First Look

October 27, 2009

"Non-obvious individuals"—outsiders, including women—may be your best bet for solving problems that defy the experts. Innovation relies on openness to diverse viewpoints, and in the field of science that could mean tapping into talent and technical expertise several steps removed from the problem at hand. A market mechanism such as a problem-solving contest is one way to invite more useful solutions to vexing problems. Research by HBS professor Karim R. Lakhani and Copenhagen Business School professor Lars Bo Jeppesen that was described earlier on this site ("Open Source Science: A New Model for Innovation"), and that is featured in a forthcoming issue of Organization Science, details how and why at the theoretical and practical level. Lakhani and Jeppesen's research also underlines the value of contributions by women. As the authors write in "Marginality and Problem Solving Effectiveness in Broadcast Search," "Female solvers—known to be in the 'outer circle' of the scientific establishment—performed significantly better than men in developing successful solutions." Working papers, other articles, and cases round out this week's new offerings.
— Martha Lagace

Working Papers

Money or Knowledge? What Drives Demand for Financial Services in Emerging Markets? (revised)


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 financial incentives (ranging from U.S. $3 to $14) to open bank savings accounts. 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.

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Medium Term Business Cycles in Developing Countries


We build a two-country asymmetric DSGE model with two features: (1) a product cycle structure determines the range of intermediate goods used to produce new capital in each country and (2) there are investment flow adjustment costs in the developing economy. We calibrate the model to match the Mexico-U.S. trade and FDI flows. The model is able to explain (1) why U.S. shocks have a larger effect on Mexico than in the U.S. and hence why the Mexican economy is more volatile than the U.S.; (2) why U.S. business cycles lead over medium-term fluctuations in Mexico; and (3) why Mexican consumption is not less volatile than output.

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Marginality and Problem Solving Effectiveness in Broadcast Search


We examine who the winners are in science problem-solving contests characterized by open broadcast of problem information, self-selection of external solvers to discrete problems from the laboratories of large R&D intensive companies, and blind review of solution submissions. We find that technical and social marginality, being a source of different perspectives and heuristics, plays an important role in explaining individual success in problem solving. The provision of a winning solution was positively related to increasing distance between the solver's field of technical expertise and the focal field of the problem. Female solvers—known to be in the "outer circle" of the scientific establishment—performed significantly better than men in developing successful solutions. Our findings contribute to the emerging literature on open and distributed innovation by demonstrating the value of openness, at least narrowly defined by disclosing problems, in removing barriers to entry to non-obvious individuals. We also contribute to the knowledge-based theory of the firm by showing the effectiveness of a market mechanism to draw out knowledge from diverse external sources to solve internal problems.

Creating Common Ground: Propositions about Effective Intergroup Leadership

Banking Deregulations, Financing Constraints and Firm Entry Size


We examine the effect of U.S. branch banking deregulations on the entry size of new firms using micro-data from the U.S. Census Bureau. We find that the average entry size for startups did not change following the deregulations. However, among firms that survived at least four years, a greater proportion of firms entered either at their maximum size or closer to the maximum size in the first year. The magnitude of these effects was small compared to the much larger changes in entry rates of small firms following the reforms. Our results highlight that this large-scale entry at the extensive margin can obscure the more subtle intensive margin effects of changes in financing constraints.

Cases & Course Materials

Avid Radiopharmaceuticals and Lighthouse Capital Partners

Matthew Rhodes-Kropf and Ann Leamon
Harvard Business School Case 810-054

In fall 2008, a venture lender must decide whether to make a loan to Avid, a small but promising venture-backed life sciences firm. In reviewing her proposal, Cristy Barnes considers the company's characteristics and how they differ from a typical investment. At the same time, the CEO and the venture capitalist are exploring the true costs and benefits of taking the loan, particularly in the uncertain economic climate of the time.

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Citigroup's Exchange Offer (A)

Robin Greenwood and James Quinn
Harvard Business School Case 210-009

Citigroup faced considerable distress in early 2009. In late 2008, the bank had accepted $45 billion in preferred equity from the United States government via the Troubled Assets Relief Program (TARP). Yet, the stock had continued to slide in early 2009. In late February, the company announced that it would convert as much as $50 billion of preferred stock into common stock, at $3.25 per share. The case asks students to evaluate the pricing of preferred stock relative to common stock at this time. As the case takes place during a period of considerable uncertainty in global capital markets, and conventional sources of arbitrage capital have been depleted, the apparent mispricing may not be as attractive as it initially seems. In the B and C cases, students must decide whether their view of the appropriate pricing changes, when the apparent mispricing worsens. A final additional teaching point relates to the formation of a synthetic short position using the options markets.

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eBay Partner Network (A)

Benjamin Edelman and Ian I. Larkin
Harvard Business School Case 910-008

eBay considers adjustments to the structure and rules of its affiliate marketing program, eBay Partner Network (ePN). In particular, eBay reevaluates affiliate compensation structure, the role of bonuses for especially productive affiliates, and the overall rationale for outsourcing online marketing efforts to independent affiliates. The case presents the history and development of ePN, ePN's importance to eBay, and the mechanics of online affiliate marketing.

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Eden McCallum: A Network-Based Consulting Firm

Heidi K. Gardner and Robert G. Eccles
Harvard Business School Case 410-056

Eden McCallum pioneered the network-based ("virtual") consulting firm model in the U.K. Contracting freelance consultants on a per-project basis keeps overheads lean so that Eden McCallum's fees are a fraction of the big firms' rates. Their flexible, low-cost model has attracted top-notch corporate clients, resulting in steady double-digit annual growth in its first nine years. In January 2009, however, the global economic crisis has dramatically reshaped the competitive landscape and the founders must decide between pursuing their high-growth strategy versus retrenching—including cutting costs and pulling out of their first international expansion that they had launched the prior year. This case explores how the elements of a firm's innovative model reinforce each other and what happens when the environment changes.

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The Risk Management Foundation of the Harvard Medical Institutions, Inc.

Richard Bohmer, Stephen P. Bradley, and Natalie Kindred
Harvard Business School Case 610-014

Through its uniquely proactive approach to medical malpractice risk management, the Risk Management Foundation (RMF) has decreased claims—and premiums—for the Harvard hospitals it insures. The RMF is the captive medico-legal insurer of the Harvard medical institutions and affiliated physicians. Over the last two decades, through a combination of active legal defense and medical error prevention, the RMF has successfully controlled the medico-legal costs of physicians practicing at the Harvard teaching hospitals; consequently, its insured physicians pay notably lower premiums than similar specialists outside the Harvard system. The RMF's success has been due, in large part, to the close working relationships it has cultivated with the insured physicians and hospitals. However, as the hospitals expand their networks into Boston's suburbs, new, less tightly affiliated doctors whose medico-legal risk is higher than those practicing at the hospitals are coming under the RMF's umbrella. This case describes RMF's approach to risk management and the challenges its managers face in accommodating these new physicians.

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Scharffen Berger Chocolate Maker (B)

Daniel C. Snow
Harvard Business School Supplement 610-035

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Transworld Auto Parts (A)

V.G. Narayanan and Lisa Brem
Harvard Business School Case 110-027

Transworld Auto Parts had to implement its new strategy flawlessly to survive the auto industry upheaval. The new CEO asked her leadership team to craft strategy maps and balanced scorecards to help each division implement its strategies.

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