Blinded by the light: how the “halo effect” distorts our view of company performance
Edward Teach
WHAT LEADS TO HIGH BUSINESS performance? Consultants and journalists have advanced many answers to this question, both in print and from the lectern. But most of those answers are little more than educated guesses. In fact, most of them are probably bunk.
That, in a nutshell, is the message of a provocative new book, The Halo Effect (Free Press, February 2007). Written by Phil Rosenzweig, the book debunks that staple of the best-seller list, the corporate success story. According to Rosenzweig, popular and even academic studies of successful companies are commonly shaped by one or more of nine “delusions,” which trump the basics of research and logic (see “A Taxonomy of Delusion,” page 22).
The master delusion that gives Rosenzweig’s book its title is a well-known cognitive bias. Basically, the halo effect refers to how a general or overall impression of a thing influences the perception of other attributes of the thing, or related things. For example, a job seeker with a top-notch school on his resume tends to shine a little brighter during interviews. Auto dealers place exotic “halo cars” on the showroom floor, knowing that their luster rubs off on their duller brethren.
Analysts hail Apple’s iPod as a “halo product” that draws consumers to the rest of the company’s wares.
In Rosenzweig’s usage, the halo effect refers to the glow that financial performance casts on a company–a glow frequently reflected in business articles, he maintains. Has Standard Widget’s stock price outpaced the S&P 500 for the past few years? Journalists readily assume that it must have a brilliant strategy, or superior leadership. Or terrific execution. Or an intense focus on customers, or happy employees, or a strong corporate culture.
The effect also works in reverse. If a company’s stock is a laggard, depend on business writers to deride its strategy as misguided, its managers as shortsighted, its execution as sloppy, and so on, says Rosenzweig. Or perhaps the company “strayed from its core.”
Rosenzweig devotes a chapter to how the halo effect shaped press coverage of Cisco Systems, positively and negatively. When Cisco was the darling of the New Economy, it could do no wrong. Its strategy was brilliant; its CEO, John Chambers, was a visionary leader; its devotion to its customers was exemplary. But when the Internet bubble burst and Cisco’s stock swooned, the press pounced on the company for its alleged shortcomings in all of the above respects. Had the company really changed so dramatically in a short time, between 2000 and 2001? Or had the overall perception of Cisco changed?
“The story of Cisco is perhaps less an example of intentional journalistic hyperbole than it is of something more basic: the difficulty we have in understanding company performance, even as it unfolds before us,” writes Rosenzweig.
BUILT TO REGRESS TO THE MEAN
A management professor at the International Institute for Management Development in Lausanne, Switzerland, Rosenzweig sees halos everywhere, notably in best-selling business books such as In Search of Excellence, Built to Last, and Good to Great.
Typically, the authors of such books round up case studies of market-beating companies. With the power of hindsight, they identify the factor or set of factors that produced that market-beating success and distill principles of management wisdom. This approach is flawed, says Rosenzweig, for a variety of reasons.
For one, choosing only successful companies for study is a methodological error, a form of selection bias. (That’s Delusion #4 on Rosenzweig’s list: “Connecting the Winning Dots”) lust as you can’t find out what leads to high blood pressure if you study only people with the condition, so you won’t nail down the drivers of high performance without looking at companies that didn’t excel, says Rosenzweig.
And while it is true that certain attributes, such as customer satisfaction or employee happiness, may be correlated with high performance, it doesn’t necessarily mean they cause that performance. In fact, it might well be the other way around (Delusion #2: “Correlation and Causality”). By way of example, Rosenzweig cites a 2003 study by researchers at the University of Maryland that found that financial performance was a better predictor of employee satisfaction than vice versa.
Business gurus may rest their case on extensive research (Delusion #5, “Rigorous Research”). But much of that research is compromised, says Rosenzweig, since it relies on halo-distorted articles and books, and on surveys of employees who themselves are blinded by the light. (Will managers at an industry leader be likely to say that their company lacks commitment to its customers?)
What’s more, market-beating success may be short-lived (Delusion #6: “Lasting Success”). Of 35 “Excellent” companies studied in In Search of Excellence, 30 declined in profitability over the 5 years after the authors’ study ended in 1979, Rosenzweig found. Similarly, of 17 of the 18 “Visionary” companies studied in Built to Last, only 8 outperformed the S&P 500 market average for the 5 years after the authors’ study ended in 1990.
“Nothing recedes like success” says Rosenzweig, quoting Walter Winchell. Long-term studies by McKinsey, he notes, show that the prevailing pattern of company performance is one of growth and decline.
CINDERELLA INC.
“Some of what I talk about in The Halo Effect is Research Design 101,” Rosenzweig tells CFO. “You gather your independent variables, independently of the thing you’re trying to explain. You don’t confuse correlation with causality, and you don’t confuse ends with means. You control for other variables. It’s basic stuff.”
But that basic stuff is hard to translate into a Business Week best-seller. “We want to have explanations” says Rosenzweig. “It’s uncomfortable sometimes to say, you know, we don’t really know what’s happening here.” Many popular business books operate at the level of fable and myth, he says. In Rosenzweig’s view, Jim Collins’s Good to Great is essentially a collection of Cinderella tales. “We all love a 2rags-to-riches story,” he says.
When Rosenzweig is through exposing misconceptions about company performance, what is left? Above all, a heightened appreciation, he hopes, of the importance, and riskiness, of strategy. You won’t find the subject in the index of Good to Great, he points out. Why? “Because strategy is about choice, and choice is about making decisions under uncertainty that are risky” he says. “Risky decisions sometimes fail.
“Collins wants to talk about how you can choose to be great, and if you do these specific things you will be great. That’s fundamentally different from an understanding of the business world as being inherently involved in uncertainty and risk? In real life, managers may weigh the odds, consider alternate strategies, and make a good decision–and still fail.
Not all stories have happy endings. And as The Halo Effect instructs us, many of the best stories may be fiction.
A TAXONOMY OF DELUSION
1 THE HALO EFFECT. The tendency to look at a company’s overall performance and make attributions about its culture, leadership, values, and more.
2 CORRELATION AND CAUSALITY. Two things may be correlated, such as employee satisfaction and company performance, but we may not know which one causes which.
3 SINGLE EXPLANATIONS. Many studies show that a particular factor leads to improved performance. But since many of these factors are highly correlated, the effect of each one is usually less than suggested.
4 CONNECTING THE WINNING DOTS. It’s not enough to compare successful companies to isolate reasons for their success; you have to compare successful companies with less-successful ones.
5 RIGOROUS RESEARCH. Research is only as good as the quality of the data.
6 LASTING SUCCESS. Almost all high-performing companies regress over time.
7 ABSOLUTE PERFORMANCE. Company performance is relative, not absolute. A company can improve and fall further behind its rivals at the same time.
8 THE WRONG END OF THE STICK. Successful companies may often pursue highly focused strategies, for example, but that doesn’t mean highly focused strategies often lead to success.
9 ORGANIZATIONAL PHYSICS. Company performance doesn’t obey immutable laws of nature and can’t be predicted with the accuracy of science.
Source: The Halo Effect (Free Press, 2007)
EDWARD TEACH (EDTEACH@CFO.COM) IS ARTICLES EDITOR OF CFO.
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