Tuesday, October 14, 2008

"Reverse causality" – sorry, but life's not that simple

“In Search of Excellence”, “Built to Last”, “Profit from the Core”; you may have read some of these best-selling business books.

They usually follow a simple yet appealing formula. They look at a number of very successful companies, see what they have in common, and then conclude “this must be a good thing!” Yet, reality – and strategy research – is a bit trickier than that.

One conclusion many of these business books draw is that one should focus on a limited set of “core activities”. For example, “Profit from the Core” authors Chris Zook and James Allan find that 78% of the high-performing firms in their sample of 1,854 companies focus on just one set of core activities, while a mere 22% of the low-performing companies did. Hence, they conclude that companies should focus.* Simple isn't it? Yeah, but a bit too simple...

What this “advice” ignores is that often underperforming companies diversify into other businesses in order to try to find markets that are more rewarding for them. Thus, their “non-focus” is the result of poor performance, rather than the cause! In contrast, it’s very common that very successful companies narrow their strategic focus in order to concentrate on the business that brings them most success. Again, their focus is not the cause of their success; it is the result of it. Our best-selling-business-book-friends may be reversing cause and effect; recommending everybody to apply more focus may be dubious advice at best!

Similarly, many of these business books conclude that the high-performing companies they looked at all had very strong and homogeneous corporate cultures. Hence, they conclude: create a strong corporate culture! Seductively simple again... Unfortunately, not so sound.

It is a well-known effect in academic research that success may gradually start to create a homogeneous organisational culture. Again, the coherent culture is not the cause of the company’s success, but the result of it! What’s worse, a narrow, dogmatic corporate culture may be the foreboding of trouble. When the firm’s business environment changes – and all environments eventually do – it makes the company rigid and unable to adapt; a phenomenon known as the success trap.

Indeed, the authors of “In Search of Excellence” – Peters and Waterman – published in 1982, who analysed 43 of "the most excellent companies in the world", also concluded that a strong corporate culture was a necessity for business stardom. However, if you look at their list of 43 "most excellent companies” today, only three or four might still make the list (Johnson & Johnson, Intel, Wal-Mart, Mars); the remainder has gone down or disappeared altogether.

Hence, remember that “association is not causation”. For example, that successful companies are associated with a very focused set of business activities and strong corporate cultures does not mean that this is what caused their success. Importantly, trying to replicate these symptoms of success may actually prevent you from attaining it.

* For more insight into these type of effects, see for instance the work of Stanford Professor Jerker Denrell