The Halo Effect
The impact of first impressions & recency effect on our impressions and decisions
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. It is one of the ways the representation of the world that System 1 generates is simpler and more coherent than the real thing.
Thinking, Fast and Slow by Daniel Kahneman
The Halo Effect
The Halo Effect, as described by Daniel Kahneman in his book Thinking, Fast and Slow, is a psychological phenomenon in which our overall impression of a person colours our perceptions of their specific traits. It’s a cognitive shortcut in which one positive attribute extends an angelic halo to overshadow and enhance everything else about them.
Consider the case of Susan, a manager known for her charismatic presentations. Her team is so dazzled by her public speaking skills that they overlook the occasional slip in project deadlines. Susan's halo shines so brightly that her minor flaws seem to vanish in its glow.
Kahneman attributes this bias to the workings of System 1, our brain's fast, automatic, and often subconscious mode of thinking. The mental system helps us make snap judgments and decisions but is also prone to errors like the Halo Effect. System 2, on the other hand, is our slower, more analytical mode of thought that can counterbalance these biases—if we take the time to engage it.
The Halo Effect simplifies our complex reality, but it's crucial to remember that it's just a mirage. A single trait doesn't define a person's entire being, just as one ray of light doesn't make a summer. It's a reminder to look beyond the halo and see people and situations with the multifaceted clarity they deserve.
The Halo Effect within Business
The Halo Effect influences our perception of individuals and extends to the corporate world. In his book "The Halo Effect... and the Eight Other Business Delusions That Deceive Managers," Phil Rosenzweig delves into the business delusions that mislead even the most astute managers. He argues that analysts and commentators often base their company evaluations on its most recent performance, which can cloud the halo of that success or failure.
For instance, when a company diversifies its business and thrives, analysts may attribute the success to the diversification strategy. However, if the diversification fails, they might criticise the company for a lack of focus. This retrospective shaping of narratives based on outcomes is a classic example of the Halo Effect in business analysis.
Rosenzweig's insights remind us that companies, too, can be unjustly glorified or vilified. The Halo Effect can lead to an oversimplified and skewed understanding of a company's strategies and outcomes. It's a cautionary tale for managers and analysts alike to look beyond the glow of recent performance and consider a more nuanced and comprehensive view of a company's actions and potential.
When evaluating performance, it is crucial to assess multiple dimensions rather than letting one good or bad trait overshadow others. By recognising the Halo Effect, we can avoid the delusion of a single explanation and the delusion of connecting the winning dots.
Nvidia
Let’s consider the current media darling - Nvidia. Nvidia has always been a great company. In 2008, when I graduated with an electrical engineering degree, it was one of the aspirational companies to work for (for people who took electrical engineering seriously :P). How many business articles did we read about Nvidia from the business press between 2008 and 2020?
If you connect the winning dots, Nvidia’s triumph in the graphics card market and AI research could be perceived as a stroke of strategic genius. Nvidia's agility in capitalising on the AI wave—something that its competitors like Intel and AMD have missed—speaks to a certain level of strategic foresight, and it's also crucial to acknowledge the role of pure luck.
Initially designed for gaming, the company's graphic chips found an unexpected but highly effective application in AI research, propelling Nvidia as the driver of Artificial Intelligence. The pioneering work of AI researchers like Geoffrey Hinton, Yann LeCun, and Andrew Ng and subsequent exponential growth in AI research opened an unexpected market for the company. The leap forward with Generative AI, thanks to OpenAI, has now led Nvidia to over $3 trillion valuation. Without this AI growth, the gaming graphics market would never have been this big for Nvidia to reach this valuation. You can have the best culture, employees, management and CEO; without this stroke of luck, Nvidia would not be where it is today.
There is a distinct possibility that AI growth will slow down in the medium term, resulting in lower chip demand, or competitors like Intel, AMD, and Qualcomm will catch up. This will undoubtedly affect Nvidia's stock, and analysts will blame its poor performance on the factors that make it appreciate it today.
(I don’t intend to take away any credit from Nvidia. You must have a great product and be agile to ride the luck. Sometimes, the second-order effects of innovations are unprecedented.)
This scenario exemplifies the essence of the Halo Effect in business. It reminds us that while management's decisions play a significant role, they are but one piece of the puzzle. It's a balance of management acumen, individual brilliance, industry trends, and, sometimes, being in the right place at the right time.
Startups
The Halo Effect is particularly pronounced in the world of startups, where the narrative can shift dramatically based on the company's growth phase. During the heady days of venture capital rounds, startups often bask in the glow of positive media coverage. This coverage emphasises their vibrant culture, innovative mindset, and disruptive potential. The halo shines brightly, bolstering the company's image until the moment of its initial public offering (IPO).
However, this positive halo can quickly dim post-IPO significantly if the stock underperforms (high probability). What was once lauded as agility is now criticised as chaos. The shift from positive to negative coverage can be abrupt; for some companies, the negative halo becomes a lasting shadow. WeWork is a notable example of a company that struggled to recover from its post-IPO downturn. In contrast, companies like Facebook, Tesla, and Uber have soared after initial setbacks, regaining their positive halo in the media and market perception.
Paytm & Zomato are prime examples of this in the Indian start-up ecosystem. While Zomato is recovering the halo with improved performance, Paytm seems likely to carry the negative halo for the long term. This cycle of positive and negative halo effects highlights the fickle nature of start-up sentiment in the media.
The greatest halo of all
History is always written by the victors.
Perhaps history is the greatest halo effect in the grand scheme of things. In selective storytelling, the complexities and nuances of events are often simplified into a singular, victorious perspective, e.g., Mahatma Gandhi won independence for India, or Winston Churchill won World War 2 for Britain.
Reading “The Halo Effect” reminds me that the next time I read about a company or a person, I should approach it with a healthy dose of skepticism and a pinch of salt. Halo Effect can cloud our judgment. By being mindful of this cognitive bias, we can strive to see beyond the halos and recognise the diverse factors that shape outcomes and narratives.
The halo effect always affects the data, from Bloomberg columns and McKinsey Insights to history books and alluring biographies!
Appendix: The 9 Delusions of Business (directly quoted from the book)
Delusion One: 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.
Delusion Two: 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. Success has a stronger impact on employee satisfaction.
Delusion Three: The Delusion of Single Explanations
Many studies show that a particularly 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.
Delusion Four: 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.
Delusion Five: 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.
Delusion Six: 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.
Delusion Seven: 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.
Delusion Eight: The Delusion of the Wrong End of the Stick
It may be true that successful companies often pursue a highly focused strategy, but that doesn't mean that highly focused strategies always lead to success.
Delusion Nine: 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.