The Business Side

From learning from our failures to building better financial systems, the reach and real-world impact of Tuck faculty research is profound—and it resonates far beyond the classroom.

Kusum Ailawadi and Scott Neslin: The Power of Promotions

the idea

Few things are as reliably constant as the marketing of toothpaste and laundry detergent—and that’s just how the packaged-goods industry likes it. “The packaged-goods industry is a very stable and mature industry,” says Kusum Ailawadi, Charles Jordan 1911, TU’12 Professor of Marketing. “Not much happens to shake things up in a big way.” Problem is, when nothing changes, it can be hard to figure what works and what doesn’t. That’s why Ailawadi and her Tuck colleague, Scott Neslin, Albert Wesley Frey Professor of Marketing, along with Professor Don Lehmann of Columbia University, were excited to learn in the early 1990s that Procter & Gamble intended to shift its marketing policy from frequent price promotions to an everyday low-value price and heavier advertising spending to support its brands. It was a move that flew in the face of current trends. “In the decade before that, promotions had steadily grown their share of firms’ total marketing budgets at the expense of media advertising,” says Ailawadi. “And the business press was full of how bad this was for brand manufacturers.” P&G’s reasoning was that frequent promotions were eroding consumer loyalty to its brands. In place of “high-low” promotions, it proposed a “value-pricing” strategy that would keep its prices consistent at reasonable levels, and it aimed to foster brand loyalty by increasing advertising beyond its already high levels. Ailawadi and Neslin were not convinced. The evidence to date had shown that advertising has a positive but small effect on brand loyalty, whereas the jury was still out on the extent to which promotions hurt loyalty. Here was an unprecedented opportunity to get to the bottom of it: Not only did Ailawadi and her colleagues have in P&G a market leader whose changes in advertising and promotion would not go unnoticed by competitors, retailers, or consumers, but the changes would be dramatic enough for them to reliably quantify the impact of the tools in P&G’s marketing mix.

the results

For the study, Ailawadi and Neslin put together a comprehensive dataset from multiple sources. A particularly important source was the Marketing Fact Book, an exhaustive listing of prices, promotions, coupons, and market share of all major brands in the packaged-goods industry. They compiled six years of data on 24 different categories of products—everything from diapers to detergents—for both P&G and its competitors. Their first surprise was that despite P&G’s claims of value pricing, net prices paid by consumers actually went up 20 percent as a result of the cuts to promotions. Secondly, as they suspected, increased advertising had little effect on brand loyalty, while the cuts to promotions and coupons were devastating to the company’s market share. “The negative impact of cutting promotions and coupons was three to four times bigger than the positive impact of increasing advertising. Promotions really help customer acquisition—that was not surprising to us. What was surprising was how little they hurt customer retention.” When the researchers estimated complete models, simultaneously accounting for the impact of all these changes and for competitors’ reactions, they found that the net price increase had the biggest effect—equivalent to a 5.4-percent drop in market share for every 10-percent increase in price. A 10-percent decrease in promotions decreased market share by 1.7 percent, while advertising barely budged market share. Magnifying thenegative impact of the company’s own actions, P&G’s competitors actually increased their promotions during the same period, grabbing even more market share from the company. The net impact for P&G was a 17-percent loss in market share over a five-year period, which translates to an average of five percentage points of share. While there’s no way to tell the effect on P&G’s profits, which may have actually increased temporarily due to its increased prices, clearly the value-pricing strategy was a revenue-killer in the medium and long term. “When you lose five percentage points of share in the intensely competitive packaged-goods market, that is going to come back and bite you in terms of retail support, competitor reaction, and shelf presence in the store and therefore create a downward spiral, even if you succeeded in cutting your costs in the short term,” says Ailawadi.

the impact

By the time Ailawadi, Lehmann, and Neslin’s paper came out in 2001, P&G saw the writing on the wall and abandoned its strategy, without ever publicly labeling it a failure. Of course, it’s impossible to say what effect the research had in that decision. “We know folks from P&G were exposed to the paper,” says Ailawadi. “Certainly their subsequent actions were consistent with what our paper advises, but it would be overreaching to claim that they did so because of our paper.” P&G claimed the strategy was meant to reduce costs and had nothing to do with market share, which Ailawadi finds suspect. Even so, she gives them a lot of credit for trying something different. They changed the conversation from “promotions are a cost of doing business” to “let’s evaluate the ROI of promotions and learn how to use them more efficiently,” Ailawadi adds. “They are an innovative company, and I admire them for this. Not all companies would have the courage to experiment with something like this and, more importantly, not all companies would learn from their experiment and correct course fast.” More broadly, after the paper was published, it spurred a body of research that showed the power of promotions and countered the bad rap that promotions typically get in the business press. The researchers gave presentations at the invitation of companies like Colgate-Palmolive and in executive programs to detail their findings. And for Ailawadi at least, it highlighted the importance of conducting research on events in the real world; she has recently researched the effect that Walmart has on competing stores when it moves into a community. And she is currently studying how families change their food-purchase behavior when there is a major change in the health or economic status of the household. “This paper really highlighted for me how valuable it is to study natural experiments as they unfold in the field,” she says. “It’s a great opportunity to study how competitors, consumers, and other stakeholders respond.”

Rafael La Porta: A Common Language

the idea

Given the diversity of culture among all of the countries of the world, one might assume that their regulatory styles are equally diverse. However, economists have found that countries fit ostensibly into just a few boxes when it comes to their regulatory styles, says Noble Foundation Professor of Finance Rafael La Porta. “You look at the bankruptcy law of Mexico, then that of Peru and Argentina, and it becomes quite clear that the honor code does not apply to legislators when it comes to writing laws; these laws are very often word-by-word copies from a common  source,” he says. In fact, the vast majority of countries fit into one of two traditions: English common law and French or German civil law, depending on which country colonized or conquered them. (Even China falls into the latter category with its financial laws; exceptions include the Scandinavian countries and isolated communist countries such as Cuba and North Korea). “What this work showed was there were two basic regulatory styles, one that is associated with common-law countries that seeks to support unconditioned private contracting and another associated with civil law that supports socially-conditioned private contracting; one approach embraces market outcomes, the other distrusts market forces and seeks to direct them toward achieving social goals.”

the results

La Porta put theory into practice by first painstakingly collecting an immense database of laws and regulations from a large number of countries, and then using them to sort countries into groups by legal origin. Next he and his co-researchers, Florencio Lopez-de-Silanes of the EDHEC Graduate School of Management in France and Andrei Shleifer of Harvard University, cross-referenced a variety of data ranging from the legal protection of shareholders, creditors, and workers to the time it takes to start a new business or adjudicate a simple commercial dispute. What they found was striking: compared with those following French civil law, common-law countries provided better protection for investors, less government ownership and regulation, and more independent judiciaries. Many of these indicators of government ownership and regulation are associated with adverse impacts on markets, such as greater corruption, larger unofficial economy, and higher unemployment. While La Porta stresses that his research does not declare one system better than another, it does provide a framework to analyze a country by the content of its laws and regulations. “What we would say is that [common law] is better for capitalist development, but there are many ways of development.  For example, countries may rely on government-owned banks rather than stock markets. But if you want to have big stock markets, you need to protect shareholders, and this is what you need to achieve that.  At the end of the day, France and the United States have very different regulatory styles but similar levels of income and one needs to be open to the idea that that there are many ways of accomplishing a goal.”

the impact

Shortly after their paper was published in 2008, the World Bank adopted many of their measures in assessing the business environment in countries around the world in their annual “Doing Business” report. The institution catalogued 216 reforms across the world between June 2009 and May 2010 that have made it easier to open new businesses, fire workers, or file for bankruptcy. “Naturally, we don’t want to take credit for the fact that reforms took place since some of them might have taken place anyway,” says La Porta. “The point is that by turning institutions into measurable objects, one can keep track of their evolution over time and study the impact of different interventions.” By analyzing those measures, La Porta’s research has allowed countries for the first time to systematically choose reforms that will have the greatest potential in reforming their markets. “Multinational lenders can say to a country, for example, ‘we would like you to work on reducing the amount of time that it takes to adjudicate a commercial dispute.’ That seems better than saying, ‘we’d like you to improve property rights since policymakers don’t really know what levers to pull to improve property rights.’” At the same time, if a country has good reasons for its laws, it can justify them to investors. “The country can say, ‘we take 500 days to adjudicate a simple commercial case because we do it very well,’ or ‘it takes two years to open a restaurant in our country because we screen applications very well.  To the extent that those statements are testable, we have made a little progress.” Over time, the approach has given countries a common language with which to speak about economic institutions—no matter what language they might speak at home.

Sydney Finkelstein: Success Through Failure

the idea

Bookshelves are lined with biographies of companies and executives who made it big, implying that if you do what they do, you will make it too. “When you look at the business section at Barnes & Noble or Amazon, what you discover is a really tremendous collection of books by former CEOs talking about how great they are,” laughs Sydney Finkelstein, Steven Roth Professor of Management. “Then you see a group of books from consultants who make broad generalizations based on their clients. The third thing you see is books about success and ‘if you follow these five principles you will be successful.’” One day, while browsing through those titles, it struck Finkelstein that something was missing. “What happened to all of the companies that did the same things those writers did but ended up falling apart?” After all, he thought, there’s the old saw that we learn more from our failures than we do from our successes. What lessons might we learn from those who made mistakes in the business world? With that, the idea for Finkelstein’s 2003 book, Why Smart Executives Fail and What You Can Learn From Their Mistakes, was born.

the process

Without a broad cross-section of literature to draw from, Finkelstein knew he’d need to conduct his own research into the topic. So he embarked on a six-year study that grew into the most comprehensive examination of failure in business ever done, encompassing 200 interviews with executives at all levels of failed companies and accompanied by a rich set of data that supported their opinions. To surmount the difficult hurdle of getting people to talk about their mistakes, Finkelstein started close to home, contacting 20 Tuck graduates who were associated with failed companies at some point in their careers. “All 20 of them responded, which tells you something about the loyalty of Tuck alums, not only in helping people find jobs but also in helping professors do their research.” As he honed his interview technique and learned which questions to ask, clear patterns emerged in the case studies of the various companies’ missteps. As the title implies, Finkelstein discards the idea that these executives simply weren’t smart. “It couldn’t be further from the truth,” he says. “The people running these organizations were superstars. They were very, very successful, but they were all vulnerable to the same breakdowns.” For his book, Finkelstein placed the cases into broad categories, including breakdowns in strategy, culture, and organization. One of the key themes that emerged from the case studies is a remarkable absence of open-mindedness. “It’s not that you can’t change, it’s that you choose not to,” says Finkelstein. “You are not facing up to what is going on around you. That is really the killer.”

the impact

Within weeks of the book’s publication, Finkelstein had garnered positive reviews in The Wall Street Journal, the Financial Times, and The Times (London), which he attributes to the originality of the work. “No one had done this kind of study before,” Finkelstein recalls. “It appealed to people on a very intuitive level and was a real eye-opener to a lot of CEOs and senior executives.” While he’s received letters from everyone from Bill Gates to Donald Rumsfeld (who joked he had nothing to learn from it), one of his favorites is from a woman on a church volunteer committee, who said that everything he had written applied perfectly to her organization. Another highlight was a recent Washington Post column in which the writer commented that in the midst of a report analyzing the failure of Fannie Mae, he felt he’d read it before—yup, it was in Finkelstein’s book. Since the initial waves of publicity, Finkelstein has consulted for Fortune 500 companies and taught Tuck Executive Education classes to hundreds of business leaders, implementing some of the corrective practices he prescribes in his book, like enshrining a “mistake of the quarter” in company culture. Ultimately, he sees the influence of his research as a natural extension of teaching at Tuck. “Like all my colleagues, I’m in the business of creation and dissemination of knowledge,” says Finkelstein, who teaches the core Analysis for General Managers course and the Top Management Teams elective in the MBA program. “Tuck often talks about ‘thought leadership,’ and that is really a label you can put both on this creation of original knowledge and its dissemination to people around the world. The most important thing for me is to see how it can have an impact on people. There’s nothing better than that.”