Successful companies are successful

23 Mar 2024 | A fact is not data, A statement is not fact, Data is not evidence

I was struck by the Harvard Business Review headline “Companies that Practice ‘Conscious Capitalism’ Perform 10x Better“. On the one hand, it appealed to my confirmation bias. Conscious capitalism involves serving stakeholders, not just shareholders, in line with my book Grow the Pie and work on purposeful busienss more generally. On the other hand, the effects seemed too big to be true. If conscious capitalists could really perform ten times better than the competition, they’d quickly drive their rivals out of business and we’d only be left with conscious capitalists – just like if a footballer could score ten times as many goals as his peers, the title would already be decided.

This exemplifies a broader point: if a book promises success with just a “four-hour workweek”, or a motivational speaker pledges to increase your productivity by 578%, many people will place the order or buy the seminar ticket immediately. Bold claims make the biggest splashes – but they should instead invite the greatest scepticism. We should pause and ask ourselves if the author has climbed the Ladder of Misinference

Despite my skepticism, I was sufficiently intrigued to read on. The article mentioned a book called “Firms of Endearment” which, according to the article, found that 18 companies, chosen “based on characteristics such as their stated purpose, generosity of compensation, quality of customer service, investment in their communities, and impact on the environment … outperformed the S&P 500 index by a factor of 10.5 over 1996-2011.”

Measuring Conscious Capitalism

I’d heard of the book “Firms of Endearment” – indeed, I’d had this book quoted at me many times. However, I’d not yet read it, so this bold result prompted me to pick up a copy. For any study of an intangible asset – be it purpose, sustainabilty, conscious capitalism, or corporate culture – the key is how to measure it, otherwise you have the problem of “garbage in, garbage out”. So I went first to the methology section, which said (my numbering added):

1. “What we did was ask people, “Tell us about some companies you love. Not just like, but love” ”

This led to “60 or so” companies. To refine this further,

2. “We … assigned teams of MBA students to research them … to gauge the extent to which a company qualified as a company loved by its stakeholders”

This whittled them down to the final 28 “firms of endearment”, of which 18 were publicly traded, and the basis for the “10.5” result.

This methodology is highly problematic. By asking people to name companies that they “love”, it immediately skews them towards financially successful companies. Financially successful companies are more likely to be loved: employee love working for successful companies, customers like the products of successful companies (would you rather own an iPhone or a Blackberry?), and successful companies are more likely to advertise and be in the media. Indeed, the sub-questions that elaborated on question 1 include “How extensive a track record have they built? Do they have intensely loyal customers?” This is just good business, and little to do with conscious capitalism. Tobacco companies may have intensely loyal customers, but this doesn’t mean that they create value for wider society.

Turning to question 2, asking MBA students to select companies is not a precise research methodology. Moreover, even if the researchers specified that they had to identify companies loved by their stakeholders, rather than their shareholders, the Halo Effect rears its ugly head. If a company is successful on one dimension, people typically rate it as successful on other dimensions – regardless of whether they actually are. The book simply finds that “successful companies are successful” (or, more precisely, “companies viewed by MBA students as successful are successful”).

This is an example of the first misstep up the ladder: A Statement is not Fact, because it may not be Accurate. The authors claim to be measuring conscious capitalism, but may actually be meauring success.

Sample Size

Let’s ignore the first problem and assume that the authors had identified “conscious capitalists” based purely on stakeholder performance, irrespective of financial performance. The headline result is based on just 18 companies – a handful of anecdotes, far too few to make bold, sweeping conclusions (the authors use their results to prescribe a recipe for success for all firms). There is a huge risk that the results may be driven by a couple of outliers.

I had the Second Edition, which didn’t mention the original 18 Firms of Endearment, and couldn’t find them online anywhere; this may be because those original 18 ended up underperforming shortly after the book was written, casting doubt on whether they were truly successful – a problem that plagues similar books such as In Search of ExcellenceGood to Great, and Built to Last. But the second set of Firms of Endearment included the likes of Amazon and Google, which have enjoyed stellar performance. It may be that the outperformance of the FoE were driven by Amazon and Google, rather than the FoE in general outperforming. The standard way to deal with outliers is “winsorization” (truncating their performance), as I did in my study of the 100 Best Companies to Work For in America. But because this was a commercial book designed to sell, rather than a peer-reviewed paper designed to be accurate, the authors were not required to perform this check.

This is an example of the second misstep up the ladder: A Fact is not Data, because it may not be Representative. The success of 18 (or perhaps even just 2) companies cannot be used to make broad claims about what drives success in general. According to the authors, the success of Amazon is due to the endearing way it treats its staff, but it may instead be due to its first-mover advantage or ruthless efficiency.

Survivorship Bias 

Conscious capitalism is likely a risky strategy. Investing in stakeholders may well pay off many times over – but it could lead to famine as well as feast, as building intangible assets rather than bricks and mortar makes you susceptible to a downturn. The performance of the original FoE was measured over 1997-2006, but – crucially – the FoE were identified in 2006. Thus, even if the FoE were identified purely on their stakeholder performance, and not their profitability, the firms had to have survived until 2006 to be in the authors’ sample. If a FoE in 1997 had gone bankrupt by 2006, it would have never been in their sample. It’s like going to the Hamptons in Long Island and asking how many of the residents traded cryptocurrency. Many of them may have got rich trading cryptocurrency, but that doesn’t mean that crypto is the road to riches. Other crypto traders may have come a cropper, and would have never been able to buy a house in the Hamptons.

This is another example of the second misstep: 18 companies that survived until 2006 may not be representative of conscious capitalists in general.  example of the third misstep up the ladder: Data is not Evidence, because it may not be Conclusive.

No Controls

As with many studies of this ilk, the book simply compares a set of firms against the broader market with no controls. This makes it impossible to identify what actually caused the outperformance of the FoE. As is well known, there two reasons why correlation may not be causation:

  • Common causes. Perhaps FoE are more likely to be in the tech sector, because workers are more likely to be happy than in coal mining, and it’s being in tech, rather than practicing conscious capitalism, that led to outperformance. Or a great CEO leads to outperformance, and a great CEO also treats her stakeholders well.
  • Reverse causality. It may be that good performance allows you to practice conscious capitalism, rather than conscious capitalism leading to good performance. As the authors write, the FoE “pay their employees exceptionally well, do not squeeze their suppliers, deliver great products and experiences at fair prices to customers, are conscious of their environmental impact, and spend significant resources in the community”. These are simply characteristics of a successful business.

The Takeaways

Why has such a book been so successful despits its glaring errors? Confirmation bias is a likely cause. People want to believe that conscious capitalists perform better, and so they’ll lap up such a conclusion uncritically. Indeed, a quick Google search will find blogs and LinkedIn posts from people who attended a talk by the authors and say how it confirmed everything they thought to be true. It’s not clear whether the author of the HBR article actually read the book, let alone scrutinized it with a discerning eye, as he refers to the performance of 18 companies over 1996-2011. The first edition studied 18 companies over 1997-2006 and the second edition analyzed 28 firms over 1998-2013. Indeed, the author heard about the study from “a small gathering sponsored by an organization called Conscious Capitalism, Inc.”, so he likely did not read the study or its methodology. But it didn’t matter because he wanted it to be true. Indeed, the very next sentene after describing the “10.5” outperformance is “And why, in the end, should that be a surprise?”.

In Chapter 4 of May Contain Lies, I describe the even more serious problems, and even more exaggerated claims, in Built to Last, another book in this genre.

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