First Look

June 5, 2007

"Why do so many companies infuriate their customers by binding them with contracts, bleeding them with fees, confounding them with fine print, and otherwise penalizing them for their business? Because, unfortunately, it pays," write HBS professors Gail McGovern and Youngme Moon in the June issue of Harvard Business Review. Their article, "Companies and the Customers Who Hate Them," details customer-unfriendly strategies across industries as diverse as the cell phone service business, retail banking, and health clubs, though hotels, video stores, and ticketing and car rental agencies have their bad apples, too. McGovern and Moon explain why otherwise good companies adopt harmful strategies and how they can change their adversarial ways.

"In industries where squeezing value from customers is commonplace, a transparent, value-creating offer can exploit customers' dissatisfaction with incumbents and drive rapid growth," they advise.

Also this week, new cases on Whole Foods Market, Chinese retailer Hualian, and an innovative destination for migraine relief, The West German Headache Center.

— Martha Lagace

Working Papers

None this week.


Cases & Course Materials

Artisan Entertainment Inc.

Harvard Business School Case 207-067

Geoff Rehnert and Marc Wolpow have left Bain Capital to launch Audax Group. As part of their separation, they have been granted 90-day options to purchase Bain Capital's stake in a number of portfolio companies at Fair Market Value. As they conside whether to exercise their option to purchase Bain Capital's stake in Artisan Entertainment, the company has an extremely successful launch of "The Blair Witch Project." However, Rehnert and Wolpow have not yet raised Audax Group's first fund, and are not able personally to finance the purchase, which would require approximately $30 million. They must decide whether to go through with the purchase, and how to finance it, keeping in mind any issues such an investment would raise for prospective investors in their first private equity fund.

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Bankinter: Deploying the Mortgage Simulator to the Branches

Harvard Business School Case 107-070

Describes how Bankinter, a mid-sized Spanish bank, altered the information set available to its customer-facing employees. In the spring of 2003, Bankinter introduced an Excel-based program called the Mortgage Simulator that helped branch managers calculate the price of a mortgage and estimate the customer lifetime value (CLV). Facilitates a discussion of the impact of such a change in the information set for employees when the incentives and decision rights remain unchanged. Also examines the tradeoffs front-line employees face as they divide their efforts between reaching new customers and increasing the amount of cross-selling to existing customers.

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Beijing Hualian

Harvard Business School Case 906-403

China's fifth largest domestic retailer faced intensifying competition from Wal-Mart and Carrefour with the opening of China's fast-growing retail market in January 2005. In response, Beijing Hualian developed a new "Family Store" format targeted at the nation's growing middle class, made up of younger consumers with more fashionable tastes. Like hypermarkets, Hualian Family Stores include both food and nonfood lines, but differ in design and in the product and brand mix that would be carried. Results from the pilot store (a remodeled hypermarket in Beijing) were encouraging, with revenues and profits up and customers spending more on each visit. The company must decide how quickly to roll out Family Stores in China. Strategic issues include preempting competition by moving quickly into new cities, balancing the buying power of multinational retailers who were also purchasing merchandise for export, leveraging Beijing Hualian's understanding of the rapidly changing domestic market, accessing capital for expansion, and training and retaining Chinese management talent.

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Best Buy Stores, Inc.: Competing on the Edge

Harvard Business School Case 706-417

While Circuit City struggles, Best Buy has overtaken it to become the premier consumer electronics retailer in the United States. What has driven its success? How can it be sustained?

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John Mackey and Whole Foods Market

Harvard Business School Case 807-111

Traces the history of organic agriculture from its pre-industrial roots to the present day, and examines the growth of Whole Foods Market in the context of the broader growth of the organic industry. Also investigates John Mackey's role as a founder and leader of the largest natural-foods retailer in the world.

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OuterLink Corp. (A)

Harvard Business School Case 806-059

Zero Stage Capital is addressing a troubled investment in OuterLink Corp., which has a capital deficit of $30 million and was written off by all but one of its investors as a victim of the technology bubble. The venture organization must decide whether to shutter the investment or put more capital to work.

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OuterLink Corp. (B)

Harvard Business School Supplement 807-158

Supplements the (A) case.

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Westin Hotels and Resorts: Operations of a Lifestyle Experience

Harvard Business School Case 607-129

Westin Hotels and Resorts adopted a new "lifestyle" brand strategy which provided guests with a new service experience. The dilemma Westin faced was how to operationally build a brand that delivered consistent service on intangible values.

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The West German Headache Center: Integrated Migraine Care

Harvard Business School Case 707-559

Describes the joint efforts of the German health plan KKH and Essen University Hospital to develop an integrated practice unit (IPU), and the West German Headache Center's efforts to improve the quality of migraine care. Provides an overview of the German health care system detailing its provider, health plan, and reimbursement structure. Following new legislation in 2004, which allowed health plans and selected providers to contract outside of the regular group purchasing scheme, KKH and Dr. Deiner of Essen University Hospital developed a novel delivery structure for migraine care. Challenges and hurdles to implementation are described for both the health plan and the IPU. Provides detailed data to allow students to evaluate success, identify current challenges, and recommend improvements to the integrated care system.

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Vitreon Corp.: The Hyalite Project

Harvard Business School Case 607-031

Considers decisions facing the leader of a manufacturing staff project team assigned to a plant where yields have deteriorated sharply. The process is complex: the plant organization is not cooperative, and there are deep disagreements about what is wrong and how to fix it. Provides an opportunity to analyze yields and productivity, as well as the organizational and personal challenges inherent in line-staff interaction.

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Capital Rules: The Construction of Global Finance


The rise of global financial markets in the last decades of the twentieth century was premised on one fundamental idea: that capital ought to flow across country borders with minimal restriction and regulation. Freedom for capital movements became the new orthodoxy. In an intellectual, legal, and political history of financial globalization, Rawi Abdelal shows that this was not always the case. Transactions routinely executed by bankers, managers, and investors during the 1990s—trading foreign stocks and bonds, borrowing in foreign currencies—had been illegal in many countries only decades, and sometimes just a year or two, earlier.

How and why did the world shift from an orthodoxy of free capital movements in 1914 to an orthodoxy of capital controls in 1944 and then back again by 1994? How have such standards of appropriate behavior been codified and transmitted internationally? Contrary to conventional accounts, Abdelal argues that neither the U.S. Treasury nor Wall Street bankers have preferred or promoted multilateral, liberal rules for global finance. Instead, European policy makers conceived and promoted the liberal rules that compose the international financial architecture. Whereas U.S. policy makers have tended to embrace unilateral, ad hoc globalization, French and European policy makers have promoted a rule-based, "managed" globalization. This contest over the character of globalization continues today.

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Career Concerns and Mandated Disclosure


This paper examines the effects of mandated disclosure on the design of contracts and induced behavior in the presence of career concerns. We analyze the impact of two key properties of a mandated performance measure that is publicly disclosed: its sensitivity to the agent's effort and its informativeness about the agent's ability. We find that when the mandated measure is highly sensitive to the agent's effort but the measure is relatively uninformative about the agent's ability, the agent's effort (and the firm's output) will be higher and the pay-for-performance sensitivity will be lower relative to a scenario in which the measure is not mandated. In contrast, if the mandated measure's informativeness dominates the measure's sensitivity to effort, then effort is lower and the pay-for-performance sensitivity is higher in the mandated setting. We also characterize settings where a mandated disclosure would be desirable or not; variations arise because mandated disclosures can increase both effort and risk. Our results imply that mandating the public disclosure of performance measures, particularly measures that are relatively informative about ability but are difficult to influence through managerial effort, may have the unintended consequence of generating inefficiencies in firms' employment contracts.

Companies and the Customers Who Hate Them


This article includes a one-page preview that quickly summarizes the key ideas and provides an overview of how the concepts work in practice along with suggestions for further reading.

Why do companies bind customers with contracts, bleed them with fees, and baffle them with fine print? Because bewildered customers, who often make bad purchasing decisions, can be highly profitable. Most firms that profit from customers' confusion are on a slippery slope. Over time, their customer-centric strategies for delivering value have evolved into company-centric strategies for extracting it. Not surprisingly, when a rival comes along with a friendlier alternative, customers defect. Adversarial value-extracting strategies are common in such industries as cell phone service, retail banking, and health clubs. Overly complex product and pricing options, for example, may have been designed to serve various segments. But in fact they take advantage of how difficult it is for customers to predict their needs (such as how many cell phone minutes they'll use each month) and make it hard for them to choose the right product. Similarly, penalties and fees, which may have been instituted to offset the costs of undesirable customer behavior, like bouncing checks, turn out to be very profitable. As a result, companies have no incentive to help customers avoid them. Tactics like these generate bad publicity and fuel customer defections, creating opportunities for competitors. Virgin Mobile USA, for example, has lured millions of angry cell phone customers away from the incumbents by offering a straightforward plan with no hidden fees, no time-of-day restrictions, and no contracts. ING Direct, now the fourth-largest thrift bank in the United States, offers accounts with no fees, no tiered interest rates, and no minimums. In industries where squeezing value from customers is commonplace, companies that dismantle these harmful practices and design a transparent, value-creating offer can head off customer retaliation and spur rapid growth.

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The Emergence of Governance in an Open Source Community


We have a good understanding of organizing processes in bureaucratic organizations, but not in community forms. More specifically, we know little about how communities producing collective goods govern themselves. With a multi-method study of one open source software community, we found that members developed a shared basis of formal authority, but limited it with democratic mechanisms that enabled experimentation with shifting conceptions of authority over time. When members settle on a shared conception of authority, it is more expansive than their original design. This finding is reinforced with a statistical test of the predictors of leadership. By blending bureaucratic and democratic mechanisms, the governance system designed was able to evolve with the community's changing conceptions of authority.