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.

April 21, 2009

Two new working papers closely examine different ills within the health care industry. The first, "Where is the Pharmacy to the World? International Regulatory Variation and Pharmaceutical Industry Location," traces the industry's shift during the past 20 years from Germany, Switzerland, and France to the United States, and the controversial role of consumerism and government regulation.

"The era of paternalistic medicine has passed, but the notion that patients can act as consumers and make appropriate decisions concerning medical treatment poses countervailing risks of its own," writes HBS professor Arthur Daemmrich. "A better accommodation among key players needs to be struck to foster safe use of pharmaceuticals."

The second paper probes the optimal scope for firms: narrow or broad? While some scholars assert that a narrow specialization is best, others argue for casting a wider net. Looking within the hospital industry, findings by HBS doctoral student Jonathan R. Clark and HBS professor Robert S. Huckman emphasize complementary services. As they found, "Hospitals devoting a greater portion of their business to treating patients in related service categories (i.e., those with the potential for knowledge spillovers) experience higher returns" than those with more narrowly focused services. Their paper is titled "Broadening Focus: Spillovers and the Benefits of Specialization in the Hospital Industry."

Other working papers this week look at platform strategies and innovation in Japan, among other topics.

 

Working Papers

How Firms Respond to Being Rated (revised)

Abstract

While many rating systems seek to help buyers overcome information asymmetries when making purchasing decisions, we investigate how these ratings also influence the companies being rated. We hypothesize that ratings are particularly likely to spur responses from firms that receive poor ratings, and especially those that face lower-cost opportunities to improve or that anticipate greater benefits from doing so. We test our hypotheses in the context of corporate environmental ratings that guide investors to select "socially responsible," and avoid "socially irresponsible," companies. We examine how several hundred firms respond to corporate environmental ratings issued by a prominent independent social rating agency and take advantage of an exogenous shock that occurred when the agency expanded the scope of its ratings. Our study is among the first to theorize about the impact of ratings on subsequent performance, and we introduce important contingencies that influence firm response. These theoretical advances inform stakeholder theory, institutional theory, and economic theory.

Download the paper: http://www.hbs.edu/research/pdf/08-025.pdf

Broadening Focus: Spillovers and the Benefits of Specialization in the Hospital Industry

Abstract

The long-standing argument that focused operations outperform others stands in contrast to theory and evidence supporting a broader scope for organizations. The literature on related diversification at the level of the firm provides some reconciliation of these conflicting observations by suggesting that multi-unit firms with a portfolio of related businesses outperform both single-unit firms and multi-unit firms composed of unrelated businesses. Explanations for this relationship between focus and firm performance have largely centered on economies of scope achieved by sharing common resources, such as advertising or production capacity. We consider whether there are similar benefits to relatedness at an operating unit level and whether such benefits stem from spillovers between operating activities. Using data from the hospital industry, we first examine the relationship between focus and performance in cardiovascular care. Then, distinguishing between direct and complementary spillovers, we examine (1) the extent to which a hospital's specialization in areas related to cardiovascular care directly impacts performance in cardiovascular care (direct spillovers) and (2) whether the marginal benefit of a hospital's focus in cardiovascular care depends on the degree to which the hospital "co-specializes" in related areas (complementary spillovers). We find evidence of complementarities in specialization between cardiovascular care and related service areas.

Download the paper: http://www.hbs.edu/research/pdf/09-120.pdf

Financial Literacy, Financial Decisions, and the Demand for Financial Services: Evidence from India and Indonesia

Abstract

Why is demand for formal financial services low in emerging markets? One view argues that limited cognitive ability and financial literacy stifle demand. A second view argues that demand is rationally low, because formal financial services are expensive and of relatively low value to the poor. This paper uses original surveys and a field experiment to distinguish between two competing answers to this question. Using original survey data from India and Indonesia, we first show that financial literacy is a powerful predictor of demand for financial services. To test the relative importance of literacy and price, we implement a field experiment, offering randomly selected unbanked households financial literacy education, crossed with small incentive (ranging from U.S. $3 to $14) to open a bank savings account. We find that the financial literacy program has no effect on the likelihood of opening a bank savings account in the full sample but do find modest effects for uneducated and financially illiterate households. In contrast, small subsidy payments have a large effect on the likelihood of opening a savings account. These payments are more than two times more cost-effective than the financial literacy training, though this calculation does not take into account any ancillary benefits of financial education.

Download the paper: http://www.hbs.edu/research/pdf/09-117.pdf

Barriers to Household Risk Management: Evidence from India

Abstract

Financial engineering offers the potential to significantly reduce consumption fluctuations faced by individuals, households, and firms. Yet much of this promise remains unrealized. In this paper, we study the adoption of an innovative rainfall insurance product designed to compensate low-income Indian farmers in case of deficient rainfall during the primary monsoon season. We first document relatively low levels of adoption of this new risk management technology: only 5%-10% of households purchase insurance, even though rainfall variability is overwhelmingly cited by households as the most important risk they face. We then conduct a series of randomized field experiments to test theoretical predictions of why adoption may be low. Insurance purchase is sensitive to price, with an estimated extensive price elasticity of demand between -0.66 and -0.88. Credit constraints, identified through the provision of random liquidity shocks, are a key barrier to participation, a result also consistent with household self-reports. Several experiments find an important role for trust in insurance participation. We find mixed evidence that subtle psychological manipulations affect purchase and no evidence that modest amounts of financial education changes participation decisions. Based on our experimental results, we suggest preliminary lessons for improving the design of household risk management contracts.

Download the paper: http://www.hbs.edu/research/pdf/09-116.pdf

Where Is the Pharmacy to the World? International Regulatory Variation and Pharmaceutical Industry Location

Abstract

A consumer-oriented model for drug development and use has attracted attention in recent years as an alternative to the much-maligned approach of mass-marketing blockbuster drugs. In a parallel development, patients and disease-based organizations have assumed greater roles in defining disease categories than in the past and now influence clinical trials and participate in regulatory decision making. Yet these developments are far from universal and are taking very different forms around the world. Building on data showing that pharmaceutical firms headquartered in the United States have performed well since 1980 when compared to firms in Europe or Asia (measured both by sales and by numbers of new product introductions), this essay explores the interplay of regulation, definitions of "patient" and "consumer," and centers of power for the pharmaceutical industry. A comparison of the United States and Germany in particular, and the United States and European Union more generally, suggests that how countries resolve tensions between protecting patients and empowering consumers will impact the international competitive standing of their domestic pharmaceutical industries.

Download the paper: http://www.hbs.edu/research/pdf/09-118.pdf

Capitalizing On Innovation: The Case of Japan

Abstract

Japan's industrial landscape is characterized by hierarchical forms of industry organization, which are increasingly inadequate in modern sectors, where innovation relies on platforms and horizontal ecosystems of firms producing complementary products. Using three case studies—:software, animation, and mobile telephony-we illustrate two key sources of inefficiencies that this mismatch can create. First, hierarchical industry organizations can "lock out" certain types of innovation indefinitely by perpetuating established business practices. Second, even when the vertical hierarchies produce highly innovative sectors in the domestic market, the exclusively domestic orientation of the "hierarchical industry leaders" can entail large missed opportunities for other members of the ecosystem, who are unable to fully exploit their potential in global markets. We argue that Japan has to adopt several key legislative measures in order to address these inefficiencies and capitalize on its innovation: strengthening antitrust and intellectual property rights enforcement; improving the legal infrastructure (e.g., producing more business law attorneys); lowering barriers to entry for foreign investment; and facilitating the development of the venture capital sector.

Download the paper: http://www.hbs.edu/research/pdf/09-114.pdf

Multi-Sided Platforms: From Microfoundations to Design and Expansion Strategies

Abstract

Multi-sided platforms (MSPs), which bring together two or more interdependent groups of customers, have recently risen to economic and business prominence in many industries. This paper first lays out a simple micro-founded framework that aims to organize academic and managerial thinking about MSPs. It argues that any MSP performs one or both among two fundamental functions: reducing search costs and reducing shared transaction costs among its multiple sides. Using a variety of illustrations, the framework is then used to formulate general principles driving MSP design and expansion strategies: choosing the relevant platform "sides," deciding which fundamental activities to perform, and trading off depth against scope of MSP functions.

Download the paper: http://www.hbs.edu/research/pdf/09-115.pdf

Proprietary vs. Open Two-Sided Platforms and Social Efficiency

Abstract

This paper identifies a fundamental economic welfare tradeoff between two-sided open platforms and two-sided proprietary (closed) platforms connecting consumers and producers. Proprietary platforms create two-sided deadweight losses through monopoly pricing but at the same time, precisely because they set prices in order to maximize profits, they partially internalize two-sided positive indirect network effects and direct competitive effects on the producer side. We show that this can sometimes make proprietary platforms more socially desirable than open platforms, which runs against the common intuition that open platforms are more efficient. By the same token, inter-platform competition may also turn out to be socially undesirable because it may prevent platforms from sufficiently internalizing indirect externalities and direct intra-platform competitive effects.

Download the paper: http://www.hbs.edu/research/pdf/09-113.pdf

Quantity vs. Quality and Exclusion by Two-Sided Platforms

Abstract

This paper provides a simple model of two-sided platforms, in which one side (W) values not just the quantity (i.e., number) of users on the other side (M), but also their average quality in some dimension. In this context, platforms might find it profitable to exclude low-quality users on side M, even though some would be willing to pay the platform access prices. Platforms are more likely to engage in exclusion of low-quality M users when W users place more value on the average quality and less value on the total quantity on side M. Exclusion incentives also depend on the proportion of high-quality users in the overall M population and on their cost advantage in joining the platform, relative to low-quality M users. The net effect of these two factors is ambiguous: it generally depends on whether they have a stronger impact on the gains from exclusion (higher average quality) or on its costs (lower quantity).

Download the paper: http://www.hbs.edu/research/pdf/09-094.pdf

Traveling Agents: Political Change and Bureaucratic Turnover in India (revised)

Abstract

We develop a framework to empirically examine how politicians with electoral pressures control bureaucrats with career concerns as well as the consequences for bureaucrats' career investments. Unique micro-level data on Indian bureaucrats support our key predictions. Politicians use frequent reassignments (transfers) across posts of varying importance to control bureaucrats. High-skilled bureaucrats face less frequent political transfers and lower variability in the importance of their posts. We find evidence of two alternative paths to career success: officers of higher initial ability are more likely to invest in skill, but caste affinity to the politician's party base also helps secure important positions.

Download the paper: http://www.hbs.edu/research/pdf/09-006.pdf

The Cost of Property Rights: Establishing Institutions on the Philippine Frontier Under American Rule, 1898-1918 (revised)

Abstract

We examine three reforms to property rights introduced by the United States in the Philippines in the early 20th century: the redistribution of large estates to their tenants, the creation of a system of secure land titles, and a homestead program to encourage cultivation of public lands. During the first phase of American occupation (1898-1918), we find that the implementation of these reforms was very slow. As a consequence, tenure insecurity increased over this period, and the distribution of farm sizes remained extremely unequal. We identify two primary causes for the slow progress of reform. The first was the high cost of implementing these programs, together with political constraints that prevented the government from subsidizing land reforms to a greater degree. The second was the reluctance of the government to evict delinquent or informal cultivators, especially on public lands, which reduced the costs of tenure insecurity.

Download the paper: http://www.hbs.edu/research/pdf/09-023.pdf

Responding to Public and Private Politics: Corporate Disclosure of Climate Change Strategies (revised)

Abstract

The challenges associated with climate change will require governments, citizens, and firms to work collaboratively to reduce greenhouse gas emissions, a task that requires information on companies' emissions levels, risks, and reduction opportunities. This paper explores the conditions under which firms participate in this endeavor. Building on theories of how social activists inspire changes in organizational norms, beliefs, and practices, we hypothesize that shareholder actions and regulatory threats are likely to prime firms to adopt practices consistent with the aims of a broader social movement. We find empirical evidence of direct and spillover effects. In the domain of private politics, shareholder resolutions filed against it and others in its industry increase a firm's propensity to engage in practices consistent with the aims of the related social movement. Similarly, in the realm of public politics, threats of state regulations targeted at a firm's industry as well as regulations targeted at other industries increase the likelihood that the firm will engage in such practices. These findings extend existing theory by showing that both activist groups and government actors can spur changes in organizational practices and that challenges mounted against a single firm and an industry can inspire both firm and field-level changes.

Download the paper: http://www.hbs.edu/research/pdf/09-019.pdf

Asset Specificity and Vertical Integration: Williamson's Hypothesis Reconsidered

Abstract

A point repeatedly stressed by transaction cost economics is that the more specific the asset, the more likely is vertical integration to be optimal. In spite of the profusion of empirical papers supporting this prediction, recent surveys and casual observation suggest that higher levels of asset specificity need not always lead to vertical integration. The purpose of this paper is to uncover some of the factors driving firms to (sometimes) choose to remain separated, rather than integrate, in the presence of high specificity. Its main economic message is that in a world where outside options matter and investments are multidimensional, high levels of asset specificity can foster non-integration: a low level of specificity provides the most misdirected incentives when transacting in a market (because the outside option of external trade becomes so tempting), thus making a stronger case for non-integration when specificity is high.

Download the paper: http://www.hbs.edu/research/pdf/09-119.pdf

 

Publications

Entrepreneur Behaviors, Opportunity Recognition, and the Origins of Innovative Ventures

Abstract

This study traces the origins of innovative strategies by examining the attributes of 'innovative entrepreneurs.' In an inductive grounded theory study of innovative entrepreneurs, we develop a theory that innovative entrepreneurs differ from executives on four behavioral patterns through which they acquire information: (1) questioning; (2) observing; (3) experimenting; and (4) idea networking. We develop operational measures of each of these behaviors and find significant differences between innovative entrepreneurs and executives in a large sample survey of 72 successful and unsuccessful innovative entrepreneurs and 310 executives. Drawing on network theory, we develop a theory of entrepreneurial opportunity recognition that explains why these behaviors increase the probability of generating an idea for an innovative venture. We contend that one's ability to generate novel ideas for innovative new businesses is a function of one's behaviors that trigger cognitive processes to produce novel business ideas. We also posit that innovative entrepreneurs are less susceptible to the status quo bias and engage in these information-seeking behaviors with a motivation to change the status quo.

Letting Misconduct Slide: The Acceptability of Gradual Erosion in Others' Unethical Behavior

Abstract

Four laboratory studies show that people are more likely to overlook others' unethical behavior when ethical degradation occurs slowly rather than in one abrupt shift. Participants served in the role of watchdogs charged with catching instances of cheating. The watchdogs in our studies were less likely to criticize the actions of others when their behavior eroded gradually, over time, rather than in one abrupt shift. We refer to this phenomenon as the slippery slope effect. Our studies also demonstrate that at least part of this effect can be attributed to implicit biases that result in a failure to notice ethical erosion when it occurs slowly. Broadly, our studies provide evidence as to when and why people overlook cheating by others and examine the conditions under which the slippery slope effect occurs.

Customer-Based Valuation

Abstract

Customer lifetime value (CLV) has emerged as an important metric to manage and grow customers. Marketing scholars have written many books and articles on this topic. However, most of this research has focused on tactical marketing decisions. While this is important, it is not enough to gain attention of senior managers who are concerned about firm level metrics such as stock price. To have greater impact marketing needs to go beyond brand-level profits to show the impact of marketing actions on firm profitability. In this paper we focus on customer lifetime value and its link to firm value. We discuss research that provides customer-based valuation of firms and suggest directions for future research.

Nonlinear Pricing

Abstract

A nonlinear pricing schedule refers to any pricing structure where the total charges payable by customers are not proportional to the quantity of their consumed services. We begin the chapter with a discussion of the broad applicability of nonlinear pricing schemes. We note that the primary factor for the use of such schemes is the heterogeneity of the customer base. Such heterogeneity of preferences leads customers to choose different pricing plans based on their expected demand. We describe past analytical and empirical research. Past analytical work is categorized based on whether it is in a monopoly setting or a more general oligopoly context. Most past research has found two-part tariffs to be optimal in many settings. More recent research has begun to investigate the limits of such optimality and when a more general pricing scheme can be optimal. In the summary of empirical research on multi-part tariffs, we note that while nonlinear pricing schemes are popular, any analysis of demand under such schemes is nontrivial. One important reason is the two-way relationship between price and consumption in multi-part tariffs—the pricing scheme influences consumption, and the level of consumption determines the applicable per-unit price. We describe how researchers have addressed this and other such issues and then show a modeling framework that integrates all the issues. We end by discussing empirical generalizations, which also suggest some promising areas for future research.

Direct versus Indirect Colonial Rule in India: Long-term Consequences

Abstract

This paper compares economic outcomes across areas in India which were under direct British colonial rule with areas which were under indirect colonial rule. Controlling for selective annexation using a specific policy rule, I find that areas which experienced direct rule have significantly lower levels of access to schools, health centers, and roads in the post-colonial period. I find evidence that the quality of governance in the colonial period has a significant persistent effect on post-colonial outcomes.

 

Cases & Course Materials

Baosteel Group: Governance with Chinese Characteristics

Harvard Business School Case 309-098

The new outsider-dominated board of directors of China's state-owned Baosteel Group must decide whether to modify the Group's structure. With the completion of a pending acquisition, the Group will control four publicly listed steel-producing subsidiaries, and board members are concerned about competition among the subsidiaries and about the subsidiaries' public shareholders. Selected by the Chinese government as the first company to take part in a pilot project on corporate governance in state-owned enterprises, Baosteel and its board are under intense scrutiny by Chinese and overseas investors in the listed subsidiaries as well as by China's political leadership and the media. The case provides background on Baosteel, China's SOE reform, the Chinese government's pilot project on corporate governance, and the functioning of Baosteel's newly constituted board of directors.

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Barbara Norris: Leading Change in the General Surgery Unit

Harvard Business School Case 409-090

Barbara Norris struggles to address the many problems facing her as a recently promoted nurse manager in the General Surgery Unit (GSU) at Eastern Massachusetts University Hospital (EMU). She has inherited a unit with the lowest employee satisfaction scores and highest employee turnover rate among all of the departments at EMU. Furthermore, her new unit was infamous for its culture of confrontation, blaming, and favoritism. The staff that has remained is dissatisfied, unmotivated, and not functioning as a team to deliver patient care. In fact, GSU's patient satisfaction scores, although average, had been declining steadily over the past few years. Barbara has been asked by EMU's Director of Nursing to turn the unit around in the midst of an economic crisis and deep cost-cutting measures throughout the hospital. Where and how should she begin?

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Cherrypicks

Harvard Business School Case 807-106

Cherrypicks is a Hong Kong communications start-up approaching a large Korean mobile operator for a partnership to take the operator's products to markets outside of Korea. SK Telecom's (SKT) Ring Back Tones (RBT) product is a spectacular success in South Korea, but the partnership will require major changes in Cherrypick's business model. Further complicating matters, SKT is also a strategic investor in Cherrypicks, a very large service provider focused on South Korea and China, and typically partners with Korean entrepreneurial firms. The Cherrypicks management team must decide how they should pitch the partnership opportunity to SKT and what their preferred deal structure would be.

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Note on Biotech Business Development

Harvard Business School Note 807-032

Describes the business development process in biotechnology companies. Topics covered include participants in the licensing process and their interests, the major steps in the licensing process, the terms that are part of most agreements, and the most contentious issues that arise in the implementation of licensing agreements.

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A Note on the Legal and Tax Implications of Founders' Equity Splits

Harvard Business School Note 809-110

This note summarizes key legal and tax issues that founders should consider as they contemplate an equity split and ownership structure. Specific issues covered include why founders should not delay splitting the equity and whether they should involve an attorney or accountant when they do; the importance of considering intellectual property (IP) issues when splitting the equity and the need to do so consistent with Section 351 of the Internal Revenue Code; and the need to make timely and valid Section 83(b) elections if the founders adopt vesting as part of the equity split.

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Orange: Read&Go

Harvard Business School Case 809-122

In late 2008, Orange (aka France Telecom) must decide if launching Read&Go, an electronic newsstand built around an e-paper reader, would be successful. The case describes (1) Orange's strategy; (2) the company's new product development process; (3) e-paper technology, which simulates the appearance of printed paper on a screen; (4) consumer demand for e-paper services; (5) potential competitors, including Amazon's Kindle; (6) business model options for Orange's service; and (7) the reactions of French newspapers—crucial content partners—to Orange's proposal.

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Special Economic Zones in India: Public Purpose and Private Property (A)

Harvard Business School Case 709-027

In 2005, the government of India enacted the Special Economic Zones (SEZ) Act in order to attract investment, generate export revenues, and create manufacturing jobs. However, several planned projects faced difficulties in acquiring land for setting up the SEZ. In December 2007, the government introduced a new piece of legislation, which proposed to extend the power of eminent domain to allow the government to acquire land for SEZs. Was this the right response to the land acquisition problems of private firms? Was the SEZ strategy the right one for India's economic growth?

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State Street Corporation

Harvard Business School Case 209-112

State Street Corporation reports a 13% gain in EPS in 2008 amidst a global financial crisis. The stock price declines 59% on the day of the earnings report. This one-day decline was exceeded in the prior 12-month period by only one non-bankrupt S&P 500 company. That company was AIG, Inc., which declined 61% on the day Lehman Brothers declared bankruptcy. While State Street reported $5 billion in profits over the 4-year period 2005-2008, the company also sustained $10 billion in after tax mark-to-market losses on its "available for sale" investment portfolio and the investment portfolios of its conduits. The question is, how has the firm performed over the past four years? Has it earned $5 billion or lost $5 billion? Fair value accounting plays a key role in the dilemma. How should a financial services firm measure and report income in the face of disorderly and illiquid markets for its principal assets? The case also examines how management at State Street responded to the deterioration in its capital ratios generated by "fair value" accounting.

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Tokyo AFM

Harvard Business School Case 109-056

This case was written as the financial accounting portion of the final exam for a first-year MBA course at Harvard Business School. The goal was to test students' ability to apply major concepts taught during the course to an industry which they had not covered, but which shared similarities in terms of economics with issues addressed in the curriculum. The company, Tokyo Auto Fire & Marine (hereafter Tokyo AFM), is a fictitious insurance company based in Japan. The new CEO is revisiting the accounting choices of his predecessors in light of changes in the economic environment of the firm. The case can also be taught as a review session.

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Yelp

Harvard Business School Case 709-412

Yelp was a popular online destination for reviews of local establishments, written by volunteer Internet users and read by 20 million people per month. However, the company made meager profits. The CEO needs to decide between two options to increase the revenue. First, the company can maintain its existing monetization model and quickly build a massive sales force to enroll many local business owners as advertisers and sponsors. The second option was to change the monetization model completely and charge readers for access to Yelp reviews.

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