Complexity is the indispensable thread in the fabric of world of business today. As a result, in spite of all the secrets formulas and all the self-proclaimed thought leadership, success in business is as elusive as ever. Unlike hard sciences there are no immutable laws in management because managing business isn’t a science.
Rajiv Bajaj, Managing Director of Bajaj auto, said this in one of his talks –
I joined the company [Bajaj Auto] twenty years back. In my college I was trained to think ‘Just in Time’ because it was supposed to be one solution for all the problems. And then somebody said, Just in Time is not enough. They said there must be Kaizen, World class manufacturing, Toyota production system, Kawasaki system, automation and robotics. Then they said you must also know CAD, CAM, simultaneous engineering, re-engineering, six-sigma, TQM, and you must wear six hats, follow seven habits, look for blue oceans, be a bit of a maverick and indulge in management by walking around. Every time I learnt something new, I found myself back at the starting point. There was always the new book on the shelf, and there was always the new consultant on the seminar circuit. And these guys would do anything to keep themselves in demand and keep all of us confused. So I decided to ignore all of these.
Rajiv Bajaj turned around Bajaj Auto from a loss making company in the year 2000 to the most profitable auto company in world and it’s pretty clear from his talk that he didn’t do it just by blindly listening to those management experts and celebrity CEOs who claim to have the next new thing.
Most theories and expert advice are either anecdotal or riddled with hindsight bias. A significant part of so called scientific research in business is nothing by pseudoscience in the garb of storytelling. Halo Effect is one psychological bias which clouds our ability to think clearly and critically about problems especially when it comes to understanding the reasons behind successful businesses.
Halo effect is the tendency to make inferences about specific traits on the basis of a general impression. It’s a way for the mind to create and maintain a coherent and consistent picture, to reduce cognitive dissonance.
A simple example would be when you meet a person who looks sharp, handsome and has a great posture, (which are all positive external qualities) it might lead you to make a subconscious judgement about his internal qualities also i.e. you’d think this person to be intelligent and extrovert.
The psychologist Edward Thorndike discovered halo effect in 1920. His research documents how U.S. army soldiers who earned high scores from commanders for one quality (such as neatness) also got high marks for entirely unrelated qualities (such as loyalty and physical strength).
It’s interesting how people seem not to think of other individuals in mixed terms. Instead we seem to see each person as roughly good or roughly bad across all categories of measurement. The halo of one good or bad quality severely affects our judgment about other uncorrelated qualities.
Daniel Kahneman, a nobel laureate and a pioneer in the field of behavioural finance, has a little more technical term for halo effect – Exaggerated Emotional Coherence. In his book, Thinking Fast and Slow, Kahneman writes –
The tendency to like (or dislike) everything about a person—including things you have not observed—is known as the halo effect. The term has been in use in psychology for a century, but it has not come into wide use in everyday language. This is a pity, because the halo effect is a good name for a common bias that plays a large role in shaping our view of people and situations.
You meet a woman named Joan at a party and find her personable and easy to talk to. Now her name comes up as someone who could be asked to contribute to a charity. What do you know about Joan’s generosity? The correct answer is that you know virtually nothing, because there is little reason to believe that people who are agreeable in social situations are also generous contributors to charities. But you like Joan and you will retrieve the feeling of liking her when you think of her. You also like generosity and generous people. By association, you are now predisposed to believe that Joan is generous. And now that you believe she is generous, you probably like Joan even better than you did earlier, because you have added generosity to her pleasant attributes.
Come to think of it, brands are nothing but halos. We may not know if a new product is good, but if it comes from a well-known company with an excellent reputation, we might reasonably infer it should be of good quality. That’s what brand building is about.
Companies that own famous brands are primarily in the business of creating halos so that consumers are more likely to think favourably of a product or service.
Phil Rosenzweig, in his book The Halo Effect, writes –
Perhaps nothing lends itself to the Halo Effect more than leadership. Good leaders are often said to have a handful of important qualities: clear vision, effective communication skills, self-confidence, personal charm, and more. Most people would agree these are elements of good leadership. But defining them is a different matter altogether, since several of these qualities tend to be in the eye of the beholder — which is affected by company performance.
And when the fortune turns for the company, experts opine that those very same leaders had lost their focus, became complacent and arrogant. Phil argues –
…you can always find good things to say about leaders at successful companies, and you can always find reasons to criticize leaders of failing firms. A critical reader ought to ask if any successful companies have inauthentic leaders, and if any unsuccessful companies are run by authentic leaders, because if not, it’s quite possible we’re just throwing around Halos.
Another example of the halo effect: We believe that CEOs who are successful in one industry will thrive in any sector. Whenever a successful CEO decides to venture into a new unrelated business, the news is met with excitement and great anticipation among investors and analysts. But the list of companies is endless where the CEO failed to replicate his earlier success in another unrelated new venture.
Investors tend to focus on easily available facts, such as a company’s recent financial situation, and extrapolate conclusions from there that are harder to measure, such as the quality of its management or the feasibility of its strategy. Call it the halo of the last quarter performance.
Jason Zweig, a famous investment journalist, has written an excellent column on how halo effect can lead investors astray. Here’s an excerpt from the same –
Mr. Buffett’s reputation for probity and unrivalled investing record can cast a warm glow over the stocks he buys. In 2008, Goldman Sachs Group got the same kind of boost from his buying that Bank of America got this week. That is partly because many money managers, and countless individuals, copy any trades Mr. Buffett discloses.
…a soaring stock price can lead investors to regard the company’s managers as focused, disciplined and passionate—while, in the negative halo of a falling stock price, the same executives will now seem stubborn, unimaginative and resistant to change.
Investors think, at either time, that they are evaluating the stock and the managers independently, but one opinion inevitably colors the other, often leading investors to be too bullish on the upside and too bearish on the downside. The managers haven’t changed; our perceptions of them have.
I started this post with an excerpt from Rajiv Bajaj’s talk where he mentions how he disregarded the advice of experts as a measure to save himself from halo effect. In most of his talks he comes out as a thoughtful and intelligent business leader. It impresses me that Rajeev Bajaj will not allow halo effect to pollute his thinking and decision making. However, if one invests in Bajaj Auto only by listening to Rajeev’s talks, without evaluating the business of Bajaj Auto, he or she would again be falling for halo effect.
In fact, that’s the interesting aspect of most behavioural biases. Just when you think you have managed to avoid a bias, it secretly gains entry in your mind from a back door.
Flavours of Halo Effect
Halo effect has a cousin called devil effect. Just like halo effect is used mostly in context of positive qualities, devil effect explains the same phenomenon in context of bad traits. For example, selfishness of an individual can lower people’s opinion of all of his or her other traits.
If you were told that Hitler loved dogs and little children, your brain will find it extremely hard to accept this particular trait of the German dictator. Any trace of kindness, writes Kahneman, “in someone so evil violates the expectations set up by the halo effect.”
An extreme example of the devil effect is Stereotypes; where we know nothing about the person but use our quick judging mind to make snap decisions. All of the sudden our mind starts to think, because someone is dishonest he must not be good at sports, or he must be less intelligent.
Occasionally, halo effect has pleasant consequences at least in the short term, writes Rolf Dobelli in his book The Art of Thinking Clearly, “Have you ever been head over heels in love? If so, you know how flawless a person can appear. Your Mr. or Ms. Perfect seems to be the whole package: attractive, intelligent, likeable, and warm. Even when your friends might point out obvious failings, you see nothing but endearing quirks.”
In most simple words, halo effect occurs when a single aspect dazzles us and affects how we see the full picture. It increases the weight of first impressions, sometimes to the point that subsequent information is mostly wasted.
According to halo effect, first impression is not just the last impression but a lasting impression. If you look closely, you’ll find that halo effect is nothing but another interesting way in which confirmation and consistency bias shows up in human behaviour.
In the end, halo effect is the manifestation of human desire to tell a coherent story.
The need of the hour for investors and business managers is to think for themselves. And independent thinking requires a strong bullshit filter. And Halo effect mental model is one such bullshit filter.
Let me remind you again the importance of mental models. Mental models are to your brain as apps are to your smartphone. Just like apps, there are a ton of mental models. They help you make decisions, solve problems and see the world in an entirely new way… they basically make your brain more useful.
Take care and keep learning.
ABDUL AFEEF says
I had no idea that i would complete this whole article when i began reading it. Its awesome, I must say.
It was great to learn about the halo affect as well as about the Devil effect. We must be more conscious in performing fundamental research because algorithms can not help us in it like technical analysis. The psychological effect is more Important.
Anshul Khare says
Thanks Abdul. I am glad you liked it.
Ashish M says
Good write up Anshul. It also works in our organisation. Some employees automatically becomes favourite of management because of one great skill which leads to his / her promotion to a role needed different set of skills and then the person flops. Numerous examples of how an excellent salesperson or an excellent engineer has turned out to be poor manager. Halo effect is all around us and we need to be ultra watchful.
Anshul Khare says
Thanks for sharing the example Ashish.
Shubhankar Roy says
Didn’t know this was called “Halo effect”. Fans of celebrities don’t want to hear anything bad about them. Then there are some, who’ll be judged by their personal life stories and not how they perform their jobs. Something similar to, the relation between the fortune of companies and how people perceive their leaders.
These mental models that you’re enlightening us with, are very useful but difficult to keep in mind when making decisions in life and investing. How do you do it?
Anshul Khare says
Thanks for your comments Shubhankar.
I agree, it’s quite difficult to remember everything. Maintaining a checklist of these models and running through them while making important decision is one way to use them. The more you learn and the more you implement, easier it will become. It’s a life long journey of acquiring worldly wisdom. Idea is to go keep accumulating knowledge slowly and steadily.
rahul chandalia says
This is simply great writeup. Kudos sir.