The halo effect and other managerial delusions

Posted on: April 29th, 2017 by bobmorris

Companies cannot achieve superior and lasting business performance simply by following a specific set of steps.

Here is a brief excerpt from an article written by Phil Rosenzweig for the McKinsey Quarterly, published by McKinsey & Company. To read the complete article, check out other resources, learn more about the firm, obtain subscription information, and register to receive email alerts, please click here.

To learn more about the McKinsey Quarterly, please click here.

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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.

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Here is a direct link to the complete article.

Phil Rosenzweig is a professor of strategy and international management at the International Institute for Management Development (IMD), in Lausanne, Switzerland.

This article is adapted from The Halo Effect: . . . and the Eight Other Business Delusions That Deceive Managers, New York: Free Press, 2007.

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