Tuesday, 25 September 2007

More on The Halo Effect

Just about finished this excellent book, and I have to say it's one of the best finance/business books I have read in long time. Much of it is taken up with trashing the typical "analysis" you find in the business pages and management books. A key element is this idea of the Halo Effect, namely if a company does something right - performance - people often see (or choose to see) success in other areas. So a successful company is accredited with having a great culture, or management, or both. In contrast poor performers are are seen as getting the same things wrong.

In addition, many studies of successful companies look backwards. They find successful companies and ask them, or search the business media, for what the company got right. As such they tend attribute success to certain factors once they know what the performance 'answer' is. Although some studies try to overcome this by also including a sample of less good or poorly-performing companies, they often still draw on the same kind of flawed reporting (business press 'stories', asking managers what they got 'right', etc).

The book also argues that success is temporary. Not only is there the effect of mean regression, but companies are also not operating in a vacuum. Competitors can copy products or practices and thus close the gap. Therefore advice (consulting) that claims to offer management techniques that are surefire winners on some quasi-scientific basis, is basically rubbish. In addition performance is, unfortunately, relative, not absolute. A company can significantly improve, becoming more efficient and profitable, yet still lose ground if its competitors are improving at a faster rate. So a business can fail even when it is doing well.

Perhaps my favourite thing about the book is the emphasis on story-telling in both the business press and management books. Much commentary stresses the roles of key individuals, certain decisions, or elements of a particular business's culture or strategy. Yet these are really little more than narratives with a moral in them (ie focus on your core business). I've always had a gut feeling that business reporting works primarily on this basis, and is therefore fundamentally misleading (if perhaps inspiring to some). I don't think I'll ever be able to read the business pages in the same way now.

Great stuff all round. I suppose the next question is how do we apply it?

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