Strategy Research Worth Your AttentionPosted: October 31, 2011
Here is an article listing the names of 20 retail firms that have been more profitable than their competitors over the last 5 years (plus, there is an interactive chart showing average analyst recommendations for the stocks of the top six through Oct., 2011). When I tell you that, across a broad spectrum of measures, Target persistently outperforms its direct competitors, what explanations leap to mind?
Whether you are an active strategy scholar or someone whose only exposure to strategy was a first-year course in an MBA program somewhere, my guess is your train-of-thought goes something like: the fact that Target’s performance superiority is repeated year after year makes “sheer luck” an unlikely explanation; therefore, Target must have superior capabilities; moreover, these capabilities must exhibit certain features (e.g., inimitability), otherwise competition would quickly erase its relative advantage. Then, you would be off and running, digging deeper into such possibilities as: superior information technology, better understanding of customers, economies of scale, excellent brand equity, more flexible something-or-other for “competing on the edge of chaos,” etc.
Sadly, it turns out, you may have jumped the gun when you ruled out the “sheer luck” hypothesis. Denrell, Fang and Zhao have a new paper forthcoming in SMJ entitled, “Inferring Superior Capabilities from Sustained Superior Performance.” In it, they explore the problem of inferring superior skills from data on relative firm performance. The paper is an instance of what I have come to consider classic Denrell: take a central central piece of conventional wisdom in management scholarship (the roots of which are probably the informal, intuitive conjectures in some famous paper from the 1980s), analyze the issue with a stochastic model that is at once simple and general, and demonstrate — yet again — that human intuition with respect to statistical inference is really, really bad. This is a salient trait in even the smartest among us. In this paper, the analysis shows why persistent superior performance may not imply superior capabilities. As a bonus, they go on to apply Bayesian methods to a large data set to infer the luck versus ability components of observed sustained advantages.
I always think of papers like this when I hear someone jumping on the “dude, your ivory tower social science is totally irrelevant to real-world business practitioners like me” bandwagon. (In fairness, this bandwagon is presently a fashionable place for fellow academics to be as well.) The moment we accept that humans are inherently bad at logical and probabilistic processing is the moment we flag the importance of learning rigorously derived general principles. Knowing how to decide whether the sustained ass-kicking your are receiving from your competitor is due to luck or ability is, actually, an important skill in real-world business management.