The Halo Effect and the Eight Other Business Delusions That Deceive Managers

by Phil Rosenzweig

Many business books and articles have been written about what Phil Rosenzweig calls “the mother of all business questions… What leads to high performance?” This book explains why much of this analysis is “riddled with errors.”

Using the examples of Cisco, ABB, and others, the author demonstrates the phenomenon. When times were good—strong revenue growth and a soaring stock price—these companies were praised for their exemplary strategy, culture, and CEO. When financial performance fell, the same strategy, culture, and CEO were ripped apart as severely flawed.

Why does this happen? Because we love stories. “As long as Cisco was growing and profitable and setting records for its share price, managers and journalists and professors inferred that it had a wonderful ability to listen to its customers, a cohesive culture, and a brilliant strategy. And when the bubble burst, observers were quick to make the opposite attribution. It all made sense. It told a coherent story.”

“Yet there’s a bit more to it. Our desire to tell stories, to provide a coherent direction to events, may also cause us to see trends that do not exist or infer causes incorrectly. We may ignore facts because they don’t fit into our story.”

How does this happen? Introducing the Halo Effect.  “During World War I, an American psychologist named Edward Thorndike was conducting research into the ways that superiors rate their subordinates. In one study, he asked army officers to rate their soldiers on a variety of features: intelligence, physique, leadership, character, and so on. He was struck by the results. Some men were thought to be ‘superior soldiers’ and were rated highly at just about everything, while others were thought to be subpar across the board… Thorndike called it the Halo Effect.”

The Halo Effect is “a tendency to make inferences about specific traits on the basis of a general impression. It’s difficult for most people to independently measure separate features; there’s a common tendency to blend them together. The Halo Effect is a way for the mind to create and maintain a coherent and consistent picture to reduce cognitive dissonance… It’s also a heuristic, a sort of rule of thumb that people use to make guesses about things that are hard to assess directly.”

“Fortune claims that the World’s Most Admired Company survey is ‘the definitive report card on corporate reputations.’ … For all the appearance of rigorous research—thousands of executives providing responses to nine separate questions, which are then combined for an overall ranking—there’s a serious Halo Effect. Respondents may be asked nine questions, but it’s unlikely that they have nine different opinions about the company. More likely is that one or two general impressions are expressed nine times. Moreover, the most important opinion is likely to be based on overall financial performance. Look at any company with healthy revenues and strong profits, and it’s likely that I’ll infer it has good management, high quality products, and more… Two different studies showed that a company’s financial performance explained between 42 and 53 percent of the variance of the overall rating.”

“So many of the things that we—managers, journalists, professors, and consultants—commonly think contribute to company performance are often attributions based on performance.”

This leads us to the Delusion of Correlation and Causality. “If we want to test whether customer orientation leads to high performance, the last thing we should do is ask managers: ‘How customer oriented is this company?’ We’re likely to get an attribution based on performance. To have any validity at all, we need to rely on measures that are independent of performance.”

“But suppose we look at a measure that is not tainted by Halos—say the rate of employee turnover—and we find a high correlation with performance. Now the challenge is to untangle the direction of causality… As long as we gather data at one point in time—cross-sectionally—we won’t know.”

“One way to improve our ability to explain causality is to gather data at different points of time so that the impact of one variable on some subsequent outcome can be more clearly isolated. This approach, called, longitudinal design, is more time-consuming and expensive to carry out, but it stands a better chance of avoiding mistaken inferences from simple correlation.”

Next, there’s the Delusion of Absolute Performance. “Companies are often described as succeeding or failing on the merits of their actions alone, as if performance were absolute. But in a competitive market economy, the performance of one company is always affected by the performance of other companies.” It’s all relative.

Kmart is a good illustration of this point. Kmart improved inventory turns from 3.45 in 1994 to 4.56 in 2002, a 32% improvement. Impressive, right? “Over the same eight years, Wal-Mart’s inventory turns went from 5.14 all the way to 8.08, up 63 percent. Wal-Mart had faster turns at the start of the eight-year period than Kmart had at the end. Kmart got better in absolute terms and yet fell further behind at the same time—and the gap between the two retailers was growing ever wider.”

“The Delusion of Organizational Physics implies that the business world offers predictable results, that it conforms to precise laws. It fuels a belief that a given set of actions can work in all settings and ignores the need to adapt to different conditions: intensity of competition, rate of growth, size of competitors, market concentration, regulation, global dispersion of activities, and much more. Claiming that one approach can work everywhere, at all times, for all companies, has a simplistic appeal but doesn’t do justice to the complexities of business… Execution, like strategy, doesn’t lend itself to predictable cause-and-effect relationships.”

The Delusion of Lasting Success: “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.”

The book also includes: the Delusion of Single Explanations, the Delusion of Connecting the Winning Dots, the Delusion of Rigorous Research, and the Delusion of the Wrong End of the Stick.

Rosenzweig hopes this book will “help managers think for themselves.”

Rosenzweig, Philip M. The Halo Effect … and the Eight Other Business Delusions That Deceive Managers. New York: Free Press, 2014. Buy from Amazon.com

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