Recessions and Differentiation Strategies

Eac day brings news of slowing economic growth. Moroever, we see many retailers reporting disappointing earnings and/or slicing their outlook for the year ahead. These reports raise an interesting question. How should retailers with a differentiation strategy react during a recession? By differentiation, I mean retailers who try to create better-than-average willingness to pay on the part of their customers, thus enabling them to charge premium prices. Limited Brands, for instance, employs a differentiation strategy in its businesses such as Victoria's Secret. Meanwhile, TJX tends to employ a low cost strategy in its businesses such as Marshall's.

The challenge during a recession is that many differentiated players may suffer larger declines in sales than low cost players, as budget-conscious shoppers flock to outlets that offer rock-bottom prices. My view is that differentiated retailers must be very careful during recessionary periods. The natural inclination might be to slash prices to retain customers during sluggish economic times. However, lower prices means lower margins, unless the retailer can also reduce costs. Herein lies the problem. If differentiated players are not careful in their cost reduction efforts, they may damage their brand, quality, and market reputation - thus compromising their position in the market and their ability to return to premium pricing in the future. Thus, the differentiated players in the retail sector have to be very careful, as efforts to shore up their financials during a recession can have long term detrimental effects that persist long after robust economic growth resumes.

New Strategies for the TV Networks

The Wall Street Journal reports today that the major broadcast networks are considering doing away with some age-old conventions of the television business in an attempt to entice viewers and advertisers back after the lengthy writers' strike. Well, it's about time!!! I've wondered for many years now why the broadcast networks have adhered to certain conventions, while their ratings have deteriorated. It's seems a classic case of a business being caught in a particular mental model, and not able to shake those basic assumptions while the world around them is changing dramatically.

Here are some questions that all the networks should consider: Why should most new shows premiere in September? Why must the season run from September to May for most shows? Why should nearly every series air episodes once per week? Why not have some series that run episodes in a more condensed fashion, perhaps with 2-3 episodes per week for a few months? Why not create an event, some hoopla, out of the testing of new pilots, perhaps creating a 2-3 day block several times per year filled with a whole array of pilots? Why not couple that with a huge web-based effort to collect feedback about those pilots? We could go on and on... this is clearly a business that needs to be re-tooled, and that begins with shaking the old conventions. I'm glad to hear some executives are beginning to question the conventional wisdom in the business.

Selling the Chicago Cubs

The Wall Street Journal has a story today on page B1 about Sam Zell's attempt to sell the Chicago Cubs. Apparently, Zell would like to sell the Cubs and Wrigley Field separately to different buyers. The paper reports that Zell is exploring the sale of the ballpark to a state agency in Illinois, while seeking a private buyer for the team. The paper also reports that "most observers believe he will make more money" by selling the two entities separately.

I wonder about this conclusion. Strong arguments can be made that, in fact, it makes more sense for the Cubs to remain a vertically integrated organization - with both the team and the ballpark sitting under one corporate umbrella. When we think about vertical integration, scholars tend to think about transaction costs, i.e. the costs associated with contracting and coordination between two parties. Some would argue that the transaction costs associated with the team and the ballpark trying to cooperate as separate entities exceed the transaction costs associated with that same cooperation if the two entities were part of the same corporation, with the same owner.

What drives transaction costs? Well, scholars like to think about what they call "transaction-specific assets." An example of a transaction-specific asset would be if a supplier had to invest in specialized technology in order to manufacture components for one of its customers. In that scenario, the two parties can become beholden to one another. The opportunity exists for what economists call "holdup" i.e. one party can try to renege on obligations and perhaps try to extract additional value from the other party. In that type of situation, we tend to see vertical integration arise, i.e. the customer merges with the supplier.

In this case, I think that there may be a high degree of asset specificity... to put it simply, the Cubs are closely linked to Wrigley; it's highly unlikely that the Cubs will have the option to play anywhere else in the foreseeable future. Thus, I think the potential for holdup and opportunitistic behavior exists if the two entities are owned separately and trying to negotiate contracts to cooperate with one another. I think that transaction costs associated with coordination and cooperation might be lower if the team and ballpark are owned by the same corporate parent.

Save the planet AND make money

Gary Hirshberg, CEO and founder of Stonyfield Farms, has a great new book about how his company has managed to become very profitable, while adhering to "green" environmental practices and principles. Stonyfield is quite a company; they generate $300 million in annual revenue, and have become the world's largest organic yogurt producer. Hirshberg's book offers practical advice for managers by detailing the specific ways in which his firm has managed to increase revenue and profits, while also promoting sustainable environmental practices. I'm looking forward to hear Hirshberg talk about his book when he visits our campus here at Bryant University on March 19th.

Yahoo in Play

With Microsoft's unsolicited bid for Yahoo, it's now clear that Yahoo is in play. It's likely that other offers will follow, particularly with Google now poised to perhaps help Yahoo find a white knight. My guess is that Yahoo's board and management will try to raise the selling price by attracting other bidders, recognizing that shareholders will not accept a rejection of the bid and maintenance of the status quo.

One key question is: Can Yahoo find a bidder whose culture represents a better fit than Microsoft? Cultural mismatch represents a key hurdle in many acquisition integration efforts, and it surely would be an obstacle if Microsoft purchases Yahoo. Perhaps another company could provide a better match.

Alternatively, we could see a bid by a firm such as News Corporation. Murdoch has a reputation for allowing each of his businesses to run fairly autonomously, though he intervenes selectively on key strategic choices. Perhaps Yahoo's board and management would conclude that they can live with a takeover by News Corporation, because those top managers who remain would maintain some autonomy, rather than facing full integration with other News Corp businesses.

The Financial Meltdown: From Blame Game to Collaborative Problem-Solving

The WSJ's Davos Blog has some interesting comments from Charles Dallara, managing director of the Institute of International Finance. Dallara argues that people around the world need to stop pointing fingers at the US for the current crisis, and instead, begin thinking about how central banks and governments can work collaboratively to improve economic conditions. He points out that the financial system is a global one, with many interconnections. All problems can't be solved at the national level.

I think Dallara makes a good point about the need to shift from the blame game to some collaborative problem-solving. Yes, the US regulatory system may need some fixing, but I'm sure that no nation has a perfect system. It's time to work together to iron out some of these issues that led to the current situation.

I find the finger-pointing so interesting because employees in companies do this all the time. Too often, managers spend far too much time assigning blame when a problem occurs, or trying to dodge blame, rather than confronting the issues openly and fixing them collaboratively.

Developing the Leadership Capabilities of Your Children

Michael McKinney of The Leading Blog points parents to a great article by Tim Elmore of GrowingLeaders.com about the attributes that we should be nurturing in our children. I especially liked the points about humility, gratitude, and being teachable - i.e. being willing to seek advice and wisdom from others, and being a good listener in those situations. We can all work on being more teachable - children as well as adults. As a faculty member, I think this list is useful to think about in terms of how we can nurture the development of our students personally as well as professionally.

Challenging the Tipping Point

Great article in Fast Company about Columbia sociologist Duncan Watts and his research that challenges a key assertion in Malcolm Gladwell's book - The Tipping Point. Watts studies social networks. He has done a number of studies, using computer simulations, to examine Gladwell's assertion that a small group of influential and connected people tend to trigger social trends. He concludes from his work that these influencers don't have nearly as much influence as Gladwell believes. It's a fascinating debate about how social trends emerge, and not surprisingly, many marketers are deeply skeptical about Watts' research findings.

Evaluating Companies...Lessons from the Jim Rice Debate

This week, Jim Rice, a famous Boston Red Sox slugger of the 70s and 80s, was denied entry into the Hall of Fame once again. To explain this, many sportswriters point out that he "only" hit 386 career home runs. Yet, he played when hitting thirty home runs in a season actually meant something. Many others have played during a more recent era in which balls have flown over the fences at an unprecedented rate. Rice was one of the game’s most feared hitters for a decade. How should we measure his performance? For starters, we should not focus on raw numbers alone, because today’s offensive numbers are grossly inflated relative to the 1970s (thank you, steroids and HGH). Instead, we ought to see how a player fared relative to others who competed during the same era.

Let’s see how Rice stacks up . One good measure of preeminence in a particular era is the Most Valuable Player award voting. Right away, we see a stark contrast between Rice and many other great ballplayers. Jim Rice earned one MVP award, but he also finished in the top five in the MVP voting on six separate occasions - a remarkable feat. To put this in perspective, Rice finished in the top five more often than many Hall of Famers including Reggie Jackson, Willie McCovey, Willie Stargell, Dave Winfield, George Brett, Tony Perez, and Boston's own Carl Yastremski!

Why do I bring up the example of Jim Rice? For one, I'm a Red Sox fan who believes that it is wrong for him to have been repeatedly denied entry into the Hall of Fame :-) However, I also bring up Rice's case because, too often, journalists, students, and practicing managers make the mistake of looking at company's financial results in isolation, rather than thinking about how they are doing relative to their competitors. They make the same mistake that sportswriters have made with regard to Rice.

With the economy slipping perhaps into recession, many firms are experiencing a deterioration in their financial results. The key question, however, is this: Are some firms able to weather the storm more effectively than others? The headlines shouldn't be: XYZ retailer experiences downturn in comparable store sales growth. Why is that newsworthy these days? Almost all retailers are experiencing softness in their numbers. What we really want to know, particularly as investors, is this: Is XYZ retailer experiencing more or less of a downturn in performance relative to its rivals? Too often, articles fail to explore this very important comparative data.

Entrepreneurship Myths

On Guy Kawasaki's blog, Professor Scott Shane of Case Western has a phenomenal post on the ten biggest myths about entrepreneurship. It's a must-read.

Schultz Returns as CEO of Starbucks

Breaking news this afternoon that Howard Schultz has returned to the role of CEO at Starbucks. The news comes on the heels of a front page article in the Wall Street Journal today, which focuses on how McDonald's is expanding its direct competition with Starbucks in terms of coffee sales. That article proved very interesting, because it is clear that the strategies and product offerings of Starbucks, Dunkin' Donuts, and now even McDonald's have been converging over time. Strategy convergence generally isn't a good thing in industries; it tends to enhance direct and intense rivalry among firms and diminish overall industry profitability.

Kudos to Schultz for finally recognizing that Starbucks needed to re-think its strategy. They had drifted from their core strengths in recent years, and ultimately, it began to affect financial performance. In the letter Schultz posted on the Starbucks website, he notes that the company will scale back the growth of domestic locations and even close some underperforming stores. Moreover, Schultz states that Starbucks will seek to reconnect emotionally with their customers, enhance differentiation relative to rivals, and launch new products.

Here are some issues that should definitely be on the table as Starbucks considers its strategy moving forward:

• Should the company continue to serve breakfast sandwiches? Does this really fit with the Starbucks experience? Do the sandwiches take away from the atmosphere in the store, and from the focus on coffee?
• Should the company continue to build drive-thrus? Do these fit with Schultz' initial vision of Starbucks as a "third place" where people gather and enjoy coffee together?
• Should the company take some products off of the menu? Is the product proliferation diluting both product quality and the quality/speed of the service by the baristas?
• Should the company consider offering free wireless, as competitors such as Panera Bread do, so that customers may come and spend more time in the stores?

Naturally, the list goes well beyond these questions. Schultz' return provides a tremendous opportunity for Starbucks to confront key strategy issues such as these and rekindle the magic that drew in so many customers over the past twenty years.

Training Generation Y

Fortune magazine had an article last month about how UPS transformed its training practices to address the unique ways that Generation Y tends to gather information, communicate, and learn. The story is fascinating for me as a professor because it shows the power of active learning.

Let me explain. Lectures invite passive learning; the student sits and listens quietly as the professor drones on and on... The student isn't involved in the creation of knowledge; they are an empty vessel hoping to be filled up with knowledge. Active learning involves participation by the student in the educational process. It involves discussion, hands-on projects, simulations, experiential exercises, etc. Ideas and knowledge emerge from the process of trying to apply concepts to real problems.

UPS recognized that Generation Y tends to react in a particularly negative way to passive learning techniques. Thus, they shifted to an approach that emphasizes hands-on training - very much an active learning orientation. Here is one great example from the article:

The final kinetic-learning module - or for non-academicians, hands-on learning tool - is the crowd-favorite slip-and-fall simulator. UPS incurs significant costs every year from slips and falls, and it is first-year drivers who succumb the most. Lucky for first-years then that Thurmon Lockhart, director of the Locomotion Research Laboratory at Virginia Tech, has devoted his entire life to the issue. In his studies Lockhart has found that the only way to help people avoid falling is to "perturb" them - i.e., to put them through the motions of falling - which causes their bodies to adjust during subsequent encounters with falling hazards.
To that end, Lockhart's lab houses a falling machine - a nine-foot-high metal frame with a body harness attached to it. A subject puts on the harness and gets comfortable walking back and forth, and then someone sneaks up behind her and spills soapy water, causing the subject to slip, scream, and flail around before getting caught by the harness. It sounds funny - until you wipe out. For the record, having experienced this first-hand, I was perturbed, and my gait remains adjusted. "This type of research has been going on since the 1920s," Lockhart says, "but UPS is going to be the first to apply it. And when their guys get out of the program, they'll almost be ergonomists. The training is that good." Now there's a shiny new brown version of the simulator at the training center.

The article reports that UPS has experienced much success with these new training methods. My belief is that active learning always trumps passive learning, though perhaps that is even more true with Generation Y. The lesson of this UPS story applies in a range of settings... from the classroom at business schools, to corporate training programs such as the driver training at UPS, and even to corporate leadership development programs populated by senior executives. Let the lectures cease!

Develop Teams, Not Just Individuals

Fortune recently published an article on how great companies develop future leaders. While the article did not provide any earth-shattering new insights, it did point out some key practices that are often discussed, but not always put into practice. One technique that warrants a great deal of attention has to to with team development. The article suggests that companies should "develop teams, not just individuals." They point out that General Electric now sends entire management teams to Crotonville, and each team goes through a developmental experience in which they apply what they are learning to their business. Given that many leadership development programs seek to address topics such as team dynamics, communication, decision-making, and the like, it makes sense for intact teams to experience these programs together.

Of course, organizations must not allow the intact teams to isolate themselves in these types of leadership development experiences. One key benefit of leadership development programs is that emerging leaders have the time to network with their peers in other parts of the organization. Often, these peers work in far-flung parts of the world, and they don't know one another quite well at all. The leadership development program offers them time to get to know one another, share best practices, and explore collaboration opportunities to advance the business. If intact teams attend these leadership development programs, one has to be careful that managers don't spend all their time with their own team, thus spending far too little time networking, sharing, and learning from their peers in other parts of the business.

Apple Video Rentals

Yesterday, Apple made major headlines with news of a possible deal with Fox to offer video rentals via iTunes. The fundamental question, in my view, is how Apple will leverage a movie rental business into the sale of more hardware. It's hard to imagine a dramatic new surge in iPod sales because of the movie rental launch. Moreover, it's easy to imagine price battles among the major players, such as NetFlix, who compete in the movie rental business . On the other hand, perhaps Apple is poised to build upon its early Apple TV product, or launch an altogether new product designed for consumers to easily view movies downloaded via iTunes. If Apple can couple the on-line movie rentals from iTunes with an easy-to-use piece of hardware, then they can generate substantial profits. Once again, they will have executed a successful blades and razors strategy, i.e. selling inexpensive blades (movie rentals) to generate high profits from hardware sold at a price premium (Apple TV or some other product used to view the movies, transfer them easily from PC to TV, etc.).

Moneyball & The Lessons for Business Leaders

Several months ago, I was interviewed by Bret Dougherty, author of The IronDog Chronicles, a very interesting blog about sports, media, and entertainment. Bret co-hosts WXYC’s ‘Sports Rap’ on Sunday nights in Chapel Hill, North Carolina, while also pursuing his MBA at UNC-Chapel Hill. Here is the link to the recorded interview, which focused on my case study about the rise of sabermetrics in baseball, and some of the lessons for business decision-makers.

Dsylexics as Entrepreneurs

Business Week had a fascinating article about new research suggesting that dyslexics may tend to become successful entrepreneurs, particularly in the United States. Here is a brief excerpt from the article:

That kind of rejection, along with a penchant for creativity, may help explain why so many dyslexics are inclined to become entrepreneurs. Julie Logan, a professor of entrepreneurship at Cass Business School in London, believes strongly in the connection.

In a study to be published in January, Logan found that 35% of entrepreneurs in the U.S. show signs of dyslexia, compared to 20% in Britain. Logan attributes the gap to a more flexible education system in the U.S., vs. rigid tracking in British schools, and better identification and remediation methods. "Most of the people in our study talked about the role of the mentor and how important that had been," Logan says. "The difference seems to be somebody who believes in you in school."

The broader implication, she says, is that many of the coping skills dyslexics learn in their formative years become best practices for the successful entrepreneur. A child who chronically fails standardized tests must become comfortable with failure. Being a slow reader forces you to extract only vital information, so that you're constantly getting right to the point. Dyslexics are also forced to trust and rely on others to get things done—an essential skill for anyone working to build a business.

The article raises some interesting points regarding dyslexics as entrepreneurs, but I think it also should cause us to consider some more fundamental questions about our entire education system . In the era of self-esteem promotion during the 1990s, our schools often heaped praise on children. They sought to bolster each child's self-image. For me, this article suggests that we should make sure that we also focus on building our children's capabilities with regard to coping with failure. All of us fail many times in life, and entrepreneurs, in particular, must be able to deal with failure. They must be able to experiment, learn from those experiments, and then adjust or adapt their strategies.

Back to the Blog

Sorry to those readers who have been wondering where I have been for the past two months. Well, it's been a busy time in the Roberto household, as we have welcomed a third child into the family. Baby Luke Roberto was born in November, and he's doing very well. I'll be posting again on a regular basis going forward.

Amazon vs. Apple

Amazon made big news lately when they launched a new digital music service to compete with iTunes. Some news reports suggested that Amazon would pose a threat to iTunes' dominance. Perhaps that may prove to be true, but there is one important way in which Amazon may actually HELP Apple. How is that?

iTunes songs and iPods are complementary goods. If consumption of digital music rises, it will fuel more demand for digital music players - and iPod is the dominant player in that market. Where does Apple make their money? They appear to make far more profit from selling iPods than from selling songs on the iTunes stores.

Think of it the way that Harvard Professor David Yoffie explains it in his classic case study about Apple. Yoffie draws on several sources that describe the Apple business model as razors-and-blades in reverse. He quotes Steve Jobs stating that Apple makes very little profit on a song sold through iTunes. Yet, the profit margins on iPods are very healthy. They essentially provide the blades (songs) at a low price as a means of driving demand for the razors (the very profitable iPods).

If this is indeed the business model, then Amazon's latest move in digital music may actually HELP Apple... by fueling further demand for iPods, iPhones, and iPod accessories.

The Ethics of Guerilla Marketing

This article, about a singer named Marié Digby, caught my attention. It appeared in the Wall Street Journal last week. One has to wonder about the ethics of such marketing tactics, in which a young woman presents herself on YouTube as a complete amateur, while in fact, she has been working with a large media company for some time. The record company helps create quite a stir on the web about this supposed amateur sensation. Then, the firm announces the signing of this young YouTube phenom, without making it clear that they had been supporting her rise in on-line popularity all along.

Selling Home Depot Supply

This article describes critics who think Home Depot should not be selling its Supply unit, which serves contractors. The critics argue that the firm is forsaking the potential growth in that segment simply because it wants to "exorcise Nardelli's ghosts." The critics argue that the private equity firms will make a great deal of money on the Supply unit.

The critics are missing a crucial point. The issue is NOT whether the Supply unit is an attractive and potentially quite profitable business. This issue is whether the Supply unit is BETTER OFF as an independent company vs. within Home Depot. Moreover, the issue is whether Home Depot's retail business is better off on its own or when combined with the Supply unit.

This example demonstrates a larger point. When firms consider diversification, they must not only look at whether a new business unit will provide higher growth and profits... they must also consider whether that new unit will perform optimally as part of the diversified firm, or whether it will be better off on its own or as part of some other corporation. Shareholders benefit most when a business unit is located in an organizational situation in which it can perform best.