Wednesday, February 29, 2012

GM Alliance with Peugeot? Risky Business

News reports indicate that GM is considering an alliance with (and investment in) French automaker Peugeot. I'm skeptical of this strategic move.

The French automaker is struggling, as is GM Europe. It is rare that two weak companies join together and become formidable. Beyond that, here are three other reasons to question this deal:

1. GM has a poor track record of international alliances, joint ventures, and acquisitions.

2. GM execs may find this move distracting, when it should be focused on strengthening its position in the US and China, where profit potential is greater.

3. Why does GM need cooperation with Peugeot to build cars? Shouldn't GM have already moved toward global platforms that are only slightly adapted for local markets? Shouldn't GM Europe cooperate with GM China instead? Shouldn't it maintain a rationalized product line rather than proliferating similar models around the globe? It is possible to take localization too far, and GM has done so in the past, losing valuable scale economies.

Tuesday, February 28, 2012

Does "Buzz" Stimulate Creativity?

Building on yesterday's post regarding introverts and creativity, I thought that I would share news regarding an interesting study about creative cognition.  Christopher Shea of the Wall Street Journal reported this weekend on a new research study by Ravi Mehta, Rui Zhu, and Amar Cheema - forthcoming in the Journal of Consumer Research.   According to Shea,

"A moderate level of noise—the equivalent of the background buzz of conversation—prompts more-creative thought, according to a study.   More than 300 people worked on mental exercises, solving word-association puzzles and pondering practical problems (say, improving a mattress). At the same time, researchers played ambient noise recorded in a cafeteria, roadside, and at a construction site softly, moderately, or loudly, with the moderate level being about what you'd hear in a bustling cafe. People in the moderate-noise groups scored higher on the objective word-association test, and their answers to the other problems were rated, subjectively by peers, as more creative. The study adds to research suggesting that small doses of distraction prompt the mind to work at a more abstract—and creative—level."

Naturally, we need to be careful about drawing conclusions from these types of simple experimental studies.  However, the results do point to possible benefits for the type of collaborative spaces that Google, Pixar, and other firms have tried to create. These environments may be fertile not only because they bring people together, but perhaps because a bit of background noise might be stimulating. 

Monday, February 27, 2012

Introverts and Creativity: A Critique of Susan Cain's Argument

I've begun reading Susan Cain's best-selling book, Quiet, about introverts and creativity.   I also read her thought-provoking article in the New York Times several weeks ago.   Cain argues that introverts are exceptionally creative, and yet the world has become so "noisy" and "collaborative" that we might inhibiting these folks' creativity.   This weekend, I read an interesting, must-read rebuttal from Keith Sawyer, the outstanding creativity scholar who wrote a book titled Group Genius.  Sawyer argues,

"Psychologists who study creativity know that it requires both solitude and collaboration. Exceptional creativity involves a lot of hard work, and that often happens in solitude. But Cain misses the big picture: Researchers have found that breakthrough ideas are largely due to exchange and interaction, and that’s because breakthrough ideas always involve combinations of very different ideas." 

Sawyer also points out that most studies do not show a relationship between introversion and creativity.  I find Sawyer's argument about exchange and interaction very compelling.  It fits nicely with the argument put forth by Steven Johnson in his terrific book, Where Good Ideas Come From.  Johnson argues that good ideas emerge from "fertile environments" that enable "adjacent" ideas to "connect, fuse, recombine."  He argues  that collaboration and communication are essential elements to breakthrough innovation.  Innovators often take ideas from multiple disciplines and fields and recombine them in ways that lead to new insights and breakthroughs.  They have to immerse themselves in a domain and connect with others to achieve that synthesis and integration.

Friday, February 24, 2012

Deepening your competitive position - P&G tries Tide Pods

P&G has announced the launch of new Tide laundry detergent pods - single-dose, dissolvable packets of detergent, stain fighters and brighteners. The launch comes after a significant delay, as well as some uncertainty regarding the extent to which US consumers will embrace this premium-priced product.

We don't know if P&G will succeed with this particular innovation, but it illustrates the right kind of approach to competitive strategy. As many firms face slowing growth in a mature category, they diversify and turn their attention to new areas. However, that often accelerates the decline of their core business because they stop innovating with the seemingly mature product. Then someone does innovate and hurts the company badly. P&G is choosing to try to deepen their competitive position in household products rather than simply diversifying to new areas in search of growth. They have identified two possible consumer needs that pods may fulfill: convenience and better cleaning. Why better cleaning? Many consumers do not use the right amount of detergent - they just pour some liquid in the machine. These pods will provide just the right amount for a load. Naturally, the pods also provide convenience and less mess. Will consumers pay a premium? That's the key question. Still, the attempt to innovate and deepen the firm's competitive position in a mature market should be lauded.

Thursday, February 23, 2012

Sears Spinning Off Hardware Stores

Sears continues to struggle.  Yesterday, it reported a net loss for the last quarter of $2.4 billion. Same store sales declined during the quarter as well.   The firm announced that it will be bolstering its balance sheet by selling off its Sears Hardware stores (along with several other moves designed to increase cash).  I understand the move, given the liquidity concerns about the company.  However, I found one item in Chairman Lampert's letter to shareholders rather puzzling.  He described the third pillar of the company's strategy:

With regard to our third pillar, we still have a long way to go but Kenmore and Craftsman have held up relatively well, despite our overall company performance and housing builds and turnover continuing at relatively low levels.  In the fourth quarter of 2011, Kenmore maintained its market leadership in appliances, while Craftsman, too, gained market share.  But, market share alone is not enough.  When we think about brands, we think about brands like Nike and Apple, and we aspire to have Kenmore and Craftsman be the Nike and Apple of the appliances, tools, and lawn and garden industries.

If a key pillar of the strategy is to build the Kenmore and Craftsman brands, then why sell off the hardware stores?   Is Sears more known for and appealing to customers with regard to apparel or hardware?  Sears already had announced the intent to sell Kenmore and Craftsman products at other retailers.  Will the brands thrive if the hardware stores are spun off entirely?  Are there synergies that will be lost as a result of the sale of the hardware stores?  I don't know the answers to these questions, but I think management must address these issues and explain their thinking to investors. 

Tuesday, February 21, 2012

The Debate about Brainstorming

Jonah Lehrer recently wrote a fascinating New Yorker column in which he argued that brainstorming doesn't work.   In some ways, he's right on the money.   Academic studies often have demonstrated that individuals could perform better at a creative task than a group engaged in brainstorming.  For instance, Lehrer cites one of the early studies at Yale:

The first empirical test of Osborn’s brainstorming technique was performed at Yale University, in 1958. Forty-eight male undergraduates were divided into twelve groups and given a series of creative puzzles. The groups were instructed to follow Osborn’s guidelines. As a control sample, the scientists gave the same puzzles to forty-eight students working by themselves. The results were a sobering refutation of Osborn. The solo students came up with roughly twice as many solutions as the brainstorming groups, and a panel of judges deemed their solutions more “feasible” and “effective.” Brainstorming didn’t unleash the potential of the group, but rather made each individual less creative.

Unfortunately, Lehrer's column draws some misleading conclusions as well.  Scott Berkun, author of Mindfire: Big Ideas For Curious Minds, has written a strong rebuttal to Lehrer's essay.   Berkun offers four key criticisms of Lehrer's conclusions:

1. Nothing matters if the room is filled with morons or strangers (or both).

2.  Brainstorming is designed for idea volume, not depth or quality. 

3.  The person leading an idea generation session matters.

4.  Generating ideas is a small part of the process.  

Berkun takes particular issue with the conclusions that Lehrer draws from a study by Charlan Nemeth.  Brainstorming typically involves a shared norm called "deferred judgment."  Under that norm, participants do not criticize each others' ideas during the idea generation process.   Berkun explains Nemeth's study:

The primary thrust of Lehrer’s critique is based on 2003 study by Nemeth, where students were divided into groups and given 3 different sets of instructions.  In one group, no instruction was given (‘Minimal’). In the second group, basic brainstorming rules were given (‘Brainstorming’). In the last, brainstorming rules were given, plus students were allowed to critique each others ideas (‘Debate’).... The results do show that the group that could critique generated more ideas... [However] The debate groups was given brainstorming instructions, as well as an instruction to debate. It should be labeled “Brainstorming with debate“. If the only instruction they were given was to debate, it’d be a fair comparison. But it isn’t.

Lehrer concludes from this Nemeth study that stimulating dissent and debate works much more effectively than brainstorming.  I'm with Berkun - that conclusion is a step too far.   My work over the past fifteen years has focused a great deal on the importance of debate and dissent.  I'm glad that Lehrer has chosen to emphasize its importance.  However, an effective group process doesn't employ either deferred judgment or dissent and debate.  It involves both!  In the idea generation phase, deferred judgment makes sense as a norm employed to encourage the generation of many different ideas and options.  Later, dissent and debate become critical as a means of comparing and contrasting those options, and perhaps facilitating the development and generation of more ideas and alternatives.

One final point - Later in the article, Lehrer describes the many innovations that emerged from Building 20 at MIT over the years.  He concludes, "The lesson of Building 20 is that when the composition of the group is right—enough people with different perspectives running into one another in unpredictable ways—the group dynamic will take care of itself."  In other words, if you get the team composition right, you will automatically get lots of constructive dissent and debate.  I disagree wholeheartedly with this conclusion.  It's just not right.   You do not guarantee constructive dissent and debate simply by building a diverse team and giving them a forum for dialogue.  In many settings, people simply don't speak up.  Groupthink occurs even in diverse teams at times.  Yes, you have to get the composition right, but group dynamics do not take care of themselves. They take hard work on the part of a leader.   Leadership matters!  Process matters!  

Friday, February 17, 2012

Big Data,, and the Importance of Analytics

Several days ago, the New York Times published an article titled, "The Age of Big Data."  The newspaper described how companies will need many more data analysts who can "help businesses make sense of an explosion of data — Web traffic and social network comments, as well as software and sensors that monitor shipments, suppliers and customers — to guide decisions, trim costs and lift sales."   The article cited a McKinsey Consulting study which predicted that the United States will need 140,000-190,000 more employees with “deep analytical” expertise" in the coming years. 

As an example of the importance of big data, consider the online retailer (owned by Amazon).   Forbes writer Meghan Casserly describes the firm's use of big data in an article published on the magazine's website.  The company has built powerful proprietary algorithms over the past few years based on tons of transactions.  These algorithms predict what customers are likely to buy in the future, how much they will spend, and whether they will be profitable for the firm.  The company's strategy focuses on building loyal customers who purchase low margin baby supplies initially, and then buy higher margin items such as car seats, strollers, and the like in the future.  The algorithms not only help predict purchasing patterns, but they enable and its sister sites to market appropriately to different customers.  Perhaps most importantly, the firm can identify which customers will be profitable for the firm.  Thus, they can spend their time catering to the most profitable customers, rather than wasting marketing expenditures on consumers who will be a drain on resources. 

Every company should be thinking about how it can use algorithms to drive performance.  Analytics can be used in a myriad of ways.   However, building a strategy based on big data requires the right talent.  Therefore, firms need to begin thinking carefully about how they will attract, develop, and retain the talent needed to collect and analyze the huge volumes of data that now exist.  Universities need to think about how to educate people for these roles, as demand will be strong.  We need to do more than educate people in mathematics and statistics though.  We need analysts who can understand business models and strategies, and who have a deep understanding of consumer behavior too.   The best analysts will be those who can marry statistical knowledge with a broader understanding of the entire organizational system.  

Thursday, February 16, 2012

Top 50 Business Professors on Twitter

I'm very honored to have been named one of the top 50 business school professors on Twitter by the website.   Thank you so much!   I hope my blog readers will follow me on Twitter.  The handle is @michaelaroberto

Kellogg, Pringles, and P&G

Over the past few weeks, a scandal at Diamond disrupted the firm's intent to purchase the Pringles business from P&G.   As a result, Kellogg swooped in yesterday to acquire Pringles instead.  Investors and analysts generally reacted positively to the deal.  The Kellogg stock price rose 5% on the news of the deal.  Analysts believe that Kellogg will accelerate its international growth with the Pringles purchase for two reasons.  First, many countries do not consume cereal as much as the United States.  Second, the existing snack business at Kellogg is fairly US-centric as well.  Pringles offers access to many international markets through its extensive distribution channel, as well as a product more appealing to many foreign consumers. 

While most people are focused on Kellogg today with this news, my attention has turned to P&G.  The Pringles divestiture continues a strategy undertaken by former CEO A.G. Lafley several years ago.  Lafley began to divest many of P&G's low-growth food businesses such as Jif, Crisco, and Folger's Coffee.  He refocused the firm on two categories in which it was dominant, and in which it had strong international growth prospects - i.e. health/beauty and home care/household cleaning. 

A natural question to ask:  What remaining brands might be candidates for divestiture?   I would focus on the Iams pet food business.   While the product line represents a billion dollar brand for P&G, it faces a number of challenges.  First, private labels represent strong competition in the pet food category (unlike some strong P&G categories such as razors/blades).  Wal-Mart's private label, Ol' Roy, is the top-selling dry dog food in the United States!   Second, Iams doesn't benefit from purchasing synergies with other food businesses, as some pet food brands owned by rivals do (for instance, Nestle owns the Purina family of brands, as well as a host of other businesses that procure agricultural inputs).  Third, the Iams business has not performed as well financially as many other parts of the P&G portfolio. 

Wednesday, February 15, 2012

Paul Levy's New Book: Lessons about Leadership from the Executive Suite... and the Soccer Field

As many of my readers know, I'm the co-author of a multi-media case study and a Harvard Business Review article about Paul Levy's turnaround of the Beth Israel Deaconess Medical Center.  Paul took the helm in January 2002, when the hospital was in dire straits.  As CEO, he helped the hospital return to profitability, after years of losses.  Prior to his tenure at the BIDMC, Levy served as Executive Dean for Administration at Harvard Medical School, where he was responsible for administrative, budgetary, and facility issues.  He also served as Executive Director of the Massachusetts Water Resources Authority, where he led the "Boston Harbor Cleanup," one of the largest pollution control projects in the country.  Levy also writes a popular blog titled "Not Running a Hospital.

Levy now has written a terrific new book, which I highly recommend.  The book - Goal Play! Leadership Lessons from the Soccer Field - weaves together anecdotes from his twenty years of youth soccer coaching with his experiences as a chief executive.  Levy uses examples from these disparate settings to illustrate his theories of effective leadership.   This book is not the usual fluff that we read in books that try to apply lessons from sports to business.  Levy offers concrete lessons that can be applied by leaders in many different kinds of organizations.  He illustrates his ideas with anecdotes from soccer, but then shows you those ideas in action in the executive suite.   Along the way, he describes the effective actions of other executives too, rather than simply drawing on his personal stories.

Levy describes how you can be a supportive and transparent leader.  However, he also describes how to make the tough calls required to improve organizational performance.   Levy's book and his experiences show that making tough decisions doesn't mean simply dictating plans to the troops in your organization and ordering them to follow you.   How can you be supportive and empowering, yet still move quickly and get results?  That's the question Levy seeks to answer in this book. 

Monday, February 13, 2012

Team Scaffolds: Enhancing Group Effectiveness

Melissa Valentine and Amy Edmondson of Harvard Business School have published an intriguing new working paper about team effectiveness.  Valentine and Edmondson explore a concept that they call "team scaffolds" in this paper.   The scholars ask the question: "It is increasingly necessary for 24/7 shift operations to include some component of team-based work. But how can organizations support such work among constantly changing groups of people in a setting where stable teams are not feasible?"  They examine this question by studying an urban hospital's emergency room.  However, the findings apply to other settings in which people often work in unstable/transitory teams. 

The scholars begin by pointing out that many organizations cannot design and use stable teams for certain types of work.  How then can they make these teams effective, given that the team design literature suggests a certain level of structure and cohesion boosts group performance?   Valentine and Edmondson explain that scaffolding proves quite effective in the emergency room setting that they studied.  Team scaffolds consist of "a bounded role set with collective responsibility for interdependent tasks."   In other words, team roles have been so well-defined that members can step into a role and interact effectively with their peers, even though they haven't worked together as a unit on a regular basis.

The emergency room in the study underwent a major transformation.  The ER did not have a team structure prior to the change.  Patients were treated in a sequential/linear process with various functions performed by different staff members who did not work as a team.  The hospital changed its organization structure, creating what they called "pods" - a physical location with dedicated computers, counters, supplies, beds, and crash rooms. The authors explain:

The pods were each staffed by one attending, one in-charge resident and possibly another resident or intern, and typically three nurses, one of whom was designated the “Pod Lead.” The pods themselves were stable structures that persisted over time, but the staffing of the pods changed constantly. Within some five-hour periods, all of the individuals staffing the pod composition may have turned over completely as a result of shift changes staggered across roles. The nurses, residents, and attendings (collectively called providers) were assigned to a pod at the beginning of each shift. Provider pod assignments were made more-or-less at random, and a provider may have been assigned to a different pod every shift. Their “pod mates” were typically different every shift as well. Education tended to happen within each pod following the redesign, rather than through a department-wide formal rounding process. The attending and resident worked closely together as they cared for patients and informally rounded together several times during the shift, as well as during the shift change between attendings or residents. Note that the pod system connected a clearly defined set of roles (the attending, one or two residents, and three nurses) with collective responsibility for a set of tasks (the patients assigned to the pod) bounded by a shared physical location.

What happened as a result of the structural transformation?   Valentine and Edmondson found that patients’ average time in the ER fell by nearly 40% after implementation of the pods.  The key, though, is that these pods did not constitute stable teams.  However, people worked together quite effectively in these group structures.  The authors argue that the well-defined boundaries and roles facilitated effective coordination.

Thursday, February 09, 2012

Leaders, You Should Read History

Fortune recently interviewed Bob Rodriquez, CEO of First Pacific Advisors. He explained the best advice he ever received. The guidance came from Charlie Munger of Berkshire Hathaway, when he visited a class Rodriquez was taking at USC in the 1970s. Rodriquez said, "After the class was over, I walked up to Charlie and asked him if there was one thing that I could do that would make me a better investment professional. His answer was, 'Read history, read history, read history.' And so I became a good historian, reading both economic and financial history as well as general history.What I learned is that people relate to the crises they have experienced. So when the crisis of 2008 came, it felt like an old friend to me because it had so many similarities to the banking crisis of 1907. Asking Charlie's advice and then reading history allowed me to put those things in context." I agree wholeheartedly. However, I would note that one must scrutinize historical analogies very carefully. We have a tendency to focus on similarities and ignore differences when drawing historical analogies. For more on reasoning by analogy, I highly recommend the work of Ernest May and Richard Neustadt - great book called Thinking in Time.

Wednesday, February 08, 2012

Old Milwaukee: A Low-Budget Super Bowl Ad?

Companies spend enormous sums of money advertising during the Super Bowl.   If you are Budweiser, you can afford to invest in this type of marketing.  However, if you are Old Milwaukee beer, it becomes more difficult to justify that type of marketing expense.   The firm simply doesn't have the scale to support that type of advertising.  Moreover, it's not a premium beer; the firm has a simple, low cost strategy.  Old Milwaukee came up with an ingenious solution though.  They developed a simple TV commercial with Will Ferrell, who happens to love their beer.   It didn't run nationally though.  The firm ran the commercial in only one market - North Platte, Nebraska.  The town has approximately 15,000 homes.   It's the second smallest TV market in the country by Nielsen standards.  Why run the ad in this market?  Old Milwaukee actually leveraged that low-cost TV ad to create excitement via social media.   Boston-based advertising agency Mullen has reported that the Old Milwaukee ad generated more mentions on Twitter Sunday night than many nationally aired Super Bowl ads.  Moreover, a user uploaded a low-quality copy of the ad onto YouTube.  Old Milwaukee set up a link to YouTube on its official Facebook page.  Soon, the ad had been viewed more often than Budweiser's primary Super Bowl commercial!

What's the lesson here?  If your firm has a low cost strategy, it must think creatively about how to market its products.  Social media offers an opportunity to promote a brand at very little expense.  However, many firms are blitzing social media platforms these days.  It's become a cacophony at times.  Therefore, you have to think about how to emerge from the clutter.  Old Milwaukee did just that with an ad that not only generated buzz initially on Twitter and Facebook, but that also had a second life as a story picked up in the mainstream media about an innovative marketing strategy.  That story, of course, will live on far longer than the immediate surge of interest generated on Twitter and Facebook Sunday night.  After all, look at this blog and many others which are writing about it!

Tuesday, February 07, 2012

Do Colleges Need to Change Their Pricing Model?

CNNMoney writer Blake Ellis wrote today about the substantial tuition reduction enacted by the University of Charleston in West Virginia.   According to the article, "After seeing enrollment decline for the first time in a decade, the University of Charleston, in West Virginia, slashed tuition by 22% for the upcoming school year hoping to entice more students."  Interestingly, applications haven't increased since the move, but deposits have risen substantially.  Obviously, the jury is still out on the move. 

How did the university afford the move?   They cut some costs, but they also chose to reduce financial aid.  Thus, the net price did not actually fall by 22%.  What rationale drove the change in pricing strategy?  Here is an excerpt from Ellis' interview with the university's president, Dr. Edwin Welch:

We realized parents and families were now considering the overall price, not just the discount [financial aid and scholarships] they would be able to get. As universities we tend to market education the same way Joseph A. Banks advertises clothes, thinking the advertised price is not that important but the discounts are the most important part. But that's what is driving middle-class students away. So it seemed we needed to take a fresh look.

Could he be right?  Does the price tag at many universities drive away certain families, because they fixate on the overall list price rather than the net price (after aid and scholarships)?  After all, families don't learn their net price until late in the process?  By then, perhaps the overall list price has framed their view of a school.  I wonder if other schools might try this "Everyday Low Pricing" model of college tuition, in hopes that prospective students will look first at them because they have the lower "everyday price."  

Monday, February 06, 2012

The Changing Composition of Top Management Teams

Maria Guadalupe, Hongyi Li, and Julie Wulf have published an interesting paper that examines the changing size and composition of senior management teams.   The scholars compiled a dataset of US firms from 1986 to 2006.   They found that the size of the top management team doubled during this twenty year period (from 5 members to 10 members).   What drove the increase in size?  The researchers found that CEOs tended to add more functional executives to their senior teams (rather than more general managers with P&L responsibility for specific business units).   For instance, many senior teams now have a Chief Technology Officer, EVP of Human Resources, EVP of Supply Chain, etc.   Finally, the study shows that, "General manager pay decreases as functional managers join the executive team suggesting a shift in activities from general to functional managers-a phenomenon we term 'functional centralization.'" 

Are these trends all positive?  It's not clear to me.  In particular, I worry about the growing size of these teams.  Groups have a hard time being productive and efficient when they grow to double digits in terms of members.  The opportunity arises for more fragmentation within the teams.  Scholars have described a phenomenon called "fault lines" - where subgroups form along certain demographic lines, and friction emerges among the subgroups.  Communication patterns and information sharing may also suffer as team size increases, even if the group remains fairly cohesive. 

Friday, February 03, 2012

Will Facebook Acquire Zynga?

The Wall Street Journal has a good article describing the co-dependency that has evolved between Facebook and Zynga.  The paper reports the following statistics about the two firms:

"Facebook, based in Menlo Park, Calif., derived 12% of last year's $3.71 billion in revenue from Zynga, according to the social network's IPO prospectus released Wednesday.  Meanwhile, Zynga, the San Francisco-based social gaming company that makes many games that are played on Facebook, received 93% of its revenue last year from virtual goods it sells on the social network."

Economic theory suggests that the two firms may be headed for a merger.  Why?  Oliver Williamson, the Nobel-prizing winning economist, has argued that companies consider transaction costs when determining how to organize themselves.  Put simply, firms compare the efficacy of using the market to organize economic activity to the efficacy of organizing such activity within the firm.  Often, companies establish contracts, strategic partnerships, or formal alliances with other firms if the arrangement provides value to both parties.  However, these market-based transactions sometimes become problematic.  Why? One reason is that the potential for opportunism and hold-up occurs.  That is, the firms may try to take advantage of each other.  Such holdup tends to occur in situations of co-dependency. 

Let's take a classic example from Williamson's work.  Imagine an oil refinery adjacent to a pipeline, each owned by separate parties.  What if the refinery and the pipeline each had no alternative uses.  That is, the only way to ship the oil from the refinery was from the pipeline, and the only use of the pipeline was to ship that refinery's output.  In that situation, each party would be beholden to the other, and they might find it hard to work together amicably via contract or alliance.  Merger tends to be an outcome in such circumstances.

We had a similar situation in the entertainment business recently.  Disney and Pixar had worked together through a contractual relationship for many years.  Then, Disney and Pixar entered into contract renewal negotiations in 2005, and the relationship became strained.   Why?   I would argue that the two firms had become co-dependent over time.  Disney needed Pixar, because its own animation studios had fallen on hard times.  Meanwhile, Pixar needed Disney because the original contract had given Disney certain rights even if Pixar terminated their relationship.  Disney could continue using the characters from the early Pixar movies, and they could make sequels to those movies, even if Pixar partnered with someone else in 2006.  Pixar really didn't want to see that happen to their beloved characters.  Not surprisingly, Disney acquired Pixar in 2006, thereby choosing horizontal integration over a market-based relationship - just as Williamson's theory would predict.

Now, we could have a similar co-dependency emerging between Facebook and Zynga.  Could a merger be in the cards?  It's certainly something to watch.  On the other hand, Zynga has been working to diversify its revenue base lately.  That may lessen the co-dependency over time.

Thursday, February 02, 2012

Overestimating economies of scale

The Wall Street Journal's Heard on the Street column yesterday discussed Fiat's relationship with Chrysler.  The article cites the risks that Fiat faces, particularly in its home market given the EU fiscal crisis.  It suggests that Chrysler and the American market may be even more key to Fiat's future viability than many people originally thought.  The column stresses, however, that Fiat remains a sub-scale automaker, with only about 2 million units of production annually.  It points out that Fiat CEO Sergio Marchionne believes automakers must reach 6 million units to be cost competitive in the global market.  I think it's dangerous to simply take a CEO's assertions about economies of scale at face value.  CEOs often over-estimate minimum efficient scale for several reasons.  First, they assume market share is more highly correlated with profitability than it actually is.  Second, executives are often obsessed with top line growth, believing it will always bring greater profits.  Of course, undisciplined growth often harms earnings.  Third, CEOs derive personal satisfaction from running bigger and bigger firms.  They garner power and fame as a firm expands in size.  Fourth, leaders often overestimate synergies that will emerges they merge entities to go after scale economies.  Finally, executives forget to account for the very real possibility of diseconomies of scale that may emerge as large firms become more complex and bureaucratic.