Book Review: The Halo Effect

The Halo Effect: How managers let themselves be deceived by Phil Rosenzweig. ISBN: 978-1-84739-336-4

Business academic Rosenzweig has written a definitive book about critical thinking in the context of business success. A lot of people claim to understand why businesses succeed or fail, whether in journalism such as Fortune magazine, in bestselling books such as In Search of Excellence or in academia. With admirable clarity, Rosenzweig sets out the scientific failings of these, boiling down the errors to a list of nine “delusions” which infect even some of the most prestigious business research.

For instance, business writers neglect the role of external factors in performance (similar to what Taleb’s Fooled by Randomness says about the financial sector). They mistake correlation for causality. They amass huge corpuses of data without addressing the known biases in that data. The Halo Effect of the title is an example of what is known in psychology as attribute substitution. Researchers want to measure a company’s customer focus (or strategic leadership, commitment to its people, etc.) to correlate against performance (such as profitability). However, customer focus is incredibly hard to measure, so in practice the estimates are based on the company’s profitability. It shouldn’t be surprising that this gives a strong positive correlation, as they are in effect correlating a variable against itself.

The book considers a succession of cases where companies were described as well-led, customer focused and innovative when their share price increased, but as soon as their fortunes changed suddenly “became” complacent, reckless or outdated in the eyes of commentators, or vice versa. It looks in detail at some of the books that claim to offer the secrets of guaranteed business success. Not only does he undermine the arguments of these books with straightforward science, but he shows that lasting business success, in the sense of staying ahead of the market for more than a generation, has never happened. He teaches you to recognise the delusions so you can apply the same critique to other claims.

The book examines some contrasting business science which is more rigorous but makes more modest claims, then concludes by discussing how to manage without pseudoscience. This requires that we acknowledge the role of chance and uncertainty, and stop looking for a list of “secrets” that will make success inevitable.

In a few generations, medical research has come from pseudoscience to some of the most rigorous controlled research, and for that change to happen it was necessary that people be unhappy with the status quo and complain that scientific-ish evidence just isn’t good enough. Rosenzweig has done the business and management field a big favour with this critique by setting out what needs to change for it to mature to a proper science. My reaction after reading The Halo Effect is to wonder when the other shoe will drop: which area of academic literature will next be elegantly demolished by an insider in this way?

The list of delusions:

  1. The Halo Effect: see above. In statistical language, the independent variable is actually the dependent variable via an imperfect measure.
  2. The Delusion of Correlation and Causality: A company is doing especially well and has high employee satisfaction. Some authors would conclude that employee satisfaction strongly benefits performance, but more likely is that people get satisfaction from knowing they are on the winning team.
  3. The Delusion of Single Explanations: Arguments that factor X improves performance by 40% and factor Y improves by another 40%, so do both at once and you’ll get an 80% improvement. The fallacy is that X and Y might be very strongly correlated. E.g. X might improve performance by causing Y.
  4. The Delusion of Connecting the Winning Dots: Looking only at successful companies, without comparing them against unsuccessful companies, is a useless way to gather evidence. You may as well conclude that buildings are the secrets of a company’s success, because every high-performing company has at least one building.
  5. The Delusion of Rigorous Research: some authors boast of the amount of data that they have collected, as though that in itself made the conclusions of the research valid.
  6. The Delusion of Lasting Success: the “secrets of success” books imply that lasting success is achievable, if only managers will follow their recommended approach. Rosenzweig shows that truly lasting success never happens in business (data presented in an appendix)
  7. The Delusion of Absolute Performance: your market performance is down to what your competitors do as well as what you do. You can do everything right and yet still fall behind.
  8. The Delusion of the Wrong End of the Stick: getting cause the wrong way round. Eg. successful companies have a Corporate Social Responsibility policy. Should we infer that CSR contributes to success, or that profitable companies have money to spend on CSR?
  9. The Delusion of Organisational Physics: the idea that business performance is non-chaotically determined by discoverable factors, so that there are rules for success out there if only we can find them.

Update July 2009: I’ve created a Wikpedia page for the book, including some content from my post above, at The Halo Effect (business book).

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