The Halo Effect: . . . and the Eight Other Business Delusions That Deceive Managers by Phil Rosenzweig, NOOK Book (eBook) | Barnes & Noble
The Halo Effect: ... and the Eight Other Business Delusions That Deceive Managers

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

by Phil Rosenzweig

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Much of our business thinking is shaped by delusions -- errors of logic and flawed judgments that distort our understanding of the real reasons for a company's performance. In a brilliant and unconventional book, Phil Rosenzweig unmasks the delusions that are commonly found in the corporate world. These delusions affect the business press and academic research, as


Much of our business thinking is shaped by delusions -- errors of logic and flawed judgments that distort our understanding of the real reasons for a company's performance. In a brilliant and unconventional book, Phil Rosenzweig unmasks the delusions that are commonly found in the corporate world. These delusions affect the business press and academic research, as well as many bestselling books that promise to reveal the secrets of success or the path to greatness. Such books claim to be based on rigorous thinking, but operate mainly at the level of storytelling. They provide comfort and inspiration, but deceive managers about the true nature of business success.

The most pervasive delusion is the Halo Effect. When a company's sales and profits are up, people often conclude that it has a brilliant strategy, a visionary leader, capable employees, and a superb corporate culture. When performance falters, they conclude that the strategy was wrong, the leader became arrogant, the people were complacent, and the culture was stagnant. In fact, little may have changed -- company performance creates a Halo that shapes the way we perceive strategy, leadership, people, culture, and more.

Drawing on examples from leading companies including Cisco Systems, IBM, Nokia, and ABB, Rosenzweig shows how the Halo Effect is widespread, undermining the usefulness of business bestsellers from In Search of Excellence to Built to Last and Good to Great.

Rosenzweig identifies nine popular business delusions. Among them:

  • The Delusion of Absolute Performance: Company performance is relative to competition, not absolute, which is why following a formula can never guarantee results. Success comes from doing things better than rivals, which means that managers have to take risks.

  • The Delusion of Rigorous Research: Many bestselling authors praise themselves for the vast amount of data they have gathered, but forget that if the data aren't valid, it doesn't matter how much was gathered or how sophisticated the research methods appear to be. They trick the reader by substituting sizzle for substance.

  • The Delusion of Single Explanations: Many studies show that a particular factor, such as corporate culture or social responsibility or customer focus, leads to improved performance. But since many of these factors are highly correlated, the effect of each one is usually less than suggested.

In what promises to be a landmark book, The Halo Effect replaces mistaken thinking with a sharper understanding of what drives business success and failure. The Halo Effect is a guide for the thinking manager, a way to detect errors in business research and to reach a clearer understanding of what drives business success and failure.

Skeptical, brilliant, iconoclastic, and mercifully free of business jargon, Rosenzweig's book is nevertheless dead serious, making his arguments about important issues in an unsparing and direct way that will appeal to a broad business audience. For managers who want to separate fact from fiction in the world of business, The Halo Effect is essential reading -- witty, often funny, and sharply argued, it's an antidote to so much of the conventional thinking that clutters business bookshelves.

Editorial Reviews

From the Publisher
"I was taken by this book. It destroys myths concerning the attribution of success in the management literature using potent empirical arguments. It should stand as one of the most important management books of all time, and an antidote to those bestselling books by gurus presenting false patter and naive arguments." — Nassim Nicholas Taleb, author of Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets

"In The Halo Effect, Phil Rosenzweig has done us all a great service by speaking the unspeakable. His iconoclastic analysis is a very welcome antidote to the kind of superficial, formulaic, and dumbed-down matter that seems to be the current stock in trade of many popular business books. It's the right book at the right time." — John R. Kimberly, Henry Bower Professor of Entrepreneurial Studies, The Wharton School, University of Pennsylvania

"Business books all too rarely combine real-world savvy with scientific rigor. Rosenzweig's book is an outstanding exception — it's a superb work and long overdue." — Philip E. Tetlock, Lorraine Tyson Mitchell II Chair in Leadership and Communication, Haas School of Business, University of California, Berkeley

"Rosenzweig doesn't only poke fun at the mass of bad writing and bad science in the management world. He explains why it is so bad — and how you can learn from it, despite the efforts of the authors." — John Kay, Financial Times columnist and author of Everlasting Light Bulbs: How Economics Illuminates the World

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Read an Excerpt

Chapter One: How Little We Know

How little we know, how much to discover...

Who cares to define what chemistry this is?

Who cares, with your lips on mine, how ignorant bliss is?

"How Little We Know (How Little It Matters)"

Words by Carolyn Leigh, music by Philip Springer, 1956

In January 2004, after a particularly disastrous holiday season, Lego, the Danish toy company, fired its chief operating officer. No one doubted that Poul Plougmann had to go. Miserable Christmas sales were the last straw at the end of a terrible year -- Lego's revenues were down by 25 percent, and the company lost $230 million for the year, the worst in its history. What went so badly wrong? Chief executive Kjeld Kirk Kristiansen, grandson of the founder, explained it simply: Lego had "strayed too far from its roots and relied too heavily on merchandising spin-offs, such as Harry Potter figures, which proved unpopular this season despite the continuing success of J. K. Rowling's books." The solution? Lego announced that it would "return to basics." Kristiansen vowed: "We will focus on profitability, especially the attractive potential of our core products."

There's nothing especially remarkable about a story like this. Every day we read about companies that are doing well and someone gets promoted, and other companies that fail and someone gets the ax. Today it's Lego, and tomorrow it'll be someone else. The beat goes on.

Now, I'm really not very interested in Lego. As Rick might have said in Casablanca, the problems of one family-owned Danish toy maker don't amount to a hill of beans in this crazy world. What does interest me is how we explain Lego's performance, because the way we think about what happened at Lego is typical of how we think about success or failure in countless other companies. We don't want to read just that Lego's sales were sharply down, we want an explanation of what happened. It can't just have been bad luck -- there must have been some reason why a proud company, a fixture on toy store shelves all around the world, a faithful playtime companion to generations of children, suddenly did so badly. So how did the business press explain Lego's downfall? A few newspapers reported that Lego was hurt by the fall of the U.S. dollar against the Danish kroner, which meant that North American sales -- about half of Lego's total -- were worth less on Lego's books. Some reporters also noted that a strong new rival, Montreal-based Mega Bloks Inc., was chipping away at Lego's dominant market share. But these were side issues. The main explanation for Lego's losses? Lego had strayed from its core. It lost sight of its roots. That's what Lego's chief executive said, and that's what the media reported, including the Financial Times, The Wall Street Journal, the Associated Press, Bloomberg News, Nordic Business Report, Danish News Digest, Plastics News, and about a dozen others. Depending on the source, Poul Plougmann was variously sacked, fired, axed, ousted, removed, dismissed, replaced, or simply relieved of his duties. But aside from the verb used to describe his departure, not much differed among the articles. Lego's big blunder was straying from the core.

Consider for a moment the word stray. The American Heritage Dictionary of the English Language defines to stray as "to wander beyond established limits," "to deviate from a course that is regarded as right," and "to become lost." A guided missile can stray off course and hit the wrong target. A dog that runs away from home is called a stray. A company can stray, too, if it goes off on a foolish adventure, if it wanders off course, if it gets lost. Apparently that's what Lego did -- it chased merchandising spin-offs when it should have been focusing on its core product line. It strayed.

Chris Zook at Bain & Company argued in his 2001 book, Profit from the Core, that companies often do best when they focus on relatively few products for a clear segment of customers. When companies get into very different products or go after very different sets of customers, the results often aren't pretty. But here's the catch: Exactly how do we define a company's core? Zook identifies no fewer than six dimensions along which a company can reasonably expand its activities -- into new geographies, new channels, new customer segments, new value chain steps, new businesses, and new products. Any one of them might be a sensible step into an adjacent area, radiating out from the core and bringing success. It's also possible that any one of them might be fraught with danger and lead to disaster. So how do we know which path to take? Where does the core end and where does straying off course begin? Of course, it's easy to know in retrospect -- but how can we know in advance?

Which brings us back to Lego. For years, our friends at Lego did just one thing: They manufactured and sold construction building blocks for children. That was the core. Lego made millions of blocks thanks to modern injection molding manufacturing techniques, it turned out blocks in plenty of different colors, and it made them in different shapes and sizes so they could be easily manipulated by little hands. Children could build just about anything out of Lego blocks -- the only limit was their imagination. Lego was always about construction building blocks, nothing else. It built a dominant market share and had huge power over distributors and retailers. In this segment, Lego was king.

Unfortunately, nothing in the business world stands still -- customer preferences change and technology marches on and new competitors appear. The market for traditional toys stagnated as kids shifted to electronic games at an earlier and earlier age. By the 1990s, simple plastic building blocks were a mature product and, in a world of video games and electronic toys, well, a bit boring. If Lego wanted to grow, or even if it wanted to stay the same size, it would have to try some new things -- the question was what. Of all the things Lego might try, what would make the most sense? If Lego decided to expand into, say, financial services, that would be straying from its core. No one would be surprised if the venture flopped -- "What's a toy company doing trying to become a bank? What do they know about banking?" -- and the responsible manager would have been removed without a second thought. What if Lego launched a line of children's clothing? That one's not so clear -- Lego knows a lot about kids, and it understands consumer products. It has plenty of power over retail distribution, just not in clothing, at least not yet. Maybe it could succeed, maybe not. What about electronic toys? Again, debatable -- maybe Lego could build on its experience in toys, and with all the growth in video games, why not? And in fact, Lego had developed Bionicle CD-ROM games and Mindstorm robots made of building blocks controlled by personal computers. But Harry Potter figures? Little toys with little plastic parts that snap together? That should be smack inside Lego's core. If Harry Potter figures are outside Lego's core, we ought to ask exactly how broad Lego's core really is. Because if Lego's core is nothing but traditional blocks, we'd have to wonder how it could possibly provide sufficient growth opportunities for a company with revenues of $2 billion.

In fact, Plougmann had been brought in from Bang & Olufsen, a Danish maker of high-quality audio equipment, in part to go after new opportunities. His hiring was seen as a coup, symptomatic of Lego's commitment to new avenues of growth after the company posted its first loss ever in 1998. Under his guidance, Lego began to branch out into electronic toys and merchandising spin-offs, and the initial response was good. At the time, no one said Lego was moving outside its core. But when sales fell sharply in 2003, Kristiansen lost patience and pulled the plug on Poul Plougmann. "We have been pursuing a strategy based on growth by focusing on totally new products. This strategy did not give the expected results." So in 2004, Lego decided to "return to its core" and "focus on profitability." Strange, because profitable growth was presumably what Lego had in mind when it went after those new opportunities in the first place.

Imagine, if we could turn the clock back to 1999, that Lego had decided to stick to plastic building blocks, nothing more. Nope, we're not interested in a tie-in to Harry Potter, which was only the most popular children's book of all time, whose first two movies racked up box office receipts of $1.2 billion worldwide. Next year's headline? Probably something like this: executive sacked as lego sales flat. And the story line? Something like this: "Danish family firm stays too long with a mature product line and misses out on growth opportunities to more innovative rivals." Analysts will comment that Lego failed to go boldly forward. It lacked vision. It was inward looking. Its managers were timid and complacent -- or maybe even arrogant.

Of course, some ventures outside the core are spectacularly successful. During the 1980s, General Electric, America's largest industrial company long associated with light bulbs, refrigerators, airplane engines, and plastics, sold some of its traditional businesses -- home appliances and televisions -- and went in a big way into financial services -- commercial finance, consumer finance, and insurance. Today, these financial services bring in more than 40 percent of GE's revenues and a corresponding amount of its profits, close to $8 billion. Did GE go beyond its core? Absolutely. But nobody called for the boss's head because GE was successful. In fact, GE was ranked at the top of Fortune magazine's 2005 survey of Global Most Admired Companies, ahead of Wal-Mart, Dell, Microsoft, and Toyota, and was ranked second in the Financial Times's 2005 World's Most Respected Companies survey, down one notch after six consecutive years at number one. So much for the perils of straying from the core.

In the weeks following Plougmann's ouster, the U.K. magazine Brand Strategy looked a bit more closely into Lego's prospects. Like everyone else, it reported that Lego's problems were the result of "focusing on new products such as licensed Star Wars and Harry Potter ranges, to the detriment of its core business." But Brand Strategy went a step further and asked several industry experts what Lego should do. Maybe these industry experts, who presumably know the toy industry and its major players very well, would be able to offer some incisive advice. They were asked: What should Lego do now?

Here was the view of a marketing manager at Hamley's, London's legendary toy store:

Lego mustn't lose sight of what it's become known for -- reliable, colorful construction toys. Its marketing is impressive but Lego needs to continue having the wow factor.

This was the advice from a toy and games industry analyst:

Lego has lost its way to some extent in recent years. It has diversified into a number of sectors and this hasn't worked. Lego should focus on what it does best and it's right to focus back on toys.

And here was the view from another toy industry expert:

Lego has to remember its heritage; listen to customers; be innovative; focus on the key issues for long-term success; and go for evolution, not revolution.

A nice set of advice! Every one of these industry experts wants Lego to have it both ways: on the one hand to remember its heritage and focus on what it's known for, and on the other hand to be innovative and achieve a wow factor. (Remember, pursuit of the wow factor was exactly what Lego had tried to do -- and it got creamed for losing sight of its core. Guess that was the wrong wow factor!) Not a single expert suggested that Lego make a clear choice and follow a definitive direction -- they all want Lego to have the best of everything. You can bet that if Lego returned to profitability, every one of these experts would say, See, Lego followed my advice, and if Lego continued to lose money, they could say, Lego didn't do what I told them. And these are industry experts, who presumably understand the toy industry better than you and I do.

Ted Williams, the great Red Sox outfielder, once said there was one thing he always found irritating: With runners on base and the opposing team's slugger coming to the plate, the manager walks to the mound and says to the pitcher, "Don't give the batter a good pitch, but don't walk him," then turns around and marches back to the dugout. Pointless! said Ted. Of course the pitcher doesn't want to give the batter anything good to hit, and of course he doesn't want to walk him. The pitcher already knows that! The only useful advice is, "In this situation, it's better to throw a strike because you really don't want to walk this hitter," or, "It's better to walk this hitter because in this situation you really don't want to throw him a strike." But baseball managers, like industry analysts, find it easier to ask for the best of both.

One final note about the toy business. Lost in all the sound and fury about Lego was the fact that other toy makers were struggling, too. The largest U.S. toy maker, Mattel, in the midst of a multiyear turnaround after several poor years, announced in July 2004 that sales of its best-known product, the Barbie doll, had fallen by 13 percent. Part of Barbie's woes stemmed from a rival product, MGA Entertainment's Bratz dolls, said to be an "edgier fashion doll," which had eaten into Barbie's market share. What was Mattel planning to do in order to revive Barbie sales? Focus on its core? No, it planned a new line based on the American Idol television show and a fashion-based line called "Fashion Fever." Months after Lego concluded that merchandising spin-offs were a bad idea, Mattel decided to take that very approach.

Drifting with WH Smith, Expanding with Nokia

Lego isn't the only company to be criticized for wandering off course. Consider WH Smith, the troubled newspaper and magazine retail chain. WH Smith got its start more than a hundred years ago as a London newspaper distributor, and over time moved into bookstalls and stores. Nothing odd about that. The New York Times reported: "It was in the 1980s that WH Smith began to diversify well beyond books and periodicals, adding music, office supplies, stationery, and gifts to its store shelves. But in drifting away from its core products, analysts said, the company also made itself vulnerable to competition." WH Smith now found itself competing with supermarkets and other large surface stores -- a dangerous game.

Note the word: drifting. According to the Times, WH Smith didn't expand or diversify, it drifted. The American Heritage Dictionary defines to drift as "to move from place to place with no particular goal," "to be carried along by currents of air or water," "to wander from a set course or point of attention; to stray." A raft can be cast adrift, left to move with the currents. Wood that flows in and out with the tides is driftwood. A person with no direction or aims is a drifter. (At the start of The Magnificent Seven, the rootlessness -- and availability for hire -- of the gunfighters is conveyed in this exchange between Steve McQueen and Yul Brynner. "Where are you heading?" asks McQueen. Brynner answers: "I'm drifting south, more or less. And you?" McQueen shrugs. "Just drifting.")

Well, who says that WH Smith drifted? Who says that selling music and office supplies is an example of wandering off course? Why should we think that WH Smith had no particular goal when it added stationery and gifts? It didn't get into book publishing. It didn't try to sell fresh food or alcoholic beverages. WH Smith didn't add products that call for explanations by salespeople, like electronic equipment, or products that might involve returns. All it did was add a few other fast-moving consumables. It expanded the range of products on its shelves, nothing more. Isn't that exactly what WH Smith should be doing -- identify adjacent areas that draw on its existing capabilities and that appeal to its core customers? In fact, WH Smith's dilemma sounds like a classic problem of format expansion: As large stores and supermarkets expanded their formats to include some of WH Smith's products, WH Smith had to decide whether to sit still and suffer the consequences, or respond by expanding its format. It could well be that given the circumstances, adding music and office supplies was the best move it could have made. Maybe WH Smith was unable to execute its new format for some reason -- bad inventory management or poor logistics -- or maybe it simply couldn't match the buying power of Wal-Mart and Safeway. But that's very different from saying WH Smith drifted.

Let's fast-forward and see if we can spot a good strategy while it's happening. Nokia had been the leader in mobile phone handsets since the mid-1990s, combining technological excellence, sleek designs, and shrewd branding to build the world's largest market share. But by 2004, the Finnish-based company had begun to feel the heat from tougher competition, much of it coming from low-cost Asian rivals. Mobile phones, those clever compact items that now included cameras and calendars and calculators and radios, were in danger of becoming a commodity -- and Nokia's margins were under pressure. So what was Nokia going to do? Would it redouble its focus on the core and ramp up its investment in handsets? Not at all. According to Business Week, Nokia was intent on "expanding into mobile gaming, imaging, music, and even complex wireless systems for corporations." These new areas were appealing for their growth and promise of higher margins, but they were far from Nokia's core of handset design and manufacturing. They were further from Nokia's core than stationery was from WH Smith's core or Harry Potter toys were from Lego's core. So why didn't Business Week say that Nokia was straying or drifting? Why was Nokia merely expanding? Because, at the time, no one knew if Nokia would succeed or fail, so Business Week chose a nice neutral verb, expand. Plus, in plenty of ways, Nokia's strategy made sense -- it was shifting from a tough low-margin business into new areas that promised higher margins. If Nokia could make this change work, it would be celebrated for its nimble strategy and clever management. Of course, if Nokia failed, reporters would say it had erred by moving into areas it didn't understand; it strayed or drifted. The chief executive (or his replacement, if he met the same fate as Poul Plougmann) might then decide Nokia should go back to basics and try even harder with the girl it brought to the dance in the first place, handsets. Yet if Nokia had decided to stick to handsets while its market share was collapsing and margins were imploding, we'd have probably read that Nokia was complacent, inward looking, and conservative. No wonder Nokia failed, we'd be told. It didn't react to a shift in the market. It didn't change with the times.

The Mother of All Business Questions

These accounts about Lego, WH Smith, and Nokia are all variants of the most basic question in the business world: What leads to high performance? It's the mother of all business questions, a Wall Street equivalent of the Holy Grail. Why does one company achieve great success, turning its shareholders into millionaires, while another company just muddles through, earning a modest profit but never catching fire or, even worse, failing altogether? The fact is, it's often hard to know exactly why one company succeeds and another fails. Did Lego make a mistake when it added merchandising tie-ins? At the time, the decision seemed to make sense. It was only later, after the results were in, that Lego's initiatives were described as misguided and ill considered. But that's in retrospect. Lego's venture turned out badly, yes, but that does not necessarily make it a mistake. Plenty of other things, from currency shifts to competitors' actions to sudden shifts in consumer taste, could have helped bury Lego. Plus it's not clear that any of the alternatives would have been more successful. Yet when we read a word like stray, it's hard to escape the conclusion that Lego erred -- the very word implies a damning judgment. If we had a better idea of what Nokia's new directions would lead to, we would use a more precise term than expand -- we might more confidently describe it either as ill-advised or as brilliant. But we don't.

Or consider a little discount retailer, founded in a small Arkansas town in 1962. How did Wal-Mart grow up to be the biggest company in the world, spinning its cash registers to the tune of $1 billion per day, so big that it accounts for 30 percent of the sales of Procter & Gamble, that it sells 25 percent of all disposable diapers and 20 percent of all magazines sold in the United States, so powerful that it can censor magazines and CDs by threatening not to carry them? How did Wal-Mart become such a success? There's no shortage of theories: Perhaps it was a strategy of "everyday low prices," or a relentless obsession with detail, or a culture that gets ordinary people to do their best, or a sophisticated use of information technology in supply chain management, or maybe a bare-knuckled approach to squeezing its suppliers. Are some of these explanations right? Are all of them right? Which are most important? Do some work only in combination with others? Some explanations, like Wal-Mart's use of its sheer scale to get the lowest input costs, help explain high performance today but don't tell us how the company got so big in the first place. These questions are important because if we want to learn from Wal-Mart, if we want some of Wal-Mart's success to rub off on our companies, which lessons should we learn? The fact is, it's hard to be sure. As Frank Sinatra, the Chairman of the Board, used to sing: "How little we know, how much to discover."

Of course, we don't like to admit how little we know. The social psychologist Eliot Aronson observed that people are not rational beings so much as rationalizing beings. We want explanations. We want the world around us to make sense. We may not know exactly why Lego ran into a brick wall, or why WH Smith fell on hard times, or why Wal-Mart has done so well, but we want to feel that we know what happened. We want the comfort of a plausible explanation, so we say that a company strayed or drifted. Or take the stock market, whose daily fluctuations, edging higher one day and a bit lower the next, resemble Brownian motion, the jittery movement of pollen particles in water or of gas molecules bouncing off one another. It's not very satisfying to say that today's stock market movement is explained by random forces. Tune in to CNBC and listen to the pundits as they watch the ticker, and you'll hear them explain, "The Dow is up slightly as investors gain confidence from rising factory orders," or, "The Dow is off by a percentage point as investors take profits," or, "The Dow is a bit higher as investors shrug off worries about the Fed's next move on interest rates." They have to say something. Maria Bartiromo can't exactly look into the camera and say that the Dow is down half a percent today because of random Brownian motion.

Science and the Study of Business

But all of this begs a larger question. If we have difficulty pinpointing what drives company performance, why is that? It's certainly not for lack of trying. Thousands of very smart and hardworking people in business schools and research centers and consulting firms spend a great deal of time and effort looking for answers. There's a huge amount at stake. So why are explanations about company performance so often riddled with clichés and simplistic phrases?

In other fields, from medicine to chemistry to aeronautical engineering, knowledge seems to march ahead relentlessly. What do these fields have in common? In a word, these fields move forward thanks to a form of inquiry we call science. Richard Feynman once defined science as "a method for trying to answer questions which can be put into the form: If I do this, what will happen?" Science isn't about beauty or truth or justice or wisdom or ethics. It's eminently practical. It asks, If I do something over here, what will happen over there? If I apply this much force, or that much heat, or if I mix these chemicals, what will happen? By this definition, What leads to sustained profitable growth? is a scientific question. It asks, If a company does this or that, what will happen to its revenues or profits or share price?

How should we answer a scientific question? Feynman explained: "The technique of it, fundamentally, is: Try it and see. Then you put together a large amount of information from such experiences." In other words, you conduct experiments and put together information in systematic ways to deduce rules that govern the phenomena and that can lead to accurate predictions. The great thing about sciences like physics and chemistry is that we can run experiments -- try it and see -- in carefully constructed laboratory settings that let us control the settings, adjust the inputs, and observe the results. Then we can tinker with a few variables, alter some settings, and try again. Scientific progress owes a great deal to the careful and incremental refinement of experiments.

But what about the business world, which takes place not in a laboratory, but in the messy and complex world around us? Do business questions lend themselves to scientific investigation? Can we devise alternative hypotheses and test them with carefully designed experiments, so that we can support some explanations and reject others? In many instances, the answer is yes. Plenty of business questions lend themselves to scientific experimentation. Imagine you want to know where to place an item in a supermarket, or what effect a price change will have on the quantity of a product sold, or what effect a special promotion will have. What can you do? Simple, you can run trials in different stores and compare the answers. You can find out what works in a given setting. If I do this, what will happen? In fact, just about any situation with an abundance of similar transactions affords a natural setting for experiments. One explanation of Wal-Mart's success is that it was among the first retailers to apply scientific rigor to merchandising, studying the patterns of consumption and understanding the behavioral traits of its customers, then applying its findings to everything from logistics management to store layout. Likewise, some of the best Internet companies, such as and eBay, use highly sophisticated techniques to track customer clicks and understand their choices. Another example is Harrah's Entertainment, one of America's leading gambling companies -- the polite word is gaming -- with hundreds of thousands of customers visiting its casinos every day. When Gary Loveman came on board as chief operating officer in 1998, he didn't just see rows of slot machines and card tables and roulette wheels -- he saw a fabulous laboratory for running experiments. He saw that Harrah's loyalty card, Total Gold, gathered huge amounts of data about thousands of customers and their preferences. Using these data, Harrah's could run experiments and analyze the outcomes, then make adjustments to improve customer satisfaction and retention. For example, Harrah's could configure casino floors with just the right mix of slot machines to benefit both customers and the company. Did Loveman's experiments meet the standard of science? You bet. And the results were dramatic: Revenues and profits were way up, both in absolute terms and relative to Harrah's competitors. Scientific thinking -- try it and see -- helped Harrah's improve its performance.

But other questions in business don't easily lend themselves to this sort of experimentation. Take a major strategic initiative, like the launch of a new product. Coca-Cola didn't get two chances to launch New Coke in 1985 -- it got one bite at the apple and famously got it completely wrong. Daimler had just one shot at acquiring Chrysler, and mistakes were hard, if not impossible, to undo. Ditto AOL and Time Warner -- a complex merger between two entirely different corporate cultures in a rapidly changing industry. Steve Case and Gerald Levin had no way to conduct experiments. There's simply no way to bring the rigor of experimentation to questions like these. Want to know the best way to manage an acquisition? We can't buy 100 companies, manage half of them in one way and half in another way, and compare the results. We can't run that sort of experiment.

Science, Pseudoscience, and Coconut Headsets

Our inability to capture the full complexity of the business world through scientific experiments has provided fodder for some critics of business schools. Management gurus Warren Bennis and James O'Toole, in a 2005 Harvard Business Review article, criticized business schools for their reliance on the scientific method. They wrote: "This scientific model is predicated on the faulty assumption that business is an academic discipline like chemistry or geology when, in fact, business is a profession and business schools are professional schools -- or should be." The notion seems to be that since business will never be understood with the precision of the natural sciences, it's best understood as a sort of humanity, a realm where the logic of scientific inquiry doesn't apply. Well, yes and no. It may be true that business cannot be studied with the rigor of chemistry or geology, but that doesn't mean that all we have is intuition and gut feel. There's no need to veer from one extreme to the other. There's plenty of room between the natural sciences and the humanities, after all. We might not be able to buy 100 companies and run an experiment, but we can study acquisitions that have already taken place and look for patterns. We can examine some key variables like company size, industry, and the integration process, and then see what leads to better or worse results. That approach -- called quasi-experimentation -- is a staple of social science. It may never reach the ideal of the natural sciences, but it comes about as close as we can get to applying the spirit of scientific inquiry to some key business decisions.

In fact, there's a great deal of very good social science research about company performance, and I'll review some of it in future chapters. But much of it, precisely because it's done carefully and is circumspect in its findings, tends not to provide clear and definitive guidelines for action. It's just not very appealing to read that a given action has a measurable but small impact on company success. Managers don't usually care to wade through discussions about data validity and methodology and statistical models and probabilities. We prefer explanations that are definitive and offer clear implications for action. We want to explain Lego's fortunes quickly, simply, and with an appealing logic. We like stories.

It's useful to make the distinction between reports and stories. A report is above all responsible for providing the facts, without manipulation or interpretation. If the accounts about Lego and WH Smith are meant to be reports -- which presumably they are, since they're written by reporters -- then words like stray and drift are problematic. Stories, on the other hand, are a way that people try to make sense of their lives and their experiences in the world. The test of a good story isn't its responsibility to the facts as much as its ability to provide a satisfying explanation of events. As stories, the news accounts about Lego and WH Smith work just fine. In a few paragraphs, the reader learns of the problem (sales and profits are down), gets a plausible explanation (the company lost its direction), and learns a lesson (don't stray, focus on the core). There's a neat end with a clean resolution. No threads are left hanging. Readers go away satisfied.

Now, there's nothing wrong with stories, provided we understand that's what we have before us. More insidious, however, are stories that are dressed up to look like science. They take the form of science and claim to have the authority of science, but they miss the real rigor and logic of science. They're better described as pseudoscience. Richard Feynman had an even more memorable phrase: Cargo Cult Science. Here's the way Feynman described it:

In the South Seas there is a cult of people. During the war they saw airplanes land with lots of materials, and they want the same thing to happen now. So they've arranged to make things like runways, to put fires along the sides of the runways, to make a wooden hut for a man to sit in, with two wooden pieces on his head like headphones and bars of bamboo sticking out like antennas -- he's the controller -- and they wait for the airplanes to land. They're doing everything right. The form is perfect. But it doesn't work. No airplanes land. So I call these things Cargo Cult Science, because they follow all the apparent precepts and forms of scientific investigation, but they're missing something essential, because the planes don't land.

That's not to say that Cargo Cult Science doesn't have some benefits. The folks who wait patiently by the landing strips on their tropical island, dressed up like flight controllers and wearing a pair of coconut headsets, may derive some contentment from the whole process -- they may live in hope of a better future, they may enjoy having something to believe in, and they may feel closer to supernatural powers. But it's just that -- it's a story. It's not a good predictor of what will happen next.

The business world is full of Cargo Cult Science, books and articles that claim to be rigorous scientific research but operate mainly at the level of storytelling. In later chapters, we'll look at some of this research -- some that meet the standards of science but aren't satisfying as stories, and some that offer wonderful stories but are doubtful as science. As we'll see, some of the most successful business books of recent years, perched atop the bestseller lists for months on end, cloak themselves in the mantle of science, but have little more predictive power than a pair of coconut headsets on a tropical island.

Copyright © 2007 by Philip Rosenzweig

Meet the Author

Phil Rosenzweig is a professor at IMD in Lausanne, Switzerland, where he works with leading companies on questions of strategy and organization. He earned his PhD from The Wharton School, University of Pennsylvania, and spent six years on the faculty of Harvard Business School. He is a native of Northern California. Comments to the author can be sent to

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