First Look

First Look summarizes new working papers, case studies, and publications produced by Harvard Business School faculty. Readers receive early knowledge of cutting-edge ideas before they enter the mainstream of business practice. For complete details on faculty research, see our Working Papers section.

December 19, 2006

The power of networks in developing and selling products and for creating personal advancement is quickly becoming a leading topic among business researchers. A new working paper by Harvard Business School's Sunil Gupta and two colleagues is among the first to look at how to assess the lifetime value of customers in a networked setting where the presence of one type of customer can affect the value of another. One example: A buyer of an item at auction pays no fee, but yet has value because he or she attracts fee-paying sellers. How to judge that value? (See also our executive summary of this paper with a link to the pdf.)

Also released the week from HBS faculty is a paper finding both a "visible hand" as well as the well-known "invisible hand" guiding development of capitalism; an explanation of how the Balanced Scorecard approach has helped companies better understand long-time value of what were previously considered cost centers; and a series of business cases exploring how various vendors have negotiated with Wal-Mart.

 

Working Papers

Anomalies in Estimates of Cross-Price Elasticities for Marketing Mix Models: Theory and Empirical Test

Abstract

We investigate the theoretical possibility and empirical regularity of two troublesome anomalies that frequently arise when cross-price elasticities are estimated for a set of brands expected to be substitutes. These anomalies are the occurrence of: (a) negatively signed cross-elasticities; and (b) sign asymmetries in pairs of cross price elasticities. Drawing upon the Slutsky equation from neoclassical demand theory, we show how and why these anomalies may occur when cross elasticities are estimated for pairs of brands that are substitutes. We empirically examine these issues in the context of the widely used Multiplicative Competitive Interaction (MCI) and Multinomial Logit (MNL) specifications of the fully extended attraction models (Cooper and Nakanishi 1988). Utilizing a database of store-level scanner data for 25 categories and 127 brands of frequently purchased branded consumer goods, we find that about 18 percent of a total of 732 cross elasticity estimates are negative and approximately 40 percent of the 366 pairs of cross elasticities are sign asymmetric. Finally, we find that the occurrence of negatively signed cross elasticities can be partially explained by a set of hypothesized relationships between cross-price elasticities and brand share and elasticities of income and category demand.

Download working paper:
http://www.nber.org/papers/w12756

The Value of a 'Free' Customer

Abstract

Central to a firm's growth and marketing policy is the revenue and profit potential of its customer assets. As a result, there has been a recent proliferation of work regarding customer lifetime value. However, extant research in this area is silent regarding how to assess the profitability of customers in a networked setting. In such settings, the presence of one type of customer can affect the value of another. Examples of such settings include job agencies (whose customers include both job seekers and listers), realtors (whose clients include home sellers and purchasers), and auction houses (whose customers include buyers and sellers). Customers such as buyers of an auction house pay no fees to the firm making their value difficult to compute. Yet these customers generate value to the firm because their presence attracts fee-paying sellers. In this paper we consider the value of a customer in these types of networked setting. We compute the value of customers by developing a joint model of buyer and seller growth. This growth comes from three sources—marketing actions (price and advertising), direct network effects (e.g., buyer to buyer effects), and indirect network effects (e.g., buyer to seller effects). Using this growth model we concurrently solve the firm's problem of choosing optimal pricing and advertising subject to constraints on customer growth. By relaxing constraints on growth by one customer, we can then impute their lifetime value to the firm. We apply our model to data from an auction house. Our results show that there are strong direct and indirect network effects present in our data. We find that in the most recent period buyers have a value of about $550 and the sellers have a value of around $500. We also find that our approach leads to estimates of firm value that are more accurate than models that fail to consider network effects. Finally, price and advertising elasticities are low (-0.16 and 0.006) and decrease over time as network effects become increasingly important.

Download working paper:
http://www.hbs.edu/research/pdf/07-035.pdf

The Demise of Cost and Profit Centers

Abstract

The Balanced Scorecard offers a previously unrecognized benefit: a new way of looking at the traditional organizational structure of cost and profit centers. Every unit, by contributing to effective strategy execution, has the opportunity to support and create profit. This capability has important implications for specifying objectives and evaluating the performance of all organizational units.

Download working paper:
http://www.hbs.edu/research/pdf/07-030.pdf

Future Lock-in: Or, I'll Agree to do the Right Thing…Next Week

Abstract

When making decisions a person often thinks that she should make certain choices (e.g., increasing savings, reduce gas consumption) but does not want to make them. This intrasubjective tension between "multiple selves" has been referred to as a "want/should" conflict. In four experiments we show that people are more likely to choose what they believe they should choose when the choice will be implemented in the future rather than implemented immediately, a tendency we refer to as "future lock-in." We demonstrate future lock-in for decisions about donation (Study 1), organizations (Study 2), public policy (Studies 3, 4), and self-improvement (Study 3). Consistent with Temporal Construal Theory, we find that future-implemented choices are construed at a higher level than immediately-implemented choice, and that this construal difference mediates the increased support for the should-choice resulting from future implementation. We discuss future lock-in in light of hyperbolic discounting, multiple selves, and wise policy design.

Download working paper:
http://www.hbs.edu/research/pdf/07-038.pdf

The Political Economy of Capitalism

Abstract

Capitalism is often defined as an economic system where private actors are allowed to own and control the use of property in accord with their own interests, and where the invisible hand of the pricing mechanism coordinates supply and demand in markets in a way that is automatically in the best interests of society. Government, in this perspective, is often described as responsible for peace, justice, and tolerable taxes. This paper defines capitalism as a system of indirect governance for economic relationships, where all markets exist within institutional frameworks that are provided by political authorities, i.e., governments. In this second perspective capitalism is a three-level system much like any organized sport. Markets occupy the first level, where the competition takes place; the institutional foundations that underpin those markets are the second; and the political authority that administers the system is the third. While markets do indeed coordinate supply and demand with the help of the invisible hand in a short-term, quasi-static perspective, government coordinates the modernization of market frameworks in accord with changing circumstances, including changing perceptions of societal costs and benefits. In this broader perspective government has two distinct roles, one to administer the existing institutional frameworks, including the provision of infrastructure and the administration of laws and regulations, and the second to mobilize political power to bring about modernization of those frameworks as circumstances and/or societal priorities change. Thus, for a capitalist system to evolve in an effective developmental sense through time, it must have two hands and not one: an invisible hand that is implicit in the pricing mechanism and a visible hand that is explicitly managed by government through a legislature and a bureaucracy. Inevitably the visible hand has a strategy, no matter how implicit, short sighted or incoherent that strategy may be.

Download working paper:
http://www.hbs.edu/research/pdf/07-037.pdf

A Perceptions Framework for Categorizing Inventory Policies in Single-stage Inventory Systems

Abstract

In this paper we propose a perceptions framework for categorizing a range of inventory policies, including optimal inventory policies, that can be employed in a single-stage supply chain. The perceptions framework is based on forecasting with Auto-regressive Integrated Moving Average (ARIMA) time series models within the context of a single-stage stochastic inventory system with periodic review, constant leadtimes, infinite supply, full backlogging, linear holding and penalty costs and no ordering costs. Forecasting ARIMA time series requires tracking forecast errors (interpolations) and using these forecast errors and past demand realizations to predict future demand (extrapolating). Categorizing deviations from optimal inventory policies is possible if we allow the perception about demand implied by the interpolations or extrapolations to be different from the actual demand process. We do not use perception in its more conventional sense; we are not making any claims about the actual perception of any manager. Rather the perceptions here serve as a device for modeling and categorizing a range of inventory policies.

Download working paper:
http://www.hbs.edu/research/pdf/07-036.pdf

 

Cases & Course Materials

The Bollingers: Negotiating with Wal-Mart

Harvard Business School Case 907-009

More information and purchase:
http://www.hbsp.harvard.edu/b01/en/common/item_detail.jhtml?id=907009

Cinco de Mayo

Harvard Business School Case 206-115

Eldeco: Playing in the Big League

Harvard Business School Case 206-116

Inverness Medical Innovations—Born Global

Harvard Business School Case 806-177

More information and purchase:
http://www.hbsp.harvard.edu/b01/en/common/item_detail.jhtml?id=806177

King Arthur Flour

Harvard Business School Case 407-012

More information and purchase:
http://www.hbsp.harvard.edu/b01/en/common/item_detail.jhtml?id=407012

Sarah Talley and Frey Farms Produce: Negotiating with Wal-Mart

Harvard Business School Case 907-003

More information and purchase:
http://www.hbsp.harvard.edu/b01/en/common/item_detail.jhtml?id=907003

William Nichol, Jr. and Kentucky Derby Hosiery: Negotiating with Wal-Mart

Harvard Business School Case 907-001

More information and purchase:
http://www.hbsp.harvard.edu/b01/en/common/item_detail.jhtml?id=907001

 

Publications

Making Foreign Investment Safe: Property Rights and National Sovereignty

Abstract

With real case stories Wells and Ahmed bring to life both the hopes for and the failures of international guarantees of property rights for investors in the developing world. Their cases focus on infrastructure projects, but the lessons apply equally to many other investments. In the 1990s, inexperienced firms from rich countries jumped directly into huge projects in some of the world's least developed countries. Their investments reflected almost unbridled enthusiasm for emerging markets and trust in new international guarantees. Yet, within a few years the business pages of the world press were reporting an exploding number of serious disputes between foreign investors and governments. As the expected bonanzas proved elusive and the protections weaker than anticipated, many foreign investors became disenchanted with emerging markets. So bad were the outcomes in some cases that a few notable infrastructure firms came close to bankruptcy; several others hurriedly fled poor countries as projects soured. In this book, Louis Wells and Rafiq Ahmed show why disputes developed, point out how investments and disputes have changed over time, explore why various firms responded differently to crises, and question the basic wisdom of some of the enthusiasm for privatization. The authors tell how firms, countries, and multilateral development organizations can build a conflict-management system that balances the legitimate economic and social concerns of host countries and those of investors. Without these changes, multinational corporations will lose profitable opportunities and poor countries will not gain the contributions that foreign investment can make toward alleviating poverty.

Publisher's site:
http://www.oup.com/uk/catalogue/?ci=9780195310627

The Comovement of Returns and Investment within International Firms

Abstract

Can financial integration, particularly the cross-border investments of multinational firms, help explain the synchronization of business cycles? This paper presents evidence on the comovement of returns and investment within U.S. multinational firms to address this question. These firms constitute significant fractions of economic output and investment in most large economies, suggesting that they could create significant economic linkages. Aggregate measures of rates of return and investment rates of U.S. multinational firms located in different countries are highly correlated across countries. Firm-level regressions demonstrate that rates of return and investment rates of affiliates are highly correlated with the rates of return and investment of the affiliate's parent and other affiliates within the same parent system, controlling for country and industry factors. The evidence on these interrelationships and the importance of multinationals to local economies suggests that global firms may be an important channel for transmitting economic shocks. This evidence also sheds light on asset pricing puzzles related to the diversification benefits provided by multinational firms.

Detection Defection: Measuring and Understanding the Predictive Accuracy of Customer Churn Models

Abstract

This article provides a descriptive analysis of how methodological factors contribute to the accuracy of customer churn predictive models. The study is based on a tournament in which both academics and practitioners downloaded data from a publicly available website, estimated a model, and made predictions on two validation databases. The results suggest several important findings. First, methods do matter. The differences observed in predictive accuracy across submissions could change the profitability of a churn management campaign by hundreds of thousands of dollars. Second, models have staying power. They suffer very little decrease in performance if they are used to predict churn for a database compiled three months after the calibration data. Third, researchers use a variety of modeling "approaches," characterized by variables such as estimation technique, variable selection procedure, number of variables included, and time allocated to steps in the model-building process. The authors find important differences in performance among these approaches and discuss implications for both researchers and practitioners.

Self-Restraint as an Online Entry-Deterrence Strategy

Abstract

We develop a game-theoretical model to show that in the markets where price consistency across channels is critical, an incumbent brick-and-mortar retailer can deter the online entry of a pure-play e-tailer by strategically refraining from entering online. In the markets where price consistency is not a constraint, we find that the incumbent can deter the e-tailer's entry only if it enters online and credibly operates the online channel as an independent profit center. In other words, the incumbent must be willing to cannibalize its own brick-and-mortar business by charging a low online price. We also discuss some social welfare implications of retail online entry and the managerial insights of our analysis.