Philips Lighting CEO Rudy Provoost: Innovation Means Putting Consumers' Needs First

Published: February 20, 2008 in Knowledge@Wharton

   

Approximately 19% of the world's electricity bill comes from lighting, according to Rudy Provoost, CEO of Philips Lighting. As such, Philips, the world's largest producer of industrial and consumer lighting products, has a big role to play in the ongoing transformation from incandescent to solid-state lighting using LED technology. Provoost, who until last year was CEO of Philips Consumer Electronics, is no stranger to new technologies, which he says are "just a vehicle to respond to needs." Figuring out what those needs are, weeding out needless complexity and innovating with an eye on the bottom line are the keys to growth, Provoost says. He recently spoke with Wharton marketing professor George Day, academic director of Wharton Executive Education's program, Full Spectrum Innovation: Driving Organic Growth, and with Knowledge@Wharton, about the challenges of staying ahead in a rapidly changing industry.

An edited transcript of the conversation follows.

Day: Tell us a little bit about why you are here at Wharton, and about the transformation that you are undergoing, both in a new job and in an industry that is undergoing a transformation.

Provoost: I recently became the CEO of Philips Lighting, after having been, for three years, the CEO of [Philips] Consumer Electronics, which I call the "University of Life." So, I thought that it was the right way to start a new life by going through a full immersion to refresh everything that I've ever been exposed to when it comes to strategies and how to make growth happen and drive innovation. It's "Full Spectrum Innovation" week [at Wharton], and that fits into my full immersion program. 

Day: Philips is the worldwide leader in lighting and has been for many, many years. You're coming into this business at a pivotal time, with a very interesting background. The pivotal time, of course, is the steady and perhaps accelerating transition into solid-state lighting. Could you tell us what the consequences of this big transformation are for Philips Lighting? And, at the same time, maybe talk a little bit about how you're going to manage the decline of the traditional business while this is going on?

Provoost: [Those are] many questions at the same time, but indeed lighting is at the crossroads -- and I say that both from a marketing perspective and from a company perspective. There are some very important real trends that change the dynamics of the business and even the business models that go with it. There's the whole shift from incandescent lighting to new forms of lighting, solid-state lighting in particular.

There is the whole energy efficiency 'green wave' that really forces society to change, and lighting can contribute significantly. I mean, 19% of the electricity bill in the world is lighting, and so we have a contribution to make. Obviously, there are many, many companies with new disruptive technologies that are coming in, who maybe will become part of the lighting game -- which until now was very much an oligopolistic game, where the giants like Matsushita, GE, OSRAM and Philips were fighting the war.

The whole landscape is changing. Now, change means opportunity, and in that sense we have actually been anticipating what is happening. In the past two years, we did a $4 billion acquisition program. We acquired five companies: Color Kinetics, Genlyte, many of them are U.S. based. That allows us to step-up significantly. I think that we have all of the ingredients and we have the building blocks. And now the fact of the matter is that we need to put the pieces of the jigsaw puzzle together, take all of those ingredients and bring them together into a winning formula. That is what I'm supposed to do. It's a very exciting moment and I look forward to it. This is like writing history.

Day: Yes, it's a daunting prospect. But, you've had some really exceptional experience that I think equips you for this particularly, and maybe you can reflect on your experience in consumer electronics and how that might help guide you through this transformation.

Provoost: There must be a reason why they have asked me to do this job. [Laughs] And so, yes, I've been working in different businesses: Proctor & Gamble, Canon, Whirlpool, and Philips Lighting -- the last seven years in Philips Consumer Electronics, which I always call a "life-altering experience." That's a place where all forces come together. You know, consumer electronics, the whole ICT sector has gone through a dramatic transformation.

Also, there are the shifts from analog to digital; in the TV business, there are the shifts from CRT to LCD and Plasma. There was a notion before that when we talked about consumer electronics, the emphasis was on the electronics, on the hardware. And now it's about a unique combination of hardware, software services and content.

So, if you think about paradigm shifts and transformational change -- that is what I have been dealing with for the past seven years. And there's no escape: I will have to deal with it again in lighting. But, having gone through that "University of Life" and having been exposed to it, I think that we've found a successful formula to compete in a very global and dynamic market. It is hopefully going to help me to be successful going forward. So, yes, I hope that I can use everything that I have learned in the past years and apply it again and add to the learning.  

Day: I have this vision of a lighting plant that I was in one time which was immense and automated, and they could tell me the cost of everything down to a tenth of a pfennig. They managed that all for efficiency. And I'm sure that Philips is fabulous at that sort of thing. And so, you've got that kind of model, that culture and that system. How are you going to transform and disrupt that? And, what are the assets that you bring from that into the new game?

Provoost:  I think the issue is not so much how good we are in the process industry, or whether we should manufacture everything ourselves. I really believe that the issue is: Where do we have

to be a vertically integrated business? And/or, where should we depend on others or partner with others, whoever that might be? Outsourcing parts of the process or establishing value added partnerships with suppliers, open innovation. 

In that sense, again, we will not be a successful lighting company by excelling in manufacturing processes. It's really about [looking] outside and understanding what the market needs are, what the future applications are, what the requirements are for lighting solutions and experiences in various places and spaces: What does it mean in the office? What does it mean in the shop? What does it mean in terms of city beautification, street lighting?

On the technology side, we very much know what is possible. On the marketing side, we have to be more specific in answering the question of what is required -- and then bring the two together. Technologies are just a vehicle to respond to needs and come up with absolutely brilliant solutions and applications. In that sense, my focus will [much more] be outside-in, understanding what needs to be done and how I can connect the dots also between the capabilities and competencies we have now in the new lighting company, which is a mix of existing Philips businesses and acquired companies, then make sure that we are obsessed with end-user-driven innovation and just take that to its full consequence.

Again, if you want to be successful and in terms of business model control points, in some aspects, if we need to be vertically integrated, we will be. It's really more about the business model than about bits and pieces of processes -- you cannot disconnect the two.

Day: It's market-driven innovation at a scale beyond anything that you've ever had to manage -- or at least Philips Lighting has ever had to manage. What will be the biggest barriers that you think you will have to overcome, [especially] around maintaining your leadership position? 

Provoost: I guess it's a bit of a paradox, but the success of the past could be the biggest barrier for the future. This lighting company has been extremely powerful and has invented the space and came up with particularly winning technologies and there were many control points. Right now, it's all about mindset. It's about, at the end of the day, we, me, the people are probably the most important limiting factors, and so that's where the challenge is.

What I learned here is that statement of Darwin's -- that it's not about being the strongest, but it's about being the most responsive and agile [when it comes to] change. That is what it's really all about. And so, making sure that we have the culture right and that we use the DNA of success in the past, but blend it with new DNA.

As a matter of fact, in the world of solid-state lighting, LEDs [light-emitting diodes], everybody has access to LEDs; everybody has access to the basic technologies. If you have IP, fine, but a lot of the IP can be bought. It's really about a more segmented end-user application solution approach to it, rather than a pure technology view of it. This will require people changing, it will require different prioritization, and it will require different ways of spending our money and allocating resources.

Day: We did talk about one of your competitors GE, who has seen the need to bring in a lot of outsiders, a lot of fresh faces, different mental models. Do you see a substantial number of new employees, or will the acquisitions that you have already made bring in enough fresh talent for you?

Provoost:  We have got all of the fresh talent, of course, through these acquisitions. There is a very intense exchange of talent between the different sectors, within Philips. And, it is remarkable how you can blend everything together. We have a consumer lifestyle business, a lighting business, a healthcare business. There is a lot of internal talent. But, absolutely, the team of today is not the team of the future and so we will have to strengthen it.

But the answer is not only in our own talent pool. It's also about connecting with the world and working with the right partners. I mean, just here, during this week, we had the chance to listen to the lighting science group and CEO -- well, he's actually a partner. And that is typically the case, where you work with companies who, for example, can act as, to put it in IT terminology, value-added resellers or system integrators. So, it's not only about your own talent pool; it's about an extended pool of resources. To win, in the future, we need to add brain power and horsepower; and then, make sure that we have the willpower to stay the course.

Day: So, you've got a number of partners out there. One of the big challenges always in managing open innovation, with lots and lots of partners, both providing ideas and helping you to commercialize them, is who gets to keep the intellectual property and monetize that?

Provoost: Well you know, through the acquisitions that we made, we made sure that we have a very good intellectual property platform [laughs]. 

Day: That's definitely one way to do that. [Laughs] 

Provoost: We have quite a lot of intellectual property there, but if you really want to and have to partner, then you have to make sure it's a win/win. So, I guess in the way we structure partnerships, in whatever shapes or forms -- from joint ventures to alliances -- you need to make sure that it's a mutually rewarding partnership. It's not only about the IP, but the IP of course is an element. It can be an enabler, or it can simply be a control point; or it can be a shared interest. And so, I would say that we should be open to any business model and just pick the one that creates the most value.

Day: We've talked about two of what I think are the four main levers that you are working with. One is leadership and you are exercising that and you have a vision. The second of course would be the structure that you put in place, including all of the people. The third, which is the one that I want to turn to now, is the motivation part of it, the incentives and the metrics. Do you see the need for new metrics and new kinds of incentives?

Provoost: Yes, but you need all three -- I call it the "Triple As." One, the leader has to be an advocate -- he has to be an activist almost for innovation. The second A is accountability. I don't like the word "structure" too much. For me it's about accountability, it's not about org charts and re-drawing the reporting lines. It's really about accountability -- make sure you have owners with

a face and a name and then connect the right people together. So, the informal network, so to speak -- that is very critical.

The third A for me is you need amplifiers. Now, one amplifier is the reward schemes that you use. And there, it's always about the trade-off between incentive schemes that stimulate the feeling of belonging and the joining forces behavior versus the incentives that reward individual or team accomplishments. Now, we've made a very deliberate choice to actually go for the incentive scheme that stimulates the kind of "one lighting," joined forces, all-hands approach.

This is because if you want to win in the future, particularly in the context of Philips Lighting today, you need to make sure that all of the business groups, all of the units, all of the acquired companies as well as the existing teams -- you need to make sure that these teams are working together. I mean, if you just let Lamps do what they think is the best for lamps, or Lighting Electronics do what is best for lighting electronics or the Luminaires Group do just what is best for luminaires -- we will end up with a suboptimal situation.

For me, the innovation agenda is actually part of a larger growth agenda and I want to make sure that everybody feels part of that same growth objective and signs up for the same bottom line. This will make resource allocation, reprioritization or sharing of competencies and capabilities much easier. So, that is the way we are going to deal with it.

Day: This goes hand in hand with a partnering orientation, or a share-to-gain mindset.

Provoost: Absolutely.

Day: I have one final question, which is really looking at innovation in large organizations, at a time of recession. For the last five years, we have had a robust economy, notably in North America, Europe and in Asia. Innovation is at the top of most CEOs agendas as it is in yours. Now, looking at your experience and thinking about your competitors and companies that you know, what do you think is going to happen if we have a recession? What will happen to innovation, the enthusiasm for it, the willingness to support it and make the long-term investments that are necessary?

Provoost:  Well, I cannot answer for the world or for other companies. But certainly from a Philips Lighting perspective, in times of recession, the last thing you want to do is cut off the oxygen. In times of recession, you need to work harder, run faster and so you need a lot of oxygen and for me innovation is about oxygen. So, we are not going to cut the oxygen and we're not going to cut the lifeline -- because no lifeline means no survival.

Of course, a recession will probably force us to make choices. So, it's not about doing less, it's about picking the right battles. And I think that in times of recession, actually, it's a bit of a paradox. Value becomes more valuable. At the end of the day, consumers have to make choices too. And so, it's about share of wallet and the choices they are going to make. Are they going to buy Philips Lighting or something else?

Now, if the value proposition is attractive enough -- and it can only be attractive if there is a real innovative component to it. And, that could be a real energy efficient lighting solution, which helps in time of recession to keep the costs down. Then, we should be the most attractive offer for that consumer. I don't think the answer should be or could be to cut budgets. But, as consumers need to make choices, we have to maybe make choices.  And that is, for me, the way that we will deal with it. So, in that sense, I am very optimistic.

For me innovation is a little bit like acupuncture: You need to put the needles where the energy points are. This is true in general, but in times of recession, that's probably even truer. And so, I hope that we can manage it in the proper way going forward. Again, I am optimistic, even in times of possible recession.

Day: Some years ago, there was a very interesting study which looked at a couple of recessions and looked at the changes in industry structure, both before and after the recession. And it turned out that was when market shares shifted because there were some competitors who were forced, or who chose to maximize current earnings -- cutback on marketing, cutback on innovation, not to mention Executive Education and all of those other things -- and they invariably lost a lot of ground.... And that is when you can pile on and gain share. 

Provoost:  We referred to Darwin earlier and this is again Darwin at work; it is survival of the fittest. A recession can indeed trigger shake-outs and the one that prevails is the one that was the most flexible and responsive to change -- and the one that speaks to the hearts and minds of the consumer. 

Knowledge@Wharton: I have a couple of questions. Whose job is it to innovate in your company?

Provoost:  There are probably two answers to that. One, it is everybody's job because innovation is not only about product innovation or service innovation. In essence, you can innovate everything, every day, in every process. I think the notion of innovation, in my opinion, should be a very inclusive notion. This is so everybody can ask themselves, every morning: What can I do differently? And that goes from taking out unrewarded complexity in the spirit of Philips 'Sense and Simplicity' to just challenging the status quo -- and I think that that is everybody's job. 

Now, at the end of the day, if you really want to push the envelope, and you do not want to limit yourself to the small "i's" (incremental innovation) but you also want to hit the big "I's" (breakthrough innovation), you will need to have the big boss to have skin in the game, too. And so, I think that it's very important that the leader is the chief activist, so to speak, and leads by example.

Knowledge@Wharton: You referred to the sort of disruption that innovation causes. Innovation is inherently a somewhat messy process. How do you manage the balance between creativity and organization in managing innovation?

Provoost:  I don't think that the process should be messy. I think that the process should be very structured and disciplined. But what you put into the process -- and what comes out of it -- and the cycles of, I would say, diverging and converging solutions and elements of innovation -- that could be a very creative process. But, the best creative process is the one that is well structured at the end.

You look to the benchmarks, from the ideas of this world, to some companies that are very well known for their success. I mean, they all have a very structured and disciplined way of dealing with innovation, but within the boundaries, their bandwidths, they allow a lot of creativity. And, I guess that is the way to handle it and to manage it.

Knowledge@Wharton: How do you measure the returns that you earn on your investment in innovation?

Provoost:  I think it is extremely important that with whatever point of measurement you take, whether it's what you put into the innovation process, like R&D resources, or the process itself, the effectiveness of the innovation, or the output of it -- that there is always the notion of profitability. So, in one way or another, if you think about outcomes, things like R&D as a percentage of sales, I don't believe in. R&D in relation to EBITDA, I believe in.  

Every innovation project should have a return on investment, an internal rate of return, a net present value. And, you need to hardwire it and keep yourself honest, because at the end of the day, it's about generating returns. The top line is interesting, but the bottom line is what matters. You need that bottom line in order to continue to generate resources and to continue to invest in innovation. And so, that for me is a very important element -- the most important element.

And of course, there are many lagging indicators, like new products that were brought to the market in the last two years or three years. That is for me a lagging indicator. I'd rather have leading indicators like: What do we have in the pipeline? And, there again, that should stimulate that culture of innovation, of not just trying to be satisfied with simple measures that do not mean a lot.

If Online Marketing Is the Future, Why Are Some CMOs Stuck in the Past?

Published: February 06, 2008 in Knowledge@Wharton

   

Americans spend an average of 14 hours a week online and 14 hours watching TV. But marketers spend 22% of their advertising dollars on TV and only 6% online, according to data compiled and analyzed by Google.

"Of all the advertising platforms, the Internet is one of the few on an upward trend," says Wharton marketing professor Patti Williams. "But if you look in terms of the sheer amount of time most consumers are spending online and the amount of dollars being spent to reach them, it is still probably way under what it should be."

Indeed, as computer screens, mobile phones and other devices offer what amounts to billboard space for display ads, video and tie-ins to Internet searches, the advertising landscape is undergoing a major transformation. New media is growing at a fast pace, but industry analysts and Wharton faculty say senior marketers still lag in adopting the Internet and other digital technology to reach their customers.

Spending on Internet marketing is expected to grow 13.4% in 2008, but that will only add up to 7.2% of the total amount spent on all U.S. advertising, which is expected to hit $153.7 billion, according to TNS Media Intelligence.

Williams says that while the Internet provides advertisers with the ability to closely track consumer response to ads by measuring clicks or other online behavior, their reluctance to embrace the Internet may be due to uncertainty about how well it can shape broader brand messages.

"It's not clear how Crest should leverage search advertising," says Williams. "How many people are going online to search for toothpaste? It's not [obvious that] a little ad on the screen is going to attract them. For the biggest bulk of media spending, online is just hard to figure out. The Internet is not that good at big brand building objectives, so there are a lot of companies struggling with a way to take advantage of the tremendous opportunity Google and other searches offer."

It Takes a Village

According to Wharton marketing professor David Reibstein, another obstacle to moving advertising online is the difficulty of reaching a broad audience with an efficient media buying operation. When three television networks dominated the advertising world, it was easy for mass advertisers and their agencies to place commercial messages. Now, they are confronted with a

complex web of options, including the Internet, which itself is highly fragmented, in-store promotions, social networking and mobile phone technology as well as traditional media.

"Each one of the pieces is effective, but that effectiveness is overwhelmed by management of the pieces," says Reibstein, adding that many small start-up companies are going into business to help advertisers reach specific markets online, but that may only stymie advertisers more. An advertiser's response to these companies and their promising technology "is likely to be, 'Great, but I would have to deal with 10,000 of you. I would need a manager to manage this interface and that becomes an overwhelming task.' To some degree, the beauty of the new technology is its narrow, focused audiences," Reibstein notes. "The downside is that it takes a village of these before we can have an impact."

According to Wharton marketing professor Peter Fader, the possibility of a recession may further retard advertising's move online. In an economic slump, he says, marketers should move spending toward Internet platforms because they are more targeted and customer-centric, with easily measured results. "Here's the irony," he notes. "When bad times come, people say, 'We can't abandon the brand. We can do those customer-centric things next year.' The CMO will stay with the skills and responsibilities that he has traditionally relied upon."

Donovan Neale-May, executive director of the CMO Council, a marketing executive trade group, says some of the lag in acceptance of digital advertising is due to advertisers' long-term relationships with ad agencies, which focus on creative, brand-building messages, and with traditional media companies. "The media itself has yet to evolve their offerings," he says. "What's going on today with the big media companies is they are all scrambling to figure out their strategy for what advertisers want."

Differences in attitudes toward advertising online exist, depending on the specific company or industry sector, Neale-May adds. Not surprisingly, new companies -- those without a legacy of traditional advertising -- and web-based businesses are embracing digital technologies faster than other firms. "The larger global companies are works in progress. In many cases, institutionalized cultures, agency relationships and media relationships are still limiting them."

Gopi Kallayil, who leads Google's AdSense marketing team, which works with Internet publishers, says CMOs now have a tremendous opportunity to communicate with and influence audiences by leveraging Internet marketing.

"The Internet gives advertisers the opportunity to build mind share more effectively by targeting the right context at the right time, ensuring their messages are relevant to the people they are trying to reach," Kallayil says. "Advertising networks have proven very effective in building brand awareness and generating demand. In addition, the Internet gives marketers more precise, measurable accountability for their ad spending than do traditional media. Demand fulfillment has never been more accurately measured."

Large and small companies are able to use new media to engage in what Kallayil calls "mass micro marketing." Marketers can use the Internet to target specific, well-defined audience segments, yet reach a large audience scaling across many markets. By using the Google network,

Kallayil contends, advertisers could reach 80% of the estimated billion people around the world who use the Internet.

Solid Data and Gut Feel

According to Chris Moloney, CMO of Scottrade, an Internet brokerage firm, senior marketers need a better understanding of how relationships between offline and online advertising work. For example, he says, a company might run a television ad geared toward brand building that encourages a viewer to visit the company's web site. "It's hard to tell if TV or the Internet was the driver," he says. "The Internet gets credit for activity that might come from watching CNN. In some ways, the Internet causes TV to look less impactful, but in order to continue to do a mixture of both, you need to use a combination of very solid measurements and total gut feel."

And while advertisers are getting better at quantifying the payback for their investment, advertising remains as much art as science: About 75% of Internet advertising spending can be reliably tracked while the figure for television is closer to 25%. "That averages out to 50%, but it's getting better," says Moloney. Television is definitely losing appeal to marketers particularly with the medium's current rate structure. "There's a [sense] of arrogance in the TV world -- [an attitude] that their product deserves a premium price when, in fact, you can get a more measurable return on the Internet. That's going to make the road ahead for TV very hard."

Despite declining circulation, newspapers are still a good advertising buy because their demographics are strong with well-educated, high-income readers, Moloney states. "Newspapers deliver good results. While it is a smaller audience than in the past, it is very focused and has very attractive demographics. We get good results from newspapers."

At the moment, he says, the industry is focusing heavily on Internet search advertising offered at major sites such as Google and Yahoo. Indeed, potential advertising revenue is a motivation behind Microsoft's $44.6 billion bid to acquire Yahoo.

Mobile and wireless devices are also beginning to have a place in the market, adds Moloney, but many remain cumbersome. He cites the Apple iPhone as one device that has "leapfrogged" other devices in accessibility. "The opportunities with the iPhone are endless because it is a flexible software platform." Apple software, he notes, allows the creation of small applications, or "widgets," for weather or stock information that can become prime advertising vehicles because they are targeted, but not bothersome.

"Many people think of Internet advertising as an intrusive, interruptive experience with dancing aliens jumping across the screen and perpetual pop-up windows," Moloney says, adding that Scottrade favors ads that provide information that is meaningful to customers, such as a real-time stock chart it offers through an ad on Yahoo. "The opportunities on the Internet are in providing relevant content that is not intrusive personally," he says, warning Internet marketers not to target customers too closely even though current technology allows them to do so. "Never overwhelm the customer with a feeling that you know too much." For example, if a company notices a person is researching college loan packages, it would be off-putting if the firm then

approached the customer with loan information over the Internet using the name of that person's high school-aged son or daughter.

Kallayil says marketers these days are using the Internet to generate awareness, educate customers and complete sales. There are several points of touch with their audience -- when they are searching online, when they are researching and pursuing passions, and when they are spending time online engaged in other activities, such as social networking or watching videos. "In this new age of real-time advertising, it's not about eyeballs," he notes. "Marketers now have a tremendous amount of transparency and control. They know where their ads run and what their audience was doing at the moment when their ads were viewed."

For example, he says, an advertiser for yoga vacations can display ads when the customer is searching for yoga vacations, reading an article about yoga vacations, browsing a web site on holistic health or watching an online video on stress reduction.

CMOs now have more creative options online beyond text ads, including image, video and interactive ads, Kallayil says. "The kind of richness of ads that is possible on television is now increasingly becoming possible and available [online], while a few years ago it was restricted mostly to text."

Best Time to Fertilize Crops

The Internet is only part of an evolving digital landscape. In addition to search and display advertising, marketers are also using the Internet and other techniques to generate word-of-mouth or "buzz" marketing, says Neale-May.

One new idea he points to is digital printing. Companies can produce mailers, or any other literature, from a central computer, then use printers in different countries to produce exactly the number of mailers needed -- tailoring them to whatever regulatory or cultural restrictions exist. The companies thereby save time and money on warehousing and shipping costs. Another new technique is using text messaging to help customers. For example, a fertilizer company in Europe can send text messages to farmers about the best time to fertilize crops and pharmaceutical companies can text patients when it is time to update prescriptions, says Neale-May.

Moloney estimates that about half the CMOs he knows are extremely knowledgeable about the Internet and prepared to take advantage of what it can offer over traditional media. "It's going to be impossible for a CMO in the next three to five years to do their job effectively and not understand Internet metrics very well. The Internet has influenced the way we look at television. It has impacted the way we look at all advertising."

Part of CMOs' lag in moving advertising to the Internet may be generational, Fader adds. "It takes time to get up the organizational chart and they were raised on skills that are different. As time goes by they will take on the customer-centric mindset and skills, but it's not happening real fast."

He also says there are cultural reasons for delays in adding digital technology to the marketing mix. CMOs tend to give more visibility to staff focused on branding and creative work while those assigned to customer-centric, data-based work are viewed as "analytical geeks," says Fader.

Some of the lag may also be due to the nature of the CMO job itself, he adds. "When you think about it, the CMO is a relatively new position that didn't exist 10 years ago. The jury is still out on whether it is a C-level position that contributes to the firm the way other C-level positions do." There are many unrelated jobs that tend to fall under the CMO's authority -- from marketing to brand building to sales -- which creates tension in the marketing ranks that may lead to the delay in moving to digital technology, he says. "What makes you a good, warm and fuzzy creative team is very different from what makes you a good sales manager and what makes you good at interactive marketing."

Too often, Fader notes, CMOs delegate their web-oriented customer-tracking initiatives. He has a set of test questions about customers that he often asks marketing executives, "such as, 'What is the distribution of repeat purchases across your customer base?' or, 'Of all the new customers you acquire this year, what percent will be with you a year later?' Many proudly reply that they have systems in place and can get the answer in a few moments. That's not good enough, says Fader. "You need to know it. If a CMO does not have a good sense of this, all the talk about customer centricity is just lip service."

The new deal at the top

Most companies have managers reporting directly to the CEO on a one-to-one basis, with responsibility for their units or regions,” says Yves Doz, who holds the Timken chair in Global Technology and Innovation at INSEAD. The Professor of Business Policy says the result is that “the businesses or regions tend to behave in an autonomous fashion similar to the way a baron would manage his fiefdom.”

“This makes it more difficult to create an integrated corporate value creation logic,” Doz says. “Often the old deal is where the company has a sort of sub unit or divisional autonomy that leads to rivalry, the development of turf battles and separate, well-defined areas of responsibility.”

In an article called ‘The New Deal at the Top’, published recently in the Harvard Business Review, Doz and co-author Mikko Kosonen, a former Chief Strategy Officer at Nokia, look at how companies need to change their business models and, in particular, at how executives should revise the way they work together – ‘the new deal’ -- when their company strives for corporate value-creating logic that brings together the various business units.

In the 1990s, in Nokia's network and mobile integration businesses, Doz says, "each part became more independent, and felt less need for dialogue and collective commitments, or for working together."

"Nokia has been confronting the problem of dealing with the dynamics of a being both a large company and feeding off constant innovation for years - as it has been moving from being a producer of mobile phones and, to some extent, network infrastructure to worrying about services, applications and content of various types. There is also the issue of managing the integration of various technological and shared resources, while differentiating between corporate and entertainment applications.”

“Another challenge for the company is the move from voice to multimedia, of internet-based versus telephony-based communication technology.  All of this has created a strong pressure both for continuing the growth of the core business, as well as for entering new areas - thus for both decentralized entrepreneurship and integration.”

Doz and Kosonen believe that in order to create more integration and corporate value a ‘new deal’ is required at the top. Doz says “this, in a way, redistributes roles, relationships and responsibilities in a more integrated manner, that means people become more responsible for a set of inter-related tasks that fit within a corporate whole, rather than being accountable for a given business or territory.”

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Napoleon: The inventor of strategic agility?Click here

This can be in shared corporate platforms and functions, as in the case of Nokia, where there are technology and marketing platforms, along with marketing services, distribution and sales organisations that are common to the various groups “or more abstract as with the Easygroup in the UK, where what they share is business logic – a way of thinking about services, pricing, yield management and internet-based distribution that they can apply across a whole range of businesses.”

Over the last three years, Doz and Kosonen have studied the strategy and leadership of a dozen large corporations including Canon, Cisco, Hewlett-Packard, IBM, Nokia and SAP “that wanted to find a way to integrate value creation without losing the benefits of entrepreneurial growth activities.”Their goal was to understand what made a company ‘strategically agile’ with an ability to change rapidly in response to “major shifts in its market space and to do so repeatedly without major trauma”.

What they found is that collaboration in terms of a new deal is characterised by “frequency, intensity, informality, openness and a focus on shared issues and the longer term.” Conventional thinking is challenged and criticism of top management encouraged.

However, it’s not just new technology businesses that are affected by these issues. “No, it is perhaps the industry where they are more salient which is why we studied these companies,” Doz says, “but we also researched the UK’s Easygroup, that is in various types of services, such as travel and leisure, and many others. What you find are essentially companies that have this challenge of combining entrepreneurial business differentiation with corporate value added.”

“I think what is happening in some ways today is that stock market pressures are so great that CEOs are increasingly expected to articulate a corporate value creation logic. And so we basically say ‘how as a CEO do I add value’? ‘How does the staff add value?’ and ‘how do I achieve more than individual traders could obtain just by managing portfolios of companies’?” Traditionally top management thrives on rivalry, enjoys competition and treasures  autonomy. Doz says “this hits at the heart of the contradiction and it is the most difficult area because typically the ways people get promoted and rewarded at middle to upper management level in traditional companies do not prepare them for whole-hearted collaboration – but the contrary. Therefore what we advocate here is an unnatural act for them.”

“For some organizations, however, that have had a robust history and a strong common culture like SAP, it comes rather naturally at the top because most of the key people in SAP were German software engineers who ‘grew up’ together,” Doz says. But among middle managers it's more difficult. For other companies without such a tradition, with no such common origins, this is even more difficult.

“One of the challenges for the CEO is not only to create the usual incentives that are aligned to corporate performance, for instance, which is fairly obvious to do, but also to create a climate and nurture a collaborative culture.” Doz adds. “This should be one of dialogue, exchange, reciprocity, rather than a culture of debate, transactions and rampant self-interest. This is

obviously more a set of behaviours that needs to be modeled and led by the CEO, in terms of his/her day-to-day demeanour.”

Doz advises CEOs facing this dilemma to work in three ‘wavelengths’ initially. One that is intellectual and cognitive, he says, in which “you need to be able to articulate the corporate value added clearly, convincingly and compellingly enough that people start to believe in it. That’s relatively easy again for a company like SAP, talking about open platform and applications.” It's harder for a more diverse corporation, such as Hewlett-Packard.

“However, if you look at the recent and somewhat tortuous history of HP, it’s a search for a value-added across a very diverse range of businesses so I would first tell the CEO, to think very hard and creatively about the value added of the corporation, and obviously the more diverse you are, the more challenging it is.” 

The second wavelength Doz says would be to change roles, responsibilities and rewards - to make key executives less autonomous in the way their jobs and performance are defined. “Some will leave, as happened at Nokia and you must be prepared for this because individuals who are used to leading independent businesses are not necessarily going to be good at managing a collective decision process and be part of a team very easily. But basically there is no other option.”

The third wavelength is “the challenge (that) starts with you as the CEO, because if you keep managing a more comfortable one-on-one relationship individually with each member of the top management then it will never work.  But you also need to have the skills, the behaviours and perhaps the guts to take a much more collaborative role and to be a more adaptive leader.” 

In other words, the new deal has to be built around a collective agenda “that we need to work on as a team. But that starts with you!”

Globalising the brand: Looking beyond lower costs

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While many multinational firms are choosing to outsource services and production to Asia, one company says it’s looking beyond lowering costs and is aiming to ‘globalise its corporate brand,’ by developing a major R&D base in India.

Cisco’s Wim Elfrink, who holds the unique corporate title of chief globalisation officer, says cost differentiation at the company is “a bonus, but the not the main driver anymore.” The networking firm is investing around 1.2 billion dollars in a globalisation centre in India to tap not only the region’s growth but also its innovative capabilities.

“We came to the conclusion we have to think out of the box,” Elfrink told INSEAD Knowledge on the sidelines of the INSEAD Leadership Summit in Asia. The firm decided it “had to do something substantially different,” Cisco’s CGO says.

“All opportunities in Asia are almost green fields; there’s not a lot of installed base and legacy,” Elfrink says, pointing out that India has been adding eight million cell phone subscribers each month and that some 200 million people will be moving to cities and opening bank accounts as part of the trend towards urbanisation across the region.

The ‘classic way’ of exporting and localising services and products is “fundamentally wrong,” he says. “We have to start creating products and services for this side of the world and then perhaps if they’re relevant export them back to the more mature world.”He says the company will base its public sector practice in Singapore for innovation, its manufacturing practice probably in Shanghai and Chicago and financial practices in London, New York and Dubai.

He says there has been some scepticism in the company about its plans for India, but points out that, with skills involving engineering and maths in abundance there, that will allow the company to focus on R&D and innovation.“We are going to develop prototype services out of India for the East (Asia Pacific, Middle East and Africa) … We are going to create prototype services for this part of the world like connected real estate, the use of mobility, like using web screens for illiterate people … And over time we will probably export (them) back to the West.”

Wim Elfrink, Cisco

Elfrink himself moved to the Indian IT hub of Bangalore earlier this year. He says one major reason for choosing India was its proximity. As India is about 12 hours from the US, “you can rule the world for 12 hours a days from corporate America, 12 hours a day out of India. If you draw a circle around Bangalore,  (within) a four hours flight, you can basically (tap) 70 per cent of the world’s population and 70 per cent of the future GDP growth,” Elfrink says.In addition to rapid economic growth and innovation, he says India also has a big talent pool, a major attraction for companies such as Cisco, especially given ageing populations and the growing talent gap elsewhere.

“So we basically have said India is going to be a globalisation centre for us, teaming up with the ICT (infocommunications technology) industry in India.” Elfrink points out that five of India’s top IT companies, including Wipro, Infosys and Tata, are hiring 100,000 people this year.

“So tapping into that export opportunity and extending our ‘ecosystem’ made us decide to make an investment of more than 1.2 billion dollars in India to build the globalisation centre that will be a hub to go through Asia, but also to the Middle East and Africa.”

Cisco currently employs 3,000 people across India and the first phase of the globalisation centre campus in Bangalore is expected to accommodate 1,200 people initially. The second phase is due to be completed by October 2009 and will house an additional 2,000 staff.

“Make a commitment to attract talent,” Elfrink says, “because talent attracts talent.  Have a strong vision and articulate it. Make use of technology, and then start focusing.”

Cisco plans to have sales offices in emerging markets throughout the region and aims to position its network as the ‘fourth utility’, while looking to develop products and services, as well as build sustainable relationships with customers. “Why should a customer out of Malayia or Riyadh (in Saudi Arabia) spend 20 hours on a plane to meet a leadership team in California? You have to start globalising the corporate brand. That’s basically our whole aim of the globalisation centre in India.”

Elfrink says globalisation historically involved exploring new markets. Then companies looked at outsourcing manufacturing activities and having call centres overseas. Now, he says, Cisco is going one step further by globalising its brand and decentralising its decision-making processes, even though this means moving away from a traditional ‘command and control’ approach.

“It’s like 60 years ago,” he says. “If you sent somebody out to a remote place you had to trust them.  A lot of companies are now in command and control (mode) and we have to move to collaboration and team work.”

Cisco Campus, Bangalore, India

The global business leader download MP3 audio        download MP4 video

Leadership has nothing to do with titles. J. Frank Brown, the Dean of INSEAD, has met a lot of CEOs in his two-and-a-half decades in business and many of them are

little more than LINOs – Leaders In Name Only. 

“A lot of people talk about leadership and not that many actually do it,” Brown said in an interview with INSEAD Knowledge.

Brown believes there are seven hallmarks of a great leader. “I think the most important one is how you communicate and how you listen because if you’re going to be a successful leader you’ve got to be a really aggressive learner,” he said.

In his book, The Global Business Leader: Practical Advice for Success in a Transcultural Marketplace, Brown lists the hallmarks of leadership: openness, integrity, humility, a view of the present and the future, an optimistic outlook, the proper use of authority, and an understanding of personal and organisational objectives.

‘Transcultural’ leaders at the helm of international companies also need to be sensitive to other cultures and national differences. That means leaders today need to be willing to explore and travel. They need to be curious about other people and customs.

“This awareness and willingness to engage and be intellectually curious about what’s going on in the rest of the world is an absolutely critical component to being effective in a transcultural environment, and effectiveness gives you the opportunity to potentially lead,” Brown says.

LINOs aren’t very curious and they tend to surround themselves with people who look and think like them. They don’t really want to engage, learn and listen.

“In my view LINOs don’t really want your opinion, they don’t really want your input, they don’t really want you on their team. They’d like you to go away and do your job,” he says.

But this is a recipe for failure for an organisation.

“There is a failing of CEOs that surround themselves with people who aren’t as smart as they are and therefore they think they’re ensuring they’re going to stay in the top spot, but in reality they’re setting themselves and their teams up for failure.”

This is especially true for global and regional businesses. Brown tells the story of a deal between a Japanese and American company that went hopelessly wrong because the two parties simply didn’t understand each other’s culture. 

 Diversity is 'a must'

Success requires diverse teams and Brown says real leaders hire teams with differing skills and backgrounds, give them clear responsibilities, and stay in close touch with the team at all levels.

 On diversity: “Diversity is an absolute necessity for a team, and when I say diversity, I mean it in every sense of the word: gender, race, religion, nationality, sexual orientation, culture, personality type (and) area of expertise.” Read more »

“You’ve got to surround yourself with people that are diverse, have very, very broad perspectives in terms of educational background, in terms of their cultural background, in terms of the languages they speak,” he said.

He points to Europe and says the male-dominated and age-hierarchical nature of management doesn’t foster the effective mentoring that brings out the best managers. For transcultural companies to succeed, managers have to be very focused on finding the best person for the job regardless or age or gender, he adds.

When executives say that building a diverse team is much more difficult, he tells them that a homogeneous team of white, Anglo-Saxon males won’t be as successful as a diverse team. They share values, resist challenging conventional thinking and are more political.

He writes: “In the international marketplace, a diverse team is a must.”

For younger managers, Brown says team building, effective mentoring and networking are crucial. And he says today executives need to think beyond traditional borders.

On mentoring: “If I think about what have been the most important business and personal relationships to me, it’s been from people that have mentored me and people I have mentored.” Read more »

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  “I do think that anybody who aspires to be a leader in this generation, or in the generations to come, needs to focus beyond their own backyard. Anyone who says my aspirations are local is setting themselves up to fail,” he said.

He encourages the people he mentors to seek out different types of work experiences to expand their knowledge and understanding.

“I also feel very strongly that a lot of leadership is learned and a lot of leadership comes through being in a position to get the right experience and being willing to take advantage of the right experience,” he says.

 

On succession: “Real leaders don’t worry about legacies.” Instead, Brown says leaders care about the long-term viability of their companies. Read more »

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 Aspiring executives also should learn to behave like leaders, dressing and acting appropriately, showing humility, and learning to interact with peers and other team members in a way that builds rapport.

He says young managers who spend too much time gaining the perks of power often lose sight of the organisation’s goals and how to achieve them.

On work-life balance: “If you don’t communicate what your particular needs or out-of-work situation is, you’re doing yourself a disservice.” Read more »

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 Brown devotes a chapter of his book to communications and urges leaders to listen better to their staff, other managers, competitors and customers, especially in a transcultural setting. LINOs, he says, often act as though listening to customers and rank and file employees is a burden.“By investing the time to listen and learn you’ve created a much higher probability that the actions you undertake together are going to be successful and are going to be accepted.”

Create the right sort of buzz about your products

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How important is word of mouth, more popularly known as buzz, for the success of your new products? Some companies rely on product placement in movies or the endorsement of a sports star or pop singer to help create a buzz about their particular brand. But according to INSEAD Professor of Marketing, Amitava Chattopadhyay, companies may have more control than they previously thought possible regarding the buzz about their new products – they just have to take a more systematic approach.

In a recent working paper, Chattopadhyay and co-authors Jacob Goldenberg and Sarit Moldovan examine how managers can best create positive buzz about an innovative product.  Instead of just looking at the product’s novelty value or uniqueness, the authors of the study also looked at the impact of product usefulness.

What they found is that although originality is important in generating buzz about a product, the content of the buzz is harmful and has a negative impact on consumers adoption and the ultimate market size when the product is perceived as ‘useless’. Since managers have control over both the originality and usefulness of their products, they can have a considerable degree of control over word of mouth about the product as well. And remember, word of mouth can be negative as well as positive:

“What we found was uniqueness or newness drives the propensity (for consumers and others) to speak about a product, but usefulness drives what they say about the product,” Chattopadhyay says. “The evidence is clear – usefulness determines whether word of mouth is positive or negative; when you have a new product that is not useful then negative word of mouth spreads quickly and leads to that product dying quickly.”

Make sure your products are unique and useful

In effect, poor reviews from influential sources of information such as friends or colleagues, if they gather momentum, can kill off a product: “Newness per se is not good, newness accompanied by lack of usefulness is downright dangerous. In the internet age, with email and blogs to speed up the spread of word of mouth (WOM), the rapid death of a new product is a virtual certainty, if it is perceived as not useful and worse still as useless and novel!”

The authors believe that understanding how to control WOM has important implications for managers. They say that as factors such as originality and usefulness are within the control of managers, they should focus on both when products are being designed and developed, as well as later on when they are promoted and positioned in the market.

Managers should “not be blindsided by just the novelty element,” Chattopadhyay says, but they should make sure the products they are bringing to the market serve a purpose for the consumer. “Or to put it another way, that the consumer perceives this novelty to be useful. If it fails on the usefulness criterion then you will not succeed.”

Marketing: How behaviour prediction can help to reinforce good habits but break bad ones download MP3 audio

Human beings are creatures of habit. Many of our actions are repetitive and require little conscious thought or effort. However, according to a new study, by predicting our behavior we can actually reinforce good habits and break bad ones.

The study by INSEAD Assistant Professor of Marketing Pierre Chandon and four US-based Marketing professors is called ‘When Does the Past Repeat Itself? The Role of Self-Prediction and Norms.’

Chandon says 50 per cent of what we do is habitual or ‘mindless’. That, in itself, is not necessarily bad: “If we had to think about everything we do, we’d get nothing done.” He adds that their research was interested in whether people would repeat what they had done in the past and under what circumstances they would change their habits.

“What we know is that some habits are very hard to break. Anyone who has tried to lose weight or tried to change a habit knows it’s very difficult. So we’re interested in what can we do to make people change their habits,” Chandon says. “And one very simple thing is to ask people if they’re going to do it again next month. This has a very strong impact on whether people repeat what they normally do, or do what they think they should do.”

The study covered “normative” activities such as exercising, and non normative ones, such as grocery shopping. “When we ask people to predict whether or not they’re going to go grocery shopping, there’s really no norm about how often you should go grocery shopping. Just by asking people that question reminds people what they have normally done in the past and, as a result, they’re more likely to repeat it in the future.” So where there is ‘no ideal behaviour’ as is the case with grocery shopping, asking people to predict their future actions increases the likelihood that they will repeat their past behaviour.

Chandon says that by asking American college students whether they intend to exercise, a normative behaviour, they found that people who don’t normally exercise, exercise more. That much was to be expected. However he says “what’s not expected, is that people who exercise everyday, realise they should be doing something else, like maybe study and so they exercise less.”

'Everybody becomes more average'

Consequently, the researchers found that when behaviour is normative, the mere act of asking people about their future intentions regarding that behaviour  “breaks the habit. So there is a kind of regression toward the norm: everybody becomes more average.”

These findings could have major significance for marketing activities, as well for public policy with regard to health issues: “That’s where it becomes tricky,” Chandon says, “because often for

screening purposes you ask people ‘Do you smoke, do you exercise, do you do drugs, do you do unprotected sex etc.?’ And obviously the objective of the questioning is to identify people who might be at risk, but what we don’t often realise is that this simple questioning could influence people’s behaviour and what we know is it would probably move people towards the (social) norm and in fact there’ve been some studies – not ours, but others – (where) if you ask people will you cheat in the exam, miss class, they are more likely to miss class and cheat in the exam, than if you don’t ask them.”

“These are all psychological effects which are under the radar and people don’t think it influences them, which is why it’s very interesting for us to study,” he says. “In terms of eating, we make 200 eating decisions a day and I would say 80 per cent are ‘mindless’, we never really think about that and as a result it’s important to know what’s going to increase our habits and what’s going to break them. And then you can use it differently depending on what you want to do – do you want to increase people’s habits or decrease them?”

 

For New CEO John Donahoe, 'It's eBay's Game to Lose'

Published: February 06, 2008 in Knowledge@Wharton

   

On January 29, online auctioneer eBay unveiled plans to revamp the fees it charges sellers, reduce fraud and increase the volume of transactions. It's the first move by CEO-elect John Donahoe, who will take over the reins of eBay on March 31 in the wake of long-time CEO Meg Whitman's announcement that she plans to step down.

Donahoe's mission is to reinvigorate a company that remains dominant in online auctions, but is vulnerable to increased competition from large rivals, such as Amazon.com and Google, as well as smaller e-commerce sites like Etsy, which specializes in handmade crafts. EBay is also facing slowing growth. Its fourth quarter product listings -- a measure of the number of goods for sale -- were up just 4% from a year ago and the number of active users on the site is flat.

Experts at Wharton say that eBay isn't in dire straits, but if it wants to increase growth it has to make changes and focus on its core competencies. According to Wharton management professor Raffi Amit, eBay has taken a few strategic detours -- such as its 2005 acquisition of Internet telecommunications company Skype. When eBay acquired Skype, executives said its communications services would be integrated into the company's auction platform. "I never [understood] the Skype deal. I'm never sure I got down the key ideas behind it," says Amit. In 2007, eBay took a $1.4 billion goodwill impairment charge -- an acknowledgement that a particular acquisition didn't generate the value initially expected -- related to the Skype deal.

Wharton marketing professor Eric Bradlow agrees that eBay may have lost some of the focus it had as a startup. "EBay, like any mature firm, needs to understand the value added it provides over the competition.... For eBay, it is brand recognition which gives it higher awareness and higher trust." Adds Kartik Hosanagar, a professor of operations and information management at Wharton, "In some ways, the economics of eBay's business are great. The business model is such that the gross margins are very healthy. EBay's problem is just that it is mature now, and growth has stalled."

Analysts suggest that eBay's business model, which largely relies on charging merchant fees upfront, could use a few tweaks. Marianne Wolk, an analyst with Susquehanna Financial Group, said in a research note that "eBay's business model has been out of sync with the performance-based models popularized by the search economy," which dictates that users pay for performance, such as a lead to complete a sale. Applied to eBay, this approach would mean that eBay should collect more money when a sale is successful.

To remedy the problem, eBay cut listing fees 25% to 30%, but raised the fees it charges when an item is sold. In a speech before 200 North American sellers on January 29,Donahoe said that the

new fee structure minimizes the risk for sellers if an item doesn't sell. "Put simply, we will make more of our money when sellers are successful," Donahoe stated.

Wharton faculty say Donahoe will have to do more than change fees for auction listings: He will need to push eBay to be more innovative. "EBay has to be more aggressive and think about strategic planning five to 10 years down the line," says David Hsu, a management professor at Wharton. "You can't transform overnight, but you do have to be able to assess the future better than others."

One point on Donahoe's side is timing. According to Hsu, Donahoe takes over as CEO at an opportune moment. Since Donahoe is a company insider, he already has the trust of employees. Add to that the stagnant growth the company is experiencing, and the result is a mandate for Donahoe to make changes. "He knows the business and can experiment," says Hsu. Indeed, Donahoe seems prepared to take some chances, noting on eBay's fourth quarter conference call that he will "aggressively change our product, our customer approach and our business model."

Here's what should be on Donahoe's to-do list, according to Wharton faculty.

Perfect the Basics

On his earnings conference call, Donahoe outlined a few areas to address -- including fraud, the difficulties some have in navigating through eBay and the need for better search tools. All of these problems are being addressed in phases throughout 2008, he noted. "We're going to get very aggressive about making eBay easier and safer to use. The Net has evolved dramatically in recent years. Buyers have become accustomed to streamlined purchasing experiences that put a premium on speed, convenience and reliability. While we have made strides in these areas, I am clear that we need to do much more."

Analysts say that eBay needs to better integrate its auctions with the fixed-price shopping convenience offered at sites like Amazon. EBay already offers a hybrid auction/fixed price approach with its "buy it now" feature, and that could give the company an edge. The company should keep the excitement of winning an auction while providing the easy convenience of buying at a set price, says Bradlow. "This hybrid model is clever in that it allows customers to have it their way," he notes. 

Donahoe himself has suggested that "eBay's next wave of growth is going to come from weaving the strengths of auctions with our fixed price in a uniquely eBay way. Auctions attract enormous value, selection and fun to eBay but for many sellers and buyers and for many products, auctions are just not the optimal format. So what we need to do is marry the value selection fun created by auctions with the convenience and opportunity inherent in fixed price." EBay, Donahoe added, is also reworking its search abilities, making it easier to add pictures to listings, and is changing its web site to improve the company's merchant rating system.

These planned changes are good steps, but as Bradlow notes, because "people have an expectation that Internet retailers will be more innovative," eBay will be held to a higher standard than other companies, and will have to not just meet, but "exceed expectations."

Hosanagar echoes Bradlow's point about innovation being a core competency. EBay's challenge is to launch innovative new services -- either through acquisitions or experimentation within the company. "[Innovation] is always a challenge for mature firms. Some firms have successfully driven growth by innovation, like Apple, or acquisition, like Cisco. EBay has had mixed results with acquisitions. My take is that eBay has done a poor job of identifying synergistic opportunities. Similarly, although eBay has a research group, it has not been able to drive much growth by internal innovation." EBay, Hsu adds, has to get that "spark the company had in the early days."

Pick a Strategic Path

Amit suggests that another key chore for Donahoe is to outline a strategic plan. EBay has two alternatives typically faced by companies that grow fast and then mature. "It can either have total focus on the one thing that it does best and penetrate new markets. Or ... it can take its core competencies and expand into related businesses where its auctions are a complement."

If eBay were to focus on taking its core auction business to new markets, two obvious choices would be China and India, Amit says. Ebay has already ventured into China -- with mixed results. In 2003, eBay acquired Chinese company Eachnet to launch its China operation. However, in 2006, eBay put its Chinese operation into a joint venture with Tom Online, a local wireless Internet company. Analysts viewed the move as a retreat for eBay.

What's different this time? Amit says that credit card use is increasing in China and India, thereby making eBay's business model, which depends on electronic payment systems, more feasible. In that sense, eBay's first effort in China was too early, says Amit.There will be challenges in both China and India, but eBay could sustain growth for years in those markets.

Hosanagar agrees that eBay has to expand abroad, but acknowledges such moves are tricky. "EBay must figure out ways to have an impact elsewhere like it did in the United States. While eBay made significant investments in both China and India, both efforts were largely unsuccessful," he says, adding that trust is a major impediment to eBay's business in countries like India and China. But those issues could be overcome if eBay partners with local banks, insurance firms and even competitors to establish best practices. "EBay needs to do more in these countries to develop the market itself."

The other strategic approach sees eBay expanding into new, but auction-related, businesses through acquisition, says Amit. The auction giant already has a blueprint for this strategy with its acquisition of PayPal and Shopping.com. Using this approach, eBay could emulate companies like Cisco Systems and Oracle, which have completed dozens of acquisitions. The acquisition route could be risky, however, if eBay tries to diversify into unrelated businesses.

According to Hsu, another risk to any acquisition strategy is the drain on management time. If eBay were to start making larger acquisitions, it would require upper management attention to integration plans. A better route may be to focus on smaller deals. "The acquisition route is tough," says Hsu. "The question [eBay will have to face] is whether it wants to devote CEO time to integration or make smaller bets. It's best to go the targeted route."

Hosanagar suggests that before Donahoe focuses on any specific strategic plan, he needs to figure out what the company does best and then thread its existing businesses together better. "EBay must articulate a clear long-term positioning and core competence, and use that to guide its acquisition strategy." 

Can EBay Restore Past Glory?

Experts at Wharton say Donahoe will have his challenges managing eBay and boosting growth, but the company has resources at its disposal. Perhaps the biggest asset eBay has -- aside from $4.9 billion in cash and short-term investments as of December 31 -- is its community, says Amit. "Donahoe has a lot to work out, but he is sitting on enormous valuable assets such as community and reputation."

EBay can use the social nature of its site to create new tools that could improve the rate of purchases, he adds. "In many ways, the eBay community is a social network." Utilizing social networking and pursuing related businesses to complement auctions eBay could gain more "wallet share" from its existing customers.

Meanwhile, eBay's business model isn't broken. For the year ending December 31, 2007, eBay reported net income of $348 million on revenues of $7.67 billion. What is different, however, is that eBay now has more competition than ever. On Amazon's fourth quarter conference call, chief financial officer Thomas Szkutak said Amazon has been successful attracting outside merchants to use the e-commerce company's platform. Amazon's third-party merchant services resemble eBay's, with features such as seller ratings. The big difference is that Amazon's merchants sell at a fixed price while eBay conducts auctions. "Our seller business globally is very strong," Szkutak noted during the call. "We are continuing to try to work on that experience for sellers to make it even better. Certainly our goal is to have sellers increase their sales on our platform and so we continue to do a number of different things to make it easier for them" to accomplish that.

Google, which has its own payment system called Checkout to compete with eBay's PayPal, is also a threat, according to Hosanagar. But eBay has an excellent brand and can compete with its rivals. "EBay starts as a favorite," he says. "This is eBay's game to lose."

Short-Circuited: Cutting Jobs as Corporate Strategy

Layoffs. Downsizing. Rightsizing. Job cuts. Separations. Terminations. Workforce reductions. Off-shoring. Outsourcing.

Whatever the term, getting rid of employees can be a necessary and beneficial strategic move for companies to make. Layoffs can signal that a company is reorganizing and moving in a more profitable direction and, as a result, give Wall Street a reason to cheer and improve the morale of remaining employees. But unless job cuts are handled and explained properly -- and are indeed necessary to achieve a thoughtful, overarching purpose -- the solution may cause as many headaches as the ailment it was meant to cure, according to Wharton faculty members and an outplacement expert.

Consider a recent move by Circuit City Stores, a big electronics retailer based in Richmond, Va. The company announced on March 28 that it cut 3,400 jobs, or 7% of its workforce, effective that day, because the salespeople were paid "well above the market-based salary range for their role." The company did not disclose specifics, but The Baltimore Sun reported that the laid-off workers, known as "associates," made 51 cents more per hour above what the company had set as market wages.

Circuit City also announced that it had entered into an agreement with IBM to outsource its technology infrastructure operations, which would eliminate the jobs of 130 employees. Fifty of these workers, however, were to be hired by IBM and remain on-site to serve the Circuit City contract.

These various moves, Circuit City said in a news release, were part of a "series of changes to improve financial performance largely by realigning [the company's] cost and expense structure." The decision to terminate the 3,400 employees was disclosed in the fourth paragraph of the release and described as a "wage management initiative" that led to the "separation" of the workers.

The job cuts "focused on associates who were paid well above the market-based salary range for their role," the news release added. "New associates will be hired for these positions and compensated at the current market range for the job." The company said, however, that the people who lost their jobs received severance packages and could reapply for their old jobs, at lower pay, but had to wait 10 weeks to do so. The March 28 move, coupled with a decision made in February to realign Circuit City's retail structure by reducing the number of operating regions from 10 to eight, would save $250 million over the next two years, the company noted.

Peter Cappelli, management professor and director of the Center for Human Resources at Wharton, says Circuit City may have valid reasons for having to reduce costs, but the way it

treated the 3,400 workers was highly unusual. "That's the most cynical thing I've heard about in a long time," Cappelli says. "I like to think I'm cynical, but sometimes it's hard to keep up."

According to Cappelli, Circuit City's decision to replace the terminated workers with lower-paid people is like saying: "We made a mistake in compensation by paying them more than they were worth for their performance, so we're going to get rid of them." Cappelli adds that he "had never heard of that before. Companies have always done sneaky things like getting rid of higher-wage workers with two-tier wage plans, but this ... takes the cake."

A Once-Rare Occurrence

There was a time in the United States when large workforce reductions were few and far between. An employee hoped -- indeed expected -- that his or her job would last for life, and often it did. But layoffs have become so run-of-the-mill that even news editors sometimes pay them scant attention. In an April 2 column, New York Times writer David Carr lamented the lack of coverage of the Circuit City job cuts. His article was headlined: "Thousands Are Laid Off at Circuit City. What's New?" 

According to Michael Useem, management professor and director of the Center for Leadership and Change Management at Wharton, "After waves of large-scale layoffs among American companies, most notably in the early 1990s, but again in the early 2000s in the wake of the dotcom bust, we have learned a lot about good practices and bad practices [in eliminating jobs] by watching companies in action."

Research has shown that if a company announces a downsizing without a broader reference to a strategic plan, its stock price will, on average, drop 5% to 6% over the next several days, according to Useem. By contrast, if large-scale job cuts are announced as part of a broader restructuring, and a strategic plan is laid out, the firm's stock will rise some 4%, on average, in the days following the announcement. Useem says the research shows that, contrary to popular wisdom, Wall Street does not always welcome job cuts for their own sake.

"The tough-minded, big institutional equity market is actually skittish and worried about downsizings that are simply short-term cost-cutting measures without a broader plan described behind them," Useem notes. "Investors are not beating the drum for downsizing as much as it is sometimes said they are. It really is the restructuring they are applauding, not the particular method within it. It's helpful to think about downsizing as restoration -- cutting costs as a move to restore luster and performance."

Cappelli says, however, that Wall Street does sometimes support layoffs for their own sake. "If we define layoffs as being necessary because it makes sense to keep financial analysts happy, then it may make sense for companies to lay off people because analysts have a bias toward layoffs," he says. "They love layoffs because they immediately improve the bottom line. They can't easily assess what the long-term prospects of layoffs will be, but they can see immediate benefits."

Academic research, according to Cappelli, shows that layoffs usually have negative effects on a company's performance after the cuts take place. "But in fairness to companies that feel they have to cut jobs, part of the problem with the research is how the research is done," Cappelli adds. "Companies laying off people are, by definition, already in trouble. So it's not surprising that if you select companies already in trouble [for a research study], they look in worse trouble later." It typically makes sense for a company to lay off workers only "when it has a particular problem -- excess capacity. When you don't have excess capacity and you're cutting, you're cutting muscle."

Sending Signals

Wharton management professor Lawrence Hrebiniak says layoffs that are part of a restructuring can send a signal that a company is "refocusing its use of scarce resources." He likens such a move to investors who reallocate assets in their portfolios to move from poorly performing securities to more promising investments.

Downsizing can also send an important signal to customers, competitors, suppliers and Wall Street. "Years ago, Procter & Gamble cut thousands of jobs," Hrebiniak recalls. "They called it 'cost savings,' but the CEO also said P&G was sending a signal that this was a sign of a cultural revolution at P&G: to eliminate inertia, to wake people up to the focus on new markets and products and innovation, to get rid of dead wood. So layoffs can represent a refocusing."

Robert E. Mittelstaedt, dean of the W.P. Carey School of Business at Arizona State University, notes that the stock market "has more respect for [job cuts] if they are part of a broader plan. Just signaling that you're going to cut costs and not saying anything else about what you're going to do doesn't impress people a whole lot."

In fact, Wall Street respects companies for divesting themselves entirely of unprofitable or barely profitable businesses rather than trying to strengthen them through large job cuts, because jettisoning unwanted businesses can make better strategic sense, according to Mittelstaedt. "There are times companies have to say that they believe exiting a business is right," Mittelstaedt says. "That gives a better signal to the market, as opposed to trying just to cut costs."

A March 26 story in The Wall Street Journal that Citigroup was in the process of finishing up a restructuring plan that will result in the elimination of some 15,000 jobs appears designed to achieve both short- and longer-term goals -- to juice up the company's lagging stock price and to refocus the firm, according to Hrebiniak. Citigroup reportedly wants to put more emphasis on its international operations and consolidate back-office functions.

"He's getting pressure from shareholders," Hrebiniak says of Charles Prince, Citigroup's chief executive. "He's feeling no love. He's got to show he's doing something to cut costs, improve margins, make some more money. So it may not primarily be a move to restructure at all; it could be a move to get critics off his back." If Citigroup does decide to cut 15,000 jobs, it would represent nearly 5% of its workforce of about 327,000.

Adrian Tschoegl, a Wharton management lecturer who follows the banking sector closely, says the planned Citigroup layoffs have a strategic purpose: consolidating various functions that have grown redundant over the years and have become costly and difficult to manage. He calls a 5% workforce reduction far from draconian.

"Citigroup has built up lots of bits and pieces over time, and it's a culture that tends to be combative," Tschoegl says. "Clients have been known to remark that Citibank's most tenacious competitors have been other Citibank units. So this is a case of having a lot of bits and pieces and tidying things." But cost-savings also play a big role in Citigroup's restructuring. Tschoegl says the company could benefit, for example, by moving back-office functions from high-cost locations like New York to lower-cost operations in South Dakota and India.

In general, Tschoegl says, cutting jobs makes sense when a company is not only trying to reduce costs but also complexity. One common way to achieve both goals is to outsource functions -- such as security and janitorial services -- to firms that specialize in such services. In these cases, outsourcing can actually benefit janitors and security guards because they will be employed by firms that can offer them an upward career path in ways that a big corporation never could.

"Where you get into trouble is if you simply cut heads across the board," Tschoegl warns. "Then you're not being sensible; you're not getting rid of things that could be done better by somebody else ....No company has ever gotten good by simply cutting."

Another risk is that a downsizing company can get rid of people whose knowledge and experience are vital. Wharton management professor Daniel A. Levinthal points out that Circuit City's decision to cut 3,400 veteran sales people "sounds like a massive de-skilling" of the company. Since the people who will be hired to replace the laid-off workers probably will not know the merchandise as well as the workers who were dismissed, customers who want to know how to set up a high-definition TV or why one music player is better than another might not receive the best advice.

If this is the case, Circuit City might have a hard time differentiating itself from its competitors. "These new people will be order takers and have less knowledge [about the merchandise]," says Levinthal. "Circuit City would now be competing against e-commerce because it's become similar to e-commerce and lost its differentiation as a bricks and mortar store."

As for the financial benefits associated with layoffs, Wharton accounting professor Wayne Guay says eliminating jobs can help a company financially in several ways. One benefit is that labor expenses are lower and cash flow is higher in the current and following years simply because the firm does not have to pay as many people. But layoffs do not necessarily allow a company to take a large write-off that can sharply reduce its tax liability for the year in which the job cuts take place.

Bad News in One Big Dose

Typically, it is best for a company that is downsizing to announce all the bad news "in one fell swoop" rather than in a "series of smaller, separate, sequential layoff announcements," Useem

notes. "Employees don't like the sequential approach -- they don't like any downsizing, of course -- but they like least the suffering of a thousand cuts. The same thing is true for the stock market."

The way people are treated during a downsizing is a "testament of the values and soul of a company," according to Useem, and firms should follow several steps that demonstrate to employees and the world at large that the firms practice good management principles. First, companies should engage in as much transparency as possible, revealing as much financial information as they can to show the need for job reductions and help laid-off workers obtain retraining, outplacement assistance and resume-writing guidance.

Second, firms should work intensively with the employees who remain on the job because these people "will be shell-shocked and fearful that they could be next," Useem says. "Gloom and anxiety are exactly the opposite of what companies need when they go through downsizing because they need to get more work done with fewer people. Good morale is essential. If top and middle management works with the people who remain, it can be a vital formula for ensuring that the people who are survivors get behind the new, leaner company, and achieve the results top management wants to achieve."

Regardless of the motivation behind, and execution of, layoffs, it is clear that they will continue to occur with almost drumbeat regularity. "The use of layoffs as a management tool to cut costs is widespread," says John Challenger, chief executive of Challenger, Gray & Christmas, a Chicago-based outplacement firm. "Virtually every Fortune 500 company has done it. Only the absolutely most successful companies, [whose] profits have been consistently up, may have [avoided] them. Layoffs have come to be expected by shareholders, and we are more and more in an environment where shareholders drive company actions."

'Talent on Demand': Applying Supply Chain Management to People

Failing to manage your company's talent needs, says Wharton management professor Peter Cappelli, "is the equivalent of failing to manage your supply chain." And yet the majority of employers have abysmal track records when it comes to the age-old problem of finding and retaining talent.

Supply chain managers "ask questions like, 'Do we have the right parts in stock?' 'Do we know where to get these parts when we need them?' and 'Does it cost a lot of money to carry inventory?' These questions are just as relevant to companies that are trying to manage their talent needs," he says. In other words, the principles of supply chain management, with its emphasis on just-in-time manufacturing, can be applied to talent management.

"This is a fundamentally different paradigm in terms of thinking about talent," according to Cappelli, the author of a book coming out in April titled, Talent on Demand: Managing Talent in an Age of Uncertainty. His theory, he suggests, addresses a major complaint about the field of human resources -- that it is "touchy-feely, squishy stuff with little applicability to business problems. HR practices have typically been about meeting individuals' needs, figuring out what psychological profile they fit and what should be done to help them grow and advance. But if you're an employer who is worried about issues like the finances of the company, you would like HR to think about personnel from the perspective of money and costs, and what happens if you don't have the right people in place to do the necessary jobs."

Those who study supply chain management tackle these kinds of questions all the time, notes Cappelli. "Managing supply chains is about managing uncertainty and variability. This same uncertainty exists inside companies with regard to talent development. Companies rarely know what they will be building five years out and what skills they will need to make that happen; they also don't know if the people they have in their pipelines are going to be around."

Part of the problem is that many companies are locked into an older paradigm based on the assumption that they can accurately meet their talent needs through static forecasting and planning models, even though the global marketplace is an increasingly unpredictable, unforgiving environment. "The idea that we can achieve certainty through planning is no longer true," Cappelli states. "Instead, we have to deal with uncertainty by being more responsive and adaptable."

Sitting on the Shelf

The term "talent management" simply means "trying to forecast what we are going to need, and then planning to meet that need," Cappelli notes. The definition of supply chain management is essentially the same: "We think that demand for our products next year is going to be 'X'. How do we organize internally to meet that demand?"

Underlying supply chain questions is the issue of inventory, which in talent management terms often comes up when employers talk about having a "deep bench" of talent. "You hear that phrase a lot -- 'we have a deep bench,' or 'we have a big talent pipeline' -- and it is said with pride," Cappelli says. "Yet if you think about it in supply chain terms, a deep bench is the equivalent of lots of inventory, which sounds terrible when we think of products. In fact, it is worse when we talk about talent. That's because an inventory of talent is much more costly than an inventory of widgets. Talent doesn't sit on the shelf like widgets do. You have to keep paying talent. And the best way to have a piece of talent walk away is to tell it to sit on the shelf and wait for opportunity. Anyone who is ambitious will leave, and then you will lose the big upfront investment you made in that person."

Avoiding inventory buildup directly relates to companies' efforts to manage the uncertainty around their talent needs. "Suppose a company forecasts that it will need 100 new engineers this year," says Cappelli. "No one ever asks the question: 'How accurate is that forecast?' As it turns out, that forecast is almost always wrong because business needs are so hard to predict. So the way to proceed is to ask the next question: 'What happens if we are wrong?' You can be wrong in one of two ways: You can end up needing more engineers than you thought and have to either carry them or lay them off, or fewer engineers than you thought and have to scramble to find extras. Next question: 'What does that cost us in each case? Does it cost us more if we have too many, or if we have too few?' It's almost always the case that it is much worse in one context than in the other."

If companies start thinking about what the odds are of being wrong, and what the associated costs are, "then they know which way to bet and they greatly reduce their likelihood of losing a lot of money," Cappelli says.

From there, the challenge is to reduce the odds of being wrong. That points to another technique from operations research -- the portfolio approach, whose goal is to minimize the variability that occurs when different markets are headed in different directions. In the financial world, investors create a portfolio of diverse investments where some are likely to be up when others are down in order to reduce their overall risk exposure. Applied to talent management, the concept means balancing out the kinds of errors that might occur, for example, when different divisions in a large, highly decentralized organization try to predict the number of sales people (or general managers, engineers, etc.) each division thinks it will need. "Some divisions will end up with too many sales people, and some with too few, but if you pool these different divisions with respect to hiring, it's likely the variations will cancel out rather than multiply," Cappelli says. "The problem has been that companies have decentralized so much that they stopped even thinking about how to coordinate talent questions across divisions."

As he writes in his book: "In the language of operations research and supply chain management, the problems of undersupply and oversupply are collectively known as 'mismatch costs.'" The

portfolio solution addresses the mismatch problem by encouraging companies to coordinate the different talent development efforts into one common program. When some divisions overshoot demand and others undershoot it, "the company can offset the mismatch by moving candidates around."

Reducing bottlenecks is another supply chain concept relevant to talent-on-demand. The CIA had this problem when it faced a two-year waiting list to get people through security clearances, according to Cappelli. "New hires were stacked up with nothing to do, exactly the way goods can get stacked up in an assembly line. It's important to remember that the assembly line can move only as fast as the slowest part."

In the CIA's case, because it wasn't able to increase the flow of people through security, the question becomes: Why is it hiring so many people, knowing they can't get through the bottleneck? "The organization shouldn't make that many hires at once," Cappelli says. "You see this in many companies, including those that hire people only once a year, like college grads. Say they hire 50 graduates in June into training slots. At the end of the year, they have 50 people expecting to move from the training program into more permanent positions. Why doesn't the employer stagger the process and hire people twice a year instead of once? Not all college grads prefer to start work in June; some want to travel and start later in the year." The advantage of staggering the hires is that the company then needs only half the number of training positions and, more important, can adjust the amount of hiring in the latter period to changes in demand.

Other operations research practices that Cappelli relates to talent development include shortening the forecasting cycle, reorganizing the delivery of development programs to improve responsiveness, and working out "queueing problems." Queueing problems occur in situations where, for example, employees are waiting for rotational assignments but can't get them because the incumbents have no vacancies to move into -- the result of a business downturn, change in assignment length or a product redesign, for example. "The analogy in manufacturing is an 'unbalanced [assembly] line,' in which inventory builds up behind the slower-moving station, or in this case, the assignment that takes longer to complete."

Bust Instead of Boom

Many of the so-called new ideas in talent management now -- like 360-degree feedback, assessment centers, job rotation and especially long-term succession planning -- were common in the heyday of big corporations and stable growth that followed World War II, says Cappelli, who is head of Wharton's Center for Human Resources. "The current business environment bears little resemblance to the post-World War II period -- which explains why the planning-based approach no longer makes sense."

The 1970s were a case in point. Companies carefully crafted long-term plans for developing talent that turned out to be totally wrong, Cappelli says. "Everyone expected the economy to boom, and in fact it was flat. Employers turned out lots of talent they couldn't use, which led to the general abandonment of internal talent development." The early recession and re-engineering wave of the 1980s reversed that. "Companies got rid of huge numbers of employees, which

meant there was no institutional memory left in the ranks. That's when people started to reinvent practices that were common in the 1950s."

In the 1990s, Cappelli says, companies turned to outside hiring, inspired in part by the large number of laid-off employees that were a hangover from the 1980s and in part by the ability to hire workers "just in time." But employers also began to hire people away from their competitors -- a game that created retention problems and usually ended in an expensive draw once more companies started to play it. In addition, organizations found that outside hiring did nothing to improve morale for those inside the company who saw new people being brought in over them.

Companies are left facing a dilemma: On the one hand, it's hard to get a payback from investing in talent development when priorities suddenly shift and employees change jobs every few years instead of once or twice a career. But doing no internal development and relying only on outside hiring is also problematic since it leaves the employer vulnerable to the whims of the labor market. "What we need is a way to deal with the uncertainty of business needs and the uncertainty of internal talent pipelines," says Cappelli, noting that the choice is not between developing talent internally or hiring from the outside. The better option is to do some of both: Use more adaptable models of internal development that include getting employees to share the costs, and then use outside hires to fill in the shortfalls when forecasts inevitably prove wrong.

Companies that are moving in this new direction include startups, which have a clean slate as far as talent management practices go, and professional services firms, where getting the right talent mix is especially critical. "Consulting firms, auditing firms, law firms and so forth started to make the effort to calculate the costs of poor talent management back in 1999 when the labor market was so tight," Cappelli says. "Because of the need to constantly hire new people, they know that their ability to compete can be severely compromised by high turnover." Indian firms, he adds, may be the leaders in new ways to think about managing talent because the talent crunch in that country is so severe.

Cisco's 'Voluntary Sabbatical'

In his book, Cappelli cites the talent management processes at a number of companies, including Unilever, IBM, General Electric, EDS, Dow, Capital One, Citibank, Corning, Johnson & Johnson and Bear Stearns, to name a few.

He describes the sophisticated forecasting model at Dow, which incorporates traditional statistical-based forecasting with such factors as the political and business climate in each of Dow's countries of operation, changes in labor and employment legislation, and business plans for the operating units. "Standardized systems make it possible to aggregate the individual estimates up to an overall projection for the company," Cappelli says.

At Capital One, where the challenge was to help the company plan its workforce -- which had gone from 20,000 employees in 2001 to 14,000 in 2005 to 30,000 in 2007 after a series of acquisitions -- the company assembled a team with experts in marketing and operations research, but none from the traditional HR function. The group used data mining techniques, manufacturing models and information from its PeopleSoft system to generate talent planning

models for each business unit. "Rather than just predict the number of people required in each role, they also modeled outcomes such as attrition rates, employee morale, rates of promotion and outside hires." The big innovation at both companies is that these models have moved past traditional forecasting and toward simulations in order to deal with uncertainty in business. "Rather than generating a static estimate of how many workers will be needed two years out," says Cappelli, "they say to operating managers: 'Tell us the assumptions you have about your business, and we'll give you a talent estimate. Better yet, give us a range of different assumptions, and we'll give you a range of talent estimates within which the reality will most likely lie.'"

Cappelli recounts efforts by some companies to give employees more control over the career development process and thus make them more likely to stay with the company. Duke Power, for example, allows employees, under certain conditions, to post and swap jobs with other employees at their same job and salary level. Coca-cola run job fairs for its junior auditors; Gap operates an internal headhunting office where employees with at least two years' experience can look for other positions within the company.

Chubb "opened up its internal labor market by eliminating both job tenure and supervisor approval as requirements for changing jobs within the company." McKinsey posts all the projects that use associates (the level of employee below partner) on a worldwide system along with information on the relevant industry, the client, the in-house team and the type of project work. It then encourages associates to rank their preferences.

During the IT downturn in 2001 and after, Cisco offered a "voluntary sabbatical" to its employees in which the company agreed to pay one-third of their salaries while they spent time working at nonprofit organizations." Deloitte tries to keep former employees of Deloitte & Touche plugged in to the company for as long as five years after they leave (often for family reasons), provided they don't take a new job. Its Personal Pursuits program covers certification and skills programs fees to help them stay current, and offers access to company career and work-life programs, among other things. The idea in both cases is to keep employees "on the hook" with the company so that they can be brought back to work quickly should demand pick up.  

Cappelli acknowledges that uncertainty about whether skills will be needed in the future and whether employees will stick around makes it difficult for employers to recoup investments in those employees. One of the best ways to deal with that problem is to get employees to share the costs of development. "Rather than trying to guess who is ready for advancement,' Cappelli notes, "many companies have moved toward self-nomination, where individuals volunteer or apply for development experiences. The employers usually require that the candidates keep doing their regular jobs and maintain good performance in them. So the developmental experiences, which are typically work-based, are essentially free to the company."  

Selling Old Ideas as New Concepts

For the most part, however, companies are not yet going in new directions when it comes to adopting more efficient talent management techniques. This is especially so at the bigger, older

employers like General Electric, Procter & Gamble, IBM, PepsiCo and members of the oil industry. Many of these are known as "academy companies," referring to their reputations as places where employees go to learn management skills and then are hired away by other firms.

GE "is doing the same things it did in the 1950s," says Cappelli. "It laid out a model and that model is not being questioned. Some parts of this model work well and are quite consistent with what I describe -- especially the ability to make matches between people and opportunities -- but other components aren't as efficient, such as the goal of having deep benches of talent. IBM no longer guarantees people lifetime employment and they do some amount of outside hiring, but they still direct the careers of their managers from headquarters.

So many HR people were laid off during the 1980s that HR personnel don't know that the planning models many are embracing are decades old, says Cappelli. "HR people are all drinking the same Kool-Aid. They are selling these practices like they were new ideas. At the same time, internal accounting is so bad that they don't even know the costs of their inefficient talent management efforts. Companies don't realize that they need a change."

A new approach to talent management is needed for two key reasons, according to Cappelli: On the public policy side, companies are not developing the talent the U.S. needs to stay competitive. On the employer side, most of the companies aren't doing talent planning, or their planning is wrong, even as their ability to hire on a just-in-time basis is eroding. Employers can't easily find people out there to poach; it's an expensive and time-consuming process to even look.

When planning practices were first initiated, Cappelli says, markets were stable enough to make long-term planning possible. "IBM, for one, had 15-year business plans that were pretty accurate. Companies in the defense industry had 10-year plans. You didn't have to make year-end adjustments back then. But these days, demand can change within a year. Authority and accountability are pushed onto individuals and not systems, and career mobility across companies is high. Employers must adapt to that reality."

Human Resources Challenges on a Global Scale

The 57 members of AHRMIO, the Association for Human Resources Management in International Organizations, range from the UN, UNICEF and OECD to the World Health Organization, the World Trade Organization, the World Bank and the International Labour Organization. AHRMIO's goal is to improve the professionalism of those who work in human resources management in international not-for-profit organizations. Mary Jane Peters, executive director, and Roger Eggleston, president emeritus, were at Wharton recently for the group's 7th annual conference. They talked with Knowledge@Wharton about their successes -- such as the introduction of paternity leave, a policy regarding sexual harassment, competency based assessment and flexible work practices -- as well as their major challenges, starting with the lack of qualified young people around the world to carry out the missions of AHRMIO's member organizations.

Knowledge@Wharton: Could we talk about AHRMIO [the Association for Human Resources Management in International Organizations]? What exactly is AHRMIO and how do you work with international organizations?

Eggleston: Let's talk a little bit about the history of AHRMIO. It was in 1996 when Mary Jane and I were running a conference of human resources specialists in mainly the United Nations group of organizations. We had this retreat and series of interactions with all of these people, and we said that this is the time when we should create some sort of learning institute. It would be where people who are working in human resources management, in international, not-for-profit organizations, could come together because they have some unique elements in their jobs which are not common outside the international organization arena. Just to name one: We are not subject to national legislation. So we are not impacted by matters that take place in any one country. 

We said there are enough reasons to have what we called an "association" -- we dropped the name "institute." In 2000, we set up AHRMIO and it really took off, very well indeed. We have 57 member organizations now -- organizations that are members of AHRMIO. And we have over 200 individual members because we have both individual members and organizational members.

We have an annual conference, and that's why we're here at Wharton. It's our 7th Annual Conference. We have lots of developmental activities. The role of the association, in a nutshell, is to improve the professionalism of those who work in human resources management in international not-for-profit organizations.

Knowledge@Wharton: Can you give us some examples of the 57 member organizations?

Peters: Well, you have all of the United Nations family there; so you have the UN, UNICEF, UNDP, UNFPA, The World Health Organization, The International Labor Organization, The Food and Agricultural Organization -- the whole UN family, and that's about 29 entities.

In addition to that you have, I would say, all of the other leading international not-for-profit organizations. For example, The Organization for Economic Cooperation and Development, which has its headquarters in Paris, The Organization for Security and Cooperation in Europe, NATO is even there. We have the GAVI Alliance which carries out immunization programs throughout the world, the World Trade Organization, the World Bank...

Knowledge@Wharton: In other words, all of the big names.

Eggleston: If there is a lacuna, it's the NGOs, what we would call the non-governmental sector, but there are a few and we're hoping to get more. At this conference, we have the leaders of the Red Cross and the Red Crescent Societies, but we need a few more NGOs.

Knowledge@Wharton: It seems like quite an incredible group of organizations that you work with. In working with these groups, what have you found to be the biggest leadership and HR challenges that international organizations face?

Peters: Well, it's difficult to generalize across all 57 organizations. I can certainly address what I know best, given my past career, in terms of the United Nations family. From an historical perspective, many people who joined the organizations will soon be retiring. In some organizations, more than 50% of their professional staff will be leaving in the next three to five years. Yet I know that very few of them are doing any kind of serious succession planning.

So, this is a chance for all of your MBA students, because there will be a tremendous need to find talent. But then on the other side of that, of course, is keeping our institutional memory. For the missions of these organizations, that is vital. We cannot police the world; we do not police the world. We give knowledge to the world. And so, with all of the people marching out of the door, going to retire soon -- I think this is the biggest challenge for the leadership of the organizations.

I suspect that for many of the international organizations, that will be equally true, perhaps less so with some of the newer ones, such as the UN program on HIV Aids or the GAVI Alliance. These are very young institutions, and so the average age of their work forces tends to be much lower.

Eggleston: One of the challenges facing these organizations is that I don't think they have really appreciated that there is going to be a war for talent among the knowledge workers of the world. The UN family, and probably most of the international organizations that we are talking about, have had it easy, basically.

They had good brands, a really good brand image. People just applied to them for jobs. It was not too difficult to find good people, basically all around the world. But it will be much more

difficult, and I'm not sure that they have professionalized their area of recruitment well enough to really know how to target and how to get the best people. 

It's still very much, I won't say hit or miss, but they're very much... just waiting for people to apply and come on board. But you get all sorts of strange applications -- too many and not the right type.

Knowledge@Wharton: What should recruiters be looking for when they try to fill these jobs that are going to become vacant?

Peters: Well, I'm going to have to address one issue which is even written in the charter of the United Nations as well as the constitutions of most organizations -- the need for universality, what we would call geographic distribution. I think that our organizations have handled diversity from a nationality perspective very well.

However, for the future, this will become a far greater challenge because, as Roger said, while the brand was good for the first 60 years, now the same diversity is needed by a lot of other organizations, development aid agencies and the private sector. They want as diverse a workplace as we do. So, we are really all competing for the same talent among the knowledge workers. All of these groups have higher-level educational qualifications.

In many cases, these organizations would not take someone with less than a Master's Degree. Some of our economists or lawyers have PhDs from leading world institutions. They will be required to be linguistically flexible. They will have to be geographically mobile in most instances, and that is a challenge for all global employers, given the growing importance of dual careers.

That has been a challenge for the organizations up to now, especially vis-à-vis women, and I would say as far as gender balance, that's where the organizations have done less well than in terms of geography. But dual careers for the younger male will also be just as important. The world has changed.

Eggleston: We're going to have to think out of the box. Years ago, when I began my career in the World Health Organization, we did not employ spouses -- we called them "wives" in those days -- never mind partners. The organization was not allowed to employ the spouse of an employee. That of course has all changed; we've wiped all hose silly rules away. But we're going to have to get with it as far as dual careers are concerned.

One of the things that we're just going to have to do is to team up with other people who have the same problem in the world. There are international corporations of all varieties and they all are facing the same problem. We have an enormous international workforce. We've really got an opportunity to team up with other corporations and organizations which are doing similar things.

Knowledge@Wharton: What would be the attraction of your organizations to someone who could probably make more money in the private sector?

Peters: There was some research recently produced by a group called The Future Work Forum. I'm seeing, at least from the research, some very surprising and lovely trends -- and that is that the younger generation is interested in international careers; they are interested in being mobile and in getting intrinsic worth from their job.

They're interested in doing good for the world. Well, if there are ever any organizations where you can do good... And, I'm happy to see, too, that MBA students are more and more interested. You know, in the past sometimes they just wanted to go out into the financial sector. I'm being approached by more and more MBA students in terms of how to work for a UN-type humanitarian organization.

These organizations are difficult to work for in some cases. I don't want to minimize this. If you work for the High Commission for Refugees, or for UNICEF, or for the World Food Program, you have to expect to be constantly mobile. And you may never work in your home country. You may sometimes be in places where your family can't be there because they're so dangerous. But I think that there is a growing number of people in our world who recognize the importance for the world, for their own families, of the missions of these organizations and are very attracted to them.

Knowledge@Wharton: Do you find that within the international organizations with which you work that there is recognition of the seriousness of this war for talent, or are they in denial?

Eggleston: I don't think that the large majority of organizations appreciate that this war for talent is coming. It's very difficult to talk to people, for example, in organizations and say that "There is going to be a war for talent." And they say, "No, no, no, we've got 20,000 applications from Bangladesh." Or, "We've got 2,000 applications." I mean, with every job, there are lots of people from India who will apply. No disrespect, but you know it happens -- it's the reality. 

The bigger problem is sifting through those applications. But that's what I was trying to point to. The organizations haven't understood really what they're looking for. They're just receiving a lot of applications. So no, I don't think they've yet come to grips as much as they ought to with the need for understanding what the next workforce really will look like. It was very easy in 1945 and 1955 and 1965. There were bright, bushy tailed young people rushing to join the United Nations system and all of the international organizations. But it isn't like that now, and it certainly will not be like that in the future. 

Peters: Also, as far as pay trends that we see happening in the world, the organizations would admit, in most cases, that in western industrialized countries, it's gotten harder to recruit. Now what we see in terms of pay trends in Asia, in particular, but also in all of what are called the BRIC countries [Brazil, Russia, India and China], is that pay is rising so fast.

I know someone who worked for one of the international financial institutions and wanted to leave their headquarters in North America to return home to Brazil because pay was better in Brazil. There is a constraint to being a constant ex-patriot, and being away from your own professional, social and family ties back home. So sometimes people will not be attracted or will go back and we will not be able to retain that talent unless we address certain issues seriously.  

Knowledge@Wharton: We've been talking in somewhat general terms, which is good. But can you give us specific examples, without naming names, of good and bad leadership in international organizations?  

Eggleston: Certainly good leadership, and I suppose by implication bad leadership, yes. I think for me good leadership is leadership that has real integrity, real impartiality and can stand up under pressure to governmental influences. That is very difficult in an international political arena.

But I will give you one example which I witnessed, well even more than one, if you'd like. I worked for somebody in The World Health Organization. He's called Leo Caprio. He's dead and I don't think he would mind at all if I told you. I remember very well, this was that year when cholera broke out in Naples, in the 1970s. It's a famous case.

The Italian government denied that there was cholera but press reports were beginning to appear and we had information from the WHO that there was cholera. This is of course is serious for tourists and tourism and the whole economic spectrum. Leo Caprio said one Friday afternoon, I remember it very well, he talked to a group of us, and he said, "I am going to declare that there is cholera in Italy on Monday morning, or on Sunday night, if the Italian government doesn't do that, and I have told them so."

[He did this] despite the votes he would lose in his election as the chief [and the fact that] he would not be a popular person in Italy. Of course what happened was that the Italian government declared over the weekend that Naples had cholera. That [I think] is a good leader. There are fewer and fewer of those in my experience these days. There are more and more who are seeking the glamour and the hubris.

We have a hubris syndrome in leadership and in government. And we're seeing it in international government, if you like. I think the leaders of the countries that are best known to some of us are full of hubris. This is a serious problem for the future of the world, and it's certainly a serious problem for the organizations.

You don't feel that there is that commitment to the cause of the organization. There is a commitment to 'Me, I and how good and clever I am and how my story can be spun by spin doctors.'

Peters: I think that a clarification perhaps would be useful, because I know my own mother often didn't understand this. She would often say, "Well, are you representing our government in that organization?" I would say, "No, Mother, I'm an international civil servant." And that is at the heart of these organizations. We are there to serve the world community.

Yet we live in a political community around these organizations. There's always bound to be tension. You see it being played out every day in the UN General Assembly or in the UN Security Council. But this exists in all of these organizations, and the only moral authority these organizations can have vis-à-vis the world citizens is the extent to which the staff members are

politically neutral, impartial and independent -- not taking instructions from any member country.

Eggleston: That is written into the constitutions of the organizations -- that the staff should be impartial and have integrity and so on. It was that [lack of impartiality] of course that brought down the League of Nations. If you look at the history of why the League of Nations did not succeed, it was because staff from the civil services were brought in from their member states -- and they represented their member states -- and that failed as a model. Our model has been working and, I pray, will continue to work. We must be very careful to make sure that we enshrine this impartiality and integrity into the staff that come in the near future.

Knowledge@Wharton: Roger, you mention integrity as a key component of leadership, and that's of course absolutely and universally true. But, based on what you just described as the nature of these organizations, what do you think are the qualities that a leader needs to succeed in these kinds of organizations? And how would they compare, for example, to the kind of qualities you might need to succeed in business or in a company?

Eggleston: That's a tough question, but I don't think that there's any difference. I don't think that leadership is divisible by functional area. I'm sure that the dean of an academic institution or the president of an academic institution and the CEO of a major corporation and the secretary general or director general of an international organization -- I'm sure the qualities that are required will be very much the same. It has something to do with being true to oneself.

Peters: I agree with Roger. We can look at Enron, for example, and at the economic and social impact of that company's failure which ... was due to issues of the values of the leadership.

I would say that in these international organizations, the repercussions for the world at large are far greater. It's humanity that is at stake. When we fail to do something about what's happening in Darfur quickly; if we cannot convince governments to deal with a problem as far as HIV AIDS, refugee issues -- when leadership fails there -- we fail the world community at large.

Knowledge@Wharton: Can you make any generalizations about either continents versus developing countries, or specific countries versus others, that are more receptive to these messages, to your efforts, etc.?

Peters: No, I think that it's general across all regions of the world.... There will be some people who have more of a professional calling, vocation, idealism, than others. But, that would be true in any society.

Eggleston: If you want a country that is doing the most about integrity, in its national civil service, it's probably South Africa. At the moment, for me, South Africa would be the example of where an awful lot is going on to bring integrity into the national civil service.

Knowledge@Wharton: We talked about the challenge that international organizations face and the fact that they're not always fully aware of the seriousness of the problems. What possible solutions would you suggest that might address those issues?

Peters: That's another hard question. And, it's difficult to generalize across 57 international not-for-profit organizations. But, I think there is one area, and it goes back to the tension that I spoke about a moment ago. When I speak to people, I think it is really important that citizens at large not leave these organizations solely in the hands of their governments. This is because the issue of the impartiality of the institution is the most serious.

I have witnessed, in over three decades of working for UN family organizations, the pressures that come sometimes from certain member states. Even when you are trying to put in competency-based assessment, a new code of conduct for the international civil service, things that would be often times normal in a national context -- sometimes these tend to be resisted by certain governments.

For them to not be suspicious of these things and see them as normal good business practice, I think that from a management perspective, I have seen that to be a tremendous challenge. This is leaving aside all of the political issues of the problematic areas of some of the organizations -- to send peace keepers into Darfur or not to send them, for example. Those are other issues. But, on the management side, I see those issues needing to be addressed urgently.

Eggleston: Governance is a very complex and interesting subject which one really could talk about for a very long time. The governance of the United Nations and specialist organizations is made up of people who are running those organizations in terms of member state representation. They usually come from foreign ministries, or if not foreign ministries, some ministry. They are not elected officials. They are civil servants of one form or another and I don't know if they do represent 'we the people' always. I have put myself in a lot of hot water with a number of delegates in the general assembly of the United Nations because I have said to them, "I'm not sure that you really represent the people of wherever it is you are coming from," which is not a thing you should say.

A number of the older organizations, those that were born after the Second World War, had built into their constitutions a very strong international secretariat. If you look at the organizational structure of the UN, you will see that there are five pillars. There is the General Assembly, The Security Council, The Economic and Social Council and something called The Trusteeship Council.

And the fifth pillar says Secretariat. That's probably fairly equal in power. The member states do not like that; they say, "We are in charge of the organization and you will do what we say." We've had a number of discussions on that subject, about that role.

Certainly, in the newer organizations -- those that have been set up in the last 10 years or so -- you will see a very different organizational diagram. This is where the member states sort of say, "You, Secretariat, sharpen the pencils and write the reports and we'll tell you what to do." That's a different relationship, and it's happened.

Peters: But I think that it's interesting and important to note that compared to a big private sector company, imagine 180 people on your board, from 180 different countries.

Eggleston: With 180 different views.

Knowledge@Wharton: Well, given the fact that the two of you, between yourselves, have several decades of experience in this area, what would you count as your biggest successes?

Eggleston: I was thinking of that earlier. This is because there is quite a lot of cynicism, and maybe healthy cynicism in these organizations. It is sometimes difficult to keep your enthusiasm going. But I think we were fortunate to always work in areas where we felt that we were really trying to do good things. We were not subject to a lot of pressure from hierarchy about these political things and so on. So we could really introduce some changes in small and in larger areas. That was really rewarding.

These were changes like paternity leave... And then, of course, starting AHRMIO meant that we exposed people whom we were working with to a much greater array of thought about what human resources management was in the year 2000 and after, and what it really meant to be worried/concerned about the management of human resources in organizations. As for success stories -- we've had one or two.

Peters: Oh yes. I recall addressing a group of MBA students at a business school in Europe recently. I was trying to compare us, based on my experience of working in these organizations, to the private sector. I think that for a younger person, there's a lot more scope to develop yourself and your job.

We have impossible mandates -- think about peace and social justice, for example -- and very, very limited budgets. So in the private sector -- this is a generalization -- jobs tend to be much more defined and closed. Whereas, I think for a bright young person, who has good thinking, learns quickly the context in which they are working -- I think that there is tremendous scope for them to enlarge their work.

I have advised them that you get there by understanding the context, being very patient and getting there by stealth. Roger and I, together, in the HR area, used a lot of patience and stealth. And at one time, when people in these organizations wouldn't even talk about sexual harassment, for example, we managed to get through back in the early 1990s. Considering the multi-cultural setting, this was not easy -- a policy on sexual harassment in the workplace.

We managed to introduce paternity leave, which is one full month for fathers. We managed to introduce competency based assessment. We managed to do a whole range of policies that were signed off by the executive heads, including the Secretary General, for flexible work place practices. So, I think that in many respects we've had some success stories. We've had failures too, but I never saw them as failures. I've said that the time is just not right.

Eggleston: They would just say, "Mary Jane, go back to your sandbox."

Managing Emotions in the Workplace: Do Positive and Negative Attitudes Drive Performance?

You know the type: coworkers who never have anything positive to say, whether at the weekly staff meeting or in the cafeteria line. They can suck the energy from a brainstorming session with a few choice comments. Their bad mood frequently puts others in one, too. Their negativity can contaminate even good news. "We engage in emotional contagion," says Sigal Barsade, a Wharton management professor who studies the influence of emotions on the workplace. "Emotions travel from person to person like a virus."

Barsade is the co-author of a new paper titled, "Why Does Affect Matter in Organizations?" ("Affect" is another word for "emotion" in organizational behavior studies.) The answer: Employees' moods, emotions, and overall dispositions have an impact on job performance, decision making, creativity, turnover, teamwork, negotiations and leadership.

"The state of the literature shows that affect matters because people are not isolated 'emotional islands.' Rather, they bring all of themselves to work, including their traits, moods and emotions, and their affective experiences and expressions influence others," according to the paper, co-authored by Donald Gibson of Fairfield University's Dolan School of Business.

An "affective revolution" has occurred over the last 30 years as academics and managers alike have come to realize that employees' emotions are integral to what happens in an organization, says Barsade, who has been doing research in the area of emotions and work dynamics for 15 years. "Everybody brings their emotions to work. You bring your brain to work. You bring your emotions to work. Feelings drive performance. They drive behavior and other feelings. Think of people as emotion conductors."

In the paper, Barsade and Gibson consider three different types of feelings:

Discrete, short-lived emotions, such as joy, anger, fear and disgust.

Moods, which are longer-lasting feelings and not necessarily tied to a particular cause. A person is in a cheerful mood, for instance, or feeling down.

Dispositional, or personality, traits, which define a person's overall approach to life. "She's always so cheerful," or "He's always looking at the negative."

All three types of feelings can be contagious, and emotions don't have to be grand and obvious to have an impact. Subtle displays of emotion, such as a quick frown, can have an effect as well, Barsade says. She offers this example: "Say your boss is generally in very good humor, but you see him one day at a meeting and his eyes flash at you. Even if they don't glare at you for the rest of the meeting, his eyes have enunciated some valuable information that is going to have you concerned and worried and off center for the rest of the meeting."

Barsade suggests that while some people are better than others at controlling their emotions, that doesn't mean their coworkers aren't picking up on their moods. "You may not think you are showing emotion, but there's a good chance you are in your facial expression or body language. Emotions we don't even realize we are feeling can influence our thoughts and behaviors."

The researchers' paper discusses a concept known as "emotional labor," in which employees regulate their public displays of emotion to comply with certain expectations. Part of this is "surface acting," in which, for instance, the tired and stressed airline customer service agent forces himself to smile and be friendly with angry customers who have lost their luggage. That compares to "deep acting," in which employees exhibit emotions they have worked on feeling. In that scenario, the stressed-out airline worker sympathizes with the customer and shows emotions that suggest empathy. The second approach may be healthier, Barsade says, because it causes less stress and burnout, particularly emotional exhaustion from having to regulate one's emotions and "play a role."

But is there a downside to being too authentic? If the company is losing money and experiencing the effects of downsizing, should the manager, feeling stressed and overwhelmed, convey his despair to his workers? Or should the manager try to appear cheerful and act as if nothing is wrong? Barsade says it's possible for the manager to convey emotions that are both authentic and positive, saying something like, "I know you're worried. Things aren't looking good, but you know, we have a way out of this and we can work [on it] together." The employees will appreciate the honesty and take comfort in the optimism, she says.

Emotions as Valuable Data

Emotional intelligence -- buzz words already familiar in psychology and education -- is now talked about in business circles as well, Barsade says. Business schools are teaching executives how to be emotionally intelligent, and how to manage the emotions of their employees.

"The idea behind emotional intelligence in the workplace is that it is a skill through which employees treat emotions as valuable data in navigating a situation," according to the authors. "Let's say a sales manager has come up with an amazing idea that will increase corporate revenues by up to 200%, but knows his boss tends to be irritable and short-tempered in the morning. Having emotional intelligence means that the manager will first recognize and consider this emotional fact about his boss. Despite the stunning nature of his idea -- and his own excitement -- he will regulate his own emotions, curb his enthusiasm and wait until the afternoon to approach his boss."

Barsade says research suggests that positive people tend to do better in the workplace, and it isn't just because people like them more than naysayers. "Positive people cognitively process more efficiently and more appropriately. If you're in a negative mood, a fair amount of processing is going to that mood. When you're in a positive mood, you're more open to taking in information and handling it effectively."

While you can't necessarily change your coworkers, people can take steps to avoid catching a negative mood, according to Barsade. They can tell themselves before attending a staff meeting

that they are not going to be bothered by the person who shoots down everyone's ideas, or that they are not going to let that person become the focus of their attention at the meeting (reducing the possibility for contagion). Or they can change their office routine. Barsade gave the example of a manager who was dragged down at the start of every day when passing by the desk of an employee who either grunted or gave no acknowledgement. The manager took control and simply started following a different route through the office.

Barsade's research has taken her into a variety of workplaces, most recently long-term care facilities. Her research found that in facilities where the employees report having a positive workplace culture -- she calls it a "culture of love" -- the residents end up faring better than residents in facilities with a less compassionate and caring work culture. The residents reported experiencing less pain, made fewer trips to the emergency room, and were more likely to report being satisfied and in a positive mood.

Overconfidence Online

E-mail, instant messaging and video conferencing have introduced new challenges to the workplace, Barsade adds. E-mails and instant messages can be misunderstood because they are devoid of facial expressions, intonation and body language -- cues that help convey emotions. Some people, she says, work hard at making their emails neutral, with the downside of sometimes sounding curt. On the other hand, while some writers may add a smattering of exclamation points, question marks and capital letters in an attempt to convey more emotion, this can also be a dangerous route, particularly when attempting humor or sarcasm to drive home a point.

"How can emotions be best conveyed via these media?" the paper asks. "What is the effect of conveying emotionally charged messages via text, when these messages are more likely to be misconstrued? How must we re-think emotional contagion and other social processes in an organizational world in which many meetings take place online?"

The paper cites a study showing that people tend to be overconfident about their ability to convey the emotion they wish in an e-mail, particularly when they are trying to be funny or sarcastic. "Video conferencing, also increasing in its use, has more cues, but it is also not yet the same as interacting face to face, particularly in group situations. Given that these technologies continue to grow as a primary means of communication within the business world, it is crucial that we understand how the interpretation and communication of affect occurs in these contexts," the paper says.

Workplaces need to get smart about the best use of e-mail, Barsade states. Her advice is that "if something is important, and you know that the emotional context is going to be an issue, then pick up the phone; don't just rely on e-mails." And even the phone may not be good enough. "Sometimes, if it is really important, you just have to fly to where they are and meet them face-to-face to get the message across."

Waking Up on the Wrong Side of the Desk: The Effect of Mood on Work Performance

You know how it goes: A traffic jam blocks your way to work. A rude driver swerves in front of your car and you spill that just-purchased café latte into your lap. You arrive late, in a lousy mood. From there, the day just goes downhill and your workplace performance falls to pieces.

Or does it? Everyone has bad mornings. But does a bad mood really color one's entire day and undermine productivity? Some people, after all, thrive on tension; for others, perhaps settling in to work helps them shake off the lousy mood they started with.

"I'm interested in what people bring with them to organizations," says Wharton management professor Nancy Rothbard. "In my experience, and in the experience of many others, people are not able to completely wall off and compartmentalize different parts of their lives. There is a spillover between the multiple roles that people inhabit."

A significant amount of research has been done in the past two decades on work-family conflicts, Rothbard notes, "but very few studies have actually looked at the effect [of mood] on performance in the workplace." Specifically, Rothbard and Steffanie Wilk, a professor at the Fisher School of Business at Ohio State University, wanted to find out which mood-altering events have the biggest effect, if any -- those that influence one's outlook at the start of the day, or those that nudge one's mood up or down as the workday advances. The results of Rothbard and Wilk's study of call-center employees at a major insurance company are reported in their paper, "Walking in the Door: Sources and Consequences of Employee Mood on Work Performance."

The researchers found that both positive and negative moods affect employee productivity, but that positive moods are more potent. Most importantly, they discovered, the mood you bring with you to work has a stronger effect on the day's mood -- and on work performance -- than mood changes caused by events in the workplace. This finding, according to Rothbard, suggests that a business's performance might be enhanced by efforts to help employees cope with mood-affecting influences in their private lives -- including advising employees on how to best handle commuting hassles or offering counseling for family problems.

"The fact that start-of-the-day mood has such a strong and consistent effect is pretty powerful," she says. "It is something that organizations don't take seriously."

The Swerving Jerk or the Cranky Customer?

In tackling the effects of mood, Rothbard and Wilk write, their first question was "whether mood on arrival at work influences employee work mood during the day.... Second, we are interested in whether employee work mood is more or less influenced by the moods people start with than by the moods generated from the interactions they have during the rest of the work day."

In other words, which upsets you more: that swerving jerk on the road, or the cranky customer on the phone?

Rothbard and Wilk wanted to advance other researchers' findings on forms of "emotional contagion" -- occasions when one person's mood influences another's "through a process of observation, mimicry, and synchronization." The two researchers also wanted to sift out any effect from employees' underlying temperament -- the basic mood one tends to have until events change it. By removing this "trait affectivity on workplace outcomes," they hoped to determine the effect of the more ephemeral mood-changing events.

"Start-of-day mood may come from myriad sources including persistent life challenges and opportunities, positive or negative family experiences before leaving for work, or even the commute into work," they write. "Non-work and work domains are permeable, and research suggests that mood often spills over from one to the other.... Specifically, start-of-day-mood might affect one's appraisal of subsequent events."

Rothbard and Wilk studied employees in call centers operated by a large insurance company on the East and West coasts. The employees included customer service representatives, claims assistants and claims adjusters, as well as their supervisors and managers. The employees completed preliminary questionnaires "to get baseline information on their trait affectivity" -- a sense of each one's basic tendency to be happy, sad and so on. The baseline allowed the researchers to determine how the day's events changed employees' moods.

The 29 customer service representatives each fielded an average of 64 calls per day, and spent virtually their entire workday on the phone. By listening in on some of their calls, the researchers found that callers expressed emotions ranging from pleasant to neutral, angry to frustrated, scared to sad.

Over a three-week period, the researchers used questionnaires, which popped up on the reps' computer screens throughout the day, to sample their moods, as well as the reps' assessment of customer moods. Typical questionnaires asked for replies, on a scale of 1 to 5, to questions about whether reps started the day feeling excited and enthusiastic, or upset and irritable. At various points during the day they were asked to rate their own moods again, and to gauge those of individual customers -- whether they were rude, calm, hostile, insulting, cheerful, friendly or frustrated. At least twice a day the reps answered questions about how well they felt they had focused on the most recent customer call.

In addition, the researchers had access to the performance metrics used by the insurance company to assess the reps' work. This computerized data gauged factors such as the percentage of time each rep had during the workday to answer calls -- in essence, the time they were logged on and not taking breaks. It also counted the number of times each rep transferred a customer call

to a supervisor, which was considered undesirable. The number of calls each rep handled per hour was also assessed, with higher numbers considered better.

After controlling for each rep's underlying temperament, Rothbard and Wilk found that reps who started the day in a good mood tended to stay that way. This was reflected in a strong correlation figure of 0.36 (with 1 being a perfect correlation) between start-of-day positive mood and positive mood during the day. Reps who started the day in a bad mood also tended to stay that way, with a correlation figure of 0.38.

"Start-of-day positive mood spills over and affects positive employee mood during the day," the researchers found, adding that "likewise, start-of-day negative mood spills over and affects negative employee mood during the day, even accounting for work-related contextual influences like customer interactions."

While those findings were not particularly surprising, the study uncovered a twist when it focused on how reps reacted to customers' moods. When reps believed their customers were in good moods, the reps' moods tended to get better, with a correlation of 0.25. But, the reps' moods did not tend to fall when they felt their customers were in bad moods. In these cases, the correlation was a mere 0.08.

When the rep's start-of-day mood was good, and the customer also was in a good mood, the rep's mood tended to remain good. But when the rep's starting mood was bad, it did not tend to get worse when the customer was also in a bad mood. Reps with less time on the job tended to be affected more by customers in bad moods. This suggests that negative customer moods have a less potent effect on reps' moods, or that reps get hardened to unpleasant interactions or leave the firm if they can't, Rothbard says.

"Overall, the combined analyses suggest that start-of-day mood had a more consistent effect on worker mood during the day than did perceived customer mood, because negative customer mood did not seem to consistently influence employee mood throughout the day," the researchers conclude.

The survey of worker performance revealed "partial" support for the hypothesis that workers perform better when they are in good moods. Those in good moods had more time to deal with customers, probably because they took fewer breaks. The happier reps also tended to transfer fewer calls. But being in a good mood did not cause them to field more calls per hour.

The effect of negative moods was slightly different. Reps in bad moods handled fewer calls per hour and were less engaged in their jobs. But bad moods did not significantly increase their phone transfers or reduce the time they had available for customers.

What does this boil down to?

"One of our findings shows that the mood people bring with them at the very start of the workday influenced employee mood more powerfully and consistently than any other variable," Rothbard and Wilk write. "We also found that for the most part, as expected, customer mood

influenced employee mood. Interestingly, negative customer interactions only affected less experienced workers. Last, we show that daily mood at work can influence important work outcomes."

Start-of-day moods may be more potent because they are caused by events that are more important to workers than interactions with customers, the researchers note. It is also possible that workers are trained to handle customer moods but get no similar training on dealing with start-of-day moods. Future research, they suggest, should look at various events that influence those start-of-day moods.

"What I think is really interesting about these findings is that the positive mood that you bring to work is very strong," Rothbard says. "People actually do a pretty good job of walling off the negatives. What's interesting for organizations to understand is that what people bring with them to work is not all bad for the organization, and in fact can be quite positive."

The Hiring Dilemma for High-tech Firms: 'Make vs. Buy'

One particular hiring conundrum is hardly a new one for those in human resource management: Is a company better off developing and training specialized workers in-house or hiring skilled workers from outside the company? The question is especially important in fast-paced, technology-based industries where investment in human capital is critical.

"If firms need to augment the skill of their workforce to complement an investment in technology, they face a traditional 'make vs. buy' problem," write Wharton management professor Benjamin Campbell and four co-authors -- Clair Brown and Yooki Park from the University of California at Berkeley, and Fredrik Andersson and Hyowook Chiang from the U.S. Census Bureau -- in a recent paper titled, "The Effect of HRM Practices and R&D Investment on Worker Productivity." Firms can "structure their HRM (human resource management) system to develop the necessary skills in-house or they can structure their HRM to attract workers with the necessary skills on the external market," he notes.

In response to this make vs. buy dilemma, Campbell and his co-authors think they have found the answer for industries that compete in cutting-edge technology. Using U.S. Census Bureau data recently made available to external researchers, Campbell says his team has statistically demonstrated when companies should hire from outside and when they should develop from within.

For Campbell, the paper's findings are particularly important on two fronts. First, his conclusions can "lay the foundation for how to think about technology and HR at the same time. HR strategy complements technology strategy, yet often people developing these strategies don't work together....  I think this is especially true in younger firms. But if you want to be in a fast-paced industry, you need to invest in an HR system that gives you the skills you need. And it has to start at the CEO level. It has to come from the top down."

Second, Campbell believes that these issues will be increasingly relevant. "More and more firms will be evolving to the spot market [external labor market] model," he says. "Most industries tend to operate in a faster-paced environment [than before]. Product life cycles across all manufacturing industries as a whole are growing shorter. Firms are facing more opportunities for change and more adjustments to the workforce." When skills need to be adjusted, "it pays to buy the skills instead of developing them. And as all industries evolve, I predict we will be seeing more and more firms adopting the buy strategy."

The Hewlett Packard Case

Using examples from the semiconductor industry, Campbell presents these scenarios. If a firm is faced with significant marketplace and technological changes, Campbell argues that it is "better off hiring workers from the outside labor market who have the skills it needs, rather than investing in developing those skills inside the firm." Examples of such firms are found in the

graphics chips industry, where leading companies like NVIDIA, VIA Technologies and ATI Technologies come out with a new product generation every 12 to 18 months. "When product generations are short, there is not necessarily time to develop the necessary skills for the next generation in-house, so these companies benefit from hiring skills from the external labor market," he says.

The opposite is true for slower moving industries operating in marketplaces with less change -- for instance, companies like Bosch and Delphi-Delco that manufacture automotive chips which often last four or five years before a new generation makes them obsolete. "When product generations last a long time, it becomes feasible to develop talent in-house in preparation for the next product generation. It is better for these firms to take the long approach and develop the necessary skills within the firm," he says.

The impact of Campbell's findings, he believes, could be significant for human resource management strategies. "As the pace of technological change has quickened, and as global competition has shortened product life cycles, firms have had to rethink their technology investment strategies and their human resource management practices in order to remain competitive," writes Campbell.

"A classic example of this phenomenon is Hewlett Packard over the last 20 years," he suggests. "They had such a reputation for these internal labor markets, where they hired employees at an early stage and then developed them throughout their careers. That was the company's reputation. But over the last 20 years, the Hewlett Packard way has eroded. They are now operating more on the spot market. In order to keep pace with other technology firms, they are forced to hire on the outside."

In their paper, Campbell and his co-authors note that "although the relationship of technological change, compensation and tenure at the individual level has been well-studied, surprisingly little is known about the relationship between technological change and an (individual) firm's HRM decisions. Previous research on this topic has been either case study oriented or has utilized data from broad establishment-level surveys. This project connects these micro and macro approaches by using data that allows us to capitalize on the strengths of each type of research."

The report pulls data from the Census Bureau's Longitudinal Employer-Household Dynamics (LEHD) Program, which covers seven large states from 1992 to 1997. Specifically, Campbell chose to look at the impact of R&D and HRM systems on firms' performance within the electronics industry "where technological investment is a critical strategic variable."

Writes Campbell: "Although firms in the electronics industry have a high level of R&D investment relative to other industries, there is a large variance in investment between firms within the industry. This variance can be observed in the length of product life cycles: from 12 months for fast-evolving consumer-based products such as graphic chips, to five years or more for slowly-evolving analog products."

Campbell acknowledges that "in the industries we are studying, 'cutting-edge' is such a complex term because there are so many facets of technology. Someone might have skills that are cutting-

edge for some products, but another (level) in the industry wouldn't be interested in that worker. It becomes a problem of identifying the right workers, including some who may be undervalued by the current workplace."

Offer Training or Go Outside

As Campbell notes, finding and keeping talent as it relates to the electronics industry boils down to one main issue: Make vs. buy. To answer this question, Campbell's paper proposes that companies analyze another question first: "How does the firm's product life, and thus its rate of R&D spending, affect how the HRM system operates?"

"We assume that a new technology requires a mix of experience on the previous generation of technology and new skills that don't currently exist in the firm," he writes. "We assume that experience and new skills are complements and firms differ in their mix of experienced and new workers. Technology firms in short product life markets, and thus with high R&D spending, must have a mix of engineers dominated by the new skills required for the new technology with a small emphasis on engineers with experience on the last generation of technology. Firms in long product life markets, and thus with low R&D spending, rely more on a workforce with experience since the firm has greater gains associated with cutting costs, improving quality, and improving throughput over the life of the product than the gains associated with developing a new product."

In short, firms must make two major decisions in creating the optimal skill-experience composition in the workforce: First, decide whether to provide formal training in the new technology to their existing workers or to purchase these skills through new hires, which is the essence of what Campbell calls the "make-buy decision;" and second, decide which experienced engineers and other workers to retain.

"The firm makes the first decision based upon the relative costs, including both the payroll costs and the time-to-market costs, of making or buying the required skills for the new technology," he writes. "The cost of 'making' the required skills is the worker adjustment cost of acquiring skills (training costs) and is proportional to the size of technological jumps over a given time. The cost of 'buying' the required skills is the firm's adjustment costs in hiring new workers, which does not depend on the size of the technological jump.

"Therefore, depending on the firm's underlying cost structures, for sufficiently large technological jumps, 'buying' will be less costly than 'making' new skills."

While high R&D firms are more likely to buy new skills compared to low R&D firms, there is an important caveat to this finding. "There are experienced workers who have firm-specific knowledge that can't be replaced on the outside market," notes Campbell. His research shows that high R&D firms in particular suffer if they lose too many experienced workers, which is why these firms must decide which experienced engineers and other workers to try and retain. Often, this can be a problem. "When you are not investing a lot in developing the skills of a work force, [employees] will leave," he says.

Campbell's research looks at many factors within human resource management practices that affect worker productivity, including performance incentives, multiple ports of entry, and low and high turnover rates. It compares different educational levels of workers; varying accession rates (ratio of total number of new hires to the total number of workers); separation rates for workers with two and five years of experience; standard deviation of earnings for various worker levels, and wage growth for workers with five years of experience. In order to characterize the human resource practices of a firm, Campbell and his fellow researchers use earnings, earnings growth, accession rates and separation rates for selected cohorts within each firm.

And finally, the researchers perform a cluster analysis of firms and HRM measures to identify and describe the four most common HRM systems that firms set up as a result of the make-buy and retention decisions:

·         Bureaucratic ILM (Internal Labor Markets): Initial earnings of new hires are similar (low variance) since most workers enter at the same level and have similar (and reliable) earnings growth. Firm experiences a low separation rate.

·         Performance-based ILM: Entry of workers and their initial earnings reflect skill requirements so average initial earnings of new hires are higher with higher variance than for bureaucratic ILM. After approximately two years, workers are selected (based upon performance) for faster career development and members of a cohort compete for entry into these favored positions, which have higher earnings growth and lower separation rates. Those who do not receive skill development have lower earnings growth and higher separation rates.

·         Spot Market (External Labor Markets): Firms can identify workers' talents and skills, and hire and pay accordingly. Firm can monitor worker performance and pay worker according to contribution. Initial earnings and earnings growth reflect market rates for skill and talent, with large initial variance, and variance does not increase over tenure. Separation rate is higher than in ILMs.

·         Spot Market with Rewards: Firms hire and pay workers in spot market, but identification of workers' talents and effort at hire is imperfect and monitoring of worker performance is imperfect. Variance of initial earnings is lower than in spot market. Firm must include performance rewards and tournament or wage-efficiency type incentives; thus variance of earnings increases over tenure. Earnings growth is higher than in spot market. Separation rate is higher than in spot market since the bad matches (both at hire and in rewards) end.

Ultimately, the report concludes, "Firms with high R&D that choose a Spot Market with Rewards HRM system will have higher worker productivity than those that choose other HRM systems. And firms with low R&D that choose Performance-based ILM HRM systems will have higher worker productivity than firms that choose other HRM systems." Interestingly enough, Campbell's research suggests that "a surprising" number of firms do the exact opposite of what the research showed was best.

"These results suggest that high R&D firms are more likely to buy new skills compared

to low R&D firms, and yet these high R&D firms suffer if they lose too many experienced

workers," Campbell and his colleagues write. "These findings are consistent with the

implications of our 'make versus buy' model of workforce skill adjustment as a response to

technological change."

Heading for the Fast Track? New Studies Examine Who Gets Promoted and Why

Maybe Oprah Winfrey knew something about workplace dynamics that other people didn't.

Winfrey, of course, is the multimillionaire founder of a media empire that includes not only her syndicated talk show but also O magazine, a members-only website, books and even weight-loss camps. By choosing self-employment over working for a TV station or network -- she began her career as a news anchor in Nashville -- Winfrey may have avoided a pitfall for many black women in the workplace, namely, being stuck in their jobs. Black women are less likely to be promoted than males and white women, according to a group of labor economists and human resource specialists who recently gathered at Wharton.

Even as two big labor unions decided this week to defect from the AFL-CIO, claiming that it had failed to stop declining union membership or push hard enough for labor reform, participants in a conference entitled "Careers and Career Transitions: New Evidence for a New Economy" debated the alchemy of promotion -- who gets it, when and why. The conference was organized by Wharton's Center for Human Resources and sponsored by career transitions firm DBM. Scholars presented evidence from different places -- Fortune 500 companies, call centers, Canadian firms -- and parsed it in various ways. But two findings arose repeatedly: Minority females are less likely than others to win promotions, and white males are more likely to.

Other studies probed the dynamics of promotion -- including the concept of the "fast track," the effect of corporate restructurings on professional advancement and the likelihood of promotion for insiders vs. recent outside hires, among other things. The goal of the conference was to understand how modern labor markets operate -- nearly everyone agreed that today's economy appears to allow for more employee mobility among firms -- and what this means for workers.

"An overarching theme was thinking about what determines career ladders within firms," said Wharton professor of business and public policy Justin Wolfers. "There's room for a number of different views here. Some scholars believe managerial policies matter. Some think demographic differences do. And if you think about types of managerial policies, some firms have what academics call internal labor markets, and some regard employees as, in effect, being bought and sold on the spot market."

The Fast Track and the "Peter Principle"

Pablo Acosta, a doctoral candidate at the University of Illinois at Urbana-Champaign, presented research based on the personnel records of a single U.S. corporation. Like several of his colleagues, he found that whites, males and more educated workers had a higher probability of being promoted. 

Nothing radical there, but as he sifted through the data he was able to test two pieces of conventional workplace wisdom. The first was the "fast track," the idea that companies often have an accelerated evaluation and promotion path for people who have been designated as stars early in their careers. The second was the famed "Peter Principle," which says that workers rise to the level of their incompetence and then stall. It was formulated by Laurence J. Peter, an education professor who taught at the University of Southern California.

In a paper titled, "Promotions, State Dependence and Intrafirm Job Mobility: Insiders vs. New Hires," Acosta found that fast tracks didn't seem to exist in any systematic or firm-wide way. If they did, previous promotions should lead to a higher probability of future promotion, but that wasn't the case.

In contrast, his analysis suggested that the Peter Principle did exist. He discovered that outsiders had an advantage over insiders when competing for a higher position. In theory, if an insider had risen to his or her level of incompetence, he or she would then be less likely to get promoted. Of course, an equally likely explanation would be "the grass is always greener" phenomenon -- or, put in the corporate context, companies like newer hires not because their longtime employees are incompetent but because people have a tendency to overvalue unfamiliar candidates and undervalue known ones. That might explain the tendency of companies to seek out savior CEOs from the outside, as, for example, Hewlett-Packard did -- with little success -- when it hired Carly Fiorina, or as IBM did, with much better results, when it brought in Lou Gerstner.

Like Acosta, John Dencker of the University of Illinois Urbana-Champaign investigated promotions within a single large U.S. firm. His research was aimed at determining what happened to employees after restructurings. The company he examined, a manufacturer, experienced major layoffs in the mid-1980s, reworked its means of employee evaluation in the late '80s and underwent another round of layoffs in the early '90s. Dencker, in a paper titled, "Organizational Structure, Gender, and the Influence of Corporate Reorganization on Employee Promotion Patterns," focused on white-collar employees because he says that they were disproportionately targeted in layoffs in the '90s. During that time, middle managers accounted for 20% of job losses but only 10% of the workforce.

The first round of layoffs at the firm studied by Dencker appeared to turbocharge the careers of managers who survived it: Their promotion rates increased. And that makes sense. A firm would want to try to keep its best people, and thus it effectively signals that layoff survivors are top performers. 

But promotion rates decreased after the firm reformed its means of employee evaluation. Specifically, the firm moved from a system based mainly on seniority to one based mainly on performance. Interestingly, though, the promotion rate for female employees rose after the change. Dencker couldn't explain this. Despite doing follow-up interviews with executives, he

could find little evidence of a concerted effort to advance women. What's more, "a search for legal rulings failed to uncover any evidence that the firm had engaged in blatant discriminatory practices in the past," he says.

After the second layoff, promotion rates also dipped. This drop suggests that the firm may have moved from a closed employment relationship, where it relied on promotions to reward good performance, to an open one, where, for example, it might rely on "short-term, market-driven rewards such as bonuses," Dencker says.

The Influence of Race and Gender

A pair of papers presented at the conference took direct aim at the influence of race and gender on promotions. In one, Margaret Yap, a professor at Ryerson University in Canada, explored promotions at a large Canadian company. In the second, Nancy DiTomaso, a professor at Rutgers University, and four co-authors investigated the same issues among scientists and engineers at multiple firms.

Before digging into any statistical analysis, Yap examined simple percentages and found that, in her selected company, whites were more likely to be promoted than nonwhites, men were more likely than women, and white males were more likely than white females or minorities of either gender. "This simple comparison of gross promotion rates indicates . . . that minority females seem to suffer a double whammy in their prospect for career advancement," she writes. White males also earned more on average -- $68,000 -- compared with $64,000 for minority men and $54,300 for women.

Yap then split the firm's employees, looking separately at lower-level employees and senior managers. At the lower level, white males had the highest promotion rate. But at the senior level, white and minority females beat them, while minority males still lagged. Yap applied a variety of statistical tests to her findings, and the results held: White men were the most likely to receive promotions, even when other workers appeared equally or even more qualified. This led her to conclude that "systemic barriers must have existed in the company's policies, programs and practices."

Many would feel that Yap's conclusion is tentative: After all, she examined a single firm. And one doesn't need to look far to find examples of individual firms that have discriminated against one group of employees or another -- or at least have been accused of it. Earlier this month, a male violinist sued the New York Philharmonic Orchestra, accusing it of favoring female violinists. And an arbitration panel ruled that Merrill Lynch had to rehire a female financial consultant against whom it had discriminated. Last year, the panel ruled that Merrill had exhibited a pattern of gender discrimination. Another New York investment bank and brokerage, Morgan Stanley, paid $54 million last year to settle accusations that it, too, had discriminated against women.

DiTomaso and her co-authors tried to overcome what researchers call the "small-sample problem" by examining promotions of scientists and engineers at 24 firms. Like Yap, they found an advantage for white males. White male scientists had greater control over the content of their

work, which the authors regard as a key driver of professional satisfaction among scientists and engineers, and received higher performance ratings. Interestingly, "[white males] receive greater access to favorable work experiences and higher performance ratings no matter who is rating them," the authors note. In other words, they are well rated by fellow white males and by minority females.

The authors found no evidence that firms knew they were favoring white males. In fact, interviews and focus groups revealed that white males themselves tended to feel "disadvantaged vis-a-vis other groups, owing to what they perceive as their employers' emphasis on workplace diversity."

The only group whom the authors found to be consistently disadvantaged was U.S.-born black females. All other groups experienced what the authors call "the absence of advantage," that is, no special advantage or, for that matter, disadvantage.

"The process by which U.S.-born white men accrue advantage -- by receiving favorable

treatment in the workplace that then helps them become more competent and worthy which then

reinforces the belief that people like them are competent in these kinds of jobs -- has important

consequences," the authors conclude. "Since no one is ostensibly guilty of discrimination, ill will

or intentional unfairness, without attention to favoritism as well as discrimination, there is no

remedy for those who either lack favor or suffer disfavor."

Corporate Culture Can Break (or Make) a Merger

Published: September 26, 2001 in Knowledge@Wharton

Among concerns raised by industry analysts who are tracking Hewlett-Packard’s proposed acquisition of Compaq is the thorny question of corporate culture.

Hewlett-Packard, founded in Palo Alto in 1939, has long been famed for the "HP way," its much-touted corporate culture which fosters innovation by giving employees autonomy and opportunities for professional growth. Compaq’s image is very different: Newsweek, while terming HP "literally the original high-tech garage startup," describes Compaq’s 1982 origins as "reflecting the giddy period when PCs were busting out." BusinessWeek notes that Compaq has been viewed as "a mere purveyor of hardware" and that the employees it will be contributing to the deal will be mostly lower-paid computer-repair people. The merger announcement led Slate.com to wonder: "If HP Swallows Compaq, Is It Still HP?"

Can a mega-company absorb another mega-company and still run things the way it used to? Should it even try? How large does corporate culture loom in the high-tech sector, or in any industry? Is there one type of culture that holds the key to success? And how important is the smooth blending of two distinct corporate environments to the success of a merger or acquisition?

"HP has generated a lot of enthusiasm and energy from their employees because the company has recognized their individual achievements and given them broad opportunities for individual growth," says Wharton management professor Nancy Rothbard, noting that HP’s corporate culture has up until now made it an industry leader. "That’s also important for retaining people. Even in a tighter labor market when it might seem like keeping employees isn’t as important, it still has a huge value because bringing in and training new employees can be so costly. The HP way continues to be useful in today’s environment." HP, Rothbard adds, should be sure to handle the innovators in the newly-merged company with kid gloves because "in the technology business, innovation is the ultimate survival game."

Rothbard also cites the capacity for change as an important element in successful companies. "A culture that is adaptable - both to market conditions and to the firm’s leadership - will help a company survive and grow long-term. Consider GE, where Jeff Immelt is in the process of taking over for Jack Welch. He’s not Jack Welch - he won’t be able to lead in exactly the same way - but hopefully the culture is adaptable enough to his leadership style that he will have the chance to be effective."

Wharton management professor Peter Cappelli, director of the school’s Center for Human Resources, believes that corporate culture is most effective when it is aligned with a firm’s business strategy. "If you are making widgets or producing hamburgers, basically doing the same thing over and over, an approach like the HP way isn’t helpful at all." And in various kinds of low-cost manufacturing like the textile industry, the business is so highly cyclical, cost-driven and variable that companies can’t afford to protect their employees.

"But if HP is trying to do what it’s always done," says Cappelli, "which is create innovative products and not necessarily low-cost products, then preserving the HP way makes sense. The interesting thing about HP is that they have always tried with great care to make what they were doing in the product market align with how they managed their people. They buffered employees from the ups and downs of the business, because they wanted long-term commitments from those who had been working with the products over time and understood all the ins and outs. Compaq doesn’t have the same approach."

Patti Hanson, a human resources consultant with FBD Consulting based in Leawood, Kansas, points out that there are limits to how entrepreneurial and innovative a firm can be - especially a firm the size of a merged HP and Compaq. "Certainly you have to have some entrepreneurial spirit; if you don’t in high-tech, you’ll be obsolete in no time. Yet if you’re totally that, and don’t have the structure or discipline to figure out how to set goals and meet budgets, you won’t be successful either." Hanson suggests that this failing was what brought down many of the dot.coms. "I think you have to watch both sides of the house."

Ultimately, though, high-tech firms can succeed with either an entrepreneurial or a structured approach, but not both, Hanson says. "One group might say, ‘Ask first, then do it if it’s approved at all levels while the other group says, ‘Do it, then ask for forgiveness.’ That creates problems. A high-tech company I used to work for was pretty entrepreneurial and allowed a lot of risk-taking. We would roll out a new process just with an email and six steps to follow. One executive we hired from a highly structured company would say, ‘Aren’t there going to be operations manuals and train-the-trainer classes?’ I’m not saying one is right and one is wrong. You just need to make sure everybody is marching to a similar tune."

Mauro Guillen, professor of management and sociology, questions the whole notion of discussing a company’s overall culture. "If you are specifically talking about the parts of HP that have to come up with new products and figure out how to sell them, then the HP way is probably the best. But I am skeptical about generalizations that any Fortune 100 company operates under a specific culture. R&D people are probably organized very differently than in operations, and production people differently than in marketing. They are dealing with distinct problems, time pressures and external constituencies. Yet the company needs to act as if it were one organization. This is a huge problem not just for HP but for all firms." Guillen says that a merger then greatly complicates the already complicated task of integration. For example, the cultures of two different firms’ marketing departments may not only be organized differently from each other, but will have developed their own idiosyncrasies over time.

"Effecting change in a strong, decentralized culture like HP requires power and energy from the top, because there will probably be a lot of resistance," says Rothbard. "And because the culture is decentralized, you can’t anticipate where the resistance will come from and proactively target it. HP is spending significant time right now managing its external constituencies such as stakeholders and institutional investors. That’s absolutely critical, but they should also think about drumming up support internally."

Culture clashes can be a surprisingly large stumbling block in creating profitable mergers, adds Hanson. She cites a recent study sponsored by the Society for Human Resource Management and conducted by Towers Perrin that was titled "Making Mergers Work." In the study, HR professionals listed "incompatible cultures" as among the biggest obstacles to success in mergers and acquisitions. "The companies may go in and do due diligence, look at all the financial matters, but it’s really the cultural and people issues that can mean the demise of a successful merger."

She offers examples of incompatible cultures. One is structured vs. entrepreneurial, requiring written processes as opposed to "winging it." Another is formal vs. informal, having strict rules for attire, chain of command and obtaining approvals, while another company allows employees to wear khakis and has an open-door policy. Centralized vs. decentralized can also cause problems: Does corporate make and hand down all the decisions, or can managers respond at the local level to individual clients? And a company focused on producing good value at a low price won’t combine well with one focused on asking higher prices, but tailoring their solutions to clients’ needs.

With the merger, HP reportedly aims to move away from products to focus more on providing services. Will its corporate culture, in addition to successfully absorbing Compaq, need to undergo a paradigm shift? Most of the professors agreed that HP would have to thoroughly transform itself to make it in the service sector - an effort not necessarily facilitated by the merger. "I’m not quite sure how this merger will help them get into services," says Rothbard. "HP tried to buy PricewaterhouseCoopers last year explicitly to get their expertise in services. One reason the deal fell through may have been HP’s realization that PwC’s business was so different from theirs that it would be really hard to implement. Maybe they are hoping with Compaq and a new economy of scale, they can grow in the services area in a more incremental way."

"Innovation in product is not the same thing as delivering services," Cappelli says. "There are competencies and capabilities you need to be a service-sector, customer-service-oriented organization. It requires more sales emphasis, for one thing. That’s not necessarily the most obvious fit with the competencies HP has had before." Guillen agrees. "A typical plant manager has very different problems confronting him or her during the day than a manager of a service operation, who has to think about ways to increase customer loyalty, create bundles of services to offer and so forth. The world of manufacturing is so different from the world of customer relationships, that it seems the leadership style and culture need to change as well."

Who initiates the cultural sea changes that may be necessary when a company absorbs another company and also tries to change course? Rothbard believes a lot depends on who is at the helm. "Research suggests that effective corporate culture change happens most often with a CEO who comes in as an outsider to the firm, or as an unconventional insider - somebody who has had a reputation all along for being different. For example, when IBM CEO Lou Gerstner was at American Express, he was the outsider coming in. (He had previously been at McKinsey, where his main client had been AmEx.) And at GE, Jack Welch was the unconventional insider. He grew up in GE’s plastics business, a newer, non-mainstream part of the business. They could be change agents because they weren’t bound by the tradition." She notes that HP’s CEO Carly Fiorina, an outsider to the firm, seems to have been trying to alter HP’s culture - to make it more centralized -since long before the merger was announced.

In any case, Rothbard says, "merging corporate cultures is a difficult process that doesn’t happen overnight. And it requires a tremendous amount of initiative from the firm’s leadership to make it happen."

How Online Recruiting Changes the Hiring Game

Online recruiting is changing the way employers think about finding good employees and the way employees think about their jobs and their employers. Indeed, the Internet may completely change the way companies manage human resources, says Peter Cappelli, a professor of management at the Wharton School.

For example, says Cappelli, some 18 million resumes are posted just on Monster.com, the largest Internet job site. Monster.com boasts it has almost 500,000 jobs available. With more than 5,000 job boards where resumes and job opportunities are posted, the Internet has become, by far, the most effective way to broadly disseminate information about the availability of jobs and people.

And that’s just the tip of the iceberg. Recruiters who wish to do so can access millions more resumes and biographical data that are posted on the Internet but are not intended for job searches. Take Ed Melia, a consultant with Monster.com. With virtually no effort, says Cappelli, Melia can find the resumes of employees at any company. With another command, Melia can narrow the search to just those with specific skills – 567 individuals at IBM, for example, who have C++ or Java programming skills. These are not people who are looking to change jobs. Their resumes are posted on various web sites for a variety of other reasons. Recruiters can also, as Cappelli describes it, "flip the URL"; that is, follow links back through the web sites and get into a company’s intranet to get lists of employees. The recruiters aren’t hacking into the sites. These sites are legally accessible, but were never intended for outsiders to see.

The yield of such searches is a rich trove of skilled employees who would be excellent recruits – if they were looking for jobs. They are called "passive applicants" in the business – people who aren’t looking for jobs, but might be induced to do so if approached. The Internet has thus become an extremely valuable resource for recruiters to find talented individuals who might be wooed into looking for new jobs. A recent survey by Wetfeet.com, a recruitment management firm, points out that 36% of employees are happy in their current jobs but are also willing to move within six months if something better comes along.

But significant ethical issues are inherent in the ubiquity of this information.

In the heyday of the corporation, there was an implicit contract between employers and employees. Employers received loyalty and conscientious work. In return, employees received job security and a career track. That contract has long been eroding because of such things as layoffs, corporate mergers, or sudden surges in hiring (like the recent dot-com boom), but online recruiting could put the final nail in the coffin.

Cappelli argues that online recruiting merely levels the playing field between employer and employee. "It changes the notion of equity," says Cappelli. "Issues of fairness, with respect to

things like compensation, opportunities, etc. [used to be] all based on internal criteria. Now, increasingly, they are based on external criteria. The rate of pay we [the employer] decided was fair for you used to be based on how long you’ve been with the company, your job title and position within the hierarchy of the company. Now it’s increasingly based on the rate for similar jobs elsewhere, and that’s pretty much it. It makes the balance of power [between employer and employee] much more based on a market relationship rather than on a kind of inside political relationship."

At the same time, however, online recruiting further erodes loyalty. Before the Internet made so much information available, an employee competed mainly with others in the same firm for raises and promotions. No longer. Today, anyone doing a particular job anywhere is competition. "It’s now so much easier to hire talent on the outside than it was," Cappelli says. "It’s so much easier to get information about passive applicants that it alters the balance between inside development and outside hiring. It throws everybody into a more open labor market."

The majority of those who post their resumes on job boards are not actively looking for jobs. "They’re willing to be talked to, but they’re not actively looking," says Cappelli. "But if something terrific comes up…." The danger is that such postings invite retaliation by employers, which is why some job boards block access by employers to the resumes posted by their own employees. However, such screens cannot block companies or individuals who have been hired by employers to search for resumes posted by their employees. In the tight labor market of recent years, there has been little incentive to search for such postings. Indeed, it might even work in the employee’s favor, if an employer did so, in eliciting incentives not to look elsewhere. But as the economy softens, such simple curiosity might well cost employees their jobs.

There are also issues of privacy in online recruitment, particularly when it comes to the so-called passive applicants. Many companies screen applicants or take job applications online. That’s not surprising, but some companies seed their applications with questions that elicit personal information unbeknownst to the applicant. JP Morgan’s online application, for example, is in the form of a computer game. The answers, says Cappelli, reveal information about interests and attitudes of applicants. Cisco Systems, among other technology companies, offers research facilities like libraries in part to identify and track users to recruit. And some recruiters acquire "passive applicants" by posing questions to user groups and tracing those who answer correctly.

Some of these practices disturb Cappelli. "The bigger privacy issue of online recruiting is when you think you’re playing a game, only they keep score," he says. "What happens to that information? Who has access to it and how is it used?"

Nevertheless, the rapid growth and cost efficiency of online recruitment is beyond argument, despite the privacy issues. "It’s a general characteristic of the Internet that once anything is put on [it] for any purpose, it is available to anyone for any [other] purpose," Cappelli says. "That’s the essence of the Internet, you know – that information is free[ly available] and cheap."

The solution, as with many other aspects of the Internet, is more disclosure. "The technology has gotten way ahead of the ethics," Cappelli says. "It would be nice if companies would tell people

that they are interested in hiring, and that they are using the information you provide online to pitch jobs at you. Or anything at you."

Super Bowl Showstoppers: Despite the Economy, the Big Game Is Still on for Advertisers

The big game is even bigger this year. As media markets grow increasingly fragmented and the ongoing writers' strike creates uncertainties about the upcoming television season, the Super Bowl is carrying more weight than ever among advertisers hoping to reach a mass of viewers.

Despite the increasing likelihood of recession, Super Bowl spots were nearly sold out by early January -- several weeks sooner than in the past. Advertisers are paying record prices of $2.7 million to $3 million for a 30-second commercial during Fox Broadcasting's telecast of Super Bowl XLII on February 3, which is expected to draw more than 140 million viewers around the world.

While the power of television has waned as new media compete for consumers' attention, the Super Bowl appears to have retained -- and solidified -- its position as the ultimate in television marketing, according to Wharton faculty and industry analysts.

"TV is still the place to go to get an ad in front of large audiences. The Super Bowl obviously has the largest [audience] of all," says Wharton marketing professor Patti Williams. "In addition, consumers tune in precisely to see the ads and so are more likely to pay attention to them than they are to ads on other TV vehicles."

Despite the early action to secure ad time for the Super Bowl, a few companies, particularly in the auto industry, have indicated some concerns about the economy. Nonetheless, they decided to remain on board and the current economic gloom is not likely to change the nature of the ads, Wharton faculty and advertising executives say. Viewers will continue to see high-quality commercials, many of them humorous in tone, designed to broadly promote products or brands without too much hard-sell.

"I suspect the ads will continue to be primarily emotional rather than 'rational,' and that we will see a mix of humor -- probably heavy on the humor -- and the warm and fuzzy, 'lump in your throat' kind of ads," says Williams. "I think consumers want the ads to be entertaining. Ads that move us in some way do that."

Paul Tilley, managing director of creative at DDB Chicago, the agency developing ads for perennial Super Bowl participant Anheuser-Busch and newcomer Cars.com, says a bleak economic mood will not lead to "downer" Super Bowl ads. Following the attacks on September

11, 2001, the Super Bowl did take on a somber tone because, he says, the country was still in shock. An economic downturn is different.

"We're doing the same kind of humor that people expect from us," says Tilley. "If you think about it, the Golden Age of American comedy and musicals was produced during the Depression. If anything, people want to be entertained. They want to escape."

Wharton marketing professor David Reibstein says Super Bowl advertisers cannot afford not to be funny, no matter the economic climate. "One of the downsides of buying time is that your competition is so intense in overall creativity and quality that it forces you to spend more to break out and win awards for ads," he says. "The reality is that most of the rating of the ads is done in the public domain, and the ratings are all around entertainment. I don't think that the fact we're in a recession is going to lead to a more somber mood."

An 'Artful Interruption'

The Super Bowl remains a sweet spot for companies with a target segment that overlaps the characteristics of the audience for the game, such as men who drink beer. As in past years, Anheuser-Busch has purchased more Super Bowl time than any other advertiser. "This is a golden opportunity to get their product mentioned to their target audience," says Wharton marketing professor Eric Bradlow.

At the same time, he agrees with Reibstein that companies choosing to play in the Super Bowl must come prepared with their A-game. Super Bowl ads can backfire if a competitor comes up with a better spot. "The degree of scrutiny of Super Bowl ads is very high, and hence things tend to bifurcate -- there are definite winners and losers," he says.

Tilley, the Chicago advertising executive, contends that the Super Bowl is now something of a throwback in today's increasingly fragmented media markets. More than ever, he says, the Super Bowl is the one chance for companies to get the attention of a vast audience in real time. For much of the last 50 years, the role of advertising has been to artfully interrupt programming that consumers were already engaged in, he explains. Mass audiences would tune in to prime-time television shows and special live events, such as the Super Bowl, the Olympics or the Oscars, while advertisers scrambled to outdo one another and capture the audience's attention with memorable ads.

As TiVo and other time-shifting technologies weaken the power of advertisers to reach a large audience at once, that model is becoming less effective. "Now, the value of advertising is not in interrupting, it is in creating a destination," says Tilley. Today's destinations are typically Internet sites, cable television or specialty publications. The trend represents a return to the early days of television, Tilley adds, when soap operas and shows such as the Texaco Star Theater were, in effect, "destinations" designed to showcase content designed by single advertisers to convey their message.

In the meantime, as other mass advertising vehicles grow weaker, the Super Bowl remains the best way to reach a vast audience with interruptive advertising in real time. "The benefit with an

interruptive message is that you control it. You know who is watching. You're in command. There are benefits to more experiential advertising, but there are times you want to say what you want to say to people. That's the power of the Super Bowl, and there will be fewer and fewer alternatives in the future as people use more technology."

Animals and Celebrities

Tilley says the Super Bowl is most appropriate for companies with a new message that is relevant to a large audience, like Cars.com. "The audience for that product is everyone who will ever buy a car, so it's a great window to create huge awareness in a short time," says Tilley. "It's not about maintaining a position, but really about introducing themselves to a lot of people."

Large, mainstream brands, such as his other super client this year, Bud Light, can use the powerful reach of the Super Bowl to remind viewers they are a leading brand. "Bud Light is expected to be there," says Tilley. "I would almost say that their fans expect it of them. There's not a lot of news in those spots, but a lot of momentum. They remind people why they love Bud Light."

Super Bowl newcomer Bridgestone Firestone North America is entering the game with a big stake -- two commercials along with sponsorship of the half-time show this year and in 2009. The company's Super Bowl participation is part of an even larger agreement with the National Football League that includes other advertising sponsorships and designation as the "official tire" of the NFL.

The Bridgestone Firestone ads will emphasize product performance, but with a humorous slant. According to Michael Fluck, the company's brand marketing manager, an analysis of the 50 most popular Super Bowl commercials in the past five years showed that 46 of the spots featured animals or celebrities. Not surprisingly, one of Bridgestone's spots will feature animals and the other will focus on celebrities. A total of 28 animals were filmed for one spot, but that number will be culled to nine or ten for the final cut. For the celebrity commercial, the company has signed on Alice Cooper and Richard Simmons.

After scoring a huge hit with its ad last year featuring Kevin Federline flipping burgers, Nationwide Insurance is taking a pass on the Super Bowl this year to focus on other advertising choices, including its NASCAR sponsorship.

Steven Schreibman, vice president advertising and brand management for Nationwide Insurance in Columbus, Ohio, says the company's ad agency presented six ads this year, but none were Super Bowl caliber. "We could have done any of them, but my heart just wasn't in it," he says. "With Federline, we knew this was it. This year, there were some good concepts, but nothing really floated my boat."

Instead, he says, Nationwide will plough the money it had set aside for the Super Bowl into NASCAR, which has the potential to pay off for 10 months of the year. Schreibman also notes that the Federline commercial was so successful it generated publicity before it was even

broadcast, and it is still working for Nationwide in media coverage about memorable Super Bowl ads.

Feeding the Hype

In addition to the game itself, the hype over Super Bowl commercials now extends into the pre- and post-game environment. New research shows companies that announce their plans to advertise during the game receive more buzz than companies that keep their plans secret, hoping to jolt the audience into remembering their products with a big surprise.

According to Cymfony, a division of TNS Media Intelligence Co. in Watertown, Mass., which analyzed media attention to last year's Super Bowl ads, companies that showed their actual ad online before the game generated 4.3 times greater post-game coverage. Despite that finding, Jim Nail, chief marketing officer at Cymfony, says this year's Super Bowl advertisers are still holding their cards close. He said newcomers to the bowl, such as Audi and Under Armour, should reveal previews of their ads to build interest before the game.

"They're going to wait until the last minute and hope in the 48 hours after the game -- when they will be battling with the other 40 advertisers -- that they can get more of their message across," says Nail. "Good luck to them."

Just as pre-game buzz is now a part of advertising strategies, Super Bowl ads are increasingly enjoying a "secondary market" in traditional media reports and online with sites including YouTube. As part of its agreement with advertisers, Fox also will set up a page on MySpace.com, which is owned by its parent, News Corp., to replay Super Bowl ads. Fox plans to run two spots during the game to promote the MySpace page.

Reibstein participates in the secondary market by showing the ads the following day in class. "[These] ads are on all the network news shows and there are now a lot of online sites showing the best and the worst of them," he says. "Advertisers are getting additional exposure."

How much additional exposure is difficult to measure, he says, as ads filter out into tertiary markets and beyond. Even though the post-game market is difficult to gauge, it is definitely a force. "I think that's what has lead to the continual upward pricing of Super Bowl ads."

Cymfony also tracked the effect of different types of media on pre- and post-game coverage last year. Traditional media put more emphasis on Super Bowl ads before the game, with 54% of its coverage occurring in advance. Social media was the opposite, with only 24% of the discussion taking place before the game and 76% after. In addition, Cymfony found a link between pre-game coverage and post-game discussion, with the top six advertisers in pre-game mentions all finishing in the top 10 in post-game coverage.

'Being the Best'

As is the case each year, the Super Bowl 2008 advertising environment will be shaped by some unique factors. One is the chance for viewers to see the New England Patriots complete a perfect post-season to add to their perfect season.

Reibstein says the Patriots' presence could cut both ways. For serious fans, the team's dominance may lead to less interest in the game. For less attentive fans, however, the chance to see sports history in the making may be an added draw. Indeed, the Patriots' quest for the perfect post-season, adds Bradlow, might give advertising creative teams the opportunity to reinforce brand objectives such as "perfection" or "being the best" during the Super Bowl.

Another wrinkle in this year's Super Bowl advertising market is the writers' strike, which has put the upcoming prime-time season in jeopardy as well as mega-events such as the Oscar and Grammy awards shows. "In general, with Americans watching even less television due to a lack of scripted shows this year, the Super Bowl probably plays a much bigger role than it has even in recent years for the network and for a lot of advertisers," says Wharton's Williams.

Finally, there is one highly visible group of advertisers this year that will probably steer clear of the Super Bowl. Even though the game falls just two days before the all-important Super Tuesday presidential primaries in California and many other key states, faculty and advertising analysts do not expect to see a presidential pitch along with the traditional Super Bowl Buffalo wings.

According to Nail, most political ads are not anywhere near the quality of the corporate spots shown during the Super Bowl, which typically take months to craft. A political campaign ad is likely to look lame compared to the spots Corporate America can deliver, potentially tarnishing a candidate's image. He adds that Super Bowl commercials are expensive for a political campaign budget, although the Super Tuesday races will be "do-or-die" for a number of contestants. "From that standpoint, if they wanted to take their last $2.7 million and blow it, that would be a Hail Mary pass."

Still, he says, audiences might resent political party crashers. "People are there to watch the Super Bowl to forget all that -- to escape and cheer on their team," says Nail. "I think it would be a very unwelcome intrusion into that social, friendly-rivalry atmosphere at all those Super Bowl parties in living rooms across America."

Illusion, Not Quality: The Transformation of the Luxury Niche into a Global Mass Market

When Givenchy dressed Audrey Hepburn for her role in Blake Edwards' 1961 film, Breakfast at Tiffany's, luxury was still exclusive, the particular provenance of the refined social elite. Wearing couture specially tailored to her slim and graceful frame, Hepburn exemplified the allure of luxury even as she played a character who could only dream about it: In a classic Hollywood paradox, the world Holly Golightly glimpses through Tiffany's window is the one Hepburn is wearing.

By 1980, all that was changing. When Brooke Shields announced that nothing came between her and her Calvins, the message was not that Calvin Klein jeans were for her alone -- it was that they were for everyone. Hepburn wore hand-sewn dresses specially crafted for her gamine physique; Shields wore her designer jeans off the rack -- and so did the millions of others who followed her example.

The contrast denotes a decisive historical, economic and philosophical shift: In the 20-year span between the film and the ad, luxury entered the mass market -- and, quite arguably, stopped being truly luxurious.

In Deluxe: How Luxury Lost Its Luster, Dana Thomas, Newsweek cultural correspondent, explains what fashion was and what it has become. She documents how a niche industry once oriented around providing the finest hand-made goods to the few who could afford them has morphed into a global cash cow, a $157 billion-a-year mega-enterprise that places a far greater premium on global marketing and profit margins than on crafted quality, tasteful sophistication and refined exclusivity.

Surveying fashion's origins, Thomas introduces us to Louis Vuitton, a trunk maker whose distaste for standard luggage design spurred him to launch what would become the world's first luxury travel line. We meet Parisian milliner Coco Chanel, a bottle of whose "No. 5" perfume is sold every 30 seconds. Living designers such as Miuccia Prada and Giorgio Armani make memorable cameo appearances.

Thomas also takes us on trips. We visit a flower farm in southern France where a small, family-owned operation produces the special Centifolia roses that form the essence of Chanel No. 5. We get to see high-end bags hand-stitched at the Louis Vuitton compound in Paris. We enter Chinese factories, where many luxury items are now cheaply, and secretly, mass-produced. We explore the exploding luxury markets in China, Russia and India, where new wealth has created an insatiable appetite for designer brands. We learn how a certain Honolulu street became a tourist destination for Japanese luxury shoppers. And we discover how Las Vegas has become a hub for the new, democratic ideal of luxury: The city where fortunes are made and lost in moments is now a fitting anchor for the dream of a classless society where everyone has equal access to the

most exclusive, high-status goods. Along the way, we meet Hollywood stylists, visit outlet stores and explore online luxury boutiques.

Combining compelling character vignettes and sharp market analysis, Thomas shows us how, over the course of the 20th century, individual artisans became brand names. Beginning in the 1950s, she says, the highly individualized, necessarily limited business of made-to-order couture ceded to a mass-market model with unlimited profit potential. During that decade, designers such as Christian Dior and Pierre Cardin began licensing their names in exchange for royalties on the sale of products they did not themselves make. Soon after, Yves Saint Laurent introduced Rive Gauche, a lower-priced, ready-to-wear line aimed at a younger demographic. It wasn't long before the current "pyramid" model was in place -- genuine luxury couture at the top, for the very rich; off-the-rack ready-to-wear clothing from the same designers for the middle class; a wide, affordable spectrum of fragrances and accessories for everyone else.

This, in turn, set the scene for the 1980s, when big business definitively transformed a small, decentralized cottage industry into a massive corporate conglomerate. Louis Vuitton, for example, is now part of LVMH (Louis Vuitton Moet Hennessy), an international group that comprises more than 50 brands. Today, luxury has consolidated. Approximately 60% of the business is concentrated in 35 brands. The largest of these -- Louis Vuitton, Gucci, Prada, Giorgio Armani, Hermes and Chanel -- are corporate behemoths in their own right. Louis Vuitton brings in nearly $4 billion in sales annually, while the others rake in more than $1 billion each.

Gucci Shoes on Amazon.com

The key figure in this transformation is French entrepreneur Bernard Arnault. Ranked seventh on Forbes' 2006 list of the world's wealthiest people, Arnault came to fashion through the back door. In 1985, he was a retired businessman looking for a challenge -- and so he bought the struggling Christian Dior for $15 million and proceeded to reinvent the entire fashion industry. Today, Arnault presides over LVMH, whose brands include Marc Jacobs, Dom Perignon, Pucci, Fendi and Donna Karan. In the two decades since acquiring Dior, Arnault has both created and cornered the global luxury market. In 2005, LVMH did $18.1 billion in sales and made $3.5 billion in profits. During the first half of 2007, LVMH reported a 16% increase in profits over 2006.

In drawing luxury into the world of big business, Arnault has altered it indelibly. Today, fashion is more visible and more widely available than ever before. You can shop for Gucci watches, shoes and wallets on Amazon.com. Dolce and Gabbana fragrances are available at Target. Sunglass Hut sells shades by Bulgari, Versace, D&G, Prada and Ferragamo. Airports make it easy to shop for luxury goods while you wait for flights, and airlines are promoting travel packages for people who want to spend their vacations shopping until they drop. "Luxury is crossing all age, racial and geographic brackets," an LVMH executive told Forbes in 1997. "We've broadened the scope far beyond the wealthy segments."

But such easy availability underscores the fact that luxury is not what it used to be. Mass-produced luxury, Thomas explains, is a contradiction in terms. "The contradiction between

personal indulgence and conspicuous consumption is at the crux of the luxury business today," she writes, noting that the real work of the luxury industry is increasingly not to produce genuinely luxurious goods, but to shave costs while pretending that quality remains as high as ever.

For this reason, the luxury industry -- as hugely profitable as it is -- hinges on a fragile paradox. Once the rarified prerogatives of the privileged few, designer goods have been democratized into commodities anyone can own. But this is one industry that cannot be democratized without losing its identity, and thereby imperiling its economic viability. Luxury's mystique must be able to transcend the vagaries of the market. Precisely because luxury is supposed to be immune to market fluctuations -- because its value is by definition timeless and transcendent -- it is subject to an unrelenting economic bottom line: Its stock simply cannot go down.

And prices must remain comparatively high. We applaud when expensive products, such as computers and cell phones, become more affordable, but the luxury industry does not -- and cannot -- play by the same rules other consumer industries do. The gradual decline in the price of a laptop means that we are absorbing ever greater technological capacity into mainstream culture. But luxury is synonymous with expense. Cheap, in the world of luxury is, well, cheap. We are meant not to mind, it seems, when the profit imperative translates into a decline in quality: Thomas describes paying $500 for a pair of Prada pants in 2002, only to have them fall apart the first time she wore them.

The Aura of the Brand

Mass marketing has thus permanently changed the meaning, purpose and function of luxury. You can still pay top dollar for designer goods, but you are most likely paying more for a label than for luxury. Luxury is no longer a private, indelible, privileged experience. It is public, superficial, forever changing and infinitely available, which means it's not luxury at all. Today, what we are buying into when we buy a luxury brand is not an experience but an image, not quality but illusion. What we are buying into is the aura of the brand.

We know this, of course. We acknowledge it every time we refer to brand name items as status symbols. And luxury brands know we know this, which is why they plaster their logos so relentlessly over their products. "When you look at [Louis Vuitton]," LVMH designer Marc Jacobs remarks, "you see it is mass-produced luxury. Vuitton is a status symbol. It's not about hiding the logo. It's about being a bit of a show-off." Thomas is precise and cutting in her discussion of luxury's newly democratized landscape. "Vuitton is the McDonald's of the luxury industry," she states. "It's far and away the leader, brags of millions sold, has stores at all the top tourist sites -- usually steps away from a McD's -- and has a logo as recognizable as the Golden Arches."

The point here is not that we ought to return to the days when few people could afford nice things, but that we must be alert to marketing techniques that attempt to exploit our appetite for an impossibility: a luxury market that is at once truly democratic and truly exclusive. 

Much of the mystique behind luxury goods hinges on the assumption that they are handmade by skilled European craftsmen. But facts belie the mystique. Hermes has openly outsourced the sewing of scarves to Mauritius. Louis Vuitton, a $3 billion a year leather industry in its own right, has recently announced plans to build a shoe factory in India. Armani has embraced Chinese laborers.

And these are the brands that are honest about what they are doing. Some, like Prada, claim not to outsource manufacturing -- but close inspection of certain Prada products reveals cleverly hidden "Made in China" labels. Burberry downplays the extent of its outsourcing, as does Ralph Lauren. Some designers do manage to keep the manufacturing in Europe but rely on illegal immigrant labor to keep costs down. Still others, Thomas reports, actively deceive customers about just where their designer bags, shoes and clothes were made.

Thomas teasingly describes visits to Chinese factories that make luxury goods for designers who swear that all their products are handmade in Europe. Allowed inside these factories on condition of confidentiality, she does not name the designers who go to such lengths to dupe -- and fleece -- their customers. But she does describe seeing a handbag stitched together for a brand that claims to produce all its goods by hand in Italy. Made on an assembly line for about $120, the handbag was later sold for 10 times that amount in a Hong Kong department store.

The market for cheap luxury goods is so strong that fakes regularly make their way into major retail outlets. Wal-Mart has been sued by Fendi, Gucci, Tommy Hilfiger and Louis Vuitton for selling cheap counterfeits of their clothing and accessories. Costco has also been caught selling fakes. Amazon and eBay are well known dumping grounds for counterfeits. In 2004, Tiffany sued eBay, claiming that 80% of the Tiffany goods for sale on the site were fakes. In 2006, LVMH sued eBay on the grounds that 90% of the Vuitton and Dior products for sale there were counterfeit.

All in all, Thomas argues, we have been sold an overpriced, badly made bill of goods -- regardless of whether our designer possessions are real or fake. And, ultimately, she suggests, it's because we have sold our souls for an impossible dream. In the brave new world of democratized exclusivity, one's identity is confirmed and even enhanced by the branding of one's clothes.

The strangeness of this -- and the newness -- was captured succinctly by the 1985 film, Back to the Future. Transported back to 1955, Marty McFly can't understand why everyone keeps calling him "Calvin." When he asks about it, he receives a telling answer: "Well, that is your name, isn't it? It's written all over your underwear."

This clever punch line -- and wry commentary on how times have changed -- expresses the subtle but definitive cultural shift brought on by the mass marketing of luxury brands. At mid-century, the only name a teenager could possibly have on his skivvies was his own. At century's end, the name on the underwear identifies the owner, who could be anyone, with the designer, thus conferring upon him a borrowed status. In the movie's joke, the boy is the brand.

Now, as our economy tightens, so does our hold on luxury. Newsweek recently described people downsizing their homes (though keeping their granite countertops) and skipping the Starbucks

run (though buying espresso machines to make cheaper gourmet coffee at home). People are cutting back on accessories such as watches, jewelry and handbags. But true luxury -- the stuff that has always transcended mass marketing -- remains stable. Despite the financial uncertainty of recent times, Tiffanys reported a 17% jump in same-store sales during the second quarter of 2007, and is, appropriately enough, opening a new outlet on Wall Street.

A year ago, the little black Givenchy dress that Audrey Hepburn wore in Breakfast at Tiffany's sold at auction for $807,000. Holly Golightly would approve. So would Bernard Arnault: Today, LVMH owns Givenchy.

Brand Managers' High-wire Act: Going Global and Staying Local

For marketers, the Internet changes everything -- and nothing at all. For example, it enables companies to instantly reach consumers in different countries and economically tailor messages to them based on demographics, buying habits and other information. Yet it doesn't free these companies from the constant challenge of building distinct, durable brands.

As participants on a panel titled, "The Challenge of Going Global and Staying Local," noted during the 2007 Wharton Marketing Conference, a brand like Coke or Budweiser can be the greatest asset that a company has, but the brand can quickly lose its power if it comes to signify something different in every market.   

To balance these sorts of challenges, marketers at Johnson & Johnson start out by trying to identify the "heart and soul of every one of our brands," said Lynda Wallace, vice president for global topical healthcare and a panel participant. "We then have to express that in words, images and music.... We allow a fair amount of executional flexibility there because consumer preferences and habits differ, market to market."

In allowing that flexibility, Johnson & Johnson's marketers consider how the current positioning of a product in a particular market might shape the company's future offerings. "There's a risk that, if you position a product too differently in different markets, your logical follow-on products" will have to be different as well, which can raise costs and create operational problems, she said.

One thing Johnson & Johnson won't do is sacrifice premium pricing for its well-known brands, Wallace added. The company believes its Band-Aid adhesive bandages beat competitors' products, and a premium price is a way to signal that. But even on this dimension of its marketing tactics, the company allows improvisation as it expands around the world and pushes

deeper into less-developed countries. "We are willing to accept lower margins in a developing market," she notes, "or we will deliver a smaller quantity of the product to make it more affordable."

For example, Johnson & Johnson, based in New Brunswick, N.J., might sell a four-pack of Band-Aids instead of the larger box that's available in the developed world. Or it might sell a sample-sized bottle of baby shampoo instead of a full-sized one.

'You Are What You Drink'

Diageo, the British beer-and-spirits maker, also hews to premium pricing wherever it does business, even when entering a new market, said Rob Warren, senior vice president for global tequila. "We wouldn't lower our price to get more volume. You wouldn't take Johnnie Walker Black and charge less for it." Johnnie Walker is Diageo's well-known scotch. The company also makes Smirnoff vodka, Captain Morgan rum, Tanqueray gin and Guinness stout, among other beverages.

Instead of cutting prices, Diageo does its homework before entering a market, identifying consumers who will pay for its well-known products. "A lot of times, you are what you drink," Warren pointed out. "People will pay more for better things, and they will pay more for image." As a result, alcoholic beverage makers tend to market their drinks as either sophisticated, as Diageo does with Tanqueray, or cool, as it does with Captain Morgan in its recent "Got a Little Captain in You?" ad campaign. "In alcoholic beverages, we can't sell functional benefits," Warren added. "We all want to project symbols."

In the United States, brewers even try to associate their beer with patriotism -- an effort that recently led to a dispute between Anheuser-Busch and SABMiller. Anheuser-Busch, based in St. Louis, has long marketed Budweiser as the "King of Beers" and began poking fun at Miller as "the Queen of Carbs." Miller, according to newspaper reports, answered with a jibe of its own, saying it wanted to be the "President of Beers," not the king, adding, "This is America! We don't kowtow to a bunch of tiara-wearing crumpet eaters." Anheuser-Busch shot back by calling Miller "South African-owned" because SABMiller, which is actually based in London, was formed by the merger of U.S.-based Miller Brewing and South African Breweries. The two companies ended up in court over their competing claims, with SABMiller suing for an injunction to block the "queen of carbs" ads. Miller later dropped its suit.

The brewers' brouhaha points to another challenge for marketers -- how best to enter a new market. A popular option is buying an established local firm, as South African Breweries did with Miller. That offers a host of operational benefits -- knowledgeable employees, immediate scale in distribution and, of course, a locally popular brand. But it can be a Faustian bargain. "You have to ask yourself whether the local brand overwhelms what you want to do as a global company," said Diageo's Warren. "Local brands are a great way to gain experience in a market. But if you stay as a locally branded business, then they may not do what you need."

J&J's Wallace agreed, pointing out that buying a local brand can delay the introduction of the parent company's brands and lead to duplication and higher costs. "It's hard to take the hit to

make the conversion [from local to international branding], but it's also hard to support a lot of different brands," she said. "It takes longer to get into a market with your global brand than by buying a local one, but in the end, you will establish your global brand faster." 

In Australia, for example, the Burger King fast-food chain operates as Hungry Jack's because an Australian franchisee established the business there under that name. Interestingly, Burger King operated in the country for years using both names. In 2003, it chose to rebrand all of its outlets as Hungry Jack's. 

Names are not the only means for signaling a product's provenance as its owner expands around the world. Colgate-Palmolive, for example, labels its Colgate toothpaste differently around the world, said Sylvia Lin, associate director of global oral care long-term innovation. "Sometimes, you will see the word 'Colgate' in English, even in non-English-speaking countries, and sometimes in the local language. But we have a great big red box for our toothpaste in every single country." Consumers, she noted, notice colors and shapes before words and numbers. "The big red box may be more important than the actual words."

To complement its toothpaste, New York-based Colgate also sells toothbrushes. As it's trying to increase brush sales in China, it has chosen an unusual tactic -- competing with itself -- that underscores a marketer's challenge when thinking globally but acting locally. "We have the largest toothbrush plant in the world in China," Lin said. "We make Colgate-branded toothbrushes there and sell them for a premium price. But in the same plant, we have another production line that copies those toothbrushes and sells them at a discount [under a different name]. It sounds crazy, but the market in China is such that somebody will copy you anyway. So we made the decision, 'Why don't we do it ourselves?' Most people don't realize that we own both brands." 

Local adaptations can take all sorts of different forms, said Susan Piotroski, a partner with Accenture, the information-technology consultancy. They arise in the ways in which firms tailor their offerings and the forms of media through which they try to reach consumers. "In some parts of the world, quality matters more than trendiness," she noted. "In other places, it's the opposite. In China, the styling of wireless handsets is extremely important to people. So Motorola and Samsung will move some of their jazziest handsets there."

As for reaching consumers, different cultures and even groups within cultures respond differently to advertising and marketing campaigns. "Direct marketing is big in North America, but doesn't work in China," Piotroski said. "Yet there are a lot of cool electronic billboards in Shanghai and Beijing, and you don't see that a lot in the U.S., outside of Times Square."

Direct marketing -- that is, the use of letters, phone calls and emails to bypass the media -- depends upon reliable postal systems and widespread use of phones and computers, and not all countries have those. At the same time, many U.S. communities have laws limiting the use of billboards. 

Cultural differences can matter just as much as technological and legal ones as companies promote their brands internationally, noted Francesca Stobbe, a manager with Disney's consumer

products division. And while Stobbe said her company won't compromise its core brand, it does try to tweak its toys and other products based on its knowledge of cultural differences. "In the U.S., 80% of moms know the gender of their babies before they're born, and Disney adapts accordingly," she said. "But that's not the case for all countries. Elsewhere, you have to be more gender neutral."

Blogging on Motherhood

The Internet, of course, offers a wealth of ways for tailoring messages, if not products. The impact of new media on marketing was the topic of another conference panel which posed the question: "Ready to Sweep Out Traditional Media?" According to panel participant Elizabeth Poon, regional brand development manager for Netherlands-based Unilever, which owns Dove cosmetics, "People want to interact with your brand." She said that Unilever uses the Internet to encourage this kind of two-way communication. "For our Dove Cream Oils campaign, we let consumers create ads and enter them in a contest. Then we broadcast the winner. We also have a blog on motherhood. In the evenings, after the kids have gone to bed, women like to surf the web and engage in communities. So we invited moms to blog their funniest mom moments." 

Erin Matts, group director of digital strategy for OMD, a marketing consultancy, agreed that the Internet has created a wellspring of new opportunities for marketers. But she cautioned that it's still in its infancy as a marketing tool. It produces a gush of measures like click-through rates and unique visitors, but so far, all of those measures haven't yielded much meaning.

People talk about how the Internet creates engagement, said Matts. "But what they mean by 'engagement' is so subjective. Bank of America may be worried about people opening checking accounts. That's easy to measure. The trickier thing is measuring brand perception. Take click-through rates. What do they really mean? Okay, consumers took action, but do they really like the brand? We need more than just numbers. We need understanding."  

Michael Lamb, an associate principal with McKinsey, pointed out that web-based marketing excels at reaching people who already know a company's products or its business category. But it doesn't provide the same ability to reach uncommitted consumers that, say, an ad that airs on TV during the Super Bowl does. Yes, he said, Google's strategy of selling search words has been "tremendously successful." Still, he added, "It's an open question how broadly applicable digital media will be for other marketing goals. Can you use it to build brand awareness?"  

Online video may be beginning to break down that divide, giving marketers a digital tool with a reach that could come to rival traditional TV. But unlike old-fashioned broadcasting, online video requires that marketers give up the control that they are accustomed to, said Shiva Rajaraman, product manager for YouTube, a pioneer of online video-sharing. "Brand marketers are learning how to put messages in entertaining forms and are giving users control over the distribution of that content," he noted. Their thinking is that committed customers will see the online videos, find them amusing and share them with their uncommitted friends.

In some cases, companies are doing more than just making wacky videos and allowing them to be posted and shared on sites like YouTube. They are turning content creation over to

consumers, just as Dove did. Another firm that has tried that approach is Frito-Lay, which created a campaign called "Crash the Super Bowl," noted Matts of OMD. The snack maker, a division of Pepsico, invited people to make TV ads for its Doritos tortilla chips and submit them to a contest. The two top vote-getters were broadcast during this year's Super Bowl. "To give that kind of power to consumers requires a lot of confidence in your brand," Matts added.    

According to Eileen Mulloy, associate publisher of CondeNet, the online division of the Conde Nast publishing company, short videos that consumers can access anytime fit changing media consumption habits. "Today, people are having snack-size bites of media throughout the day, rather than sitting down and reading the paper for an hour," she said. A person might, for example, check the online news headlines in the morning, sports scores or stock returns at lunch and an online video recommended by a friend at night.  

Each time somebody does something like that online, a marketer could conceivably measure it. That measurability is both the promise of new media marketing and, perhaps, one of its biggest frustrations as well. "The measurability may have slowed down growth [of online marketing]," added McKinsey's Lamb. "It creates the expectation that everything is equally easy to measure, and that's not realistic. You get back to the question that has always challenged traditional media: 'How do you measure engagement?'" 

The Price Is Right, but Maybe It's Not, and How Do You Know?

When Apple dropped the price of its iPhone by a third after only two months on the market, even its most loyal buyers complained bitterly, forcing chief executive Steve Jobs to apologize and offer a partial rebate.

According to Wharton faculty and analysts, the iPhone episode reveals the perils of pricing in a marketplace where constant innovation, fierce competition and globalization are changing the rules of the game. "The product lifecycle is short and the market is moving quickly," says Wharton marketing professor John Zhang. "You don't have a lot of time to learn from your mistakes. You have to price the product right the first time."

Pricing is gaining new interest as management looks for ways to increase revenues after years of focusing their attention on downsizing and cost-cutting. Firms are only now beginning to apply to pricing some of the data collection and management tools they have been using in supply chain management and other parts of their businesses. "Pricing is the last bastion of gut feel," says Greg Cudahy, managing partner of Accenture's pricing and profit optimization practice.

According to Cudahy, companies that take a strategic approach to pricing throughout their business and monitor their success with hard numbers can raise revenue by between 1% and 8%. "That's a huge shift in pure revenue improvement."

For example, New York drugstore chain Duane Reade increased baby product revenues by 27% after using pricing software to examine sales data, according to an article titled, "The Price Is Right...Isn't It?" that appeared in the January 2007 edition of Accenture's business publication Outlook. In the article, Cudahy and George L. Coleman, a leader of Accenture's retail pricing group, describe how the data showed that parents of newborns are not as price-sensitive as parents of toddlers. In response, the company cut prices on toddler diapers to remain competitive with other stores and raised prices on diapers for infants.

Cudahy says better pricing can help businesses on many other levels beyond revenue boosts. For example, he worked with a parcel delivery company that introduced a coherent pricing strategy to its operations and found it was able to reduce by 90% the time spent working out pricing for bids. That allowed the company to focus more time and effort on building up customer relationships.

Closer attention to pricing can have payoffs in other ways, he says. Accenture found that in some retail operations a price decrease in one area can lead to beneficial pricing elsewhere in the store. Research in retirement communities in the South, for example, observed that shoppers had a high sensitivity to the price of health care goods. But saving a few cents on those items may lead them to spend 50 cents more on other items. "Pricing is not only about trying to get people to pay more," he says. "Pricing is used as a testing mechanism to find what consumers really want. It's basic supply and demand. The surest way to find out if consumers want something is their willingness to pay for it."

'Temporal Price Discrimination'

According to Wharton marketing professor Jagmohan Raju, Apple's price cut is an example of a strategy known as "temporal price discrimination." Companies using this strategy charge people different prices depending on the buyer's desire or ability to pay. As a result, companies win two ways. First, they reap wide profit margins from those willing to pay a premium price. In addition, they benefit from high volume, even at a lower per unit price, by building a wider customer base for the product later. Raju notes that price discrimination can also be structured across geographies, seasons and by adding or eliminating features, as is done with student software.

Consumers have come to accept this form of pricing in the airline industry. A last-minute traveler expects to pay vastly more than a frugal flyer who booked a seat on the same flight, in the same aisle, months earlier on the Internet. It is easier, Raju says, to apply temporal pricing structures in an industry with a service component -- like airlines -- than it is with a tangible manufactured item. Indeed, just last week, New York City's transit agency proposed a two-tier system under which people would pay a lower fare if they ride subways or buses during off-peak periods. The plan, which would take effect in 2008, would raise agency revenues as well as offset overcrowding. And, according to a report in the New York Times, the Bush administration

is considering a plan to charge airlines higher fees for landing during an airport's rush hour than for landing during off-peak hours.

However, temporal pricing can be applied to other non-service industries as well, including the technology sector, where consumers expect to pay sharply lower prices if they are willing to hold off on buying an exciting new product the minute it hits the market. In many cases, Raju says, technology marketers must set pricing below profitable levels to build an installed user base that will lead to profitable levels of sales volume later. "If I'm the only one with a video phone, whom am I going to call?" Raju asks.

Wharton marketing professor David Reibstein notes that while pricing discrimination makes sense for businesses, it can be a touchy issue. He recalls that Coca-Cola faced a harsh backlash when it tried to charge more for drinks at vending machines on warm days than on cold ones. Coke ultimately backed down. Price discrimination "is a new phenomenon that is growing. But you must approach it very delicately as Coca-Cola found out." He says professional sports teams are beginning to think about charging more for highly sought-after games, and grocery stores in Manhattan have experimented with charging less for items during the day when stores are not as crowded and consumers have more time to comparison shop.

At the moment, the acceptance of pricing discrimination varies widely among product categories, according to Reibstein. While consumers have long accepted the idea of matinee prices and senior-citizen discounts, they are outraged when street vendors jack up the price of umbrellas on a rainy day and they would never expect to receive a senior citizen discount on a new car. Reibstein says the best way to inaugurate a price discrimination scheme is to be open about the economic reasoning behind the decision. Don't "try and sneak it past the public. Be very open and honest about your rationale for doing it."

Frank Luby, a partner in the Boston office of the price consulting firm Simon-Kucher & Partners (SKP), cautions that many companies fail to take into account how their competitors will react when they lower their prices. Continued price responses among competitors can lead to an all-out price war that can be disastrous for all sides. "We would argue, in some cases, that the best response to a potential price war is none," says Luby.

He also notes that companies must take "price contamination" into account when developing pricing strategy. At the business-to-business level, the power of pricing discrimination erodes as employees move from firm to firm sharing internal information about pricing. Acquisitions also put pressure on prices as companies open their books to one another and see disparities. "What you charge one place has a risk of leaking out and coming back to haunt you. That's an incentive to keep prices as high as possible."

According to Raju, certain industries are more advanced than others in developing successful pricing strategies. In addition to airlines and mobile phones, retailers are among the most sophisticated. Wal-Mart, for example, collects detailed customer and competitor data to make pricing decisions. The apparel industry, he says, is not as complicated. Clothing retailers charge high prices when garments arrive at the beginning of a season, but then systematically make markdowns as the season progresses. "The value of the product lowers as time goes by."

Pricing is growing increasingly complex as companies expand into new markets around the world, Raju notes. "As globalization takes over, there is wide variation in willingness to pay, yet the markets are very attractive. How do you go after people who don't have high income, but whom you would like to have touch your product?"

The pharmaceutical industry, he adds, has attempted to create differential pricing structures to reach patients in developing countries while protecting profits in their traditional markets in Europe and the United States.

Zhang says companies are realizing that pricing is critically important, but difficult to do right. Typically, managers have avoided new approaches to pricing, not only because it is complex but also because it is so important. "If the decision is impactful, you don't want to do anything new. If you don't have a very sophisticated knowledge of pricing, you don't have the confidence to make those kinds of decisions. The safe thing to do is to follow whatever the convention is." Usually, he says, companies take their cost to produce a product and add a certain percentage to that as profit. Isuppli, a technology market research firm, has estimated the cost to produce the 8GB iPhone at $265.83.

Zhang points out that another obstacle to pricing new products, particularly technology gadgets, is an inability to do wide market tests without trading off the secrecy necessary to protect a developing product from copycats.

Part of the Family

Often pricing defies traditional models when products carry an emotional attachment or become a symbol of the owner's sense of self, which can happen with cars, handbags and technology products, including phones and music players.

The reversal on Apple's iPhone may have been more dramatic because the company has marketed itself as consumer friendly, says Wharton marketing professor Stephen Hoch. "People have strong positive feelings about Apple. They feel they are part of the Apple family." When Jobs announced the price decrease, "people felt betrayed. I don't know whether they should or not. It's not as though this is the first time a technology company lowered prices."

Hoch says he does not believe Apple was under pressure to boost unit sales because of lower-than-expected purchases. He notes that the company sold one million phones in a little more than two months, nearly a month ahead of its announced target. To compare, it took Apple two years to sell one million iPods. While the iPod was more or less in a class by itself, the iPhone is a new player in a fully developed, competitive cellular phone market. "The competitors will work hard to defend their positions. There will be a lot of new products and pricing."

For Luby, the iPhone pricing controversy shows that even a sophisticated marketer like Apple can be tripped up by the complexity and hidden effects of a pricing decision. "It seems like Apple made a mistake -- and many people believe it did -- but there are a lot of moving parts here." He points to the phone's new features, its exclusive tie to wireless carrier AT&T and all

the hype associated with its launch. He challenges Apple's critics to present a model of how they would tease out all these elements to determine the right price: "I'd like to see their math."

Beware the 'Walking Dead': Analyzing Customer Data from a Multi-Service Firm

Think of them as the "walking dead." They're not ghosts or freaks from a horror movie, but rather a certain type of customer whose relationship with a company will soon be history.

The walking dead are "customers who currently maintain service but whose next action will be to discontinue all services, an important economic consequence to the firm," according to a new study that examines how the customers of a telecommunications firm acquire and discard services over time. Companies would be wise to identify their walking dead and not market additional services to them because there may be an unintended effect, the paper suggests.

"Not only are you going to waste marketing and advertising dollars, you're going to remind these customers they're dead," perhaps prompting them to cancel their service altogether, said Wharton marketing professor Peter S. Fader. "It's better to leave the walking dead alone." Fader co-authored the paper, titled "Modeling the Evolution of Customers' Service Portfolios," with Wharton marketing professor Eric T. Bradlow and David A. Schweidel, a marketing professor at the University of Wisconsin-Madison. Their paper has been submitted to the Journal of Marketing Research.

In examining the subscribing patterns of more than 3,000 customers of a major telecom firm over two years, the researchers also found that it's not necessarily a bad thing when customers cancel a particular service, e.g., a premium movie channel, as long as they maintain other ones. "Though conventional wisdom would argue that a customer who has dropped a service is less valuable, such customers have told the firm that they are still making active decisions about their service portfolio and are therefore more likely to acquire other services in the future," the authors write. "Therefore, such a customer clearly is not a member of the walking dead."

The research findings are relevant to the issue of "cross-selling," the strategy of marketing additional products or services to customers who already have done business with the company. Multi-service telecom companies may decide to market Internet service to customers who already subscribe to cable, or market additional premium channels to cable subscribers who already get HBO. Cross-selling occurs in many industries. A financial services company, for instance, may target IRA account customers for other products and services, such as home equity loans, CDs and mortgages.

"By cross-selling additional services to existing customers, multi-service providers can strengthen relationships, curtail churn, and increase revenue," the researchers write. "But to make cross-selling a powerful instrument in a firm's CRM (customer relationship management) toolbox, the firm must be able to identify those customers who are most likely to adopt new

services, as well as those customers who are at risk for discarding some or all of the services to which they currently subscribe."

The researchers did their study using the telecom firm's monthly subscription information for January 2002 through May 2004. The firm, which is not named in the paper, offers a variety of services, including basic cable, a digital cable package, premium channels (HBO, Showtime, Starz, Cinemax and TMC) and high-speed Internet service. The researchers focused on a random sample of 3,393 new customers in a given region and tracked what services they adopted or dropped. "While two years doesn't sound like a long period of time, it's amazing how much movement we see, how much acquisition of new services and shedding of services customers exhibit over that time," Fader said.

The researchers wanted to see how customers' service portfolios evolved with time and examine how past subscribing behavior influenced future actions. To accomplish that, they developed a model which they said "can be used to value customers, enabling multi-service providers to determine where their money is best spent: Should resources be allocated to enhancing the relationships of existing customers or to acquiring new ones?"

Fader said the model allows for the creation of a "co-purchasing map," showing where customers lie at any given time in relation to the various services offered by the company. While previous studies look independently at the issues of customer evolution and multi-product ownership, "No one (to the best of our knowledge) has simultaneously explored these aspects in a contractual setting," the authors state in their paper.

From Chevrolet to Cadillac

According to Fader, a traditional view holds that customers progress through a fairly predictable pattern of business with a company. For instance, the bank customer starts out with a student loan, goes on to a car loan and eventually ends up getting a home loan. Likewise, there's the old image of the upwardly mobile car owner. "You first buy the Chevrolet, then you move up to the Pontiac, then the Buick, then the Oldsmobile, then the Cadillac," Fader said. But while there are certain "lifecycles" that customers move through, he added, people don't move in lockstep through the phases, and even within a phase, there is a lot of variation across customers. "Preferences are incredibly variable across people and over time."

The researchers identified three general states that define a customer's relationship with a company. In State 1, customers are close to certain key services, such as basic cable. "In this introductory state, you're just dipping your toes in the water and trying out one or two services to see if they meet your needs and if you like working with the company," Fader said.

In State 2, "you broaden your relationship, often acquiring additional services, like premium channels," Fader noted. But that's not always a good thing. "A customer who moves rapidly into State 2 is likely to reconsider his portfolio more quickly and possibly acquire additional services. However, while such customers may appear tempting, these same customers are also likely to transition into State 3 quickly and reconsider their portfolios (i.e., drop all services) without much delay," the researchers write.

State 3 customers, the walking dead, are just one move away from severing their ties with the company. "However, customers' transition to this state may not be immediately observable; they may maintain their current portfolio for several months (or longer) due to inertia. Having plateaued in their level of service, their next change almost certainly will be to drop all services," the researchers state.

Fader adds an important caveat: "While we see a relatively sudden drop in this particular dataset, there could be additional states in other settings. Customers might gradually shed their services as they slowly sever their relationship with the firm. It would be interesting to compare these evolutionary processes across different types of multi-service providers."

Knowing what kinds of customers are in each state can help a company shape its marketing efforts. With State 3 customers, for example, "cross-selling activities may actually encourage the customer to reconsider his portfolio -- and drop all services in the process," the researchers contend. "Rather than devoting resources to waning customers, it may be more profitable to target new prospects and provide them with incentives to begin (and broaden) their relationship with the firm."

In the case of those customers who "age" rapidly, going quickly from State 1 to 2 to 3, a firm may be able to develop a strategy to slow down the "aging process," thus holding on to the customer longer, the researchers note, adding that companies can determine a specific financial valuation for such a strategy.

It's important to view customers in terms of their entire history of purchasing decisions, not a single recent decision, since "the entire sequence of portfolios is informative of his current lifecycle state and future behavior," the paper states. Getting back to the concept of the co-purchasing map, a customer who already subscribes to one service may be likely to buy another one that is located nearby on the map. For instance, customers who already have one premium cable channel may be more apt to subscribe to another premium channel than to high-speed Internet access, which is located farther away on the map.

"The number of subscribers to Showtime, Cinemax, Starz and TMC closely mirrored each other," the researchers wrote. "Some customers have a high propensity to subscribe to all of these services, while other customers have a low propensity for all of them, indicating that these services are complements rather than substitutes."

The authors say their model can also be used place a dollar value on customers in the various states of purchasing behavior. Using the telecom firm data, they calculated the average remaining lifetime value of customers after 12 months in one of the three groups. Customers in State 1 were still worth $3,470 in additional business; those in State 2 were worth $1,834, and customers in State 3 were worth $555. That final figure shows why it's probably best to leave the walking dead alone, Fader said, since there are numerous customers in that category and they are still worth a considerable chunk of money to the company.

The researchers have had informal discussions with managers in other industries who indicated they could relate to the concept of the walking dead in contexts such as magazine subscriptions,

extended warranty service contracts and retirement accounts being held for former employees. "In all three cases (among others), attempts to utilize the 'relationship' a firm has with certain customers may backfire and remind them to close their accounts," the article states.

In summarizing this research project, Fader points out that every customer's "lifecycle" with a multi-service provider appears to be unique, and firms are often unable to see some strong but subtle patterns that exist across customers. "Firms want to get into each customer's mind to figure out the next service to promote to him or her. This is a good idea in theory, but it's very difficult to do this well without a formal model that captures the underlying drivers. It's clear from this research that marketing actions along these lines can hurt as much as they can help. Firms can gain a great deal if they approach these important decisions more scientifically."

Here Today, Discounted Tomorrow: Strategic Shoppers Know When to Buy, and at What Price

Some shoppers just can't help themselves and buy mostly on impulse without regard to price. Others are die-hard bargain hunters, who only open their wallets for a discount.

Then there are the strategic consumers, who are willing to buy full-price sometimes, but at other times they will wait for a bargain. According to new Wharton research, it's these customers that retailers need to focus on in order to reap the full benefits of lean retail inventory management and variable pricing.

In a paper titled, "Purchasing, Pricing and Quick Response in the Presence of Strategic Consumers," Gérard P. Cachon, professor of operations and information management at Wharton, and doctoral student Robert Swinney show how lean inventory systems are far more effective than initially thought in helping retailers determine the ideal size of their orders and the best markdown strategies when taking strategic buyers into account.

"The consumers are thinking 'Should I buy it now or later?' They form expectations about how likely it is the item will be around and how big the markdown will be," says Cachon. "If a strategic consumer concludes the markdown will be big and available, they will wait. There is an interaction between retailers and consumers when it comes to deciding on pricing and quantity.... They are playing a game."

The research shows that when strategic consumers are factored into a theoretical model, lean inventory -- or so-called "quick response" -- systems are, on average, 67% more profitable.

"Although it is well established in the literature that quick response provides value by allowing better matching of supply with demand, it provides more value, often substantially more value,

by allowing a retailer to control the negative consequences of strategic behavior. Furthermore, this latter benefit can be substantial," Cachon and Swinney write in their study.

Breaking the Pattern

In 2004, after company research found that about 20% of Best Buy customers were not profitable, CEO Brad Anderson labeled them "devils." At the same time, another 20% of the retail chain's customers accounted for its profitability. Anderson dubbed them "angels."

Cachon and Swinney set out to learn more about the remaining consumers, so-called strategic buyers, and constructed a model to predict consumer behavior in various retail inventory and markdown situations. The model represents a retailer selling a single product over two periods. In the first period, the retailer sells the product at full price, and in the second at a discount. The model then factors in three types of consumers: myopic consumers, who always purchase at the initial full price; bargain-hunting consumers, who purchase only at a discount, and strategic consumers, who deliberate about when to make their purchase. For example, the authors say, a strategic consumer may be willing to purchase a barbecue for $350 at the start of summer but would prefer the chance to purchase it at the end of summer for 50% off the initial price.

Over time shoppers have been trained -- primarily by department stores -- to expect to pay full-price at the beginning of a retail selling season, but far less if they wait until inventory clearances roll in, says Cachon. More recently, the availability of coupons from Internet shopping discount sites has made it easier for every day to be a "sale day" for hard-driving bargain seekers.

Cachon's study highlights one retailer that is breaking the now-familiar full-price/markdown pattern: Spanish apparel retailer Zara, which has developed a new retail business model limiting price discounts. The chain manufactures much of its inventory in Europe. Even though the cost of production is higher than it would be in Asia, the company can take advantage of quick turnaround on hot-selling items. When an item sells out -- that's it. Zara offers very little in the way of sales.

"When consumers walk into Zara, if they like an item they are trained to buy it then and there, because waiting doesn't pay off. If you wait, it's not available anymore," says Cachon. "Even if it doesn't sell out, it's not marked down that much."

Cachon stresses that the key to Zara's successful strategy is its investment in information technology and other tools that make up its quick response system. He notes that quick response is not a new concept in retailing, but the new study shows the strategy has enormous, untapped potential when turned toward helping retailers target strategic buyers. "Quick response increases profits, even without taking into account strategic consumers, by just enabling retailers to update inventory when they learn about demand. But when you throw in strategic consumers [the increase] is even greater, often substantially greater."

More Barrys, Jills and Buzzes

Cachon says there is no hard evidence that the number of strategic consumers is increasing, but he points to anecdotal signals, including Best Buy's efforts to identify and develop new strategies for its own best shoppers, which it divides into three segments: High-income men, referred to internally as Barrys, tend to be enthusiasts of action movies and cameras. Suburban moms, called Jills, are busy but usually willing to talk to sales clerks about products that might help their families; and finally, male technology lovers, nicknamed Buzzes, are interested in acquiring and showing off the latest gadgets.

Consumers like these have ever-increasing access to pricing information, from Internet shopping site comparisons to competitor discount coupons, Cachon notes. "Consumers have a lot more information than they used to.... Over time people have become aware that there is this pattern in retailing. The price starts high, then there is a deep discount."

Zara has trained consumers the other way, although Cachon says he does not think the company set out to do that intentionally. "I think it was just a coincidence. They did production in Spain and had a quick response system and started this philosophy. Then at some point, they realized the power of that model."

According to Cachon, the importance of the research is recognizing the link between retailers' own strategies and the consumers' reaction to them, which then feeds into the profit equation. "We find that a retailer can incur a substantial loss in profit by ignoring strategic behavior," Cachon and Swinney write. "Failing to recognize strategic behavior leads the firm to order too much inventory, which makes deep discounts to clear inventory at the end of the season more likely. When consumers expect deep discounts, they are more likely to be patient and wait for a sale. Although retailers may dislike having to take markdowns, we find that a commitment to never markdown merchandise is generally not the best approach to deal with strategic consumers (even if such a commitment could be made credibly). The better approach is to be prudent with the initial inventory and then to dynamically and optimally discount."

This model is most powerful for retailers selling products affected by timeliness, Cachon adds -- for example, high-fashion apparel or technology items that might quickly be supplanted by new devices. "Apparel is very seasonal, and when you have a little too much inventory at the end of the season, the temptation is to mark it down, just to move the inventory out." Products that are commodities, such as many consumer packaged goods, are not particularly suited to adjusting for strategic consumers. "If the retailer doesn't sell a box of Tide today, he will sell it in the future," says Cachon. "This really does apply to something that has a short lifespan."

Waiting for Cheaper Tickets

The research by Cachon and Swinney might also be useful for airlines.

"[Airlines] used to be able to charge an outrageous amount for walk-ups, but in the past five to 10 years, the price differential between the most expensive and the cheapest tickets has come down," says Cachon. "I think that's partly because consumers are a little more savvy. They may be willing to pay $1,000 for a flight from Philadelphia to Chicago, but if they can get it for $150 -- why not?"

Southwest Airlines, he notes, offers low fares daily. The airline loses out on the big spenders, identified as "myopic" customers in the research, but it is also less vulnerable to strategic consumers who will adjust their behavior to save money.

A consumer's income level is just one way to determine which buyer might become a hard-core bargain hunter, a myopic spendthrift, or a strategic buyer, according to Cachon. Another consideration is the amount of time available for shopping, with time-pressed consumers willing to pay more for an item to save time.

"A really rich person does not want to be bothered with finding a good deal, but there is a middle ground -- people who make a good income and could buy something at full price but are willing to shop a little," Cachon notes.

Brand Building in the Digital Age: A Dizzying Array of Choices

For anyone who is a baby boomer, the name TV Guide still conjures up an image of that digest-size magazine that came to your home every week with its listings of the nightly shows on the four or five channels in your hometown, as well as a couple of feature stories about "Gunsmoke" or "Gilligan's Island."

That image seems quaint in the era of YouTube.com, 300 digital channels, TiVo and DVRs, and videos watched on people's iPods - but the irony is that with so many different video options, the one thing that viewers need more than ever is the original resource that drew them to TV Guide back in the 1950s and 1960s: Guidance.

"TV Guide, hopefully, still stands for your guide for entertainment," Richard Cusick, senior vice president for digital media at Gemstar-TV Guide International, told a panel on the future of digital media at the recent Wharton Technology Conference 2007. "We don't want to get caught up in what brand we deliver that in."

To that end, TV Guide has increasingly emphasized online, wireless or interactive content. In 2004, its parent company struck a $250 million partnership deal to develop an interactive program guide with Comcast, while last year it teamed up with 4INFO to send television listings to mobile phones. Gemstar-TV Guide also builds popular interactive web sites, with blogs based on popular shows like "24" and "Lost."

The company's successful initiatives seemed to drive home some of the key messages of the panel, which was entitled "Digital Media: Brand Building in the Digital Age" and also included

representatives from Comcast, the New York Times, alcoholic drinks producer Diageo Plc and ad firm MediaVest USA.

The group offered some solid advice to any executive or editor confronting a seemingly dizzying array of digital media -- from mobile devices to user-generated videos to blogs and podcasts and other types of Internet sites -- and seeking to decide how to best deliver content or sell their product.

The main message was that any media offering has to be true to the established brand name -- taking that brand's strengths and then figuring out which technology platforms are most compatible with its core mission. "We're 150 years old, and that's part of our opportunity and our challenge," said Hayley Nelson, the product manager for NYTimes.com. Simply put, that means keeping the same commitment to the qualities that have made the Times the most authoritative news source in the country, with 93 Pulitzer Prizes -- but applying those standards to news delivered on cell phones, or on interactive blogs where the general public is able to post comments.

Nelson said that NYTimes.com works closely with futurists, and its top digital executives hold a yearly meeting with information technology experts who pass new and upcoming gadgets around the table, while, she said, the journalism executives "try to envision what we can do with them."

That might sound like an odd image for a newspaper company that's nicknamed "The Gray Lady." But in fact, the Times is already a huge Internet presence. Its 42.6 million unique visitors make it the 11th most popular site on the web, with online revenues rising at an annual rate of more than 26%.

Reaching Upscale Audiences

While many Internet visitors come for the Times' core coverage of international news, an increasing lure is sites that are highly targeted at lucrative niche markets. Some of that new content is created with the needs of advertisers in mind. "We're trying to bring the advertisers earlier into product development," said Nelson, one of the few staffers at the Times who bridges the gap between the operation's editorial and business sides.

A prime example of these efforts is the relatively new blog called DealBook, a frequently updated financial news service -- including a daily emailed newsletter -- with some lively discussion areas, where occasionally a company's CEO will post a comment. "We've tried really hard to create these dialogues," said Nelson, "and one reason is so we can give advertisers a very targeted way at reaching these upscale audiences." That success allows for several ways to monetize the web traffic; recently, the Times announced DealBook Jobs, a new section within DealBook dedicated to job hunting and career management in the financial services industry, with an outlet for high-end help-wanted ads.

Several times during the discussion, panelists stressed that with all the focus on finding new media for reaching consumers, the old types of media -- including television and newspapers -- aren't disappearing and should not be neglected by advertisers. "It's not about the 15-second or

30-second commercial. Let me be clear. These aren't going anywhere; they're staying where they are" said Jen Soch, vice president and group director of advanced TV for MediaVest USA. "But it's how do we use them." For example, advertisers are frequently airing short TV spots that then direct viewers to a web site where they can be exposed to more information.

In fact, one of Soch's biggest problems seemed to be countering technology -- such as TiVo recorders -- that allow customers to skip over commercials altogether. She said MediaVest has been working on so-called "speed bumps" -- a kind of advertisement that will still appear on screen even as viewers are fast forwarding.

TV Guide'sCusick echoed the other panelists when he said that using new media or creating elaborate new web sites -- where it's to promote editorial content or to advertise a product -- is a waste of time if the subject matter is not something that interests viewers or Internet readers. On several occasions, Cusick notes, advertisers have approached TV Guide to create what he called "micro-sites" to promote a particular show or offering, but the sites have sometimes bombed because the show was not very popular.

Some of the panelists said that all the publicity about new forms of video -- which some experts are calling "Television 2.0" -- and new online communities is creating pressure from brand marketers similar to the late 1990s, when firms rushed to the Internet with little notion of how to best make use of the new medium. "We have clients who come in and say, 'Where's our RSS feed or where's our blogger?' when for some brands it doesn't make any sense," said Soch.

Interacting with the Public

One aspect of the newer Internet 2.0 that panelists had mixed feelings about is the surge in popularity of so-called "user generated content," such as posting homemade videos on web sites like YouTube.com. That development prompted Time magazine to name "You" as Person of the Year. The trend was the recipient of increased hype when leading tortilla-chip brand Doritos aired a 30-second commercial that was produced by an amateur during the Super Bowl.

But John Young, vice president for Comcast Interactive Media, wondered if there wasn't a little too much excitement about these home-grown commercials. He pointed out that amateur video on TV is about as old as the popular series "Candid Camera," and not always the most effective. "They aren't overshadowing the value of high-quality content."

The panel's moderator -- Mike Church, media director for Diageo Plc, the liquor giant that includes Captain Morgan, Guinness and Smirnoff -- noted that advertisements for alcoholic beverages are expected to also promote things like sensible drinking or safe driving, messages that don't always come across on a home video from young and enthusiastic customers. "For the liquor industry, any user content has to meet regulations and standards," he said.

The Times' Nelson agreed that moderating online sites that take comments from the public can be a time-consuming new chore, yet on many projects the benefit of interaction with the reading and buying public outweighs the risks. She said one of the Times' most successful online projects involved a reporter's six-month global travels, in which he asked online readers to suggest places

to eat, sleep and visit. The project drew thousands of comments, not to mention a high amount of traffic to the web site.

Nevertheless, TV Guide's Cusick suggested that either corporate clients or editors who want a two-way line of communication with readers or viewers need to be thick-skinned. "People aren't stupid, so just be prepared for honest feedback about your brand," he cautioned.

Even though the panelists were quite conversant in all the latest trends in video-on-demand, podcasting and so-called "place shifting" of television to mobile phone or computer locations, there was also a palpable sense of anxiety in keeping up with so many rapid technology changes at once. "These things may all be outdated by the time you get home tonight," Church told the audience. The Diageo executive also provided the lightest moment of the event, when he asked the audience how many people had ever visited a liquor company web site.

Not a single hand went up. "That's it. I'm fired!" Church laughed, turning his place card around in a visible sign of frustration at trying to find the consumer in an increasingly fragmented media environment.

What Are Your Customers Really Worth?

In their book titled, Managing Customers as Investments: The Strategic Value of Customers in the Long Run (Wharton School Publishing), authors Sunil Gupta and Donald R. Lehmann offer practical examples and case studies to help companies estimate the lifetime value of their customers. That information, the authors suggest, can then be used to make better strategic decisions about customer acquisition, service, retention and segmentation. Knowledge@Wharton has excerpted a section of the book below.

If you walk into Stew Leonard's, a unique grocery store on the East Coast of the United States, you will probably notice a sign engraved in stone. This sign, which represents the company's philosophy and is meant as much for its employees as its customers, highlights two rules. It reads, "Rule #1: The Customer Is Always Right. Rule #2: If the Customer Is Ever Wrong, Re-Read Rule #1."

A focus on customers is not unique to this company. For years, managers all over the world have reiterated the need to focus on customers, provide them good value, and improve customer satisfaction. In fact, metrics such as customer satisfaction and market share have become so predominant that many companies not only track them regularly but also reward their employees based on these measures.

However, this kind of customer focus misses one important component -- the value of a customer to a company. Effective customer-based strategies take into consideration the two sides of customer value -- the value that a firm provides to a customer and the value of a customer to the firm. This approach recognizes that providing value to a customer requires marketing investment and that the firm must recover this investment. In other words, this approach combines the traditional marketing view, where the customer is king, with the finance view, where cash is king.

This chapter describes how a strategy that focuses on the two sides of customer value differs from traditional marketing strategy. We argue that traditional marketing's focus on customer satisfaction and market share may be counterproductive at times. We demonstrate that the two approaches use different metrics for measuring success and frequently lead to quite different insights and strategic decisions. Finally, we discuss in detail the three strategic pillars of this new approach -- customer acquisition, customer margin, and customer retention.

Traditional Marketing Strategy

A longstanding approach to marketing strategy discussed in almost every marketing management textbook and taught in most business schools can be summed up as consisting of 3 Cs, STP, and 4 Ps.

The first component of this framework is the analysis of customers, company, and competition (the 3 Cs) to understand customer needs, company capabilities, and competitive strength and weaknesses. If a company can fulfill customer needs better than its competitors, it has a market opportunity. The second component is to formulate the strategy for STP -- segmentation, target-ing, and positioning. This part recognizes that customers are different in terms of their needs for product and services, so a firm has to decide which of these customer segments it should target. After selecting a target segment, the firm needs to decide on the value proposition or positioning of its products with respect to competitive offerings. The final component of this framework designs the 4 Ps -- product, price, place (i.e., distribution channels), and promotion or communication programs.

This framework is logical and useful. However, implicit in this structure is an emphasis on providing value to customers by satisfying their needs with little focus on cost. Metrics used to measure success in this framework, such as sales, share, or customer satisfaction, drive decisions. What is missing is the explicit recognition or measurement of return on marketing investment. For example, it is not uncommon for firms to spend billions of dollars on advertising. For example, in 2002, GM spent $3.65 billion in advertising in the United States alone. It also offered billions of dollars in discounts to attract customers. What is the return on these investments? Do they build customer value in the long run? Do they eventually help the financial health of the company? It is difficult, if not impossible, to answer these questions within the traditional marketing framework.

Customer-based strategy does not completely ignore the key principles of the traditional marketing approach. Providing value to customers is still critical. However, this approach recognizes that marketing investment in customers must be recovered over the long run.

Specifically, this approach highlights the two sides of customer value -- the value a firm provides to a customer and the value of a customer to a firm. The first part is the investment, and the second part is the return on this investment.

The Two Sides of Customer Value

[There are] four scenarios with different values to and of customers. Star Customers get high value from the products and services of the firm. These customers also provide high value to the company by way of high margins, strong loyalty, and longer retention time. The relationship is balanced, largely equitable, and mutually beneficial. This is clearly a win-win situation where customers get superior value, which earns the firm loyalty and higher profitability. A firm would be well-advised to build this type of customer.

In contrast, Lost Cause customers do not get much value from the products and services of the firm. Generally these customers are marginal for the firm; their main value, if there are enough of them, is to provide the economies that come with greater sales --  e.g., reduced production costs and promotion efficiencies. Absent economies of scale, if the company cannot migrate them to higher levels of profitability, it should consider either reducing its investment on these customers or even "firing" (dropping, shifting to other suppliers) them.

One cross-sectional study of U.S. banks found that in the early 1990s only 30% of a typical bank's customers were profitable over the long run.  In other words, 70% of customers destroyed value! Some insurance companies found themselves in a similar situation a few years ago when they realized that after several natural disasters in Florida, their zeal to grow and add more customers had led them to acquire a large number of customers in disaster- prone areas. For long-run profitability, it is imperative for these companies to either convert unprofitable customers to a profitable status or "fire" them. This notion of dropping customers runs counter to the intuition of managers who have been trained to think that adding customers, increasing sales, and gaining market share are good per se. In many cases, market share and revenue growth may be the wrong metrics to gauge success.

The other two cases show unbalanced, and hence unstable, relations. Vulnerable Customers provide high value to the firm but do not get a lot of value out of company's services. These may include newly acquired large customers whose experience is less than stellar and who may be wondering why they chose your product in the first place. These may also be longstanding customers who, largely through inertia, remain loyal. In a sense, they are exploited, much like overworked cows or farmed-out fields. These customers are vulnerable and prone to defect to competitors unless corrective action is taken.

A company can invest in these customers through better product offerings, additional services, and related activities. These customers may deserve better service than others. The concept of service discrimination is similar to the idea of price discrimination, where not all customers pay the same price for a product (e.g., an airline ticket). Airlines and casinos have provided prefer-ential treatment for their best customers for many years, and more and more companies are beginning to implement a similar strategy. For example, the call centers of Charles Schwab were configured so that the best customers never waited longer than 15 seconds to get a call answered,

while other customers could wait for as long as 10 minutes. Even airlines that pioneered loyalty programs are now adjusting their frequent flier programs on the basis of ticket price (and hence profitability to the firm) rather than simply the number of miles flown. Although such service discrimination can generate a backlash from customers, it is also possible that customers will accept the old adage that "you get what you pay for," especially if the policy is clear and trans-parent.

Free Riders are the mirror image of the Vulnerable Customers. These customers get a superior value from using the company's products and services but are not very valuable to the firm. For whatever reason (e.g., large size, strong competition), these customers are "exploiting" the relationship with the company, appropriating the lion's share of value.

Consider the case of supermarkets. Every week, supermarkets promote certain products at a low price in order to attract customers to their store. Several items are treated as "loss leaders." A supermarket does not expect to make money on these items but hopes that their low prices will attract more customers to the store. Once these customers are in the store, the hope is that they will buy other items that are profitable. However, many customers are cherry-pickers -- i.e., they only buy those few items that are on sale. It is somewhat ironic that supermarkets have a special line for customers who buy a few items while heavy spenders wait in long lines. Doesn't it make more sense to treat your more profitable customers better by opening a special line for them? Clearly, care is needed in implementation. In general, however, a firm should either reduce its service level or raise prices for the Free Riders. Although this will reduce the value to customers and risk losing them, it will, if successful, enhance their value to the firm. As someone once said, "The difference between a sales and marketing person is that a good marketing person knows when to walk away from a sale."

In sum, successful customer-based strategies require that a company consider both the value the firm supplies to the customer and the value the customer offers to the firm.

Key Marketing Metrics

How do we "keep score" in marketing? Each of the strategic approaches has its own key metrics. Unsurprisingly, these metrics drive decisions. They become goals and are stated everywhere from annual reports to marketing plans as objectives and measures of success.

The key metrics in the traditional marketing approach are sales and share. Ancillary metrics may include customer satisfaction and brand image. Profit is typically measured at a product or brand level. As already illustrated, market share or sales may be the wrong metric in many cases. A credit card company may acquire a lot of low-value customers, which will increase its share but not its long-term profitability. Improving customer satisfaction is good in principle but the benefit of this improvement has to be weighed against the cost to achieve it. Measuring profit at a product or brand level is useful but incomplete for at least two reasons. First, most firms focus on the short-term or quarter-by- quarter profits of a brand and treat marketing as an expense. This short-term focus is counter to the very concept of marketing as investment. Second, measuring profit at the product level ignores the vast differences in the profitability of customers. A bank may be losing money on its mortgage business. This aggregate profit measure hides the

fact that the problem may lie with the bank having too many customers who are Free Riders. Adjusting the price and service to customers based on their value to the firm can significantly enhance the profitability of this product.

In sum, capturing share, increasing satisfaction, and enhancing the brand experience are all useful. They also serve as motivators toward measurable goals. However, they are neither consistent with each other nor necessarily good business. For example, increasing share typically requires bringing in more marginal customers, who inherently are less likely to be satisfied. A study of 77 firms across a wide range of industries confirmed that increasing share may lower satisfaction. Similarly, increasing average satisfaction ratings doesn't guarantee increased profits, as Cadillac discovered in the 1980s, when it increasingly appealed to a smaller, aging customer base.

Customer Metrics

The customer approach focuses on customer value or customer profitability in contrast to share, satisfaction, or product profitability. A focus on customer profitability has several advantages. First, it inherently takes a long-term view, emphasizing that customers are assets who provide long-term returns and that marketing is an investment in these customers. This also shows how to assess the return on this marketing investment. Second, it recognizes that the value of customers may vary substantially. For example, in many business-to-business situations, it is not uncommon to find that while large customers are generally the largest revenue generators for a firm, they are not necessarily the most profitable because of the high cost required to serve them. Note, if a firm keeps track of profit at only the product level, it will never be able to uncover this. As we will discuss in Chapter 6, a focus on customer profitability may require a major change from product-based accounting to customer-based accounting to keep track of revenues and cost for each individual customer. In other words, this new metric is more than a mere difference in semantics. It will not only drive decisions in a different direction but it may also entail significant changes in organization structure.

As discussed in Chapter 2, customer profitability and the value of customers are primarily driven by three major components -- customer acquisition (acquisition rate and cost), customer margin (dollar margin and growth), and customer retention (retention rate and cost). These three factors are the key metrics of the new approach. They not only provide tangible and measurable metrics but also make clear the inherent tension between growth and efficiency. For example, it is hard to simultaneously increase customer acquisition and cut total or average acquisition cost. Similarly, increasing the acquisition rate is likely to draw marginal customers and may negatively impact customer retention rates and margin per customer. Such trade- offs are the essence of astute business decisions and the hallmark of profitable growth.

A Case Study

To highlight some of the differences in the strategic insights gleaned from using the traditional versus the new approach, we present a case study for the U.S. automobile industry. The auto-mobile industry is one of the most competitive in the United States, with very heavy marketing expenditure. In 2002, the automobile industry was the world leader in advertising expenditure,

with over $16 billion in the United States alone. In addition, several billion dollars were spent on discounts in the form of cash rebates and the like. Some reports suggest that in 2003, U.S. automakers spent as much as $3,310 on each vehicle in the form of cash rebates and below-market loans.

A recent study examined the U.S. luxury passenger car market to determine how marketing efforts influence sales (the traditional metric) versus customer profitability (the customer metric).7 The study examined nine brands (Acura, Audi, BMW, Cadillac, Infiniti, Lexus, Lincoln, Mercedes-Benz, and Volvo) from January 1999 to June 2002. The data covered 26 regional submarkets, representing over 70% of the U.S. market.

Using rigorous time series models, this study arrived at some startling conclusions. It found that all brands' discounting efforts either increased or maintained sales volume. Therefore, dis-counting may be considered an effective marketing tool by the traditional metric of sales. However, on average, across these nine brands, discounting rarely increased a brand's customer equity (i.e., profitability of current and future customers) in the long run. The results were even more dramatic in some cases. For example, discounting had a positive effect on Lincoln's short- term sales, but the brand's discounting activities hurt its customer equity in the long run due to the negative long-term impact on its acquisition rate. This is consistent with other studies that find that discounting does not help in the long run, with either customer purchases or the firm's shareholder value.

Results for advertising were also different when viewed from the traditional versus the new lens. For example, while the advertising for BMW had a positive short-term effect on its sales, it did not have any significant impact on its customer equity. Advertising for Acura increased its sales in the long run but not its customer equity. Only the advertising for Mercedes-Benz had a positive influence on its customer equity. If $16 billion of advertising expenditure does not affect the long-term profitability of customers (which, as we will show in Chapter 4, is closely linked to shareholder value), then the industry needs to re-examine its marketing strategy.

This study also emphasized the differential impact of marketing instruments on customer acquisition and retention rates. For example, when high-quality brands offer discounts, it affects their customer acquisition rate more than their retention rates. Evidently, if customers are satisfied with a high-quality product, their repeat purchase decisions are less likely to be affected by their favorite brand's price discounting. This suggests that different brands may need to monitor different metrics (e.g., acquisition or retention) to assess the impact of their marketing investments on customer profitability.

This study illustrates the value of understanding how marketing dollars affect customer profitability and why this focus may lead to very different conclusions than those obtained from traditional approaches.

The 'Myth of Market Share': Can Focusing Too Much on the Competition Harm Profitability?

It is a common practice of many companies to focus their attention on grabbing market share from their competitors. But such efforts can actually be detrimental to the firm's profitability, according to Wharton marketing professor J. Scott Armstrong.

For years, Armstrong has been conducting research showing that competitor-oriented objectives, such as setting market-share targets, are counterproductive. After co-authoring a paper in 1996 that reached this conclusion, he and a different co-author, Kesten C. Green of Monash University in Australia, have written another paper summarizing 12 new studies that add additional weight to the original conclusion. Their study is titled, "Competitor-oriented Objectives: The Myth of Market Share."

Business has long been likened to warfare, Armstrong says, so it is hardly surprising that companies want to beat their competitors. In the 19th century, it was common for many American executives to strive for revenue maximization. To see how well they were doing, companies compared themselves to competitors in their industries. But in the mid-20th century some academic scholars began to question the widespread focus on market share. In 1959, one researcher "lamented the common use of market-share objectives and discussed the logical and practical flaws of pursuing such objectives," according to Armstrong and Green.

In the 1996 paper, Armstrong and Fred Collopy of Case Western Reserve University summarized a host of studies by other researchers that examined the prevalence of competitor-oriented objectives.

For instance, several researchers in the 1950s and 1960s had groups of subjects play repeated games in which cooperation was necessary to maximize profits. The researchers found that when they provided feedback to subjects on other subjects' performance, nearly 90% of the choices that the subjects made were competitive and hence low-profit. In another example, Armstrong and Collopy asked 170 MBA students over a period of years whether the "primary purpose of the firm is (a) to do better than its competitors, or (b) to do the best it can." One-third of the students chose (a), suggesting that a large number of the students believed that beating the competition is more important than other goals, including profitability.

In their 1996 study, Armstrong and Collopy also analyzed data amassed by scholars to measure the level of competitor orientation of 20 major corporations, as stated by the companies themselves, and how the level of competitor orientation was related to the firms' after-tax return on investment (ROI) for five nine-year periods beginning in 1938 and ending in 1982. "Competitive-oriented objectives were negatively correlated with ROI for these data," Armstrong and Collopy concluded. In other words, the more managers tried to be the biggest in their market, the more they harmed their own profitability.

For example, companies whose only goal was profit maximization -- DuPont, General Electric, Union Carbide and Alcoa -- posted stronger returns on investment than did the other firms studied. By contrast, the six firms whose only goal was market share -- National Steel, the Great Atlantic & Pacific Tea Company, Swift, American Can, Gulf and Goodyear -- fared worse in terms of ROI. Indeed, some of these companies, like National Steel and American Can, no longer exist.

Armstrong acknowledges that the 1996 paper was controversial. Aside from some coverage in the popular press, corporate executives largely ignored the study and academics criticized it. Since 1996, however, Armstrong and Green have continued their efforts to collect data on the effect of competitor-oriented objectives. They have incorporated the results of these efforts into their new paper.

Competition vs. Cooperation

Once again, Armstrong and his co-author examined both laboratory and field studies conducted by other researchers. One lab study compared the performance of MBA students with that of computerized profit maximizing pricing strategies. Each game involved three players. The subjects were unaware that in two out of three games the third player was one of the computerized strategies. The game was designed to represent the market for mature, frequently purchased consumer goods. It was possible for cooperative players to make a profit of $20 if they all charged $1.50 per unit. Subjects playing the roles of managers were instructed to maximize their profits and were told that their compensation would be partly based on their profitability.

Despite these instructions, the students tended to charge close to the price that maximized the gap between their own profit and that of the other subjects. When the students played against other students only (i.e., there was no computer player),the average profit was $7.19, well below the potentially achievable cooperative profit of $20.

In another study, a team of researchers including Armstrong analyzed additional data, through 1997, on the 20 companies originally studied by Armstrong and Collopy. The researchers introduced two new criteria: real return on equity and the percent of after-tax return on sales. All of the correlations between competitor-oriented objectives and profits were negative, ranging from minus 0.28 to minus 0.73, according to Armstrong and Green.

These two studies -- and others that are recounted in the Armstrong and Green paper -- strengthen the authors' assertion that the oft-touted advice to chase market share in order to achieve greater profitability, is a harmful myth.

In addition, Armstrong and Green write, they "have not found a single paper that challenges the finding that competitor-oriented objectives harm profitability. While advocates of market-share objectives have provided no evidence to support their contention, their writings seem to have had a big impact" on strategic-management research and executives' beliefs that increasing market share is a worthwhile goal. Armstrong and Green also note that many management textbooks erroneously "repeat the claim that increasing market share will boost profitability."

Toyota and Canon

In an interview with Knowledge@Wharton, Armstrong pointed to contemporary examples that appear to underscore his long-held contention about the myth of market share.

For instance, Toyota is a profitable company and expects to build more vehicles than any other automaker in 2007, but grabbing market share is apparently not one of its goals. An Associated Press story on Toyota's imminent rise to the top described Kazuo Okamoto, executive vice president, as being "nonchalant" about Toyota's achievement. "We aren't that concerned about vehicle numbers," Okamoto told the AP. "But we are determined to go at it to develop cars that make a lot of people happy." Indeed, researchers have long known that, in general, Japanese automakers shun market share as an objective, according to Armstrong.

As another example, Armstrong points to two longstanding competitors in the printer and copier business, Canon and Xerox. During the period that Fujio Mitarai was CEO and president of Canon USA -- from 1979 to 1989 -- the value of Canon's stock rose by a factor of nine times while the value of Xerox shares was virtually unchanged. "I changed the mindset at Canon by getting people to realize that profits come first," Mitarai told BusinessWeek in a story published in 2002. Mitarai is now chairman and CEO of Canon in Japan.

The harm that competitor-oriented objectives can cause the companies that pursue them was the subject of a December 4, 2006, article in The New Yorker by James Surowiecki, the magazine's business writer. Surowiecki describes how Sony, with its PlayStation 3, and Microsoft, maker of the Xbox 360, are beating each other's brains out trying to capture the biggest share of the video-game market. Meanwhile, third-place Nintendo, with its new game console called Wii (pronounced "wee"), has quietly become the most profitable game console company in Japan.

Nintendo "has not just survived out of the spotlight; it has thrived," Surowiecki writes. "It has $5 billion in the bank from years of solid profits, and this past year, though it has spent heavily on the launch of the Wii, it made close to a billion dollars in profit and saw its stock price rise by 65%. Sony's game division, by contrast, barely eked out a profit and Microsoft's reportedly lost money. Who knew bringing up the rear could be so lucrative?"

Armstrong says the focus on beating the competition remains entrenched in the world's biggest companies. Jack Welch, the former CEO of General Electric, famously stated that GE would not be in any business in which it could not be first or second in market share. Welch's belief in the myth still holds sway in boardrooms, but Armstrong says it is never too late for CEOs to change.

"We're not saying companies shouldn't pay attention to their competitors; they might be doing reasonable things that you may also want to do," Armstrong says. "What we're saying is that the objective should not be to try to beat your competitor. The objective should be profitability. In view of all the damage that occurs by focusing on market share, companies would be better off not measuring it."

Product Placement in the Pews? Microtargeting Meets Megachurches

Haven't been to church recently? You might have missed something.

Church pastors last year had a chance to win a free trip to London and $1,000 cash -- if they mentioned Disney's film "The Chronicles of Narnia" in their sermons. Chrysler, hoping to target affluent African Americans with its new luxury SUV, is currently sponsoring a Patti LaBelle gospel music tour through African-American megachurches nationwide.

Advertising has begun to seep into churches, and the phenomenon shows no signs of slowing down, say academic, religious and marketing experts. Among the wave of early adopters: the Republican Party, which successfully sold its platform to church-goers in the 2000 and 2004 elections; Hollywood, which discovered the economic power of faith when Mel Gibson's church-marketed film "The Passion of the Christ" became a blockbuster; and publishing, with Rick Warren's best-selling The Purpose-Driven Life, heavily marketed by a Christian publishing house.

These products -- a conservative political agenda, a film about Jesus and an evangelical book -- all had at least some religious connection to Christian consumers. Now some advertisers are taking the next step: marketing products -- like an SUV -- with no intrinsic religious value through church networks. "If we are going to target the African-American consumer, we have to go where they go, rather than ask them to come to us, and the church is a major institution for that community," says James Kenyon, Chrysler Group brand marketing senior manager.

LaBelle's tour, which features both her November-release gospel album and Chyrsler's 2007 "Aspen" SUV, is passing through 14 of the largest predominantly African-American megachurches in the country. Some participating churches are also organizing "ride and drive" events, where church members and others can test-drive Chrysler vehicles.

The Chysler-Patti LaBelle tour has so far avoided the criticism that followed Chevrolet's 2002 sponsorship of "Chevrolet Presents: Come Together and Worship," a concert tour featuring leading Christian music acts and Max Lucado, a popular evangelical preacher and author. Rabbi James Rudin, then spokesman for the American Jewish Congress, called the tour a "divisive" way to reach the public, while other Jewish and Christian groups condemned Chevrolet for promoting a conservative brand of Christianity.

But Kirbyjon Caldwell, pastor of a megachurch that co-hosted the LaBelle tour in Houston, welcomes this particular pairing of church and corporation. "I would like to see more companies pay attention to the African-American consumer," says Caldwell, whose Windsor Village United Methodist Church attracts up to 14,000 worshippers every Sunday. "The Chrysler-Patti tour is a shrewd strategy to galvanize the interest of a market that has seemingly been forgotten."

For Greater Grace Temple in northwest Detroit, another concert host, the event represents a chance to extend its reach into the larger Detroit community. "Gospel music is big in Detroit, not just as a spiritual thing, but as a cultural thing," says Melvin Epps, communications director for the church, which hosted Rosa Parks' funeral in 2005.

Reaching non-believers -- known as "seekers" or the "un-churched" in evangelical-speak -- is a primary mission of megachurches, and events that make it easy for newcomers to participate are popular. "We don't just want to stay within the walls of our church," adds Epps.

Greater Grace maintains a number of corporate partnerships. Chase Bank, for example, sponsored a back-to-school festival where children received free backpacks bearing the Chase logo. When church members bought 13,500 cases of Pepsi products, Pepsi donated a 15-passenger van that the church uses to transport senior citizens. "It's a win-win situation," says Epps.

Megachurches as Consumer Aggregators

You might think of a church as a steeple-topped place of long and windy sermons, where a loyal band drinks coffee from Styrofoam cups and raises money to repair the roof. But megachurches have changed the face of Sunday mornings, combining the latest technology, a casual Starbucks-like atmosphere and upbeat preaching to draw in crowds of thousands.

They offer a particularly tantalizing opportunity for those intent on network or "word-of-mouth" marketing, a strategy that capitalizes on social relationships to spread product information and influence purchasing, according to Wharton marketing professor Patti Williams. "Megachurch members are drawn together by a strong common bond. Networks that exist naturally facilitate word-of-mouth marketing, because people tend to share information with those they are close to," she says.

Pastors make "great connectors," adds Wharton marketing professor Christophe Van den Bulte, "because they reach a large audience once a week, and their words carry extra weight." But the real potential for word-of-mouth marketing, he notes, lies in megachurches' micro social networks.

In order to create the intimate feel of fellowship in the midst of massive congregations, megachurches channel members into small groups. The affiliation groups can be based on any commonality, such as church-going neighbors, widowers, teens with divorced parents, home-schooling mothers and everything in between. In a weekly prayer group, says Van den Bulte, "you have the reinforcement of a dense social network. It's one thing to have a pastor saying something on screen, but it's a real turbocharger if you have a small group discussing it as well."

The opportunities for network marketing through churches carry their own risks, however. "If people share an ethical connection based on life values, then using those ties for blatantly commercial purposes could backfire," says Van den Bulte. "Sometimes people feel it's a sacrilege to use a human connection to further another type of goal."

But there is no doubt that megachurches -- defined as churches with weekly attendances of over 2,000 people -- offer advertisers some huge enticements. They reach more than seven million people every Sunday morning, an aggregation of potential consumers that secular advertisers have ignored until recently, according to Scott Thumma, an expert on megachurches at the Hartford Seminary in Hartford, Conn.

"Megachurches represent the concentration of larger numbers of Christians in fewer congregations," says Thumma, whose latest research will appear in a co-authored book next year. "If nearly 50% of people who attend church go to 10% of the churches, then marketers have not given that phenomenon nearly enough attention."

Christian companies have long marketed through churches, but Thumma agrees that mainstream marketers are beginning to catch on. Every week now he fields calls from companies who want to buy access to his database of megachurches. (His list, though publicly available, is not for sale.) "For a long time, companies marketed to the ideal of American culture, which didn't have anything to do with Christianity or religion," he adds. But marketers paying more attention to cultural subgroups see that "conservative Christians represent a very large group, and if they want to appeal to them, they have to go directly to the source."

Daycare and Sports Analogies

According to Greg Stielstra, vice president of marketing for the Christian Trade Book Group at Thomas Nelson Publishers, a product must tap into the church experience in order for the marketing effort to succeed. "People who gather in church on Sunday are practicing a common faith, but that doesn't make them more susceptible to margarine or minivans. The Republican Party was successful because it connected with the fundamentals of Christian faith. But it won't work if you sell a product lacking relevance," says Stielstra, who also directed The Purpose-Driven Life marketing campaign.

Megachurches do offer opportunities for secular marketers, Stielstra adds, but uncovering them may require creative thinking. He recalled a financial planner who came to him with this problem: Potential customers were likely to hire his services if they heard his presentation, but few people were willing to sit through it. The number-one reason for marital conflict is money, Stielstra told the planner, and church-going couples are likely to seek out their pastor -- rather than a financial planner -- for advice. The solution? Stielstra put the financial planner in touch with local pastors, who now provide him with a steady stream of potential clients interested enough to sit through his presentation.

Thumma, of the Hartford Seminary, points to another characteristic of megachurches. Their congregations are usually quite homogeneous. With the vast majority located in the suburbs and exurbs of sprawl cities, megachurches tend to attract "relatively modern, high-tech, middle-class, well-educated, upwardly mobile, suburban family types," he says.

The match-up between church preference and demographic profile may be more than coincidence, according to Applebees America: How Successful Political, Business and Religious Leaders Connect with the New American Community. Authors Doug Sosnik, Matthew Dowd and

Ron Fournier demonstrate how megachurch leaders target potential members based on lifestyle, often using market research techniques in order to meet specific needs. For families with small children, the churches provide high-quality child care. Men turned off by theological sermons hear pastors draw analogies from sports and business. Casual dress puts those turned off by high-church formality at ease.    

But secular advertisers have been slow to see churches as demographically aligned communities. "Who works in the marketing communications industry?" asks Van den Bulte. "It tends to be young people, liberal people, who probably don't go to those churches. There is a cultural disconnect."

Judy Smith and Candace McKeever, partners at Impact Media, the marketing company producing the Chrysler-Patti LaBelle tour are two people who have an inside track. "We're both church-going folks, and if you are in it and of it, then you know it," says Smith. In African-American churches in particular, adds McKeever, "business and church have traditionally gone hand in hand, working for the betterment of the community." Indeed, at Greater Grace Temple in Detroit, the partnership with Pepsi came about because the father of someone in community relations at Pepsi's Detroit office knew the father of Greater Grace's bishop. "It was a personal connection," says Juanita Bass, executive assistant to Bishop Charles Ellis.

The Logic of Growth

Outreach Media Group, a Christian marketing firm founded in 1996 to help churches reach potential members, receives "repeated requests from organizations wishing to get their message to pastors and churches," according to its website. While the firm was helping churches market to the unchurched, outside companies realized the process could be reverse engineered to reach pastors and church members. Though the majority of Outreach clients are companies selling faith-related products -- like church insurance policies or donor management software -- the list also includes Disney, DaimlerChrysler and other secular corporations.

Outreach's sermoncentral.com was the group that sponsored last year's sweepstakes offering $1,000 and a London trip to the lucky pastor who submitted proof of mentioning Disney's "Narnia" movie in a sermon. And as part of its promotion of New Line Cinema's 2006 church-targeted movie, "The Nativity Story," sermoncentral.com offers free sermons, PowerPoint presentations and outreach ideas based on the film. The website also allows pastors to sign up for free screenings of the film in 45 cities.

The Narnia sermon sweepstakes, first reported last December by the Philadelphia Inquirer, gave rise to the new term "sermo-mercial" -- along with concerns expressed by blogging Christians that the pulpit was now open for product placement.

While the Narnia example struck many as crass commercialism, however, the concept of harnessing sermons for sales was not new. The engine driving the runaway sales of The Purpose-Driven Life was the "40 Days of Purpose" campaign, in which author Rick Warren signed up 1,200 churches to devote six sermons to the content of the book, while church members read a

chapter every day for 40 days, says Stielstra, who was senior marketing director at Christian publisher Zondervan when it published the book.  

"That simple process created an army of 400,000 customer evangelists whose word-of-mouth recommendations sold 18 million copies in 18 months without a national advertising campaign," Stielstra says. His 2005 book, Pyromarketing: The Four-Step Strategy to Ignite Customer Evangelists and Keep Them for Life, describes how non-religious companies can use similar sales campaigns.

That secular-minded marketers could borrow models from The Purpose-Drive Life's evangelical-driven success comes as no surprise to historians of religion, who say American churches and businesses have long fed off one another. Some of the first organizations to use modern marketing and production techniques were 19th century lay religious corporations like the American Bible Society, according to R. Laurence Moore, author of Touchdown Jesus: The Mixing of Sacred and Secular in American History.

But the overlap between commerce and Christianity also leaves some churches vulnerable to purely commercial marketing, says Moore, director of the American Studies program at Cornell University. "When you have churches thinking along business lines, receptiveness to sales pitches is just the direction that things go." Megachurches are particularly vulnerable because they are so intent on growth. "Religious organizations actively seeking to grow and expand -- raise money, reach new members -- do things that are as much secular as religious," Moore notes. "When you have megachurches with huge auditoriums, and lots of stores and schools and gymnasiums inside, it begins to look less and less like a religious place."

Underwriting the Mission

Growth is key to megachurch success because large, enthusiastic congregations are what megachurches "sell" to potential members, according to James Twitchell, author of the forthcoming Shopping for God: How Christianity Went from In Your Heart to In Your Face.

The first thing you hear at a megachurch these days "is how many new members they have. Churches used to be politely non-competitive," says Twitchell, professor of English and advertising at the University of Florida. But since so many megachurches are now independent or quasi-independent of centralized denominations, they aggressively compete with other churches for members. Maintaining rapid growth is tough, and when churches falter, that's when corporations spot an entryway, Twitchell adds. "Advertisers can go to the heart of your mission -- in the case of megachurches, that's evangelism -- and underwrite it."

Even business guru Jim Collins, best-selling author of Good to Great and Built to Last, has an opinion on the topic. Growth for the sake of growth is potentially destructive, warns Collins, who spoke this summer to a megachurch leadership conference about his new publication applying Good to Great concepts to "social sector" organizations like churches. The key question for churches, he says, is, "Do they have the discipline to say 'no' to any resources that will drive them away from their fundamental mission?"

For some churches, using corporate sponsorships might be a great opportunity; for others it might lead them astray, Collins suggests. "It would be too broad a brush to say it's all good or bad for churches, just as it's too broad to say debt is all good or bad for companies. Churches need clarity to decide what's right for their financing." 

But why is it many feel, instinctively, that the market and the church should inhabit distinct spheres? The Constitution mandates the separation of church and state, but the relationship between church and commerce is largely unregulated.

One answer may lie in the gospels themselves, where Jesus spoke frequently about the dangers of wealth, warning that "you cannot serve both God and mammon." More dramatically, he overturned the tables of businessmen inside the Jewish temple and drove them out with a whip, saying "Make not my Father's house a house of merchandise."

To some Christian critics, the analogy could not be more direct. Isn't having Chrysler or Chevrolet vehicles parked in the foyer of a church "a little too much like putting the tables back inside the temple?" asks Skye Jethani, associate editor of Leadership, a journal for church pastors published by ChristianityToday. 

The dangers of commerce intruding -- or being invited -- into churches are "infinite" from a religious point of view, says Jethani, who is one of two pastors at an "accessibly-sized" congregation of 400 in Wheaton, Ill. "Christianity comes to be viewed, not as submission to Christ and love of your neighbor, but an identity like any other, defined by what you buy, who you vote for, what entertainment you consume. Becoming so cozy with the methodology of business completely warps the message of the New Testament."

Ad experts like Twitchell, however, predict that advertising will increasingly appear "inside the frame" of church experience. Look next for corporate sponsorship advertisements in church bulletins or on walls and windows of church buildings, he says. Yet Caldwell, head of the massive Windsor Village church in Houston, cautions that churches should be thoughtful about when to partner with corporations. "At the end of the day, we don't want the church to become a prostitute of business."

If You Were in Charge, How Would You Market These Products?

With more and more advertising vehicles crowding today's marketing environment -- including traditional print, television and radio ads, product placements, Internet buzz, viral campaigns and cell phone messaging -- marketers have new opportunities to reach vast pools of potential customers.

But the tangle of options also requires any successful marketing plan to take into account the nature of the product, its durability in the public's mind and the advertising budget needed to make it all work. As Wharton professor David Bell notes: It's very hard to find "the one big lever that can reach a whole lot of people in a way that is cost-effective."

Knowledge@Wharton asked four Wharton marketing professors -- Eric Bradlow, Jehoshua Eliashberg, David Schmittlein and Bell -- to suggest strategies for launching two hypothetical products, a summer blockbuster movie and a cell phone. While each professor had specific ideas, all agreed that the best way to spend marketing dollars wisely is to know the potential upsides and downsides of your product, and identify your target audience as precisely as possible.

Go for the Soft Launch

According to Eric Bradlow, no matter what the product, marketers should consider a preliminary soft launch in sample markets to determine what works best before investing in a full-scale campaign. "You have to measure the efficiencies of any given vehicle. Many companies run test launches because, as the number of options expands, it makes it more difficult for a company to know how to allocate its advertising dollars. Before I spend a lot of money, I would want to empirically validate what is going to work."

Bradlow suggests that the producers of a blockbuster action film do pre-launch advertising in several different ways. First, they should form co-branding deals with manufacturers of products to extend awareness of the movie beyond theater aisles. He also suggests sending clips to web sites to create early buzz about the upcoming film, as well as showing trailers in theaters screening similar films that might draw the same audience back for the coming attraction. "The pre-launch is to build the hype around the movie, but you must make sure you are targeting the right segment. If you are thinking about spending marketing dollars efficiently, you need to reach the most appropriate audience."

A new cell phone might benefit from product placements -- in which marketers pay to place their product in television and/or movie scenes as a more subtle form of advertisement, says Bradlow. Yet while product placement "can be an effective way to get high initial visibility, it can also be controversial. Producers of movies, sitcoms, and so forth are reluctant to do product placement too much because they feel it hurts the integrity of their shows. Also, it's not really known what the optimum level of product placement is." For example, the first couple of times you see Dr. Pepper in a movie, Bradlow adds, "it increases your awareness and is good for the product. But by the fiftieth time, you're probably going to like Dr. Pepper less."

Cell phone give-aways to celebrities or to consumers on a free-trial basis would also help generate word-of-mouth about the products, Bradlow says, noting, however, that many cell phones are now considered to be a commodity -- an ancillary item that comes with a wireless service plan. "To move it away from becoming a commodity, you might want to connect it to a show or a star to differentiate it" from other cell phones that technically many have the same features. 

Smash Hit or Big Bomb?According to Jehoshua Eliashberg, who studies the entertainment industry, movie-marketing strategies differ depending on whether the studio believes it has a hit on its hands, or smells a bomb. Studios now test films with small audiences in the weeks before the movie is released to gauge reactions. If the movie is not doing well, Eliashberg says the studio should advertise it on television, in print and on some outdoor billboards. "I would do it very close to the release date and I would prevent any special showings to the critics," he says.

Eliashberg points to the release of the 2003 film Gigli, starring Ben Affleck and Jennifer Lopez, as an example of a film that the studio kept away from critics as long as possible. When it was released, the movie was widely panned. That strategy, however, has its limits because audiences now know that if critics are not given early screenings, the movie is likely to be flawed, Eliashberg says.

This spring, Sony kept the widely anticipated movie The Da Vinci Code away from critics and it has met with lukewarm reviews. "It's hard for me to tell whether Sony made a deliberate decision not to let the critics see the movie because of what the reviews might say, or whether it felt the movie had generated enough controversy -- and awareness was high enough -- that there was no upside to previews, only a downside," Eliashberg notes.

With a bad movie, the strategy is for the studio to remain in control of the marketing and avoid spontaneous word-of-mouth. On the other hand, if the film is a gem, studios should go all out to promote buzz in public, says Eliashberg. "If the testing indicates I have something that is really good, then my strategy will be different. I will go with email and viral or buzz marketing. I will spend less on TV because that is the most costly media vehicle. The rationale is, if I know it will generate positive word-of-mouth, I can save the money I would spend on TV ads."

Eliashberg says the Internet is already used as a place to market movies, with viewers passing along video clips and trailers at social network sites. He points to a new viral strategy used last year to promote the thriller Lucky Number Slevin. The studio posted the first eight minutes of the film on the movie's web site. "I'm not talking about an advertising trailer in which they show different scenes. I'm talking about giving consumers an opportunity to observe the first 10 minutes or so of the movie with the rationale being that this will whet their appetite and encourage them to start sending those video clips to others and generate demand."

This sort of viral campaign is easier to conduct than a so-called buzz campaign, which requires companies to identify opinion leaders and then convince them to market a product, Eliashberg suggests. Procter & Gamble Co., for example, has a new word-of-mouth campaign called Vocalpoint, in which 600,000 mothers, labeled "connectors", were recruited to promote P&G products with coupons and free samples. 

Trying to Keep up the Buzz

According to David Schmittlein, buzz marketing campaigns can be more expensive than they might seem. "I have seen some field tests saying these campaigns can make a real difference in sales, but the challenge is to keep the costs low enough that the real and substantial pay-off isn't

overwhelmed by what you have to pay to get the buzz activity," he notes. "Even if you are just doing the usual kinds of freebie promotions to the buzz agents ... it's hard to make [the effort] pay for itself." It's not hard for marketers to encourage buzz agents to talk about the products initially, Schmittlein adds. "The challenge has been to get those people to keep talking to one another in such a way that it doesn't break the bank."

When it comes to marketing a summer action film, Schmittlein advises studios to seek out young males -- likely viewers of this type of movie. Sports programming, particularly on cable television, as well as web sites such as those produced by Sports Illustrated and ESPN, would be a place to start, he says, noting, however, that a viral campaign over the Internet might be hard to pull off. "It's difficult to think of a very good outbound e-mail to young males. There are some sites that will [send promotional email] if the [users] have already indicated an interest in movies, but that's a small fraction of young males. It's not good coverage overall."

In some countries, particularly China and Japan, advertisers could launch a cell phone campaign to interest viewers in a new movie, Schmittlein adds, pointing out that in the United States, most cell phones lack the technology to make this kind of marketing effort pay off. "The video cell phone campaigns are coming, but the amount of market penetration you can get is still limited. It's a place where advertisers want to experiment; they are seeing what works and what doesn't work. But it's hard to build around a cell phone campaign."

He says the future of cell phone marketing in the United States will depend on whether consumers want to view content on a tiny screen, and whether they will pay for new video cell phone content or be willing to view advertising that would reduce the cost.

To market a new cell phone itself, Schmittlein agrees that many of them have become commodities that depend more on the marketing efforts of wireless carriers. Spotty national wireless coverage causes problems when attempting to do television or print campaigns. To buy television time in individual markets adds about 25% to the cost of a campaign compared to a full national advertising purchase, he adds.

Hot Pink and Blue Models

According to David Bell, for a summer blockbuster film aimed at a wide audience, marketers should focus on broad-based media such as newspaper and television advertisements. By contrast, an avant-garde film likely to appeal to a smaller set of viewers would call for a more targeted campaign using the Internet or possibly cutting-edge cell phone advertising. "The nature of the audience and the content of the movie dictate what media one would use," he notes. For a movie with merchandise tie-ins, such as action figures, toys or t-shirts, Bell suggests marketers co-promote the film with fast-foot outlets or retailers with a broad reach.

Marketing a new cell phone requires strategic advertising decisions to be based on the nature of the product, says Bell. If the phone is a basic model, marketers might simply let it be handled through wireless carriers and broad marketing campaigns on television and in newspapers. If the phone is designed to be more of a fashion accessory, marketers could try to develop social

components in their campaign, such as a celebrity endorsement, Bell adds. For example, Madonna has promoted the super-slim Motorola Razr, which comes in hot pink and blue models.

Marketers with a phone that does have an edge with a new function, such as video or music capability, should focus on that, Bell advises. "The company should try something edgier. I might try to add something a little less traditional to generate some buzz around the product and promote it among particular users."

According to Bell, increasingly customized products and correspondingly complex marketing strategies can backfire if they overwhelm consumers. He points to Yellowtail, the Australian wine, as an example of a product that has been successful, mainly because, with a plain yellow label, it is simple and easy to understand. "It may not be the best wine, but for a large segment [of the market] it is very recognizable and simple. People know that if they buy it, they will be doing well enough."

The complexity that is now part of the marketing world represents a structural change and

is not likely to recede, Bell adds. "We have turned the corner and can never go back to a world of

homogenization."

Pricing and Positioning for Entrepreneurial Marketers

According to Wharton marketing professor Leonard M. Lodish, "positioning and pricing are the most important entrepreneurial marketing decisions that you can make. They are the two basic issues that are critical not only for the marketing of an entrepreneurial venture, but for the venture itself. Before you go out and raise a lot of money, before you invest in research and development, before you start spending serious money, you must find out if there is a demand for your product and whether or not you can price it so you can make money."

Lodish, who led a session on Pricing and Positioning for Entrepreneurial Marketers during the recent Wharton Marketing Conference, provided definitions, statistics and business case studies to illustrate his message. Using a wide range of companies, he pointed out that his positioning and pricing touchstones hold true for a major telecommunications company launching an international satellite-based cellular telephone (which failed when customers balked at the high minute-to-minute price) on down to a small bow tie Internet business operating out of Maine (a success story to which Lodish, wearing his signature silk bow tie, can personally attest).

"As an entrepreneur, can you develop a company that is going to have a long-term, sustainable, competitive, strategic advantage?" asked Lodish, who is a pioneer of Wharton's entrepreneurial marketing course, vice dean of Wharton West and leader of Wharton's Global Consulting Practicum. "That's the basic question that any business has to answer ... Positioning and pricing - it is all interrelated and intertwined to the success of your business."

First, positioning. "What am I selling to whom?" Lodish asked. "What should be the perceived value of my offering compared to the competition? Who is going to buy this? Where is my target? You have to integrate your positioning and your segmentation with a distinctive competence.  What is going to make me successful over the long-term? What is distinctive about me that will be hard for my competitors to reproduce?"

Lodish pointed out that the customer will ultimately be the judge of the entrepreneur's efforts. "Sustainable value vs. the competition comes from distinctive competence - if and only if the customer perceives it," said Lodish. And how does that happen? Through any number of ways related to a product - ranging from technology, design, perceived high quality and exceptional customer service to reliability and reputation. "You have to make sure that you have something along these lines," said Lodish.

Once value is established, "the real key is finding people who will pay more for that value, and then reaching them ... How big is the segment? If you have limited resources, you can't afford to go all over. You need to go where people will value what you are offering, compared to the competition."

In positioning a product, Lodish suggested that entrepreneurs follow several key principles:

·         Give someone a reason to buy your offering over the competition. "Ask yourself, 'Why should a member of the target segment buy my product or service vs. the competition's?'"

·         What are the unique differentiating characteristics of my product or service (the incremental value vs. the competitors) as perceived by members of the target segments?

·         Remember that humans cannot make decisions balancing more than two to four differentiating attributes at a time. "If there are six or seven of them, they will get lost," said Lodish. "If one thing really fills the value needs of customers, stick to that one. You will have an easy communications method, and you will be able to name your product offering based on that attribute."

·         Features vs. benefits. "This is Marketing 101. People buy benefits, perceived value. They don't buy features. Unless you can show how the feature relates to a benefit, it doesn't do you any good. And it's amazing how many big companies make that mistake."

·         Never underestimate the value of a good name and a good slogan. "Many people don't understand this," said Lodish. "If your name says why you are different and why you are different from your competitors, you've got yourself a good name." Some slogan ground rules? Be consistent; avoid clichés; take a stand; if you use numbers, back them up; be brief; have your slogan reflect your positioning or vision statement; and above all, make it your own.

Next, pricing. "Pricing is completely dependent on the rest of your marketing mix, especially positioning," said Lodish. "For those of you who already have businesses going, the big symptoms of pricing-marketing mix problems is what people always say is the 'commoditization' of their industry: That all customers what to know is what the price is; that customers begin to

unbundle your services and perceive your product as 'just another bid'; that salespeople have to battle constant price objections. If that's true, you have a problem. Because you are not going to make the kind of money you want to make from that industry unless you get to the point where you are perceived as valuable enough - compared to your competitors - so that you can charge some kind of a premium."

That is why, Lodish continued, "I recommend premium pricing. Premium pricing means continually improved perceived value to customers vs. the competition. How do customers get perceived value? From everything they see about your company," which includes reputation, trust, design, brochures, sales force, web site, interactions with products, other customer's recommendations, packaging, and yes, pricing. "If you price too low, you ruin the product right off the bat," said Lodish, because consumers won't believe the product is credible.

Lodish nodded his head as an audience member shared a perfect illustration for the value of premium pricing. "We started a company selling built-in vacuum systems initially priced at $500. People just loved it, but no one was buying it. We started asking questions, and everyone said, 'It can't be that low.' We doubled the price to $1,000 and sales skyrocketed. It turned out that the consumer was right. The perception was that at $500 we couldn't be delivering a quality product."

Most entrepreneurs price too low, Lodish agreed. And when that happens, it's difficult to increase prices. "Special pricing to get first users is okay, but perception is all important. You must specify a regular price and structure 'charter discounts' or 'introductory discounts' early. Let them know what the regular price is immediately, because it's easier to roll it out after that. People think it's unethical, immoral to raise prices and they really get upset. The only way you can increase prices is to talk about the fact that your costs have gone up and you have to recover them. People may say, 'Wow, that's an expensive product;' but they won't say, 'He's a bad person; that's a bad company.'" 

Setting the right price, however, isn't always easy, Lodish admitted. Entrepreneurs should recognize that perceived value determines demand curves, "which is standard micro economics," Lodish noted, pointing out that more than half of a recent survey of Inc. 500 companies used 'value-in-use' pricing as opposed to only 20% of non-Inc. 500 companies. "That tells you that one of the ingredients of successful companies in pricing is based on perceived value, which is typically going to be a premium price as opposed to a cost price."

One way to determine value-in-use pricing is to conduct market price testing. Simply stated, "You can go to different markets and try different prices. On the Internet, you can do it quite easily." Or, Lodish recommended, entrepreneurs can use concept testing.

Concept testing is defined as a research technique where one determines whether the potential user understands the idea of the proposed product, reacts favorably to it and feels that it answers a need. The primary purpose of concept testing is to estimate consumer reactions to a proposed idea before committing substantial funds to it. "The most important question you ask in concept testing is intent to purchase," said Lodish. "Would you buy this product? That's a very important question to ask. With a little bit of money, you can get a rough idea if someone is going to buy

your product, and you can get a rough idea of the demand for it. If you want to talk to 50 people, you can get enough data to go to the next step in launching your company."

According to Lodish, concept testing is:

·         Used to identify product failures without prematurely killing off promising new product ideas

·         Used to separate good ideas from bad ideas before significant resources have been committed to development

·         Especially useful for durables and B2B products

·         Used to generate rough (but very valuable) price-volume demand curves for new products

·         Relatively simple to carry out at a relatively low cost, and is extremely flexible to meet the needs of the entrepreneur.

Additional questions revolve around what Lodish calls the DEB factor: Desirability (to what extent is the concept desirable?), Exclusiveness (is it really perceived as exclusive?) and Believability (are the product claims credible?). The one question entrepreneurs should never ask, according to Lodish, is 'What's the most you would pay for it?' "Because then people will know that you are negotiating with them, and you will get biased answers. If price is considered, show only one price to each respondent. If you have four alternative prices to consider, you have every fourth concept price in the questions. But remember, you show only one price at any given time."

Data for concept testing is typically collected in any number of ways: through personal interviews at home, at work, or in centralized locations like a mall; over the telephone or Internet; or by mail or consumer panels. The most useful method of concept testing for pricing is "monadic testing," where a given respondent is exposed to only one concept and then gives a direct response, such as, 'I really like that,' 'I'd buy that' or 'I'd never buy that.'

"Another important thing to realize is that you can't take the numbers and then just run away with them," cautioned Lodish, explaining how to interpret the results of concept testing. "Purchase intent assumes a lot. And you must factor down the fraction of people who say they will buy it with the fact that not everyone is going to know about it, not everyone will be able to find it, and not everyone will buy it even if they say they will, which is what I call the 'being nice' variable. Be careful. It's not easy."

Lodish cautioned that there are limitations to concept testing. High on the list is the fact that concept testing "does not always predict market success." But it "is a lot better than nothing, and is typically a bargain, easily worth the time and expense in terms of its impact on the success of an entrepreneurial venture," said Lodish. "And the general consensus is that concepts tests are stunningly accurate, with a trial rate predicted within a 20% range, 80% of the time."

In closing, Lodish circled back to his opening statements. "Pricing and positioning are the

most critical marketing decisions for entrepreneurial ventures." The techniques, methods and

concepts discussed during the session "should help you make these decisions more profitably."

The Big Bang Theory of Advertising

AFLAC – an acronym for American Family Life Assurance Company – was an international insurance company with very low-name recognition until a duck began quacking its name on TV. 

In a new book entitled, Bang! Getting Your Message Heard in a Noisy World, Linda Kaplan Thaler, CEO of the six-year-old New York advertising agency Kaplan Thaler Group, contends that only ideas that are "simply too outrageous, too different, too polarizing to go unnoticed" will break through the "sea of sameness out there."

Like, say, a spokesduck.

Bang! is a book of advice on how to spur imaginative thinking and successfully carry out a creative idea after it arrives. The advice is interwoven with quotes from authors of books on creativity and related subjects, and, more entertainingly, with the stories of dozens of advertising campaigns.

The book's cover lists the authors as Thaler and Robin Koval, chief marketing officer of KTG, "with" writer Delia Marshall, but the advice and the stories are told in the first person as if by Thaler alone.

It was Thaler who, in 1999, received a voice mail message that led to what has become her agency's best-known ad campaign. "AFLAC? Never heard of it," she recalls thinking. "Probably some itty-bitty local company needing help with a print ad or something."

Didn't sound interesting, but it is Kaplan Thaler Group policy (which Thaler recommends) to always politely call back. It turned out that AFLAC is a successful Fortune 500 company specializing in supplementary insurance to fill gaps in health insurance such as loss of earnings in cases of catastrophic illness or injury. Its agents deal mainly with employers who offer the insurance as a benefit. And although the company had spent $100 million on advertising in previous years, says Thaler, "no one had ever heard of them."

KTG took the account on even though, she says, "aside from renaming the company ‘Tide’, we didn't have a clue how to make AFLAC a household name." But they brainstormed ideas. They came up with sentimental commercials, with possible celebrity endorsements, with "all sorts of stuff."  But none was what Thaler calls a "Big Bang."

Love a DuckThen, at lunchtime, creative team member Eric David went outside and began walking around the block saying "AFLAC" over and over in his head. Finally, he said it aloud …and realized he sounded like a duck.

That led "five minutes later" to an ad in which two men sit on a park bench throwing bread crumbs toward some nearby ducks. One man says how glad he was to have had supplemental insurance when he got hurt and missed work. The other asks: “supplemental insurance? What's that?" One of the ducks replies, "AFLAC." As the men continue to talk about the insurance but fail to come up with the name of the company, the duck keeps trying to help but is ignored. Finally, the duck is so frustrated, it kicks a bread crumb back toward the bench.

Not everybody at the agency saw this duck as a winner. Were they really going to suggest this ad to a company that sells cancer insurance? They were. They did. And, according to Thaler, AFLAC sales have risen 55% since the duck ads began. 

It was risky to inject humor into ads for a company with such a serious product. But Thaler insists that you have to take risks if you want to produce a big bang. "Big Bang ideas are "intentionally polarizing," she writes. "If you have an idea that no one hates, everyone will forget it. She points out that no one dislikes vanilla ice cream, but they don't get excited about it either.

Thaler was working for Wells, Rich, Greene in 1994 when she was asked to create a campaign for Clairol's Herbal Essence shampoo, a brand that Clairol was considering pulling from the shelves. Thaler says she knew the usual photos of models with gorgeous hair wouldn't help.  

The account planner suggested maybe there was a reason to use shampoo other than getting one's hair clean. That led to asking women at the agency how they felt about shampooing. Some said it was boring. But some said they found that massaging their scalp under a hot shower was a revitalizing and sensual experience. That led to scripts of women diving into waterfalls and women dancing in the shower but no big bang.

The big bang came, says Thaler, when she and two staffers met to moan over their lack of success. They talked about maybe bringing in a celebrity like actress Meg Ryan. They recalled the famous scene in the movie When Harry Met Sally in which Meg Ryan feigns an orgasm in a coffee shop. The upshot was a commercial featuring a woman in a shower reaching an ecstatic climax from shampooing. A couple is seen watching this on their TV set and the woman says: "I want the shampoo she's using."

Many people thought the commercial was in outrageously bad taste. But Herbal Essence sales soared, says Thaler.      

Being willing to be outrageous is just one bit of Thaler advice.

She also advises having work done in a crowded office. She contends that people are more creative when they work in such close contact because they are constantly communicating.

"Only when you get to the point where you can't answer the phone without knocking someone's coffee on the floor" should you consider moving to larger quarters, she says. 

According to Thaler, the best ideas come when a deadline is fast approaching. (The AFLAC idea arrived as panic time approached). And so she suggests creating artificial deadlines if the real ones are far away. She says she is famous for saying: "We've got nothing. It's terrible," just to get people thinking in last-minute mode.

Thaler is a big booster of brain-storming with others, holding nothing back. "Great ideas come out of boring ones,” she says, noting that one person's bad idea can jump start another's big bang.

Chaos Theory

But although Thaler favors "chaos" as a stimulator of ideas, she makes it clear that KTG is anything but chaotic when it comes to carrying out an ad campaign. A big bang is just the beginning, she says. "It has to be followed by unwavering attention to detail." For example, two different actors quack for the duck in the AFLAC ads – one when the duck is calm, the other when the duck is annoyed.

She notes that to sell an idea, it's important to thoroughly research the client. She recounts an instance in which a KTG staffer recommended replacing the current "pleasant but innocuous" design of the client's milk carton with a new design featuring cows. "Bad mooove," Thaler admits. It turned out the insulted client had designed that milk carton himself.

Client presentations have to be entertaining, she adds. There can be no dead time. She describes KTG dress rehearsals of presentations as "so exhausting they would make Actors Equity go on strike." The presenter, she says, must be the one most able to think on his or her feet. "Forget fair," she advises. "No matter who came up with the work, no matter who is the most senior, the best actor gets to present."

Thaler's advice isn't scientific. She lauds MasterCard's marketing chief for heeding his "intuition" to stick with the MasterCard "Priceless" campaign even though it didn't test well for viewer response when first aired, but she provides no hard evidence to prove that heeding one's intuition leads more often to success than failure.

What Thaler (with the help of her co-authors) offers in Bang! can be read as a book of advice on "getting your message heard" or enjoyed just for its wealth of anecdotes about ad campaigns. It can also be read as a book-length advertisement for Kaplan Thaler Group. Thaler is generous in citing great ad campaigns created by other agencies, but she is mainly focused on KTG's accomplishments – and her own (she sings, she dances, she writes songs, she wins awards). But any way you read Bang!, you will find that, just like many of the ads described in the book, the message is delivered with a sprightly  sense of humor.    

Choosing the Wrong Pricing Strategy Can Be a Costly Mistake

Prices have been at the center of human interaction ever since traders in ancient Mesopotamia -- our modern-day Iraq -- began keeping records. Who doesn’t love to guess what something costs – or argue about what something ought to cost?

So it should come as no surprise that companies spend a lot of time figuring out how to price their products and services. But two professors in Wharton’s marketing department, Jagmohan S. Raju and Z. John Zhang, say firms do not always go about pricing the right way. Raju and Zhang say devising appropriate pricing strategies is more critical than ever in a world of hyper-competition. Pricing strategies also take on added importance at a time when central bankers and economists are concerned about the possibility of deflation – a broad, general decline in prices.

According to Raju and Zhang, research suggests that pricing strategies can have a huge influence on company profits. They cite a study of more than 2,400 companies by McKinsey in 1992 showing the impact that various decisions would have on the bottom line: a 1% reduction in fixed costs improves profitability by 2.3%; a 1% increase in volume will result in a 3.3% increase in profit; a 1% reduction in variable costs will prompt a 7.8% rise in profit; but a 1% hike in pricing can boost profitability by 11%.

“In recent years, business people have paid attention to many things that can influence their companies’ success,” Zhang says. “They’ve looked at organizational behavior, downsizing, benchmarking and reengineering, and companies have done a lot to cut costs. But they haven’t spent as much time thinking about the best possible pricing strategies. I think the picture painted by McKinsey is still pretty much true today. There’s a lot of room for profit improvement through better pricing strategies.”

In the past, Zhang says, many companies “would set a price, stick to it and hope for the best. But that isn’t the best way to set prices. One reason companies took that approach is because pricing is difficult. You have to know what you’re doing and you have to take direct responsibility for your decisions. A lot of managers want to have a say in their companies’ pricing strategies but they don’t want to take the responsibility if things go wrong.”

Raju stresses that pricing must be systematic and strategic: A seat-of-the-pants attitude can hurt the bottom line. “One of the misconceptions about pricing is that it’s a decision that can be made after everything else has been done to develop a product,” says Raju. “But, actually, pricing needs to be an integral part of the plan for taking a product to market from the very beginning. It cannot be an ad hoc approach.”

Among other things, companies must carefully identify the customers they are targeting and understand how much those customers are willing to pay for a product or service. Firms also must recognize that pricing is a key tool to differentiate a product or service from those of the

competition, since prices emit signals about product quality and exclusivity. In addition, it is important to take into account the distributors who will bring the product to market; if they themselves do not make enough profit, sales will suffer. What’s more, firms must realize that a pricing strategy should be long-term in nature, in that it should pave the way to take more products to market in the future.

“When you consider pricing decisions, your overall goal is to look ahead to stay a step ahead of the competition,” says Raju. “You have to lay out the scenarios: If I do this, the competition will react a certain way. If the competition doesn’t react that way, then you have to have another plan ready. You cannot afford to fall behind your competition.”

Pricing can be thought of in any number of ways. One approach is a simple “cost-plus” strategy: You figure out what it costs to produce an item and tack on a nice profit margin. Another approach is to conduct research to determine what customers are willing to pay for your product ($200 for a tiny bottle of perfume, for example) and set the price accordingly. Another method is competition-based pricing, whereby a company figures out what its competitors are charging, then adjusts its prices up or down.

“All of these approaches make some sense, but none alone is sufficient,” says Zhang. “With pricing strategies, the whole really is greater than the sum of its parts.”

A classic example of how developing the right pricing strategy can spell the difference between profit mediocrity and profit stardom occurred at Ford Motor in the 1990s.

For years, Ford, like other auto makers, tried to hold prices as low as possible on entry-level cars, such as Escorts. Low prices represented an attempt to attract young buyers, with the hope that as they grew older and needed bigger vehicles they would remain loyal to the brand and trade up. The problem was that, while Ford sold a lot of inexpensive cars, their profit margins on these models were ho-hum or nonexistent. To earn profits, Ford relied on the higher margins on bigger cars, like the Explorer or Crown Victoria. But because the prices on the larger cars were relatively high, Ford sold fewer of them than it would have liked to.

In 1995, Zhang says, Ford made an important decision. It lowered the prices of its high-end vehicles a little bit – enough to stimulate demand but not enough to cut too deeply into its margins. This adjustment was one of the key reasons that Ford earned $7.2 billion in 1999 – the most annual profit ever for any auto marker.

What is noteworthy is that from 1995 to 1999, Ford’s U.S. market share fell from 25.7% to 23.8%, according to BusinessWeek. But the decline did not spell disaster. Although Ford sold 420,000 fewer low-margin cars because of its new pricing strategy, it boosted sales of high-margin vehicles by 600,000. “Ford cannibalized its low-end cars a bit, but it was worth it,” Zhang notes.

Pharmaceutical companies are also learning to do a smart job of pricing when they face intense competition from generics, according to Zhang. They do not always respond by matching

generic prices. Instead, they try to out-smart generics through branding. Spending money to market brand-name supremacy has worked for some drug companies for decades.

“If you have been using Bayer aspirin for a long time and it works every time for you, there’s no reason for you to change, even though the brand-name version of aspirin costs much more than a private-label product,” says Zhang. “The risk of switching from brand-name aspirin to a generic may be zero. But try to tell that to those satisfied customers. Good luck!”

Zhang offers another example of effective pricing strategies – companies that offer cellular telephone service. Their pricing plans are quite sophisticated, so much so that few customers can make sense of them. “That is done for many good reasons. Certainly it does not hurt that the consumer cannot compare rates as a result,” he explains.

Zhang says the cell phone calling business would be in danger of becoming a commodity business in a hurry, just like regular long-distance calls, if cellular companies were to take a knee jerk approach with their pricing strategies. “A sophisticated and well-thought-out pricing structure can help to prevent the industry from being commoditized.”

Raju and Zhang, who teach a new Wharton Executive Education course titled “Pricing Strategies: Measuring, Capturing and Retaining Value,” say that a deflationary environment – of the kind economists fear may occur in the months ahead – would be difficult for true commodity industries, such as oil and grains, as well as companies whose products tend to be seen by consumers as commodities.

 

Regardless of the economic environment at any given moment, a firm’s pricing strategy should always be comprehensive. “You have to analyze the pricing environment in which you are operating, determine how much pricing discretion you have and determine the value your product or services has for customers,” says Zhang. “Then you can develop a pricing structure that will be ideally suited to the marketplace to enable you to capture as much value as possible. The point is that even in a deflationary environment, your firm does not necessarily have to lower its prices. Even if you do have to, [that does not] necessarily mean lowering your prices for all of your products in all of your markets to all of your customers for every one of their transactions. To identify your pricing opportunities and to make confident pricing decisions, you have to learn the pricing basics in a systematic way.”