drives our success, and strive to do better. ICICI’s leaders wanted to focus on the real drivers of performance for a financial institution and not merely infer that they were doing well at execution or customer service just because the overall results were strong. They didn’t want to be taken in by the Halo of their own success.

The story doesn’t end there. In 2009, after the banking industry suffered a sharp downturn, the largest Indian banks—including ICICI Bank—came in for criticism. As company executives widely understood, it had been important not to be taken in by excessive praise during good times, and now it was equally vital not to take criticism to heart when times were bad. For all the tumult and anguish in capital markets, and for all the fickle responses by investors, ICICI Bank’s fundamental business model remained sound. Once again, observers were quick to make extreme attributions based on current performance, whether favorable or unfavorable. As Warren Buffett observed about investors, there’s a tendency to overshoot in both directions, on the high side and also on the low side.

I was impressed by the clear thinking of executives at ICICI Bank, and I have been equally gratified by the attitudes of managers in many other companies. I admire their desire to understand the real drivers of performance, rather than be fooled by a mirage.

Yet there’s a long way to go. Much of what we continue to read and hear in the business world is riddled with errors. There are frequent examples of the Halo Effect in the business press, in academic research, in studies conducted by leading consultancies, as well as in new business books published every year. For all their claims of rigorous research, for all their pretensions of science, the variables they draw upon are often not independent of the thing they are seeking to explain.

Indeed, since The Halo Effect was published, several more books appeared that claim to reveal the secrets of high performance. One looked at startups—a sort of Good to Great for the entrepreneurial set. Another examined European companies, a replication of Built to Last for the Old Continent. Another turned the question of high performance on its head, asking what causes successful companies to fail. The genre is alive and well because the lure of simple solutions remains strong. Most of these books make the same flaw that’s revealed in this book: If you select companies on the basis of outcomes—whether success or failure—and then gather data that are biased by those outcomes, you’ll never know what drives performance. You’ll only know how high performers or low performers are described.

To the original ten chapters—which are unchanged from the 2007 edition—I’ve added two more.

Chapter 11, Greed and the Great Recession, looks at the most important economic event since this book was published, the financial crisis of 2008–09. Rather than bestow Halos on high performers, now the opposite question was posed: What led to failure? A common explanation was greed. As we’ll see, however comforting this explanation may have been, it was really just one more example of the Halo Effect. Take any failure and it’s possible to point the finger at greed. It makes a good story, of course, but stops short of teaching the most important lessons.

Chapter 12, Back to the Present, brings the story up to date, letting us meet up with some of the people and companies introduced in the 2007 edition. We’ll see how they have fared and look at the present landscape for evidence of the Halo Effect.

One last word. A number of readers asked why the 2007 edition said so little about Enron or other examples of corporate malfeasance. It’s a good question, because Enron was a prime example of the Halo Effect. While it was racking up record gains in revenues and profits, everything from Enron’s corporate culture to its innovative financial engineering to its visionary leadership was heaped with praise.

Enron had been a poster child for innovation in Gary Hamel’s 2000 book, Leading the Revolution, which made for a bit of embarrassment when the company imploded in 2001—and which led to a rapid revision, published in 2002. At Harvard Business School, too, laudatory case studies had been written about Enron’s creativity and innovative business model, only to disappear from the HBS catalog in the wake of Enron’s collapse, where they were replaced with cautionary case studies about corruption and leadership gone astray. Nothing like closing the stable door after the horse has bolted. Hindsight is 20/20 even on the banks of the Charles.

Why so little mention of Enron in this book? Because Enron engaged in criminal behavior, which distracts us from the main lesson. My point is more fundamental: people naturally make inferences based on overall impressions. The way they do so seems entirely logical. It makes for a coherent story and helps us make sense of the world around us. When we allow an overall impression to color our thinking, however, we’re on a slippery slope. Criminal behavior isn’t necessary for us to fall for the Halo Effect. As soon as we pick our examples based on outcomes, and then make inferences based on those overall results, we’re asking for trouble.

My aim—now as well as when this book was first published—is to help managers think for themselves. It’s to let them see through the shoddy reasoning and sleight of hand that often passes for knowledge in the business world. The Halo Effect was written to help managers to develop their abilities of critical thinking, and to become more adept at grasping the more complex truths of business.

If you’re ready to sharpen your skills and to defend yourself against the deluded thinking of so-called experts, this book is for you.

Preface

This book is about business and management, success and failure, science and storytelling. It’s written to help managers think for themselves, rather than listen to the parade of management experts and consultants and celebrity CEOs, each claiming to have the next new thing. Think of it as a guide for the reflective manager, a way to separate the nuggets from the nonsense.

Of course, for those who want a book that promises to reveal the secret of success, or the formula to dominate their market, or the six steps to greatness, there are plenty to choose from. Every year, dozens of new books claim to reveal the secrets of leading companies, from General Electric and Toyota to Starbucks and Google. Learn their secrets and apply them to your company! Other books profile hugely successful business leaders like Michael Dell or Jack Welch or Steve Jobs or Richard Branson. Find out what makes them great, then go do likewise! Others tell you how to become an innovation powerhouse, or craft a failsafe strategy, or devise a boundaryless organization, or make the competition irrelevant. Here’s the way to beat your rivals!

In fact, for all the secrets and formulas, for all the self-proclaimed thought leadership, success in business is as elusive as ever. It’s probably more elusive than ever, with increasingly global competition and technological change moving at faster and faster rates—which might explain why we’re tempted by promises of breakthroughs and secrets and quick fixes in the first place. Desperate circumstances push us to look for miracle cures.

What’s going on here isn’t some vast right-wing conspiracy, or left-wing conspiracy or Wall Street conspiracy or Ivy League conspiracy, for that matter. In part it’s a marriage of convenience. Managers are busy people, under enormous pressure to deliver higher revenues, greater profits, and ever larger returns for shareholders. They naturally search for ready-made answers, for tidy plug-and-play solutions that might give them a leg up on their rivals. And the people who write business books—consultants and business school professors and strategy gurus—are happy to oblige. Demand stimulates supply, and supply finds a ready demand. Around and around we go.

But there’s more going on than just laziness or greed. Many thoughtful people work very hard to pinpoint the reasons for company success. If they have trouble finding definitive answers, we ought to ask why. Why is it so hard to determine the factors that lead to high performance? Why is it that even clever minds that earnestly want to uncover the secrets of success don’t find solid answers—even when they gather huge amounts of data about hundreds of companies over many years? Is there something about the way we ask the question, or the way we go about trying to find answers, that keeps us from getting it right?

The central idea in this book is that our thinking about business is shaped by a number of delusions. There are good precedents for investigating delusions in business and economics. Charles Mackay’s 1841 classic, Extraordinary Popular Delusions and the Madness of Crowds, chronicled the follies of public judgment, from Dutch tulip mania to speculative bubbles and more. More recently, cognitive psychologists have identified biases that affect the way individuals make decisions under uncertainty. This book is about a different set of delusions, the ones that distort our understanding of company performance, that make it difficult to know why one company succeeds and another fails. These errors of thinking pervade much that we read about business, whether in leading magazines or scholarly journals or management bestsellers. They cloud our ability to think clearly and critically about the nature of success in business.

Is delusion too strong a word? I don’t think so. A longtime friend of mine, Dick Stull, explains the difference between illusion and delusion this way. When Michael Jordan appears to hang motionless in midair for a split second while on his way to a slam-dunk, that’s an illusion. Your eyes are playing tricks on you. But if you think you can lace up a pair of Nikes, grab a basketball, and be like Mike, well, that’s a delusion. You’re kidding yourself. It ain’t gonna happen. The delusions I describe in this book are a bit like that—they’re promises that you can achieve great success if you just do one thing or another, but they’re fundamentally flawed. In fact, some of the biggest business blockbusters of recent years contain not one or two, but several delusions. For all their claims of scientific rigor, for all their lengthy descriptions of apparently solid and careful research, they operate mainly at the level of storytelling. They offer tales of inspiration that we find comforting and satisfying, but they’re based on shaky thinking. They’re deluded.

Mark Twain once said: Always do right. This will gratify some people and astonish the rest. My purpose is a bit different. Rather than gratify and astonish, I hope this book will stimulate discussion and raise the level of business thinking. The point isn’t to make managers smarter. The business world is full of people who are plenty smart—clever, quick of mind, and conversant in current management concepts. In short supply are managers who are wise—by which I mean discerning, reflective, and able to judge what’s correct and what’s wrong. I’d like this book to help managers become wiser: more discerning, more appropriately skeptical, and less vulnerable to simplistic formulas and quick-fix remedies. Why is this a worthwhile goal? I’ve lived in and around the business world for more than twenty-five years, first as a manager for a leading U.S. company, then as a professor at Harvard Business School, and for these past ten years as a professor at IMD in Lausanne, Switzerland. I work on a daily basis with executives from a wide variety of industries. What I’ve observed, over and over, is a tendency by managers and professors alike to embrace simple answers, some of them patently simpleminded and wrongheaded, and to latch on to quick solutions rather than to question and think for themselves.

But rather than tell you what to think, I’d rather have you think critically for yourself. You may find some parts of this book to be a bit provocative. If so, that’s fine. I want you to challenge what I write rather than accept it. One of my role models here is the late Herbert Simon, father of artificial intelligence, Nobel Prize winner in economics for his work on decision making, and professor at Carnegie Mellon University from the late 1940s until his death in 2001. In his memoirs, Models of My Life, Simon described how his service on several foreign fact-finding missions in the 1960s, often time-consuming and very costly, led him to formulate his Travel Theorem, which