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.

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Holiday Reading List 2018 – The Rationalist Delusion

Finally, this last year, long overdue, I picked up Daniel Kahneman’s Thinking Fast and Slow (2011). And what a book it is. If you still thought you were a rational human being, deliberately making judgements, weighing pros and cons for every decision you make, consider this quote from Thinking Fast and Slow:

(..) emotion now looms much larger in our understanding of intuitive judgments and choices than it did in the past. The executive’s decision would today be described as an example of the affect heuristic [a mental shortcut], where judgments and decision are guided directly by feelings of liking and disliking, with little deliberation or reasoning.

This resonates so strongly with the work of Jonathan Haidt in The Righteous Mind, that it made me think of one of the themes of that book, the rationalist delusion:

As an intuitionist, I’d say that the worship of reason is itself an illustration of one of the most long-lived delusions in Western history: the rationalist delusion. It’s the idea that reasoning is our most noble attribute, one that makes us like the gods (for Plato) or that brings us beyond the “delusion” of believing in gods (for the New Atheists). The rationalist delusion is not just a claim about human nature. It’s also a claim that the rational caste (philosophers or scientists) should have more power, and it usually comes along with a utopian program for raising more rational children.

How’s that for some provocative ideas worth exploring this holiday?

Haidt’s The Righteous Mind is not on this year’s list because I used it in the past for a number of blogs on biases (see this one on morality bias; and this one on confirmation bias). But the ideas of that book strongly influenced the way I progressed onto the books of this year’s list. Here we go:

Thinking Fast and Slow. Daniel Kahneman. A landmark book if you want to make better decisions. Kahneman shows, that by relying mostly on system 1 (mental shortcuts based on feelings, emotions and morality) in decision-making, and not on system 2 (our rationalist selves), we make predictable errors of judgment. The intuitive system 1 is a lot more influential than your think. Kahneman:

This is the essence of intuitive heuristics [rules of thumb]: when faced with a difficult question, we often answer an easier one instead, usually without noticing the substitution.

Learn how you fool yourself and read about: the availability heuristic (or What-You-See-Is-All-There-Is heuristic), anchoring bias, the law of small numbers, availability bias, the halo effect, and many, many more.

The Economist have their own way of describing the rationalist delusion in a review of this outstanding book:

As Copernicus removed the Earth from the centre of the universe and Darwin knocked humans off their biological perch, Kahneman has shown that we are not the paragons of reason we assume ourselves to be.

The Master and His Emissary – The Divided Brain and the Making of the Western World. Iain McGilchrist. A different dichotomy than intuition and reason is discussed in this ‘fascinating book’ (Financial Times). The leading question here is: ‘Why is the brain divided?’ McGilchrist:

(..) the hierarchy of attention, for a number of reasons, implies a grounding role and an ultimately integrating role for the right hemisphere, with whatever the left hemisphere does at the detailed level needing to be founded on, and then returned to, the picture generated by the right.

This book is almost two books into one: the first part is steeped into neuroscience, tells us why the brain is divided, and which functions the left and right hemispheres perform. (If I would have to place Kahneman’s systems 1 and 2 in McGilchrist’s left and right hemispheres, system 1 would reside in the left, and system 2 in the right hemisphere.) In the second part of the book (called ‘How the Brain Has Shaped Our World’), the story unfolds in a dramatic way. McGilchrist takes us on a tour through the Ancient World (Plato, again, also see my blog on him here), the Renaissance, Enlightenment and the Industrial Revolution, to come to some daring propositions. One of the most striking ones is that the left hemisphere (the Emissary) has become so dominant that it has seized power over the right hemisphere (the Master), creating a Western culture with an obsession for structure, narrow self-interest and a mechanistic view of the world. I had to think of books on the 2016 reading list by John Gray and Matthew Crawford when I read this. True, or not, it makes for some great reading and stuff worth discussing over a good glass of wine during the Holidays.

Why Buddhism Is True. Robert Wright. No, I’m not going religious on you. And no, I’m not going Buddhist on you. Lauded by The New York Times Book Review, The Guardian, The New Yorker and Scientific American, this book is Darwinian in nature. There’s also a good deal of Kahneman and McGilchrist here:

Again, the part of the brain that controls language [system 2; left hemisphere] had generated a coherent, if false, explanation of behavior  ̶  and apparently had convinced itself of the truth of the explanation. The split-brain experiments powerfully demonstrated the capacity of the conscious self to convince itself that it’s calling the shots when it’s not. (..) In short, from natural selection’s point of view, it’s good for you to tell a coherent story about yourself, to depict yourself as a rational, self-aware actor. (..) It is possible to argue that the primary evolutionary function of the self is to be the organ of impression management [note: Haidt has a similar wording in that he talks about the press secretary].

With the help of modern evolutionary psychology, Wright explains that the mind is increasingly seen as having a modular design. Different modules were created by evolution to size up different situations and take action towards these situations. Much of this action goes on without you (the CEO) even knowing that action is being undertaken. Think about things such as fear, lust, love and many other feelings: are you calling the shots? From a very different angle than Kahneman’s, namely the angle from Buddhist mindfulness and meditation, Wright ends up at the same conclusion:

(..) our ordinary point of view, the one we’re naturally endowed with, is seriously misleading.

Wright goes on to explain why meditation can help us understand ourselves better:

Mindfulness meditation involves increased attentiveness to the things that cause our behavior  ̶  attentiveness to how perceptions influence our internal states and how certain internal states lead to other internal states and to behaviors.

This is an extraordinary book that takes mindfulness meditation out of the esoteric realm. It puts it straight into evolutionary psychology and hands us a tool to help us understand, and improve, our own decision-making.

Mindfulness for Creativity. Danny Penman. Now that I introduced mindfulness meditation above, there needed to be a book on the actual practice of meditation on this year’s list. Mindfulness meditation is still ‘weird’ enough that you have to explain to the world that you are not a tree-hugger, an anarchist or, well, a useless creature in general. Bill Gates, far from being a useless creature, put a book on meditation on his 5 best books of this year. However, even he still felt the needed to explain what the benefits of meditation for creativity are, and that it’s nothing to freak out over:

Back when I was avoiding music and TV in the hope of maintaining my focus, I knew that lots of other people were using meditation to achieve similar ends. But I wasn’t interested. I thought of meditation as a woo-woo thing tied somehow to reincarnation, and I didn’t buy into it. Lately, though, I’ve gained a much better understanding of meditation. I’m certainly not an expert, but I now meditate two or three times a week, for about 10 minutes each time. I now see that meditation is simply exercise for the mind, similar to the way we exercise our muscles when we play sports. For me, it has nothing to do with faith or mysticism. It’s about taking a few minutes out of my day, learning how to pay attention to the thoughts in my head, and gaining a little bit of distance from them.

Well, if it’s something that Bill Gates and Steve Jobs buy into (founders of two of the most valuable companies in the world), I think we should at least give it a try.

If you need more book recommendations, check out the summer reading lists of 2016, 2017 and 2018, and the holiday reading lists of 2016 and 2017.

Happy holidays, and happy reading!

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A Roadmap Back to Business Fundamentals

One of the catch phrases I picked up in my university days, and still use when appropriate, is: ‘There’s nothing more practical than good theory’. During change efforts in any type of organization (i.e. profit, nonprofit, government), whether they are design changes or execution changes, it is always a good idea to keep a number of business fundamentals in mind to get, or keep, your organization on course. If it is true that it is more beneficial to study older literature that is still in print (see here) rather than reading the latest management book that might turn out to be another fad, you can do worse than read an old (2002) favorite of mine: What Management Is, by Joan Magretta, a former top editor at Harvard Business Review.

In a review of this book, Peter Drucker, arguably the most prolific writer on general management, wrote:

First rate as an introduction for the non-manager and especially for the beginner, but equally excellent as a rounded, complete, and comprehensive “refresher course” for the most experienced executive.

What Management Is defines a number of core management principles that, I suggest, should be at the core of what you, as a manager, try to achieve through your daily activities. By providing you with essential quotes from this book, I attempt to get the business fundamentals back into every activity and every change effort you pursue to help improve the performance of your team, department, business unit, or organization.

Throughout what follows I will use bullet points to highlight – what to me seem ­–fundamental insights into eight crucial management ideas. Beginning with why we need management in the first place, we then move onto the ideas themselves.

Why do we need management as a discipline?

  • Wherever our needs exceed our resources, we need management.
  • Management allows us to achieve a vast array of purpose that none of us could achieve acting alone.
  • We think we live in worlds of our own and can contribute as individuals, but this is only possible because some form of organization (through management) makes the specialized work we do productive.
  • Management is turning complexity and specialization into performance. As the world economy becomes increasingly knowledge based and global, work will continue to grow more specialized and complex, not less. So, management will play a larger role in our lives, not a smaller one.

Management Idea 1: Value Creation

  • Management’s mission, first and foremost, is value creation.
  • Value takes many forms and comes from many sources: a product’s usefulness, its quality, the image associated with it, its availability, the service. The more intangible the value appears, the more important it is to recognize that value is defined by customers. Value is not defined by what an organization does but by customers who buy its goods and services. There is really only one test of a job well done – a customer who is willing to pay for it.
  • Efficiency can be defined as doing things right; effectiveness as doing the right things. Effectiveness is what customers value.
  • The value chain is the sequence of activities and information flows that a company and its suppliers must perform to design, produce, market, deliver, and support its products:
    • you begin to see each activity not just as a cost, but as a step that has to add some increment of value to the finished product;
    • it forces you to see the entire economic process as a whole, regardless of who performs each activity. Managing across boundaries, whether these are between the company and its customers, or the company and its suppliers or business partners, can be as important as managing within one’s own company.

Note: for a discussion on shareholder value versus stakeholder value, see Beyond Shareholder vs. Stakeholder Value.

Management Idea 2: Business Model

  • A business model is a set of assumptions about how an organization will perform by creating value for all the players on whom it depends, not just its customers. Business models reflect the systems thinking that is so central to management.
  • A business model is a story of how an enterprise works.
  • A business model is a story about the basic human activities of making and selling. The twist in a new business model is almost always a variation on some aspect of an existing value chain.
  • Much of what ultimately determines a business model’s success is the behavior of people and organizations in markets.
  • For nonprofit or government agencies, the story always hinges on how the organization will change the world, or at least the specific aspect of the world its mission targets. Here, the twist in the plot – the critical insight about value – is what is sometimes called the organization’s theory of change.

Note: as tempting as stories on winning business models are, be aware that’s just what they are: stories. On why you should be very careful with prescriptive writing on business models, read Successful Businesses and the Halo Effect.

Management Idea 3: Strategy

  • Strategic thinking begins with a good business model.
  • Strategy goes further because the business model does not factor in competition.
  • When you cut away all the jargon, this is what strategy is all about: how you are going to be better by being different?
  • Strategy is about choices: which customers and markets to serve, what products and services to offer, and what kind of value to create.
  • Try to be all things to all people, and your organization will fail to find distinctive ways to compete.
  • A company’s profits are what’s left after subtracting costs from revenues. It follows, then, that there are only two ways one company can outperform another. It can get its customers to pay higher prices or it can operate on lower costs. To do either of those two things, it has to be different – or how else could you explain its ability to charge more or use fewer resources? That’s the simple arithmetic of superior performance.
  • One of the most effective roadblocks to pure competition is a unique positioning.
  • The five forces model (Michael Porter, 1979) has become a foundation of the strategy field. Porter identified the underlying forces that determine the attractiveness of any industry: the competition among existing players, the threat of new entrants, the power of suppliers, the power of customers, and the availability of substitute products. It is the interplay of these forces that determines where on the spectrum of competition – from perfect competition to monopoly – an industry is likely to be.

Note: in the last years, your organization’s positioning on non-financial aspects as environmental, social and human rights matters have become increasingly important for your customers and other stakeholders. For a discussion of non-financial aspects in relation to strategy, see What every manager should know about: Non-Financial Disclosure.

Management Idea 4: Organizational Structure

  • Management’s job, turning complexity and specialization into performance, requires it to draw three different kinds of lines. First, the boundary lines, which separate what’s inside and what’s outside. Second, the lines of the organizational chart, which map how the whole is divided into working units and how each part relates to the others. Third are the somewhat invisible, but always important, lines of authority. These determine who gets to decide what, and how the internal game is played.
  • Because strategy is dynamic, organizations must be flexible. Drawing the lines of organization is an ongoing struggle to stay relevant, not a job done once and for all.
  • Why do companies draw and redraw the lines that define how many of the steps in the value chain they perform themselves? Again, it’s a question of matching strategy and structure, of finding the organization best able to deliver a particular configuration of value at a particular moment in time.
  • Backward integration often made sense for two reasons: first, better coordination leads to lower costs; second, ownership guarantees a source of critical raw materials. With ownership, however, you lose the powerful incentive of the marketplace: the nervous edge that keeps suppliers on their toes.
  • Using participation instead of hierarchy, Toyota developed a host of techniques (collectively known as Total Quality Management, or TQM) to improve the quality of the manufacturing process: participation from everyone, cross-functional teams to solve problems, and cooperation and information sharing across company lines.
  • There is no one best way to organize. Scale, scope, and structure are enormously contingent on what you’re trying to do.
  • Designing an organization is frustrating, because most of the important decisions are at best trade-offs you’d rather not have to make. Treat the latest approach as a panacea, and you will surely be disappointed. Understand the trade-offs that have been made well enough to compensate for them, and everyone will perform better, whether it comes to drawing new lines or living within the existing ones.

Note: the need to manage ESG-risks in your supply chain can be another reason for backward integration. For an example, see the article on IKEA in my list of LinkedIn posts.

Management Idea 5: Measures for Your Mission

  • An organization’s purpose or mission determines what results are meaningful and what measures are appropriate.
  • One of the most fundamental managerial challenges of all is translating mission into action and into performance.
  • For most organizations, performance is multifaceted; it comes from striking the right balance. No one measure can capture 100 percent of what an organization needs to do to perform. And, like medicines, all measures have side effects, some of which can be dangerous to an organization’s health. In short, you can’t manage without measures, but neither can you apply them without thinking long and hard about how well they fit what you have to do.
  • As imperfect as any one measure might be, it’s impossible to work systematically on performance without them. Good managers know they can’t live without performance measures, but neither can they live by them without respecting their limitations.
  • Performance is all about realizing the mission. Performance and mission are never in conflict, if performance is properly understood and defined.
  • Whether we’re talking about a business or a nonprofit organization, performance is impossible without a mission.

Note: investors are increasingly calling for better performance on KPIs relating to ESG-factors, see for example my LinkedIn post on Impact Investing. This may call for an entry of some ESG-topics in your organization’s mission statement.

Management Idea 6: Innovation

  • Innovation is a very special kind of problem solving. It’s the search for new ways to create value, and new value to create.
  • An entrepreneur who doesn’t learn how to manage won’t last long. Nor will a manager last long if he doesn’t learn to innovate.
  • Gathering the information you need to create better bets requires active engagement, not just passive listening. It requires you to actively suspend your own intuition, to observe how other people behave, and without imposing your own logic, to ask why. This takes discipline because it goes against the grain in a number of ways. Most people prefer talking to listening. The more successful they’ve been, the more in danger they are of believing that when it comes to their business, they know best. True curiosity about other people – a passionate interest in understanding why people do what they do – is rare. Suspending judgment, observation, and curiosity – these are the necessary complements (and sometimes antidotes) to the prompting of instinct, intuition, and industry lore.
  • The fact that things can turn out in more ways than one is perhaps the defining characteristic of managerial decision making. You are forced to commit resources today toward performance in an uncertain future.
  • People confuse the best case (what they hope will happen) with the base case (what’s most likely to happen). The cash flows you lay out are only as good as your answers to these questions: What could go wrong? What could go right? How likely is it that those things might happen?
  • We forget that, like all models, Net Present Value rests on a number of assumptions. First, that you can translate your expectations about future events into a specific forecast of revenues and costs. Second, that you can capture the impact of both time and risk in the discount rate you use to adjust those cash flows. And third, that once you set out on the path those cash flows represent, you won’t change your mind along the way.
  • Without innovation and risk taking, there would be no economic progress. The discipline of management helps to increase the odds that the risky business of innovation will pay off.

Note: Magretta talks about ‘suspending your own intuition’. Tools to do just that, I described in Three tools to overcome confirmation bias.

Management Idea 7: Focus

  • Paraphrasing Pareto’s Law, performance will depend disproportionally on doing a few things really well. This is why it is critical to match an organization’s resources to those activities that make a difference.
  • Overriding point of Pareto’s Law: In most instances, a few things matter far more than others. An important corollary of the 80-20 principle is that averages and aggregate numbers are useless, if not misleading, because they obscure most of the decisions that are important to performance.
  • Drucker noted repeatedly that the greatest obstacle to innovation is the unwillingness to let go of yesterday’s success, and to free up resources that no longer contribute to results. The solution, says Drucker, is the discipline of “systematic abandonment”, a discipline Jack Welch applied at GE: ‘If you weren’t already in the business, would you enter it today?’ If the answer is no, then ask yourself: ‘What are you going to do about it?’
  • People much prefer to carry on in the hopes that their earlier decisions will be vindicated. The discipline of sunk costs (investments of time or money that can no longer be recovered or put to other use) helps managers avoid this trap, and can deter them from throwing good money after bad.
  • Benchmarking and best practices. These related disciplines are keeping more and more organizations marching to the steady drumbeat of continuous improvement. The idea is to compare the performance of your products or processes with those that are best in class, even if this means going outside your organization or industry.

Management Idea 8: Managing People

  • Most people are deeply – and rightly – resistant to being managed. In fact, the real insight about managing people is that, ultimately, you don’t. The best performers are people who know enough and care enough to manage themselves.
  • Management creates performance through others. Without the willing cooperation of others, management can accomplish very little.
  • Shared beliefs constitute an organizational culture – its set of assumptions about how we do things and who we are.
  • An organization’s values, unlike ethics, are matters of deep belief about which honest people can disagree. The question isn’t whether one company’s values are better than another’s, but which are better-suited to helping the organization achieve its purpose. The real measure is fit.
  • Setting an example is not the main means of influencing others, it is the only means.’ (Albert Einstein)
  • We saw earlier how performance measures make an organization’s mission concrete. Similarly, story, ritual, and symbol are powerful ways of making values tangible.
  • If management had its own golden rule, it would be this: Trust others as you would have them trust you.
  • If management is not trustworthy, employees will neither share their best ideas nor give their all.
  • Increasingly, economics has become a quantitative discipline, one of the “numbers” subjects. But its underlying aim has always been to explain human behavior. Its eighteenth-century pioneers, like Adam Smith, studied ethics and moral philosophy.
  • A manager can help people discover their strengths, and help people get better at what they’re good at, but a manager can’t and shouldn’t change who a person is.
  • Empathy is yet another instance of the outside-in perspective, of seeing the world through other people’s eyes. Working effectively with other people means accepting the limits of your own authority and of your own perspective.
  • As individuals we’re slow to apply the principles of value creation to our own efforts. We persist in defining our performance by how hard we work at something, rather than by the results we achieve.

Now ask yourself: How is my organization doing on these business fundamentals? And how can we improve our performance by looking more closely to what a manager should really do?

 

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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.

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