The halo effect, and other managerial delusions
Companies
cannot achieve superior and lasting business performance simply by following a
specific set of steps.
The quest of every high-quality corporate executive is to
find the keys to superior performance. Achieving market leadership is hard
enough, but staying at the top—given intense competition, rapidly changing
technology, and shifting global forces—is even more difficult. At the same
time, executives are under enormous pressure to deliver profitable growth and
high returns for their shareholders. No wonder they constantly search for ways
to achieve competitive advantage.
But many executives, despite their good
intentions, look in the wrong places for the insights that will deliver an
edge. Too often they reach for books and articles that promise a reliable path
to high performance. Over the past decade, some of the most popular business
books have claimed to reveal the blueprint for lasting success, the way to go
from good to great, or how to craft a fail-safe strategy or to make the
competition irrelevant.
At first glance, many of the
pronouncements in such works look entirely credible. They are based on
extensive data and appear to be the result of rigorous analysis. Millions of
managers read them, eager to apply these keys to success to their own
companies. Unfortunately, many of the studies are deeply flawed and based on
questionable data that can lead to erroneous conclusions. Worse, they give rise
to the especially grievous notion that business success follows predictably
from implementing a few key steps. In promoting this idea, authors obscure a
more basic truth—namely, that in the business world success is the result of
decisions made under conditions of uncertainty and shaped in part by factors
outside our control. In the real world, given the flux of competitive dynamics,
even seemingly good choices do not always lead to favorable outcomes.
Rather than succumb to the hyperbole and
false promises found in so much management writing, business strategists would
do far better to improve their powers of critical thinking. Wise executives
should be able to think clearly about the quality of research claims and to
detect some of the egregious errors that pervade the business world. Indeed,
the capacity for critical thinking is an important asset for any business
strategist—one that allows the executive to cut through the clutter and to
discard the delusions, embracing instead a more realistic understanding of
business success and failure.
As a first step, it’s important to
identify some of the misperceptions and delusions commonly found in the
business world. Then, using these insights, we might replace flawed thinking
with a more acute method of approaching strategic decisions.
Beware the
halo effect
Many studies of company performance are
undermined by a problem known as the halo effect. First identified by US
psychologist Edward Thorndike in 1920, it describes the tendency to make
specific inferences on the basis of a general impression.
How does the halo effect manifest itself
in the business world? Imagine a company that is doing well, with rising sales,
high profits, and a sharply increasing stock price. The tendency is to infer
that the company has a sound strategy, a visionary leader, motivated employees,
an excellent customer orientation, a vibrant culture, and so on. But when that
same company suffers a decline—if sales fall and profits shrink—many people are
quick to conclude that the company’s strategy went wrong, its people became
complacent, it neglected its customers, its culture became stodgy, and more. In
fact, these things may not have changed much, if at all. Rather, company
performance, good or bad, creates an overall impression—a halo—that shapes how
we perceive its strategy, leaders, employees, culture, and other elements.
As an example, when Cisco Systems was
growing rapidly, in the late 1990s, it was widely praised by journalists and
researchers for its brilliant strategy, masterful management of acquisitions,
and superb customer focus. When the tech bubble burst, many of the same
observers were quick to make the opposite attributions: Cisco, the journalists
and researchers claimed, now had a flawed strategy, haphazard acquisition
management, and poor customer relations. On closer examination, Cisco really
had not changed much—a decline in its performance led people to see the company
differently. Indeed, Cisco staged a remarkable turnaround and today is still
one of the leading tech companies. The same thing happened at ABB, the
Swiss-Swedish engineering giant. In the 1990s, when its performance was strong,
ABB was lauded for its elegant matrix design, risk-taking culture, and
charismatic chief executive, Percy Barnevik. Later, when the company’s
performance fell, ABB was roundly criticized for having a dysfunctional
organization, a chaotic culture, and an arrogant CEO. But again, the company
had not really changed much.
The fact is that many everyday concepts in
business—including leadership, corporate culture, core competencies, and
customer orientation—are ambiguous and difficult to define. We often infer
perceptions of them from something else, which appears to be more concrete and
tangible: namely, financial performance. As a result, many of the things that we
commonly believe are contributions to company performance are
in fact attributions. In other words, outcomes can be mistaken for
inputs.
Wise managers know to be wary of the halo
effect. They look for independent evidence rather than merely accepting the
idea that a successful company has a visionary leader and a superb customer
orientation or that a struggling company must have a poor strategy and weak
execution. They ask themselves, “If I didn’t know how the company was
performing, what would I think about its culture, execution, or customer
orientation?” They know that as long as their judgments are merely attributions
reflecting a company’s performance, their logic will be circular.
The halo effect is especially damaging
because it often compromises the quality of data used in research. Indeed, many
studies of business performance—as well as some articles that have appeared in
journals such as Harvard Business Review and McKinsey
Quarterly and in academic business journals—rely on data contaminated
by the halo effect. These studies praise themselves for the vast amount of data
they have accrued but overlook the fact that if the data aren’t valid, it
really doesn’t matter how much was gathered or how sophisticated the analysis
appears to be.
This reliance on questionable data, in
turn, gives rise to a number of further errors in logic. Two delusions—of
absolute performance and of lasting success—have particularly serious
repercussions for business strategists.
The
delusion of absolute performance
One of the most seductive claims in
business best sellers is that a company can achieve success if it follows a
specific set of steps. Some recent books are explicit on this point, claiming
that a company hewing to a certain formula is virtually sure to become a great
performer. On closer inspection these studies rely on sources of data
(including retrospective interviews, articles from the business press, and
business school case studies) that are routinely undermined by the halo effect.
Whereas a given set of factors may appear to have led predictably to success,
the reverse is more likely—it would be more accurate to say that successful
companies tended to be described in the same way. The direction of causality is
wrong.
Following a given formula can’t ensure high
performance, and for a simple reason: in a competitive market economy,
performance is fundamentally relative, not absolute. Success and failure depend
not only on a company’s actions but also on those of its rivals. A company can
improve its operations in many ways—better quality, lower cost, faster
throughput time, superior asset management, and more—but if rivals improve at a
faster rate, its performance may suffer.
Consider General Motors. In 2005 GM’s debt
was reduced to junk bond status—hardly a vote of confidence from financial
markets. Yet compared with the automobiles GM produced in the 1980s, its cars
today boast better quality, additional features, superior comfort, and improved
safety. Owing to myriad factors, including the increased prominence of Japanese
and South Korean automakers, GM’s share of the US market keeps slipping, from
35 percent in 1990 to 29 percent in 1999 and 25 percent in 2005. Its declining
performance must be understood in relative terms. Paradoxically, the rigors of
competition from Asian automakers are precisely what have stimulated GM to
improve. Is GM a better automaker than it was a generation ago? Yes, if we look
at absolute measures. But that’s little comfort to its employees or
shareholders.
The delusion of absolute performance is
very important because it suggests that a company can achieve high performance
by following a simple formula, regardless of the actions of competitors. If
left unchecked, executives may avoid decisions that, although risky, could be
essential for success. Once we see that performance is relative, however, it
becomes obvious that a company can never achieve success simply by following
certain steps, no matter how serious its intentions. High performance comes
from doing things better than rivals can, which means that managers have to
take risks. This uncomfortable truth recognizes that some elements of business
performance are beyond our control, yet it is an essential concept that
clear-thinking executives must grasp.
The
delusion of lasting success
The halo effect leads to a second
misconception about the performance of companies: that they can achieve
enduring success in a predictable way. These studies typically begin by
selecting a group of companies that have outperformed the market for many years
and then gather data to try and distill what led to that high performance.
Regrettably, however, much of the data come from sources that are commonly
contaminated by the halo effect. What the authors claim to be the causes of
long-term performance are more accurately understood as attributions made about
companies that had been selected precisely for their long-term performance.
In fact, lasting success is largely a
delusion, a statistical anomaly. As McKinsey’s Richard Foster and Sarah Kaplan
showed,1corporate longevity is neither very
likely nor, when we find it, generally associated with high performance. On the
whole, if we look at the full population of companies over time, there’s a
strong tendency for extreme performance in one time period to be followed by
less extreme performance in the next. Suggesting that companies can follow a
blueprint to achieve lasting success may be appealing, but it’s not supported
by the evidence.
High performance is difficult for companies
to maintain, for an obvious reason: in a free-market economy, profits tend to
decline as a result of imitation and competition. Rivals copy the leader’s
winning ways, new companies enter the market, best practices are diffused, and
employees move from one company to another. Of course, it is always possible to
pick out a handful of enduring success stories after the fact. Then if we study
those companies by relying on data that are suffused with the halo effect, we
may think we have discovered the keys to success. In fact, we have only managed
to show how successful companies were described—an entirely different matter.
The delusion of lasting success is a
serious matter because it casts building an enduringly high-performing company
as an achievable objective. Yet companies that outperform the market for long
periods of time are not just rare but statistical anomalies whose apparent
greatness is observable only in retrospect. More accurately, companies that
enjoy long-term success have probably done so by stringing together many
short-term successes, not because they somehow unlocked the secrets of
sustained greatness. Unfortunately, pursuing a dream of enduring greatness may
divert attention from the need to win more immediate battles.
Clear
thinking for business strategists
These points, taken together, expose the
principal fiction at the heart of so many popular business books and articles:
that following a few key steps will inevitably lead to greatness and that a
company’s success is of its own making and not often shaped by external
factors.
The simple fact is that no formula can
guarantee a company’s success, at least not in a competitive business
environment. This truth may seem disappointing. Many managers would like to
find a formula that can be easily applied—a tidy plug-and-play solution that
ensures success. But on reflection, the absence of a simple success formula
should not be disappointing at all. Indeed, it might even come as a relief. If
success could be reduced to a formula, companies would not need strategic
thinking but could rely on administrators to tick the right boxes and ensure
that formulas were followed with precision. What makes strategic decision
making so difficult, and therefore so valuable to companies, is precisely that
there are no guaranteed keys to success. The ability to make the sorts of
difficult, complex judgments that are pivotal for a company’s fortunes is, in
the last analysis, a business executive’s most important contribution. Here are
some approaches that may help.
Recognize the role of uncertainty
Rather than search in vain for success
formulas, business executives would do better to adjust their thinking about
the context of strategic decisions. As a first step, they should recognize the
fundamental uncertainty of the business world. Doing so does not come
naturally. People want the world to make sense, to be predictable, and to
follow clear rules of cause and effect. Managers want to believe that their
business world is similarly predictable, that specific actions will lead to
certain outcomes. Yet strategic choice is inevitably an exercise in decision
making under uncertainty. Another source of uncertainty involves customers:
will they embrace or reject a new product or service? Even if a company
accurately anticipates what customers will do, it has to contend with the
unpredictable actions of new and old competitors.
A third source of uncertainty comes from
technological change. Whereas some industries are relatively stable, with
products that don’t change much and customer demand that remains fairly steady,
others change rapidly and in unpredictable ways. A final source of uncertainty
concerns internal capabilities. Managers can’t tell exactly how a company—with
its particular people, skills, and experiences—will respond to a new course of
action. Our best efforts to isolate and understand the inner workings of
organizations will be moderately successful at best. Combine these factors and
it becomes clear why strategy involves decisions made under uncertainty.
See the world through probabilities
Faced with this basic uncertainty, wise
managers approach problems as interlocking probabilities. Their objective is
not to find keys to guaranteed success but to improve the odds through a
thoughtful consideration of factors. Some of these are outside the
company—including industry forces, customer trends, and the intentions of
competitors. Others are internal—capabilities, resources, and risk preferences.
On the foundation of that analysis, the role of the business strategist is to
make decisions that improve a company’s chances for success while never
imagining that a company can simply will its success.
Rather, the goal should be gathering
accurate information and subjecting it to careful scrutiny in order to improve
the odds of success. As former US Treasury Secretary and Goldman Sachs
executive Robert E. Rubin wrote in his memoirs,2“Once
you’ve internalized the concept that you can’t prove anything in absolute
terms, life becomes all the more about odds, chances, and trade-offs. In a
world without provable truths, the only way to refine the probabilities that
remain is through greater knowledge and understanding.” Wise managers know that
business is about finding ways to improve the odds of success—but never imagine
that it is a certainty.
Separate inputs from outcomes
Finally, clear-thinking executives know
that in an uncertain world, actions and outcomes are imperfectly linked. It’s
easy to infer that good outcomes result from good decisions and that bad
outcomes must mean someone blundered. Yet the fact that a given choice didn’t
turn out well doesn’t always mean it was a mistake. Therefore it’s important to
examine the decision process itself and not just the outcome. Had the right
information been gathered or had some important data been overlooked? Were the
assumptions reasonable or were they flawed? Were calculations accurate or had
there been errors? Had the full set of eventualities been identified and their
impact estimated? Had the company’s strategic position and risk preference been
considered properly?
This sort of rigorous analysis, with
outcomes separated from inputs, requires the extra mental step of judging
actions on their merits rather than simply making after-the-fact attributions,
favorable or unfavorable. Good decisions don’t always lead to favorable
outcomes, and unfavorable outcomes are not always the result of mistakes. Wise
managers resist the natural tendency to make attributions based solely on
outcomes. They avoid the halo bestowed by performance and insist on independent
evidence.
Our business world is full of research and
analysis that are comforting to managers: that success can be yours by
following a formula, that specific actions will lead to predictable outcomes,
and that greatness can be achieved no matter what rivals do. The truth is very
different: the business world is not a place of clear causal relationships,
where a given set of actions leads to predictable results, but one that is more
tenuous and uncertain.
The task of strategic leadership is
therefore not to follow a given formula or set of steps. Instead it is to
gather appropriate information, evaluate it thoughtfully, and make choices that
provide the best chance for the company to succeed, all the while recognizing
the fundamental nature of business uncertainty. Paradoxically, a sober
understanding of this risk—along with an appreciation of the relative nature of
performance and the general tendency for performance to regress—may offer the
best basis for guiding effective decisions. These complex decisions, made
without any guarantee of success, are ultimately the main contribution of
business strategists. If a set of steps that could guarantee success did exist,
and if greatness were indeed simply a matter of will, then the value of clear
thinking in business would be lower, not greater.
By Phil Rosenzweig
https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/the-halo-effect-and-other-managerial-delusions?cid=other-eml-cls-mkq-mck-oth-1712&hlkid=592b5f3e72fb4a42b291972d7707fc67&hctky=1627601&hdpid=7abb7a74-e4ed-4ec2-a156-c17b0de85316
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