The Halo Effect by Phil Rosenzweig

Great ideas, specific articulations of them and the books which present them transcend genres. The Halo Effect by Phil Rosenzweig who is a professor of strategy and international management at IMD, Switzerland will most probably, be always found in the business section of the bookstores around the world. It just shouldn’t be so as it is a book which is as genre crossing as any, which should be read by many more than the people who would browse that section and is one which will be judged as one of the most important business books ever written.

First identified by pshychologist Edward Thorndike, the phrase ‘Halo effect’ is used to refer to how an overall impression shapes specific judgments. Rozensweig dwells very deeply into this and examines with specific cases as to how in business this means that a company’s overall performance- defined mostly by financial results shape our evaluations of things which are far less tangible. Of how this ‘after results’ rationalisation of decision making happens and how it corrodes our analysis and judgement.

Here is the introduction of the concept.

Barry Straw, then at the University of Illinois and later at the University of California, conducted an experiment in which groups of participants were asked to estimate a company’s future sales and earnings per share based on a set of financial data. Afterward, he told some of the groups they had performed well, making accurate estimates of sales and earnings per share, and told other groups they had performed poorly – but Straw did so completely at random. In fact, the “high-performing groups” and the “low-performing groups” had done equally well in their financial calculations; the only difference was that Straw told them about their performance. Then he asked the participants how well their groups had done on a range of issues. The results? When told they had performed well, people described their groups as having been highly cohesive, with better communication, more openness to change, and superior motivation. When told they had performed poorly, they recalled a lack of cohesion, poor communication, and low motivation. Straw concluded that people attribute one set of characteristics to groups they believe are effective, and a very different set of characteristics to groups they believe are ineffective. That’s the Halo effect in action.

Using the examples of Cisco and ABB, Lego and British Petroleum, Prof.Rosenzweig describes how the press reports, cover stories and other press coverage of these companies were determined, almost fully by their financial performance. As he says, Cisco surged in the late 90s with a brilliant strategy, a laser-like focus on its customers, and a masterful skill for acquisitions and when the bubble burst, Cisco was said to have bungled its strategy, neglected its customers, and made reckless acquisitions. Similarly, during good times, ABB was a New Age wonder with great corporate culture, but during bad times, it was a chaotic organization with an arrogant leader. With exhaustive research, Prof.Rosenzweig lays bare as to how history gets rewritten based on performance and as to how many of the things we commonly believe lead to company performance and also told to believe including by ‘vigorous research’ – corporate culture, leadership, and more – are often, almost always simply attributions based on company performance.

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The halo effect is only one among the business delusions that Prof.Rosenzweig handles in the book. Among the others that he expounds, perhaps the most important, especially due to their universal applyability, are the Delusion of Single Explanations, the Delusion of Lasting Success and the Delusion of Absolute Performance.

The Delusion of Single Explanation is about the search for the one ‘explain everything’ answer to explain a particular result or a phenomena. It is something which can be noticed in a lot of analysis in a lot of fields. In fact, when I was watching most of the analysis and when the reason for the victory of the incumbent government in one of the most complicated exercises in the world was being reduced to the success of one policy or the impact of one leader. In a way, it is a weakness caused by our human weakness for neat stories with simple causes and effects and also a reflection of a lot of our analysis processes, which research has shown, stops at the ‘makes sense’ threshold, which actually may make no sense at all.

The chapter which deals with the delusion of lasting success is scathing on some of the popular management books and some of their authors which promise to give blue print for lasting success, if only we follow their formula for it. He is very scathing on three of the most popular management books of all time ‘In Search of Excellence by Tom Peters and Bob Waterman and the two best sellers by Jim Collins ‘Good to Great’ and ‘Built to Last’.

One of the more interesting parts of Jim Collins’ Good to Great was his Hedgehog concept, derived from Isaiah Berlin’s famous essay ‘The Hedgehog and the Fox’ in which he put down Hedghog-ness or a focus on a single unifying vision and to be methodical in its execution as one of the most important requisites to become great. The way that Rosenzweig goes on to deconstruct this argument is perhaps reflective of both the irreverence and the intellectual rigor of the book. It is indeed a long extract, but I think worth reproducing as it successfully gives out the flavor of the book.

And this [fox – hedgehog] distinction, wrote Collins, has everything to do with achieving high performance, because the eleven Great companies were all Hedgehogs. They had a narrow focus and pursued it with great discipline. Foxlike companies, by contrast, scattered their attention and energy, often changed directions, but never became Great. There is of course, a possibility that our classification is shaped by the Halo effect – when viewed in retrospect, successful companies may tend to be described as more focused and persistent than less successful companies. But lets suppose that Collins got it right and the eleven Great companies really were more focused on a narrow core vision than the comparison group… Does it follow that companies perform better when they behave like Hedgehogs? Not quite. The story is a bit more complicated.

Imagine that a thousand people spend the day betting at the racetrack and at the end of the day, we select the ten betters with the highest winnings – we’ll call them our Great betters. When we look closely at these most successful betters, we’re likely to find that all of them placed big bets on long shots- that’s how they came ahead of the 990. They were Hedgehogs, focusing on a few big things. Very few Foxes will be among the top ten, because Foxes tend to diversify their positions. Yet even if the top ten betters were all Hedgehogs, it does not follow that Hedgehogs, on average, outperformed Foxes, because some Hedgehogs may have done very well but many more have gone home broke. In fact, overall Foxes probably did better than Hedgehogs – they took more prudent risks and avoided big losses. Now let’s come back to companies. Because Collins selected eleven <i> Great </i> companies and compared them with eleven that were only Good, we have no way of knowing whether, on average, companies did better when they behaved like Foxes or Hedgehogs. We don’t know how many of the 1,435 companies in the full sample were Hedgehogs and how many were Foxes, so we can’t say which group performed better. Even if companies that racked up several years of consecutive growth were Hedgehogs, it doesn’t follow that being a Hedgehog increased the chances of success – because lots of Hedgehogs might have wound up as roadkill.

As a point of comparison, consider a study about expert political judgment by Philip Tetlock at the University of California. Using the same categories drawn frim Isaiah Berlin, Tetlock compared the predictive accuracy of Hedgehogs, experts who have a clear and strongly held worldview, with that of the Foxes, experts who take a more flexible view. Which group made a more accurate prediction of future events? The Foxes. They factored in a wider range of information and modified their beliefs in the face of changing circumstances, and as a result were consistently more accurate in their judgments about future events than Hedgehogs. Tetlock found that a few Hedgehogs were extremely accurate in their judgments, but many more were considerably off the mark, and on average scored less well.

My guess is that Tetlock’s findings about individual predictive judgement are about right for companies too: On average, companies that are resilient and can adjust to changing circumstances tend on average to outperform less flexible companies. Yes, a few hedgehogs will turn out to be spectacularly successful, bug Hedghogs will also fail in large numbers. Which group does better is an empirical question that hasn’t yet been the subject of a careful study, and until we have solid answers, we can only speculate. But until then, we’re on shaky grounds if we infer that because a handful of extremely successful companies were Hedgehogs, it follows that companies ought to act like Hedgehogs, pursuing one big thing.

One might counter that a Hedgehog focus is a risky but necessary gamble when striving for Greatness. We know, after all, that performance is relative, not absolute. Perhaps it makes sense to follow a Hedgehog approach, because although the average result may be lower, the potential payoff of winning big is so much greater. That’s a reasonable argument, and it could be correct. If that were Collins’s point, fine. But Collins does not argue that companies ought to adopt a Hedgehog focus in spite of its inherent risks. He does not suggest that the payoff of hitting it big is so great that companies should accept a correspondingly higher risk of failure. Not at all. The overarching lesson of Good to Great is that any company can become Great if it is focused and persistent, that success is not a matter of circumstance, and that the Buildup phrase inexorably leads to Breakthrough. Nowhere does Good to Great talk about the need to take calculated but sometimes considerable risks, to pursue a course of action that could lead to glory but even more likely lead to the gutter. Collins urges managers to be Hedgehogs by pointing out the upside while overlooking the attendant risks. Which is dangerous, because you can’t have it both ways.

These errors aren’t too surprising, given that Collins’s understanding of the Fox-Hedgehog parable is questionable from the start. He suggests that people who had the greatest impact on humanity – including Darwin, Marx and Einstein- were Hedgehogs, consumed with a single and simple idea, then pursuing it with dogged focus. But Isaiah Berlin made no such claim, observing only that Foxes and Hedgehogs wee two different ways of looking at human experience. There have been great people in both categories. According to Berlin, Plato was a Hedgehog but Aristotle a Fox; Dante a Hedgehog but Shakespeare a Fox; Dostoyevsky and Neitzsche were Hedgehogs while Goethe and Joyce were Foxes. Collin’s assertion about Darwin is also doubtful; After all, Charles Darwin was raised a conventional Christain and arrived at his revolutionary ideas about natural selection after decades of careful observation and reflection – challengin conventional dogma is not the sort of thing a Hedgehog normally does. It’s not even clear that Marx was a Hedgehog, as his favorite epigram – De omibus disputandum (Everything should be doubted)- has a distinct Foxlike ring. Many so-called Marxists may be Hedgehogs, but of course that’s a different matter.

Some scathing (and indeed insighful) remarks like ‘Anyone who claims to have found the laws of organizational physics either understands little about business, or little about physics, or both’ and ‘Searching for the secrets of success reveals little about the world of business but speaks volumes about the searchers – their aspirations and their desire for certainty.’ would definitely have lost him a few fans among his business school professor colleagues but indeed asks the rest of us, to look at organizations with a more objective, historical point of view and perhaps will make us read more Joseph Schumpeter and Karl Marx than Jim Collins and Peter Drucker.

Rosenzweigh concludes the book by describing the career and by trying to give an insight to the decision making processs of three business leaders – the great Andy Grove of Intel, Robert Rubin of Goldman Sachs( and the Clinton White House) and Guerrino de Luca of Logitech. He explains how these leaders, by chugging simplistic worldviews, managed while being aware of the risks they were taking while they were taking them and of their accepting the role of luck, that of unknown unknowns and of their ability to focus on the content than on keeping up appearances.

Lucidly written for a general audience, with his dry wit providing the backdrop for his meticulous research and deep reflection, the Halo Effect is one of the few books I will happily advice for pretty much anyone.A must read.