First Look

October 23, 2007

Are breakthroughs impossible to predict? Not necessarily—but you need to start with an understanding of the iterative process of invention and its distribution of outcomes, says HBS professor Lee Fleming, in a new article published (and available for purchase) in the MIT Sloan Management Review. "When all inventions are considered, they demonstrate a highly skewed distribution in which almost all inventions are useless, a few are of moderate value, and only a very, very few are breakthroughs," he writes. "Those breakthroughs constitute the 'long tail' of innovation." Fleming identifies methods companies can use to improve their capacity to innovate. Also new this week, a working paper by HBS professor C. Fritz Foley and coauthor Lee Branstetter, which explores misconceptions that distort the popular understanding of U.S. multinationals in China. Among new case studies, look for the "Central Bank" series, which examines the bank's use of information and product design for managing the counterparty risk of newly acquired customers. Former basketball star Earvin "Magic" Johnson makes an appearance as a development partner in the case "Canyon Johnson Urban Fund," which looks at how the fund decides between 2 investment opportunities.
— Sean Silverthorne

Working Papers

Facts and Fallacies about U.S. FDI in China


Despite the rapid expansion of U.S.-China trade ties, the increase in U.S. FDI in China, and the expanding amount of economic research exploring these developments, a number of misconceptions distort the popular understanding of U.S. multinationals in China. In this paper, we seek to correct four common misunderstandings by providing a statistical portrait of several aspects of U.S. affiliate activity in the country and placing this activity in its appropriate economic context.

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Accountability in Complex Organizations: World Bank Responses to Civil Society


Civil society actors have been pushing for greater accountability of the World Bank for at least 3 decades. This paper outlines the range of accountability mechanisms currently in place at the World Bank along 4 basic levels: (1) staff, (2) project, (3) policy, and (4) board governance. We argue that civil society organizations have been influential in pushing for greater accountability at the project and policy levels, particularly through the establishment and enforcement of social and environmental safeguards and complaint and response mechanisms. But they have been much less successful in changing staff incentives for accountability to affected communities, or in improving board accountability through greater transparency in decision making, more representative vote allocation, or better parliamentary scrutiny. In other words, although civil society efforts have led to some gains in accountability with respect to Bank policies and projects, the deeper structural features of the institution—the incentives staff face and how the institution is governed—remain largely unchanged.

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The Dynamic Interplay of Inequality and Trust—An Experimental Study


We study the interplay of inequality and trust in a dynamic game, where trust increases efficiency and thus allows higher growth of the experimental economy in the future. We find that trust is initially high in a treatment starting with equal endowments, but decreases over time. In a treatment with unequal endowments, trust is initially lower yet remains relatively stable. The difference seems partly due to the fact that equal start positions increase subjects' inclination to condition their trust decisions on wealth comparisons, whereas conditional trust is much less prevalent with unequal initial endowments. As a result, with respect to efficiency, the initially more unequal economy fares worse in the short run but better in the long run, and the disparity of wealth distributions across economies mitigates over time.

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Cases & Course Materials

Bunge: Food, Fuel, and World Markets

Harvard Business School Case 708-443

In 2007, Bunge, an agribusiness company, had over $26 billion in worldwide sales and was considered, along with Cargill and Archer Daniels Midland (ADM), one of 3 very integrated worldwide agribusiness companies. Headquartered in White Plains, NY, the company has traditionally possessed a strong presence in Brazil. Describes Bunge's tradeoff between efficiency of global operations and local responsiveness in an uncertain business environment. New world developments were effecting Bunge directly: high oil prices, a growing demand in emerging economies like China and India, and the possibility of agribusiness companies competing successfully in the production of biofuels. Bunge had traditionally followed an organizational model that was integrated but decentralized, trying to strike a balance between the efficiency of a global entity and the speed of local businesses. What would be the best strategy for Bunge to respond to the external changes imposed by high energy prices and increasing demand from emerging economies? How aggressively should Bunge invest in the rising biofuels markets?

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Canyon Johnson Urban Fund

Harvard Business School Case 706-442

Basketball star Earvin "Magic" Johnson and K. Robert Turner, managing partner of Canyon Johnson Urban Fund (CJUF), raised $271.7 million for investments in urban real estate. The fund considered two projects, both located in Hollywood, CA. The first was located on Hollywood and Highland. Proposed by a reputable developer who wanted to restore Hollywood and Highland to its former glory, the development included a 640,000 square-foot retail complex, a hotel, and the Kodak Theatre, the future home of the Academy Awards. The second project was a mixed-use development, located on Sunset and Vine. This property had suffered a bad run of previous development attempts, and the community had been highly critical of past projects, feeling high rental prices would lock local residents and businesses out of the market. Hollywood and Highland or Sunset and Vine? Turner planned to make his decision soon. Details the economics of both projects.

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Central Bank: The ChexSystems(SM) QualiFile(R) Decision

Harvard Business School Case 208-029

The "Central Bank" series analyzes the use of information and product design for managing the counterparty risk of newly acquired customers. Central Bank, a mid-sized regional U.S. bank, was attempting to grow its customer base by increasing the number of new checking accounts. Like many banks, Central saw checking accounts as an important tool for customer acquisition and loyalty-building. However, the bank realized that the aggressive pursuit of new accounts could result in an increased number of overdrafts and, ultimately, customer defaults. The first case, "Central Bank: The ChexSystems(SM) QualiFile(R) Decision," analyzes how QualiFile, a debit-scoring product commercialized by ChexSystems, can be used to manage this risk.

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Chile: The Conundrum of Inequality

Harvard Business School Case 907-411

Following the violent overthrow of the Allende regime, Chile embarked on economic reforms that emphasized free markets as recommended by the "Chicago Boys". In due course these reforms led to sustained economic growth. However, these reforms were legislated by a parliament under the domination of a military dictatorship, and were followed by economic instability, the need to renationalize some firms and by rising inequality. In 2005, business leaders speak out on the necessity of reducing the inequalities, and of their complicity in what has happened.

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Still Leading (A): Issues in Transitioning to New Forms of Service Later in Life

Harvard Business School Case 308-047

Identifies the challenges for experienced leaders who transition from their primary income-earning careers to a next phase of public service or social-purpose work, based on interviews and published sources.

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On the Integration of Growth and Business Cycles


This paper presents evidence on the relevance of macro models where endogenous technological change mechanisms are responsible both for long-run growth and the propagation of low-persistence shocks. Section 2 presents evidence on the persistence of macro series. Section 3 presents different strategies to modeling this persistence. Section 4 presents evidence that supports the view that high- and medium-term fluctuations are connected. Section 5 provides evidence in favor of models where the persistence of macro series originates from endogenous technological change mechanisms such as endogenous research and development (R&D) and/or endogenous diffusion of technologies. This evidence includes new estimates of the effect of medium-term fluctuations of GDP on the speed of diffusion of over 20 specific technologies in the UK. Section 6 presents a simple model of endogenous technological change and diffusion that is consistent with the evidence presented before.

Breakthroughs and the "Long Tail" of Innovation


The largely erroneous perception that breakthroughs are impossible to predict arises from the tendency to focus on just the breakthroughs while ignoring the iterative process of invention and its distribution of outcomes. When all inventions are considered, they demonstrate a highly skewed distribution in which almost all inventions are useless, a few are of moderate value, and only a very, very few are breakthroughs. Those breakthroughs constitute the long tail of innovation. If managers wish to understand how those breakthroughs arise, they cannot ignore the process that generates the entire distribution. In particular, they need to keep in mind the following 3 measures of inventive success: shots on goal (the total number of inventions a company generates), average score (the mean value of those inventions) and maximum scores (the breakthrough inventions). Various factors can affect a company's inventive output, including the presence of inventors who work alone, the type of collaboration among those inventors who work in teams, the amount of team diversity and the degree to which inventors apply science in the innovation process. Greater team diversity, for instance, will help generate more shots on goal although, on average, those shots will be less successful. But diversity also will increase the variance of the outcome, such that failures as well as breakthroughs are more likely. Thus companies first need to identify how they want to improve their innovation process and then take the appropriate measures to address any deficiencies. Only then can they improve their capacity to innovate in ways that make the best sense for the organization as a whole.

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Do Vertical Mergers Facilitate Upstream Collusion?


We investigate the impact of vertical mergers on upstream firms' ability to collude when selling to downstream firms in a repeated game. We show that vertical mergers give rise to an outlets effect: the deviation profits of cheating unintegrated firms are reduced as these firms can no longer profitably sell to the downstream affiliates of their integrated rivals. Vertical mergers also result in an opposing punishment effect: integrated firms typically make more profit in the punishment phase than unintegrated upstream firms. The net result of these effects in an unintegrated industry is to facilitate upstream collusion. We provide conditions under which further vertical integration also facilitates collusion.

Foreclosure with Incomplete Information


We investigate the robustness of the new foreclosure doctrine and its associated welfare implications to the introduction of incomplete information. In particular, we let the upstream firm's marginal cost be private information, unknown to the downstream firms. The previous literature has argued that vertical integration is harmful because it allows an upstream monopolist to limit output to monopoly levels, whereas a disintegrated structure will "oversell," producing more in equilibrium. By contrast, we find that with incomplete information, high-cost firms will often "under-sell" in equilibrium, that is, supply less than their monopoly output. Low-cost firms continue to over-sell, so all types of firms have a reason to integrate downstream, but this is socially harmful only for low-cost types. For high-cost firms vertical integration can be Pareto-improving, resulting in higher output, profits, and consumer surplus.