Readers who derive their corporate opinions from Forbes, Fortune and Business Week, or who lionize the popular management tomes of the last 25 years like In Search of Excellence, Built to Last, What Really Works and Good to Great, should be a bit circumspect when they take on The Halo Effect. For without inflammation but with surgical precision, Rosenzweig debunks the feel-good findings and interpretations of this research, leaving readers with the near-certain conclusion the books are little more than nice stories of how the business world should work. Alas, as The Halo Effect demonstrates, real business isn't as tidy or conforming as we'd like.
The Halo Effect
In psychology, the halo effect is an error in interpretation in which an evaluation of people or organizations on one dimension is generalized to other dimensions without substantiation. The halo effect was coined by psychologist Edward Thorndike during World War I to explain the phenomena where soldiers who ranked highly on leadership and intelligence, say, were assumed to be superior in other traits, while those deemed lacking in leadership were seen as inferior across the board. Over time, the halo effect has come to represent a tendency to assume specific traits based on a general impression - to blend features together, to make attributions from what is known to what is vague.
Rosenzweig argues convincingly that the halo effect is in play when companies whose financial performance is superior are presumed to have a laser-like strategic focus, to execute with aplomb, to have enabling leadership, to possess a cohesive culture and to be locked in on customer needs. Companies struggling financially, on the other hand, are assumed to have strayed from core, to be arrogant, to have lost focus, to be disconnected from customers. The big problem for the type of analyses noted in The Halo Effect is that indicators of company performance such as leadership, strategic focus, culture and customer orientation are not measured objectively and independently of financial performance, but rather assume the "halo" of that financial performance - either positive or negative.
Rosenzweig's discussion of the up and down fortunes of Cisco and the Swedish-Swiss industrial company ABB is as entertaining as it is illuminating. Citing popular business press, Rosenzweig illustrates the halo effect with all its splendor. The CEO of ABB, characterized as charismatic and visionary while ABB's performance was in orbit, is seen as arrogant and imperial on the decline. ABB's decision to expand into new areas like financial services was framed as a bold growth move in good times, but criticized as impulsive and foolish on the downturn. Cisco, lauded for its culture, customer focus, acquisition strategy and leadership in the high-flying late 90s, was denigrated as an out-of-control and overhyped underachiever in 2002. The juxtaposition of before and after quotes on the "causes" of the fortunes of ABB and Cisco - the halo effect in practice - is almost comical.
Though a psychological process that causes people to assess in certain ways, the halo effect needn't be an inevitable consequence of our desire to evaluate, our need to examine cause and effect. Indeed, the biggest problem with the assessments and studies noted in The Halo Effect is one of design and method. The dimensions of company performance in these cases - strategy, leadership, culture, etc. - are measured not by independent, objective evidence, but by individuals who are subject to a biasing halo interpretation. The inferior designs of these anecdotes, case studies and cross-sectional investigations almost guarantee that dimensional assessments will be reflective of overall performance, thus assuring a halo effect.
The halo effect is not the only validity-threatening flaw discussed in the book. Nine delusions are noted in all, among them "correlation and causality," "lasting success," "connecting the winning dots" and "the wrong end of the stick." The problem of correlation and causality is as old as science and has to do with interpreting an association between two variables. Does a strong relationship between employee satisfaction and company performance imply that satisfied employees enhance company performance? Or that good company performance makes for satisfied employees? Or both? Or neither? The directions of many such relationships between company performance and dimensions of performance noted in The Halo Effect are certainly open to debate, especially those from anecdotes or cross sectional investigations that measure at one point in time only.
The delusion of lasting success embodies the statistical artifact of regression to the mean, in which above-average performance tends not to persist, while below-average results tend to improve over time. Nowhere is this more evident than in stock prices, often the top performance measure cited in the various analyses and studies of The Halo Effect. Rosenzweig notes that over half of Built to Last visionary companies failed to match the S&P 500 over the five year period post-study, after outperforming the index by a factor of 15 for 60 years. This type of finding is commonplace in the markets. Little wonder prudent investment managers urge customers not to chase outstanding stock performance.