You’re being lied to.
Well, not intentionally.
We’re constantly being pinged with stories of companies that have rocketed to success. Especially in tech, there’s always another $1 billion unicorn around the corner. Uber, Facebook, Airbnb, Slack, Zenefits, Box, Shopify, yadda yadda yadda.
At the same time, rock-solid companies seem to lose their way and crater.
We’re all desperate to know why.
Makes sense. We want to replicate the crazy success and avoid failure.
This is where we all get sucked in the nonsense narratives. They’ll give you false hope on how to produce success.
Here’s a good example: should a company expand into different products, industries, or markets? We’ll answer this question in a minute.
But first, who loves LEGO? I DO. My favorite childhood toy by far. You know how people will buy huge mansions and a dozen sports cars if they ever hit it big? I’ll just buy every LEGO set and fill an entire room with them. These days, they even have a Batwing with Joker steamroller set. How cool is THAT?
As it turns out, LEGO is a great case study for how delusional we can be about what produces successful companies.
Go check out LEGO’s 2014 annual report. In 2014, their net profit increased by about 15% to over 7 billion Danish krone (DKK). At current exchange rates, that’s about USD$1 billion. Back in 2011, they pulled DKK 4 billion in net profit. So they’ve had similar growth rates since 2011 and have nearly doubled their net profit. Not shabby at all.
Why is Lego doing so well? Management gives the credit to expansions beyond it’s core business, they crushed it with the LEGO Movie and the new line of LEGO sets that released with it. Right on page 5 of the annual report: “new products make up approximately 60% of the total sales each year.” They’ve also seen a lot of growth from the toy market in Asia.
So we’ve answered our question right? If we want to keep growing, we’ll want to expand beyond our core product and market base at a certain point, right?
Well, wait a minute. Our story isn’t that simple.
Go back to 2004 when LEGO nearly went bankrupt. Their COO, Poul Plougmann, got sacked and the business press lambasted the company for poor results. They caught a ton of flack for releasing a LEGO Harry Potter line (apparently, sales slowed when there was a gap between some of the Harry Potter movie releases), experimenting with new toy products, jumping into video games, launching a failed TV show, and trying to go beyond it’s core brand. The consensus was that they should get back to their core base and stop messing around by trying to innovate into new products.
Wait, which is it? In 2014, product expansion from the LEGO Movie helps push the company to new heights. In 2004, the LEGO Harry Potter line, TV shows, and the first attempt at video games nearly pushes it to bankruptcy. During each period, we push narratives and recommendations that contradict themselves. Go back to your core base! Wait, never mind! Expand into new products!
I can’t take credit for this insight or finding the LEGO story. It’s one of the case studies used in The Halo Effect by Phil Rosenzweig.
Rosenzweig shows how narratives are twisted to explain results after they occur. He wrote the original version of his book back in 2007 (there’s a new 2014 copy that you should grab if you haven’t yet). Then after the book is published, LEGO turns around and we start attributing their success to LEGO’s constrained innovation:
- An interview from Wharton with David Robertson
- A brief article in the Harvard Business Review (also by David Robertson)
- An article from the Daily Mail
- Business Insider’s account of the come-back
- Another from Forbes
LEGO went back to its base. Innovation trashed the company in 2004 because it was highly unprofitable and expanded beyond its core strengths. Now LEGO has entered another golden era by constraining innovation.
But LEGO just had another huge year by expanding into its first movie. Hard to get further from its product base than that. A decade ago, the LEGO TV show got part of the credit when LEGO struggled. Now the LEGO Movie gets the credit when profits have turned around.
Again, which is it? Innovation? Constrained innovation? Innovation as long as you do these 7 simple steps? Maybe all of the above? Reducing a business to a simple narrative for a blog post or interview is incredibly difficult. And you’ll want to be careful of any source that attempts to do so.
To be fair, David Robertson and Bill Breen wrote a book that dives into the Lego story. I’m hoping they capture the nuance of what went into LEGO’s turn-around. I haven’t read the book myself but it’s on my to-read list.
We’re all exceptionally good at rationalizing any argument. If things go well, we’ll cherry pick some attributes and credit them for the company’s success. Then when things go sideways, we take the same attributes to explain the failure. It all sounds nice and tidy. Too bad it’s a poor reflection of reality.
Phil Rosenzweig calls this habit of ours the Halo Effect. When things go well, we attribute success to whatever attributes stand out at the company. When things go poorly, we attribute bad results to those exact same attributes. It’s one of the 9 delusions that he covers in his book. Let’s go through each of them.
The Halo Effect
The tendency to look at a company’s overall performance and make attributions about its culture, leadership, values, and more. In fact, many things we commonly claim drive company performance are simply attributions based on prior performance.
This is what happened to Lego. In 2004, they’re skewered by the press for trying to expand beyond it’s core business. Now it can’t get enough praise as it drives growth into new markets and product lines.
This happens to companies, teams, and you. When things go well, the quirks get credit for success. When things go poorly, those same quirks get the blame. Our stories search for what’s convenient, not what’s true.
Remember this when you’re in your next team meeting. Someone will float a story for how you got to this point. If it sounds good, the story will spread and your whole organization will start shifting in response to it. And a nonsense story means nonsense changes. There are two things you can do to limit these non-sense stories:
- Chase causality as often as you can (more on this in a moment). The better your team understands how your systems really work, the closer your stories will be to the truth.
- Realize that your stories are typically nonsense. It’s your goal to test the validity of that story as fast as you can.
The Delusion of Correlation and Causality
Two things may be correlated, but we may not know which one causes which. Does employee satisfaction lead to high performance? The evidence suggests it’s mainly the other way around — company success has a stronger impact on employee satisfaction.
We’ve all heard the adage “correlation, not causation.” But when you’re about to come up short on a monthly goal, how easy is it to remember correlation versus causation? It’s not. We all break and reach for the closest story we can. Even if we avoid throwing blame around, we still grasp for any story that will guide our way through the madness.
Proving causality is one of the most difficult bars to reach. Very few variables truly impact our goals in a meaningful way. How do we deal with this?
If you only rely on after-the fact data, you never move beyond correlation. Every insight and every bump in a metric is, at best, a correlation. The only way to establish any degree of casualty (and we’re never 100% sure) is to run a controlled experiment of some kind. You’ve got to split your market into two groups and see what happens when you isolate variables.
This is why I push so hard for A/B tests and get really strict with data quality. They allow us to break past the constraints of correlation and gain a glimpse of causation.
If you limit your learning to just correlation, you’ll get crushed by those chasing casualty. They’ll have a much deeper understanding of your environment than you do. You won’t be able to keep up.
And remember, the business myths, stories, best practices, and press rarely look at correlation versus causation. It’s all just correlation.
The Delusion of Single Explanations
Many studies show that a particular factor — strong company culture or customer focus or great leadership — leads to improved performance. But since many of these factors are highly correlated, the effect of each one is usually less than suggested.
Data is messy, markets are messy, customers are messy. The complexities of these systems vastly exceed our ability to understand or adequately measure them. Variables interact and compound in limitless ways.
Whenever someone gives you a nice, tidy explanation for why a business succeeded or failed, assume it’s nonsense.
You can’t depend on a single variable to drive your business forward. World-class teams have mastered countless business functions, everything from employee benefits to market research. The hottest New York Times bestseller may give you a 5 step process on how to conquer the world with nothing other than whatever flavor-of-the-month strategy everyone loves at the moment. But that’s a single variable among many.
Remember that your business moves within an endlessly complex system. Not only are you trying to change this system, you’ll be pushed around by it.
The Delusion of Connecting the Winning Dots
If we pick a number of successful companies and search for what they have in common, we’ll never isolate the reasons for their success, because we have no way of comparing them with less successful companies.
Good ol’ survivorship bias. We can’t just look at winners. We need to find a batch of losers and look for the differences between the two groups. Otherwise, we’re just pulling out commonalities that don’t mean anything.
The tech “unicorn” fad has succumbed to this delusion. Everyone’s looking for patterns among the recent $1 billion tech startups, trying to find the patterns so they can build their own unicorn. But they’re doing many things in exactly the same way as all the startups that blow up or stall out. We just don’t hear about those failures. And if we do, those stories aren’t deconstructed in the same level of detail as the unicorns. So we get a picture of what amazing companies look like but a very limited view on how they differ from their failed counterparts.
Study the failures just as deeply as the successes.
The Delusion of Rigorous Research
If the data aren’t of good quality, it doesn’t matter how much we have gathered or how sophisticated our research methods appear to be.
Rosenzweig takes a shot at Jim Collins with this one. Jim Collins has written several well-renowned books like Good to Great, Built to Last, and Great by Choice. Collins and his team do a ton of historical research to figure out which attributes separate great companies from average companies. As Rosenzweig points out, most of this research is based on flawed business journalism that suffers from the Halo Effect. So the raw data for Collins’ research is horribly flawed which then means his books aren’t as solid as many people think.
Regardless of how you feel about Collins’ books, this is still a critical delusion to remember. It doesn’t really matter how sophisticated you are with modeling, data science, research, or analytics if your data sucks. Fix your data first before trying anything fancy.
This is where I start with every business I work with. Before jumping into growth experiments, A/B testing, or building out channels, I always make sure I can trust my data. Data’s never 100% perfect but there needs to be a low margin of error. The quality of your insights depends on the quality of your data.
The Delusion of Lasting Success
Almost all high-performing companies regress over time. The promise of a blueprint for lasting success is attractive but not realistic.
You will regress to the mean. Crazy success is an outlier by default. Sooner or later, results come back down to typical averages.
Mutual funds prove this point perfectly. In any 2 year period, you can find mutual funds that crush the S&P 500. Wait another 5-10 years and those same mutual funds have fallen back to earth. Your company is in the same boat. If things go crazy well, it’s a matter of time before you come back down. Take advantage of your outlier while it lasts.
This is particularly dangerous with individual or team performance. Is it really talent or are you just an outlier? Sooner or later, you’ll have some campaign or project that takes off. Well… if you launch enough stuff, you’re bound to get lucky. The real question is how long can you sustain it? Can you repeat that success? And since we all regress to the mean eventually, how can you use you current success to get through the eventual decline?
All channels decline, all products decline, all markets decline, all businesses decline. You will decline. What are you doing now to plan for it?
The Delusion of Absolute Performance
Company performance is relative, not absolute. A company can improve and fall further behind its rivals at the same time.
You’re graded on a curve whether you like it or not. Even if you’re improving, customers won’t care if your competitor is improving faster than you are. You’ll need to stay ahead of the pack no matter how fast the pack is already moving.
Otherwise, it’s a matter of time before you’ve lost the market. Your success isn’t determined in isolation. Just because you did a great job doesn’t mean you’ll achieve greatness.
This stems from a basic psychological principle: as humans, we do a terrible job at perceiving absolute value. This applies to pricing, customer service, product value, and every trait around us. In order to gauge how good or bad something is, we always look for something to compare it to. It really doesn’t matter if you cut prices by 50% if your competitor found a way to cut them by 60%. You’re still considered too expensive.
Your work will always be judged in relation to the work of your peers.
The Delusion of the Wrong End of the Stick
It may be true that successful companies often pursued a highly focused strategy, but that doesn’t mean highly focused strategies often lead to success.
Another shot at Good to Great with this one.
One of the core concepts in Good to Great is hedgehog versus fox companies. Hedgehog companies focus relentlessly on one thing. Foxes dart from idea to idea. According to Collins, amazing companies are all hedgehogs with ruthless focus.
But we don’t have the full picture of the risk/reward trade-off. It’s a lot like gambling or investing. You COULD throw your entire life savings into a single stock (hedgehog) and if that stock takes off… you’ll make a fortune. But if it doesn’t? You’ve lost everything. Investors that diversify (foxes) won’t reap extreme gains but they also won’t expose themselves to extreme loses.
Companies might work very similarly. Yes, hugely successful companies could tend to be hedgehogs. They made big bets and won. But that might not be the best strategy for your company if it means taking on substantial amounts of risk. Most importantly, we can’t say for sure what the risk/reward trade-offs look like without a larger data set of companies. Even if great companies out-perform average companies when they’re hedgehogs, there could be just as many hedgehog companies that weren’t so lucky.
The Delusion of Organizational Physics
Company performance doesn’t obey immutable laws of nature and can’t be predicted with the accuracy of science — despite our desire for certainty and order.
Physics is beautiful and elegant. Business is not.
No matter what you do, you cannot remove uncertainty in business like you can with physics. Books, consultants, blog posts, and pithy tweets will all try to convince you that a simple step-by-step process will take your business to glory. As much as we’d all like to have simple rules to follow, that’s not how this game is played. Business cannot be reduced to fundamental laws or rules.
And sometimes, the outcome is completely outside your control. Even if you do everything right, follow all the right strategies, use the best frameworks, hire the best people, and build something amazing, the whole business can still go sideways on you. We can’t remove uncertainty from the system. All we can do is stack the odds in our favor. Fundamentally, business and careers are endless games of probability.
Recap Time! The 9 Delusions From the Halo Effect
Here are all 9 delusions in a nice list for you:
- The Halo Effect
- The Delusion of Correlation and Causality
- The Delusion of Single Explanations
- The Delusion of Connecting the Winning Dots
- The Delusion of Rigorous Research
- The Delusion of Lasting Success
- The Delusion of Absolute Performance
- The Delusion of the Wrong End of the Stick
- The Delusion of Organizational Physics
Don’t get sucked into the delusional narratives of success. Embrace the uncertainty.