Sunk Costs in Detroit

Something tells me that I will be able to write a great (but sad) paper several years from now about the sunk cost trap as it pertains to the federal government and the U.S. automobile industry. The sunk cost trap refers to the tendency for people to escalate their commitment to failing courses of action in the face of high sunk costs, i.e. to throw good money after bad. I fear that we will continue to engage in this type of escalation over time in Detroit.

Index Funds Still Win, Even in a Bear Market

As noted on Greg Mankiw's blog, Standard and Poor's reports that, over the five year period of 2004-2008, "The S&P 500 outperformed 71.9% of actively managed large cap funds, the S&P MidCap 400 outperformed 75.9% of mid cap funds, and the S&P SmallCap 600 outperformed 85.5% of small cap funds. These results are similar to that of the previous five year cycle from 1999 to 2003."

These results are important because many people have argued that perhaps index funds would not outperform actively managed funds in a bear market. However, this study's findings demonstrate that trying to beat the market is just as difficult in a bear market as in a bull market.

The bottom line: Your index fund may have taken a beating in 2008, but you are not likely to have been better off with an actively managed fund with its accompanying higher fee structure.

Extending the Illy Coffee Brand

I'm a big fan of Illy coffee, the high end line of espresso coffee from Italy. I discovered it at Whole Foods market, and I'm willing to pay a premium for this very good coffee. Now, I read in Fast Company that Illy is coming out with a new product line... canned coffee beverages. The article reviews the new products, and asks the question: "Is it premium enough?" That certainly seems like a relevant question. One has to wonder whether Illy risks damaging their brand with this product line introduction. Will the firm's quality image suffer at all? We certainly have seen this story before with Starbucks' expansion efforts. It will be interesting to watch consumers' reactions to Illy's growth plans. Of course, this product launch also directly threatens Starbucks' own canned coffee business. The battle is on.

End the University as We Know It

Professor Mark Taylor of Columbia University sparked some vigorous debate in the halls of higher education this week with this thought-provoking op-ed in the New York Times. It's worth reading, not only by faculty members around the country, but also by students and parents as well.

Motivating without Money - Part II

As I think more about the issue of motivating without money, I keep coming back to one of my favorite business books - Soul of a New Machine by Tracy Kidder. Kidder won the Pulitzer Prize for this fantastic book, in which he traces the efforts of Tom West and his product development team at Data General as they develop a new computer in the early 1980s. West employs a variety of unorthodox management methods to drive his team to high performance. Many of my students describe him as manipulative. Whether they approve of his methods or not, however, all students learn from this story that West has created an exceptionally high level of intrinsic motivation among his staff.

One particular lesson that we learn from the book is that many employees are motivated to work very hard on a particular exciting project if they believe that other "cool" projects will be available to them if they perform well in their current work. In Soul of a New Machine, they call this the "pinball theory of management" - i.e. if you excel on this project, you get to work on another exciting one. In short, many people want the promise of interesting future work that will help them grow and develop, and that will challenge them in a unique way. They do not necessarily need to be motivated by a huge bonus at the end of the project (thogh they would like that too!). They might also be highly motivated by the next opportunity that will come available to them.

Motivating without Money

Matthew Boyle has a good article over at Business Week on "Motivating without Money."

There is no question that many firms do not spend enough time thinking about how to enhance the intrinsic motivation of their employees. Far too much time is often spent on trying to perfect the extrinsic reward system.

Scholars Richard Hackman and Greg Oldham developed a job design model many years ago that highlights some of the key drivers of intrinsic motivation. They essentially identified key job characteristics that drive intrinsic motivation, and ultimately, task performance. Here are the five key characteristics of a job to consider:

1. Does the job tap into and regularly require use of a variety of the employee's skills?

2. Does the job entail the performance of the whole task, from start to finish, rather than a tiny portion of the task?

3. Is it clear to the employee that the task is highly significant to the organization?

4. Does the employee have a subsantial degree of autonomy with regard to how to accomplish the work?

5. Does the employee receive clear and immediate feedback regarding the job he or she performs?

Interview on Dan Schawbel's Blog

Dan Schawbel interviewed me about my new book (Know What You Don't Know), and he's posted the interview on his Personal Branding Blog. Dan is the author of Me 2.0: Build a Powerful Brand to Achieve Career Success (Kaplan, April 2009).

GE's Track Record Churning out CEOs

General Electric has a tremendous record developing talent that goes on to lead other companies. Many CEOs have worked for GE at some point in their careers. This article about Bob Nardelli's troubles at Home Depot and Chrysler reminds us that not all GE executives go on to great success elsewhere. Some, such as Bill Anders or Larry Bossidy, enjoy a great deal of success. Others stumble. Why might some executives succeed while others do not? Here are a few theories:

1. The most effective executives may go to companies that resemble General Electric, i.e. large diversified conglomerates (while less successful executives may be trying to make the leap to companies that are quite different than GE (such as a retailer).

2. Some executives may have excelled at GE because of the support network that enabled their success. In other words, they did not excel at GE simply because of their own talent, but because of the people surrounding them and the culture/systems of GE that enabled their success. It is often hard to discern whether a star at GE is capable of excelling without the support network around them.

3. Some GE executives may have tried to transplant GE processes and systems without sufficient adaptation to their new company's industry, strategy, and culture. Others may have had more success because they engaged in more effective adjustments of the "GE way" to fit their new external and internal environment.

The Art of Critical Decision Making

My new course from The Teaching Company has been released this week (24 half hour lectures available in CD, DVD, and audio download format). The title is "The Art of Critical Decision Making." For more information, click here (or see the advertisement on page B5 of today's Wall Street Journal - Thursday, April 23rd).

Advertising During a Recession

My colleague Keith Murray passed along this insightful piece by James Suroweicki, published in The New Yorker. Suroweicki, of course, is the author of the wonderful book, The Wisdom of Crowds. This article addresses the issue of the impact of cutbacks in advertising during a recession. Here's an excerpt:

A study of advertising during the 1981-82 recession found that sales at firms that increased advertising or held steady grew precipitously in the next three years, compared with only slight increases at firms that had slashed their budgets. And a McKinsey study of the 1990-91 recession found that companies that remained market leaders or became serious challengers during the downturn had increased their acquisition, R. & D., and ad budgets, while companies at the bottom of the pile had reduced them.

J&J's Secrets to Success

Geoff Colvin and Jessica Shambora at Fortune have an article about J&J's secrets to success. They point out that J&J has a remarkable record over more than 100 years as a corporation, and they try to identify five key factors that contribute to their success. Such exercises are often futile or counteproductive, but in this case, the rules are simple, but nevertheless valuable to consider:

1. Diversify within a single industry.
2. Focus on the future.
3. Let the experts run the business.
4. Stay financially disciplined - always.
5. Have a purpose beyond profits.

Gladwell on Teacher Quality

My colleague Mary Lyons just forwarded me this intriguing article by Malcolm Gladwell about teaching. Gladwell argues that teacher quality matters much more than class size or school quality when it comes to our children's learning. Here's one excerpt from Gladwell's essay:

Hanushek (Eric Hanushek, an economist at Stanford) recently did a back-of-the-envelope calculation about what even a rudimentary focus on teacher quality could mean for the United States. If you rank the countries of the world in terms of the academic performance of their schoolchildren, the U.S. is just below average, half a standard deviation below a clump of relatively high-performing countries like Canada and Belgium. According to Hanushek, the U.S. could close that gap simply by replacing the bottom six per cent to ten per cent of public-school teachers with teachers of average quality. After years of worrying about issues like school funding levels, class size, and curriculum design, many reformers have come to the conclusion that nothing matters more than finding people with the potential to be great teachers. But there’s a hitch: no one knows what a person with the potential to be a great teacher looks like. The school system has a quarterback problem.


The question then becomes: How does one find great teachers? Gladwell explains that schools face the same problem that NFL scouts encounter. NFL teams have a very hard time determining which college quarterbacks will excel in the professional game. They find it easier to determine which receiver or defensive linemen will excel. The quarterback position involves so many intangibles as well as mental aspects to the game; it's more than physical prowess that drives success at the professional level.

Similarly, Gladwell argues that it is difficult to identify great teachers. He points to research that shows that the usual qualifications don't correlate with success in the classroom. For instance, being certified or having earned a graduate degree do not lead to more effective teaching on average. He concludes that we can only identify great teachers by actually watching them teach for awhile. Observation often yields very meaningful insights which cannot be discerned from a resume. Gladwell points to one researcher's work that suggests that effective teachers have a quick sense of when behavioral problems are emerging in a classroom. The researcher describes this teacher quality as "withitness." One can detect this through observation, but it's a highly intangible, yet crucial, aspect of teacher quality.

While this essay provides insight as to teacher recruiting and selection, it also brings to light some issues for many business firms. Does your firm have a particular position that is similar to the NFL quarterback, where it is particuarly difficult to discern the likelihood of the candidate's success at your firm based on the credentials outlined on the resume? Are some positions easier to fill than others, much as NFL teams have discovered? How can you observe performance, and perhaps your firm's equivalent of "withitness", in the early days of a person's tenure at your firm, so as to discern whether they will succeed in the long term?

The Problem with Stock Options

Dartmouth Professor Sydney Finkelstein provides a clear and concise critique of stock option compensation schemes on BusinessWeek.com. Naturally, his criticism focuses first and foremost on the fact that stock option compensation tends to encourage excessive risk-taking. Finkelstein rightfully also critiques the rush to reprice stock options now in the face of huge declines in stock prices.

In general, pay for performance has the potential to be effective as part of a broader human resource management system designed to attract, retain, and motivate talented people. However, no pay for performance plan is perfect. In the case of stock options, the downside is excessive risk-taking. As companies make key decisions on their compensation plans, they must always remember that the law of unintended consquences will prevail in most situations. While trying to motivate desirable behavior X, the plan often leads to undesirable behaviors Y and Z as well.

Stand-up Economist

Check you Yoram Bauman, the hilarious stand-up economist. We could all use a laugh during these trying economic times.

Job Advice for Class of 2009

Anne Fisher at Fortune has some good advice for soon-to-be college graduates. I particularly like the notion of using volunteer work in one's field of expertise to bolster one's resume. For example, she points out that an aspiring accountant could volunteer to keep the books at a non-profit as a means of gaining valuable experience.

John Madden and EA Video Games

John Madden, the most famous NFL sportscaster of the last quarter century, announced his retirement today. Several generations of NFL fans have grown up listening to him as a color commentator alongside such accomplished play-by-play announcers as Pat Summerall and Al Michaels. Of course, his partnership with EA Sports has led to the remarkably successful Madden video game series. Today, EA announced that Madden's retirement will have no impact on their video game products. However, one wonders what will happen down the line. In 5-10 years, will the Madden brand resonate with young gamers who will not have grown up listening to John Madden on television? How will EA react? It will be interesting to watch how the brand develops and evolves during Madden's retirement.

Southwest Airlines Struggles

Southwest Airlines posted its third straight quarterly loss. The company, of course, has recorded positive annual profits for more than thirty straight years. That streak may be in jeopardy. Here is a CNN interview with Southwest CEO Gary Kelly, speaking about the future for Southwest, including some cost-cutting measures that the firm has put in place in reaction to these losses:

Teaching MBAs

We now have a video about our Bryant MBA program up on YouTube. This video provides some insight regarding my teaching philosophy for those who are interested.

Tax Day!

Here we are on April 15th. Most taxpayers do not enjoy this day, because those taxes are due! The deadline, as well as the filing process, reminds me again of the complexity of our tax code. That complexity surely costs us a great deal of money. Experts refer to these expenditures as the "costs of tax compliance." How large are these costs for Americans? Here is an excerpt from the Tax Foundation's website:

The full cost a tax system is more than the amount of tax paid. It also includes the cost of tax planning and paperwork. Economists call these "tax compliance" costs, and the IRS estimates Americans spend 6.6 billion hours per year filling out tax forms—including 1.6 billion hours on the 1040 form alone. In 2002 Americans spent roughly $194 billion dollars on tax compliance. That amounts to 20 cents of compliance cost for every dollar collected by the tax system.

Capitalism vs. Socialism

Rasmussen released a shocking poll last week about Americans' views regarding capitalism and socialism. Here's an excerpt from their report:

Only 53% of American adults believe capitalism is better than socialism.

The latest Rasmussen Reports national telephone survey found that 20% disagree and say socialism is better. Twenty-seven percent (27%) are not sure which is better.

Adults under 30 are essentially evenly divided: 37% prefer capitalism, 33% socialism, and 30% are undecided.

These numbers clearly reflect some disenchantment associated with the poor economy. Still, these data startle and worry me. Do young people truly understand what socialism means? Do they recognize that, throughout our history, well-meaning Americans of all political stripes have worked very hard to build and defend our system of democratic capitalism. This economic and political system has brought freedom and posterity to many parts of the world. Socialism has brought nothing but ruin, and with it has often come dictatorship and oppression. As an educator, I worry that perhaps we are not teaching our young people the critical lessons of history. As educators, we should never flinch from teaching that capitalism is far superior to socialism, while acknowledging that people of different political affiliations may have different views on the form of capitalism that should be employed.

Building Community

Seth Godin has a thought-provoking post over on his blog about "intentionally building communities." Godin argues that we should create opportunities within our organizations for people to identify closely with a group of colleagues. Interesting projects or experiences, even if short term in nature, can become opportunities not only to accomplish a particular task, but perhaps more importantly, to build bonds that will last for years. These connections can be instrumental to performing far more important work in the future.

Motivation for Innovators

The Innovaro Blog has an intriguing new post about the motivation for many innovators. The post specifically addresses those people inventing new apps for mobile phones such as the iPhone. Some of these innovators hope to profit from their innovation efforts, but many others do it for non-financial reasons. Companies have to be able to encourage and harness such innovation from a broad array of people, particularly when these innovators are creating complementary products that will help drive sales for their firms.

Change of Control Provisions

Business Week has an article today about change of control provisions enacted by various companies. Here's an excerpt from the article:

The tactic might well be called "the banker made me do it" defense. Amylin (a biotech firm) has in place a "change of control" debt covenant that requires it to pay back an outstanding loan if investors buy a large stake in the company or elect a block of board members. Amylin says it would be forced to pay back a $125 million Bank of America (BAC) loan if outsiders wrested control of its board, which in turn could force it to default on up to $900 million in debt. That could make Amylin unpalatable as a takeover target.

In my view, these takeover defense tactics do not serve shareholders well. A company should be capable of defending itself against a hostile takeover by performing at a high level, not through such gimmickry. If a firm isn't performing well, then perhaps a hostile takeover (or the credible threat of one) is the right medicine. After all, even the threat of a hostile takeover puts management on its toes, and it insures that management will not drag its feet on necessary restructuring moves when performance lags. That threat also insures that companies will not horde excess cash during and after a period of high performance.

One other type of change of control provision also proves troublesome. Some CEOs have change of control provisions in their compensation contracts. They stand to gain a huge windfall if the company is sold. These provisions clearly do not enhance shareholder value, nor do they help employees or customers of the firm. If the firm is performing well, and the CEO engineers the sale of the firm to another company, the CEO will benefit greatly anyway because he or she often holds a high number of shares and options (which will be purchased at a substantial premium). Why the need for an additional change of control "bonus"? If the firm is not performing well, then the CEO doesn't deserve any type of special added bonus because of a takeover. In fact, if the CEO loses his or her job in such a hostile takeover, he or she probably deserves it and certainly doesn't deserve a large bonus since the firm has underperformed.

Diseconomies of Scale AND Scope

In class yesterday, one of my exceptional students, Rick Moylan, asked me an interesting question. He said, "I have heard about diseconomies of scale. Is there such a thing as diseconomies of scope? It would seem that they must exist." What a terrific question! Clearly, we hear people talk about diseconomies of scale whenever a firm gets so large and complex that it becomes difficult to manage effectively. Recall that scale economies exist when costs per unit fall as the number of units produced rises. In other words, bigger is better. However, costs per unit often bottom out at some point, and then they start to rise again. We have heard reference to diseconomies of scale with regard to firms such as Citibank and General Motors, for instance. Frankly, I think too many executives justify large mergers and acquisitions on the grounds of scale economies without ever considering the potential for diseconomies.

What do we mean by diseconomies of scope? Well, first let's define economies of scope. We are talking here about multi-business unit corporations. In those cases, we would argue that scope economies exist if an economic benefit exists because multiple businesses operate under one corporate parent. People commonly refer to scope economies as synergies. For instance, one could argue that Disney's theme parks derive economic benefit from being in the same corporation as Disney's animation studio.

Can diseconomies of scope exist? Surely, they can. Sometimes, when firms diversify into new businesses, they actually do more harm than good. The expansion of scope does not enhance the value of the businesses in the corporate parent's portfolio, but instead diminishes their value. For instance, consider this hypothetical scenario. Imagine if Disney acquired a video game company with a reputation for making incredibly violent games. That expansion of scope may actually harm Disney's other businesses because it would damage Disney's brand image as a provider of "family entertainment." We would not have synergies, but instead a negative impact on the value of the firm as a whole. Once again, I think managers often discount the possibility of such diseconomies, focusing instead on making the argument for synergies that can justify a particular merger or acquisition.

Brad Brooks Show

Brad Brooks interviewed me for his radio show in Vancouver. The one-hour interview consists of an in-depth discussion of my new book, Know What You Don't Know: How Great Leaders Prevent Problems Before They Happen. To listen to the interview, click here to download the MP3 file. Thank you to Brad for having me on his show!

Consumer Interest in the iPhone and iPod

Piper Jaffrey has released interesting new survey results examining U.S. teenagers' interest in both the iPhone and iPod. Teens showed strong interest in purchasing an iPhone in the future. It clearly represented an aspiration for many young people, though they perhaps could not afford to buy one just yet. Here's some data that will astound you:

"[Piper Jaffrey's] Andrew Murphy attributes much of the iPhone’s popularity to the penetration of the iPod and iTunes Store among this cohort. The iPod’s market share has held steady at 86% over the past 12 months, and although only 19% of teens planned to buy a new MP3 player this coming year (down from 34% six months ago), 100%of those who did planned to buy iPods. Meanwhile, iTunes now enjoys a 97% market share among teens—up from 81% a year ago—with No. 2 RealNetworks hanging on at 2%."

We've written in the past on this blog about the power of network effects. Clearly, the iPod and iTunes are riding the benefits of a strong network effect. In other words, the more people that own an iPod or use iTunes, the more that potential new customers will value the iPod and iTunes. To give another example, consider eBay. I will value eBay more if there are lots of other buyers and sellers on eBay, because it enhances the likelihood that I will be able to find a buyer or seller for the item for which I have interest.

Apple, of course, has worked to enhance this network effect. For instance, consider the launch of Genius, which is new software that comes with iTunes. Click on any song in your library, and then Genius will create a playlist for you. That list will include songs in your library, as well as other songs that you can purchase via iTunes. How does Genius create the playlist? Well, it drives off of algorithms built based on data analysis of your preferences as well as those of millions of other iTunes users. The more people that use iTunes, the better Genius becomes at predicting what you will enjoy. Thus, Genius enhanced the network effect.

Facebook's Future

This Forbes article examines the future of Facebook. Interestingly, it calculates how many ads Facebook would have to sell to particular groups in order to offset its current burn rate of cash. The numbers are staggering. The article makes a strong case for why the site, which has done a remarkable job of attracting new users, may find it much more difficult to become highly profitable.

Dan McCarthy on Job References

Dan McCarthy over at The Great Leadership Blog has a thought-provoking post on the issue of references that are requested and/or provided when people search for employment. The post comes with a terrific Scott Adams cartoon as well!

Mission Planning

Tom Magness over at The Leader Business Blog has a series of interesting posts on mission planning based on research at the U.S. Army War College. Business leaders can learn from this work that's been done by military specialists in the area of planning and decision-making.

The Future of GE

Business Week has a great article on Immelt's strategic options at General Electric. The author, Jena McGregor, makes the case out that Immelt's options are indeed rather limited at this point. For instance, McGregor points out that some investors might believe that the company should be broken up, that the whole is no longer worth more than the sum of the parts. However, given the state of credit markets, it's hard for Immelt to find willing and able buyers for many of the GE businesses at this point.

While McGregor is correct about Immelt's short term options, I think a break-up of some kind is potentially in GE's future as the financial markets cover. Professor Stewart Thornhill of Ivey Business School is correct when he says in the article that companies do face diseconomies of scale at some point. At $180 billion in revenue, it's both hard to manage such a large and complex organization, and it's hard to grow that top line by a substantial percentage. There's simply a large numbers problem there. In fact, one might argue that Immelt's growth ambitions have been too ambitious all along. Trying to grow such a large organization at rapid rates can cause strategic missteps. Moreover, it ignores the diseconomies of scale problem that Thornhill points out.

Jon Stewart on Obama's Auto Plan

Jon Stewart delivered this very funny segment about the President's decision to provide federal government backing for automobile warranties.

Ford's Concerns

The Wall Street Journal has an interesting article about Ford's concerns regarding the federal intervention at GM and Chrysler. Ford's concerns appear very legitimate. First, they recognize the threat to their own supply chain if GM and/or Chrysler file for bankruptcy. Perhaps more importantly, they worry that a bankruptcy filing will enable GM and Chrysler to start anew with a much more competitive cost structure, perhaps giving them a leg up on Ford. I think the federal government will have to tread carefully here. While they may wish to assist GM and Chrysler, they certainly should not do so in a way that penalizes Ford. After all, Ford represents the only one of the Big Three who actually has managed to avoid having to ask for federal bailout funds.

GM and the SUV

Could journalists please stop saying that General Motors has failed because it made a huge bet on gas-guzzling SUVs. The notion is that somehow GM would be ok today if only it had been building green cars all along. This is complete nonsense. GM did not get in trouble in the past few years. Its demise traces back to the 1970s, far before the term "SUV" was even invented. In the 1960s, GM's market share stood at 50%. By the mid to late 1980s, it had fallen to 35%. By the late 1990s, GM's share had fallen below 30%. This crisis has been a long time in the making.