How to Read Companies’ Success Stories

As I argued before (read this blog post on the halo effect), we like simple stories that account for a company’s success or failure. These stories are almost always delusional. So, what should you keep in mind when you pick up the latest best-selling business book written by a famous CEO or management thinker? The answer: beware of biases. In a beautiful little chapter called ‘The Illusion of Understanding’ in Thinking Fast and Slow, Nobel Prize winner Daniel Kahneman gives an example of the biases involved when trying to explain Google’s tremendous business success:

The ultimate test of an explanation is whether it would have made the event predictable in advance. No story of Google’s unlikely success will meet that test, because no story can include the myriad of events that would have caused a different outcome. The human mind does not deal well with nonevents. The fact that many of the important events that did occur involve choices further tempts you to exaggerate the role of skill and underestimate the part that luck played in the outcome. Because every critical decision turned out well, the record suggests almost flawless prescience  ̶  but bad luck could have disrupted any one of the successful steps. The halo effect adds the final touches, lending an aura of invincibility to the heroes of the story.

Kahneman does not deny that there was skill involved in creating a great company like Google. But, since there are not many opportunities to practice how to build a great company, luck has a greater impact than skill in a business environment. (As opposed to for example Roger Federer’s grand slam record: there’s more skill than luck involved here.)

What you need to do, then, is be aware of a number of biases, fallacies and hidden statistical rules that could be at play when reading a business success story. The next sections will briefly explain the ones I found in Thinking Fast and Slow that relate to false explanations of business success.

The Halo Effect

Defined as the tendency to like or dislike everything about a person or a company (including things you have not observed), the halo effect can be an obvious bias in business books. In Rosenzweig’s book on the halo effect, he phrases it like this:

[The halo effect is] 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.

In other words, we like the performance of the company and then attribute that performance to things like culture, leadership, management techniques and more. We start to like everything about the company, and, thus, are creating a halo. The actual driver of performance, the causal link, is usually not exposed: there is surprisingly little quantitative data that links performance to a leadership style or a management technique (including highly popular ones like Agile). The halo effect stands between us and judging different elements of the organization in isolation (leadership, strategy, structure, culture, etc.): it’s either all good, or all bad.

The Narrative Fallacy

A narrative fallacy is a flawed story of the past that strongly shapes our view of the world and, not unimportant, our expectations of the future. The problem is, of course, that when we construct why things happen in stories, we are often wrong, over simplistic, too concrete and this can thus not serve as a blueprint for future success. Kahneman:

Narrative fallacies arise inevitably from our continuous attempt to make sense of the world. The explanatory stories that people find compelling are simple; are concrete rather than abstract; assign a larger role to talent, stupidity, and intentions than to luck; and focus on a few striking events that happened rather than on the countless events that failed to happen. Any recent salient event is a candidate to become the kernel of a causal narrative. (..) we humans constantly fool ourselves by constructing flimsy accounts of the past and believing they are true.

This is a very powerful trap: we just like stories too much. And once there is a convincing story, we fail to ask more questions.

WYSIATI

We actually can create better stories if we have less information (exacerbating the narrative fallacy!). Less data makes it easier to create a coherent story. What you see is all there is (Kahneman uses the rather ugly abbreviation of WYSIATI):

At work here is that powerful WYSIATI rule. You cannot help dealing with the limited information you have as if it were all there is to know. You build the best possible story from the information available to you, and if it is a good story, you believe it. Paradoxically, it is easier to construct a coherent story when you know little, when there are fewer pieces to fit into the puzzle. Our comforting conviction that the world makes sense rests on a secure foundation: our almost unlimited ability to ignore our ignorance.

Instead of asking yourself ‘What would I need to know to create an informed opinion?’ your brain will go along with many stories that sound intuitively right. But, as I argued elsewhere, intuition is usually wrong when it comes to explaining complex problems or environments. Since the business environment is indeed a complex environment (maybe even a complex adaptive system with lots of positive feedback loops), judging a company on little information only feeds the narrative fallacy and, possibly, the halo effect.

Hindsight Bias

We tend to change the beliefs we previously held in line with what actually happened. It is thus really hard for us to recall what our previously held beliefs were, once they have been changed by an actual outcome. If you ask people to assign probabilities to certain scenarios beforehand; then show them the actual outcomes and ask them again what their initial probability ratings were, they will overestimate the probability they assigned in the past to the scenario that actually played out. This is a problem. Because this so-called hindsight bias feeds the narrative fallacy; in the sense that CEOs or entrepreneurs might be portrayed, in hindsight, as having assigned the right probability to the chosen scenario that caused the company to thrive. Hindsight bias makes these leaders into true visionaries. They were probably just lucky according to Kahneman:

Leaders who have been lucky are never punished for having taken too much risk. Instead, they are believed to have had the flair and foresight to anticipate success, and the sensible people who doubted them [i.e. who assigned better probabilities beforehand] are seen in hindsight as mediocre, timid, and weak. A few lucky gambles can crown a reckless leader with a halo of prescience and boldness.

Regression to The Mean

Extreme groups (including over- and under- performers in business) will regress to the mean over time. This is a statistical fact, there’s no cause. Kahneman, when discussing regression to the mean, directs his attention to some of the most lauded management books:

The basic message of Built to Last and other similar books is that good managerial practices can be identified and that good practices will be rewarded by good results. Both messages are overstated. The comparison of firms that have been more or less successful is to a significant extent a comparison between firms that have been more or less lucky. Knowing the importance of luck, you should be particularly suspicious when highly consistent patterns emerge from the comparison of successful and less successful firms. In the presence of randomness, regular patterns can only be mirages. Because luck plays a large role, the quality of leadership and management practices cannot be inferred reliably from observations of success. And even if you had perfect foreknowledge that a CEO has brilliant vision and extraordinary competence, you still would be unable to predict how the company will perform with much better accuracy than the flip of a coin.

Conclusion

What I am not suggesting is that leadership style and management techniques do not matter. Of course, they do: not implementing best business practice already puts your firm at a disadvantage. What I am suggesting, however, is that company performance is less influenced by management and leadership styles than you would like. It all boils down to two things (Kahnemann):

  • Is the environment sufficiently regular to be predictable?
  • Is there an opportunity to learn these regularities through prolonged practice?

If the answer is yes for both questions, you find yourself in an environment where you can acquire a skill. This is why you can acquire high proficiency in tennis, surgery and firefighting (and probably in some management techniques such as Agile or performance management), but not in overall business management: the business environment is not sufficiently predictable and there’s no opportunity for prolonged practice (how many chances does an entrepreneur get to build Google?). Sure, a good CEO makes a difference. And please read her latest book. But, while reading, remind yourself of the pitfalls described in this article:

  • the halo effect;
  • the narrative fallacy;
  • what you see is all there is;
  • hindsight bias;
  • regression to the mean.

To conclude, a remarkable quote from The Economist on managers in football that might back up my claims in this post:

Fans lay most of the credit or blame for their team’s results on the manager. So do executives: nearly half of clubs in top leagues changed coach in 2018. Yet this faith appears misplaced. After analyzing 15 years of league data, we found that an overachieving manager’s odds of sustaining that success in a new job are barely better than a coin flip. The likely cause of the “decline” of once-feted bosses like Mr Mourinho is not that they lost their touch, but their early wins owed more to players and luck than to their own wizardry.

Please share my blog post with your networkEmail this to someone
email
Share on LinkedIn
Linkedin

Successful Business and the Halo Effect

Being influenced in my thinking on business strategy and execution mostly by the work of Igor Ansoff (see Implanting Strategic Management), I have always wondered why business books like In Search of Excellence and Good to Great had such huge success. Ansoff stressed that business performance is highly dependent on the specific environment your business finds itself in at any given time. Consequently, he was very much against the notion of an ‘if you do this in any situation, it’ll always work’-approach as advocated by such business books.

So, following Ansoff, to me it seems that the prescriptive mantras for long-lasting high business performance are just not in sync with a situational or conditional approach (based on so-called turbulence levels of the business environment). Moreover, companies hailed as consistent high performers at one point in time, will sooner or later come crashing down. (As you may well ascertain when browsing through the companies listed as high performers in older business blockbusters.)

So, the question really is: what’s going on here? Are there really business laws (like laws in physics) that safeguard lasting high business performance? Or are these laws a mere fallacy?

It was only recently that I came across a fascinating theory called the The Halo Effect by Phil Rosenzweig (the book with the same name was first published in 2006 with an updated version published in 2014). It tries to shed some light on the apparent attractiveness of a recipe for long-lasting business success. Rosenzweig argues that our thinking about business performance is shaped by a number of delusions:

For all their claims of scientific rigor, for all their lengthy descriptions of apparently solid and careful research, they [i.e. science in business books] 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.

He goes on naming a number of delusions in our thinking about business performance. The pre-eminent delusion Rosenzweig names the Halo Effect:

[The Halo Effect is 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.

It’s not so much the result of conscious distortion as it is a natural human tendency to make judgments about things that are abstract and ambiguous on the basis of other things that are salient and seemingly objective. The Halo Effect is just too strong, the desire to tell a coherent story too great, the tendency to jump on bandwagons too appealing.

It turns out that most business blockbusters that tell you precisely which companies to mimic for success, suffer from the Halo Effect. Consequently, the companies that are given as examples in most business books (e.g. Xerox in In Search of Excellence, Fannie Mae in Good to Great; also see this article in The Economist) are not consistent high performers after all:

Yet for all their promises of exhaustive research, Collins and Porras [in Built to Last: Successful Habits of Visionary Companies] didn’t address a basic problem: the Halo Effect. Much of the data they gathered came from the business press, from books, and from company documents, all sources that are likely to contain Halos.

You would have been better off investing randomly than putting your money on Collins and Porra’s Visionary companies.

But why the appeal then? Why are these prescriptive books such a huge success? Time after time? The answer, Rosenzweig argues, is that we like stories:

Managers don’t usually care to wade through discussions about data validity and methodology and statistical models and probabilities. We prefer explanations that are definitive and offer clear implications for action. We like stories.

Now, there’s nothing wrong with stories, provided we understand that’s what we have before us. More insidious, however, are stories that are dressed up to look like science. They’re better described as pseudo-science.

And:

Readers, too, prefer clear stories. We don’t really want to hear about partial causation or incremental effects or threats to validity. And there’s a further problem compounding all of this. As Harvard psychologist Stephen Pinker observed, university departments don’t always represent meaningful divisions of knowledge. If you’re a professor of marketing, you care a lot about market orientation and customer focus, and there’s a natural tendency to want to demonstrate the importance of your specialty.

Does this mean that everything that is written about good business practices is just nonsense and everything might as well be left to chance? No:

Success is not random – but it is fleeting. Why? Because as described by the great Austrian economist Joseph Schumpeter, the basic force at work in capitalism is that of competition through innovation – whether of new products, or new services, or new ways of doing business. Where most economists of his day assumed that companies competed by offering lower process for similar goods and services, Schumpeter’s 1942 book, Capitalism, Socialism and Democracy, described the forces of competition in terms of innovation.

But the main point is that high performance is difficult to maintain, and the reason is simple: In a free market system, high profits tend to decline thanks to what one economist called “the erosive forces of imitation, competition, and expropriation.” Rivals copy the leader’s winning ways, new companies enter the market, consulting companies spread best practices, and employees move from company to company.

These findings show that performance is not random but persists over time, yet there is also a tendency to move toward the middle, a clear regression toward the mean. Competitive advantage is hard to sustain. Nothing recedes like success.

However, real science on business performance, as opposed to mere storytelling, is out there. But it might not make for such a good story:

Anita McGahan at Boston University and Michael Porter at Harvard Business School set out to determine how much of a business unit’s profits can be explained by the industry in which it competes, by the corporation it belongs to, and by the way it is managed. This last category, which they called “segment-specific effects,” covers just about everything we’ve talked about (…): a company’s customer orientation, its culture, its human resource systems, social responsibility, and so forth. Using data from thousands of U.S. companies from 1981 to 1994, McGahan and Porter found that “segment-specific effects” explained about 32 percent of a business unit’s performance. Just 32 percent. The rest was due to industry effects or corporate effects or was simply unexplained. So maybe all of the studies we’ve looked at make sense after all! It’s just that, as we suspected, their efforts overlap – they all explain the same 32 percent [italics mine]. Each study claims to have isolated an important driver of performance, but only because of the Delusion of Single Explanations.

Rosenzweig stays clear from coming up with his own take on a recipe for long-lasting business success. However, understanding that strategy always involves taking risks, that links between input and outcomes are sketchy at best and that flawless execution (once you have made up your mind about your strategic direction) is needed at all times, can veritably be read as a good starting point for discussing your company’s performance. It also means you do not have to resort to the latest and newest four, five, or eight-point list promising the holy grail of ever-lasting high business performance.

So, what’s the very mundane advice that Rosenzweig has to offer to managers?

When it comes to managing a company for high performance, a wise manager knows: (1) Any good strategy involves risk. (2) If you think your strategy is foolproof, the fool may well be you. (3) Execution, too, is uncertain – what works in one company with one workforce may have different results elsewhere. (4) Chance often plays a greater role than we think, or than successful managers usually like to admit. (5) The link between input and outputs is tenuous. But when the die is cast, the best managers act as if chance is irrelevant – persistence and tenacity are everything.

Will all of this guarantee success? Of course not. But I suspect it will improve your chances of success, which is a more sensible goal to pursue.

If you want to read your management books more critically, the lessons drawn by Rosenzweig in The Halo Effect  might just be invaluable.

Please share my blog post with your networkEmail this to someone
email
Share on LinkedIn
Linkedin