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The Fallacy of the Formula
What do Circuit City, Fannie Mae and Pitney Bowes all have in common?
If you answered that they have all been remarkable failures in the past eighteen years, you would be half-right. If you answered that they have all been remarkable failures AND were three of the eleven “Great Companies” identified in Jim Collins’ Good to Great book, you would be more-right.
Good to Great: Why Some Companies Make the Leap... and Others Don't took the business management community by storm when it was published in October of 2001. Like the latest Hallmark movie, the book follows the same pattern of past business books: create a list of great companies based on some “quantifiable” measure and then identify the formula that brought these companies to greatness.
And imply that your readers can apply the same magic formula to achieve greatness within their own organizations!
Ignore luck, randomness and good fortune, and over-attribute all the greatness to the formula and the management team.
Oh, and one more thing – make sure you have a BHAG! (a big, hairy, audacious goal) It doesn’t matter if the BHAG is a good one, it matters that it’s HAIRY and AUDACIOUS!
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The core message of Built to Last is that good management practices can be identified and implemented, and once implemented good results will follow. The fallacy of this logic is that Collins was essentially comparing successful firms with less successful firms and attributing the success to something other than luck and randomness. Of the 5,000+ publicly traded companies that existed from 1986 to 2001, there was a reasonable probability that eleven of them would outperform over a 15-year period!
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“Knowing the importance of luck, you should be particularly suspicious when highly consistent patterns emerge from the comparison of successful and less successful firms. In the presence of randomness, regular patterns can only be mirages.” Daniel Kahneman.
Nassim Taleb touched on this human tendency when he introduced the narrative fallacy in The Black Swan.
The narrative fallacy describes how flawed stories of our past shape our views and expectations of our universe.
Driven by our need to make sense of our world, narrative fallacies are the simple, compelling stories that create meaning and assign larger roles to things like talent and intelligence rather than luck or randomness.
Focusing on the few significant events that actually happened, rather than the countless number of events that could have happened, we wrap our view around a nice clean narrative and fail to account for the randomness that exists in our world.
People have a deep need to be reassured that actions have consequences. And we all want to believe that success will be the rewards of courage and good decision-making. Books like Good to Great provide a nice clean message about the determinants of success and failure by offering a sense of understanding. But their logic is faulty and misleading.
The reality is that the world (and especially stock prices!) operates in a more-random fashion than most people care to recognize. The recognition that our world has a randomness to it does not however, leave us powerless. It can actually empower us to make better decisions when we recognize that fact.
We will address how to make better decisions in light of a random world in next week’s Insight, but before we wrap up this week, let’s look at how Collins’ eleven “great” companies have performed since Good to Great was published 18 years ago:
On a cursory look, the end results show three remarkable losers in Circuit City, Fannie Mae and Pitney Bowes; four weak performers in Kimberly Clark, Kroger, Wells Fargo and Walgreens; two market performers in Gilette and Wells Fargo and three winners in NuCor, Philip Morris and Abbot Labs:
Remarkable Losers
3
Market Performers
2
Underperformers
4
Winners
3
That doesn’t sound like “greatness.” Some underperformed, some outperformed and some were right in the middle. It sounds more like randomness and a reversion to the mean from former greatness.