Dr Chengwei Liu, Warwick Business School
Published February 2014
"Great companies, in the way they work, start with great leaders." Steve Ballmer, outgoing CEO, Microsoft
Our obsession with learning from the best and shunning the worst leads us to make irrational decisions. Anna Blackaby speaks to Dr Chengwei Liu of Warwick Business School about how firms can profit from changing the way they view those at the top and the bottom of the pile.
We are fascinated by exceptional performance. Glossy magazines regularly indulge in hero worship of superstar CEOs in the belief that we can learn from these gods among us. Equally, we are programmed to reject the worst performers, thinking they must somehow be inherently flawed.
But new research by Dr Chengwei Liu and Professor Jerker Denrell at Warwick Business School suggests that in many commercial contexts, being the best or worst is not necessarily due to innate skill (or lack of it) but instead owes a lot to plain old-fashioned luck. And when we make decisions based on the flawed perception that performance and skill are one and the same – such as who to emulate and who to reward – things can start to go very wrong.
It all comes down to the 'rich get richer' dynamic - success breeds success, creating outliers who benefit from a self-reinforcing virtuous circle.
One outlier, Microsoft, had a lucky break early on. An introduction to IBM’s chairman gave it a toe-hold in the burgeoning computing market. Fast forward 30 years and Microsoft is the biggest software firm on the planet, benefitting from classic rich get richer dynamics as people become locked into choosing its products for compatibility reasons.
“The main focus of the media is exceptional performance – outliers that attract people’s attention,” says Dr Liu.
He studies luck and rich get richer effects through computer simulations, case studies and analyses of sports data which show that it is not always the most skilled that reach the top. He calls this the ‘more is less’ effect – the more exceptional the performance, the less you can learn from it as the chances are it is down to luck and self-reinforcing dynamics.
“People try to figure out why they are so successful as presumably they have done something right but our key finding shows that is not the case, particularly for the most successful – they are probably the luckiest.”
Performance and skill
For most of us, the belief that performance and skill are always linked stems from our school years. We looked at our peers and came to the conclusion that those who do best in their exams generally have the highest level of skill.
However while this logic works for the classroom, it does not necessarily apply in business simply because of the difference in scale. In a class of 30, the rich get richer effect never really has the chance to manifest, but in a system made up of millions of firms, over time the dynamic can become very powerful.
In the big wide world of business, the overwhelming majority of firms labour away in obscurity in the middle of the performance spectrum. These mediocre businesses – the worthy but dull – are of little interest to journalists and business school academics who naturally gravitate towards outliers at the extreme end of the spectrum. But it is these attention-grabbing outlying firms which are most likely to have benefited from luck and rich get richer effects, yet we still fall into the trap of applying the same ‘best is best’ logic we learned at school.
When it comes to these outliers, Dr Liu believes there is little point in others trying to copy them as they are unlikely to be dealt the same lucky hand.
So who should you choose as a role model instead? Try aiming a little lower, says Dr Liu.
"Look at those solidly performing companies which share a similar set of circumstances to your own"
Not the superstar firms that generate all the buzz and hype, but instead look at those solidly performing companies which share a similar set of circumstances to your own. In other words, dull though it may be, go for similarity and solid performance, not glamour. Dr Liu calls these ‘the best performing network neighbours’.
He said: “Your network neighbour shares similar contextual factors, for example similar rich get richer dynamics.
“Imitating your best performing network neighbours is desirable because it’s as if the rich get richer dynamics are controlled for, so the mechanism that works for them will work for you too.
“For example, if you are a small retailer, Walmart can’t help you but you may want to look within your city at what similar shops to yours have done.”
This is not to say that firms should ignore the global best, but any serious attempt at copying the superstars should only come once they have reached the level of best in their local network.
“To dream the impossible dream helps one to avoid getting stuck in local peaks. But when encountering setbacks, one should imitate the climbers immediately ahead otherwise one will likely fall,” said Dr Liu.
The ‘more is less’ effect has implications beyond choosing a role model – it also suggests we need a radical rethink about how firms reward and incentivise their own employees.
Imagine a team of salespeople. One salesman consistently outperforms the rest – isn’t it right he gets a bonus in line with his performance? No, says Dr Liu.
“If you reward the highest performer when the exceptional performance could be due to luck, it’s very dangerous,” he said.
“It’s not just because you reward the employee who is not necessarily the most skilled – it’s also that other employees will interpret the situation and realise they have to take more risk otherwise the bonus will go to those who take excessive risk.
“If everyone in the system does that, it will become self-destructive as you cannot keep taking risk and be successful.”
"People can learn to identify that the top performers are not necessarily the most skilled, yet when it comes to acting on what they have learned, they simply ignore it"
Knowing that our brains confuse skill and performance is all well and good but although we may grasp the ‘more is less’ effect on a rational level, many of us still find it difficult to let go of the belief that the best should be singled out for praise and reward. Dr Liu demonstrates this through experiments which show that people can learn to identify that the top performers are not necessarily the most skilled, yet when it comes to acting on what they have learned, they simply ignore it and still reward the top performers the most.
In a real-life firm, managers have to tread carefully to apply this knowledge when it comes to bonus setting. They face a delicate balancing act between the need to consider luck and rich get richer dynamics, yet not upset employees who may view attempts to cut pay-outs to the top performers as unfair.
However there is a middle ground between the two, according to Dr Liu.
“When everyone’s intuition about the best is so strong, if you reward the second best you will destroy the motivation within a team,” he said. “The solution is that you reward the best most, but disproportionately less. It’s still linear, but you discount the reward going to the top performer. For example if the difference between the top and second performer is 100, the reward should discount the difference and give 10 per cent extra to the top performer.”
But what about the reverse end of the spectrum?
When failure is concerned, the human instinct to shun those who have performed badly is stronger than the compulsion to praise and copy the best, even when we instinctively know that terrible performances are often simply down to terrible luck. But for those savvy enough to recognise it, this quirk of human psychology can open up an opportunity for profit.
“We all know we should sell high and buy low,” said Dr Liu.
“If others think the worst performers are the least skilled, you can probably hire them on a lower salary while still benefiting from that talent.”
However because the association between failure and skill is so ingrained, hiring the fired is only open to the brave few – generally those companies in a position of power with no pressure to please shareholders.
“The hirer will probably be immune to some extent – for example a company with high status that doesn’t fear that if it hires a director who has been fired, it may be associated with this bad reputation,” said Dr Liu.
“But in many business situations that is not the case – if another company hired him as CEO the share price would drop. However if you are a privately owned company, you don’t care about stakeholders as much so you can implement what you believe more freely.”
Dr Liu’s lab research backs this up. He found that 92 per cent of people were able to recognise that the worst performers were not necessarily the least skilled. But when asked whether they were willing to give these worst performers a job, only 23 per cent said they would. However when people were made to feel as if they were in a position of power, that percentage jumped to 40 per cent.
“Our theory is that people can learn about this, but if they feel that they are the only one who gets it, it will feel risky to act on it,” said Dr Liu.
“They know the crowd is crazy, but they still follow it – it’s about conformity.”
It’s this drive to conform that prevents most firms taking advantage of the ‘more is less’ effect. After all who wants to be the second best? Who wants to be associated with failure? In today’s difficult economy, Dr Liu’s findings appear hard to swallow to all but the bravest few.
But there is one drive that can often be stronger than conformity – the drive to profit. Dr Liu believes appealing to the profit motive is the most powerful way to prompt people to reassess their beliefs about success and failure.
“It’s futile trying to convince people they are wrong – but if you say ‘others are wrong’, people become motivated to profit from others’ mistakes,” said Dr Liu.
In other words, for firms unafraid to embrace ‘more is less’ thinking, less focus on superstar outliers can actually mean more where it matters - on the bottom line.
- Find out more about Dr Chengwei Liu’s research at Warwick Business School.
Chengwei Liu is Associate Professor of Strategy and Behavioural Science at Warwick Business School. He is a Cambridge trained PhD who held a fellowship position in Oxford and visiting positions at NYU, NUS and Wharton (Spring 2014). Chengwei’s PhD research and joint work with Jerker Denrell, on how randomness complicates inferences about performances, have won several awards and are published in leading journals. Chengwei’s current research interests include how randomness in structural environments can generate systematic patterns that can fool naïve observers, how responses to performance differences are moderated by social dynamics such as power and status and how to profit from others’ misperceptions about randomness.