Thursday, July 27, 2006

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A business-writing tic that drives James Surowiecki nuts

Sports journalists are not the only ones to overinterpret small samples. In The New Yorker, James Surowiecki makes a similar point about business writing.

His example -- the Boeing-Airbus rivalry:

What much of the talk about the inherent weakness of Airbus ignores is that, just a few years ago, it was Boeing that looked fundamentally flawed, while Airbus was seen as the future of the industry. Beginning in the late nineties, Boeing’s commercial-aircraft business went into a long and nearly profitless slump. In 2001, Airbus surpassed Boeing in new orders, a lead it maintained until this year. During that period, Airbus’s unusual structure was praised; its insulation from the stock market supposedly allowed it to invest in long-term research and development. Boeing, by contrast, was thought to be trapped in a short-term, cost-cutting mentality, because, as one analyst put it, “the money guys don’t reward long-term thinking and investment.” In 2003, Business Week declared that Boeing was “choking on Airbus’ fumes,” and warned that Boeing’s “slip to No. 2 could become permanent.”

The problem with such prognostications is that they infer basic truths about a company’s prospects from its short-term performance. In fact, present success is often determined as much by context and chance as by fundamental viability. This is particularly true of the aerospace industry, because success is heavily dependent on a small number of big gambles. If you bet right, you look like a genius for a few years, even if the success of your bet was due to factors out of your control. The 787 may now look like Boeing’s salvation, but Boeing built it only after more ambitious plans—for a plane, known as the Sonic Cruiser, that would have been the fastest passenger jet in the air—fell through, partly because of the slowdown in air travel after September 11th. And had Boeing not been in such straits in 2003 it probably wouldn’t have risked the investment required for the 787.

People are generally bad at accepting the importance of context and chance. We fall prey to what the social psychologist Lee Ross called “the fundamental attribution error”—the tendency to ascribe success or failure to innate characteristics, even when context is overwhelmingly important. In one classic demonstration, people shown a person shooting a basketball in a gym with poor lighting and another person shooting a basketball in a gym with excellent lighting assume that the second person hit more shots because he was a better player. This problem is compounded by the tendency to extrapolate big conclusions from small samples, something that behavioral economists call “the law of small numbers.” In the decade or so that Airbus has been a serious competitor to Boeing, this is its first really bad patch, and its difficulties are due mainly to making one bad bet while Boeing made one good one. That’s a minuscule sample size on which to base any kind of conclusion. But this is exactly what we like to do: sports fans assume that a few excellent performances are proof of a player’s underlying ability, while investors assume that a mutual fund’s record over one year is a reliable indicator of the manager’s skill.

Because we underestimate how much variation can be caused simply by luck, we see patterns where none exist. It’s no wonder that management theory is dominated by fads: every few years, new companies succeed, and they are scrutinized for the underlying truths that they might reveal. But often there is no underlying truth; the companies just happened to be in the right place at the right time.

posted by Dan on 07.27.06 at 12:06 AM


> People are generally bad at
> accepting the importance of
> context and chance.

I agree with this, but in this particular context I find it quite amusing since 99.5% of all management, strategy, and theory-of-the-firm models and curricula that I know of utterly reject those two concepts. And standard micro theory doesn't have much to say about them either.


posted by: Cranky Observer on 07.27.06 at 12:06 AM [permalink]

Business and sports writing are like celebrity gossip rags for men.

posted by: Dude on 07.27.06 at 12:06 AM [permalink]

Having seen a number of fads come and go in the business world, Surowiecki is obviously correct. There's a correlary. Any CEO who is fortunate enough to preside over a successful period due to a combination of luck, timing, talented staff, or whatever, will always attribute the success to his own genious. Prime example: Jack Welch.

posted by: OpenBorderMan on 07.27.06 at 12:06 AM [permalink]

I think that Surowiecki is spot on, but I have two quibbles with his Boeing-Airbus example.
1)By 2003, Boeing execs had been arguing for several years that the future of long haul transoceanic travel (or at least the biggest part of the market, the sweet spot if you will) was multi-point to multi-point rather than hub and spoke, and that this future required a very different type of aircraft than an super-jumbo (i.e., the A-380). So I think that Boeing would have gone ahead with the 787 irrespective of its straits in 2003.
2) In mainframe aircraft, one "bad patch" can kill you since a major new model can be a bet-the-company proposition. The A-380 may turn out to be a $10-15 billion mistake. If Boeing makes a mistake like that, it may be all over as an independnet company. So it's an industry (unlike, say, PCs or autos or fast food resaurants) where it seems reasonably rational for investors to extrapolate based on small sample sizes.

posted by: Gene on 07.27.06 at 12:06 AM [permalink]

OpenBorderMan: "Any CEO who is fortunate enough to preside over a successful period due to a combination of luck, timing, talented staff, or whatever, will always attribute the success to his own genious. Prime example: Jack Welch."

I don't agree. Welch had a long enough period of success that I don't think he's a fair example pf the phenomena. I do have two possible substitute examples though, one from business and one from politics:

Michael Eisner and Bill Clinton.... ;)

posted by: Don S on 07.27.06 at 12:06 AM [permalink]

One thing which Surowiecki seems to miss is that judging by orders from the first 6 months of 2006 Airbus is in much sadder shape than Boeing was in any particular period since it's slump began in the late 90's. Airbus surpassed Boeing in orders throughout that period but Boeing was within striking position of Airbus throughout.

That isn't the case with first-half orders in 2006: "Boeing took almost five hundred new orders for planes, while Airbus took just a hundred and seventeen."

That is a hell of a disparity and suggests that the Airbus crisis isn't confined to the 380 but has also hit its traditional bread'n butter, those midsize jets.

It's probably too soon to judge - but it looks like Airbus did itself a serious mischief by investing $15 billion in an aircraft which seems to have an increasingly limited market niche. Airlines may be asking whether they should schedule 4 flights a day between Boston and London with the 380 - or 6 flights with smaller aircraft. Most business-class passengers would prefer the latter, I think.

The other question is whether the spoke system makes sense for trans American or trans European flights? You won't see RyanAir or EasyJet using 380's because their market is point to point to small airports - and they are the growth sector in European aviation.

Why fly London-Paris and transfer to a domestic flight to Strasborg when you can fly direct and save time and money doing it?

posted by: Don S on 07.27.06 at 12:06 AM [permalink]

Don S,
I agree that both Clinton and Eisner are better examples. Still, GE was in strong shape when Welch took over. I give him credit only for not screwing it up, not for being the God that he thinks he is.

posted by: OpenBorderMan on 07.27.06 at 12:06 AM [permalink]


While I might agree that Welch isn't as great as he thinks he is, I did work at GE Medical Systems for a while during his tenure - and saw a very well-managed operation. Not sure whether that was Welch or others, but...

I think the defense unit was on the downs at the time so some of the GE Aerospace's best imaging engineers (the people who design heads-up fighter controls) were working with me at GE Medical on medical imaging technology.

That kind of cross-fertilization is almost unheard of at other multinationals, which is one reason I think he might have been very good; perhaps almost as good as Albert Sloan.

I live in the UK now and have been in the body shop a few times lately (aka the NHS). They use a lot of GE equipment and most of them swear by it. Best of breed and all that....

posted by: Don S on 07.27.06 at 12:06 AM [permalink]

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