Revised but not Rejuvenated

The GDP numbers for 08Q1 was revised to show a 0.8% growth instead of the 0.6% growth. But the growth components still do not show healthy growth. We are not in a recession by the NBER definition, but the higher expectation among consumers for a faster price increase and the anemic growth point to a worser condition, stagflation.

Budget Hero

Budget Hero is a Flash based interactive game from American Public Media (the MarketPlace people).

The game lets you play with the multiple levers the Federal Government has and see how the national debt performs. Are you for big Government? big defense spending? tax cuts?

Play the game and see.

I left all the Bush tax cuts alone and played the cards like Cap and Limit Greenhouse gases and increase Federal gasoline tax (yes the 18 cent tax that McCain and Hillary wanted waived). But it is hard to see the macroeconomic impact from the results. Here is mine.

Economics or Emotions

Professor Robert Shiller of Yale, wrote for The New York Times on the human side of foreclosures and supporting Rep. Barney Frank's plan. He argues:

It’s easy to take a stern view of this spectacle.
...
This stern view may, in fact, be winning the battle of public opinion.
...
But instead of having sympathy for these homeowners, many people blame them for their predicaments. That isn’t surprising. It’s an example of a general tendency that was documented by social psychologists decades ago.

To put things in perspective:

1. Homeownership rate is about 68% (i.e, 68% of the housing units are occupied by owners). The rest that are occupied by renters who chose not to buy, because they understand the responsibilities that come with a mortgage one can't afford and because some can never afford a house.
   
2. Is there another higher purpose for the $300 billion proposed package to help homeowners? There are 43 million people without medical insurance in America. Can we achieve a much better impact and improve the lives of a vast number of people if we employ the funds to insure the uninsured?
   
3. Shiller paints a picture of 243,353 families losing their homes, moving to other side of town. Compared to the number of renters who move continuously and are always at the mercy of the owners this is still a small number.
4. Shiller described the economical view as "stern" and referred to studies that found people attributing predicaments to one' behavior. Then how would you reconcile the enormous amounts of contributions from the public after man-made and natural disasters? Americans gave $295.2 billion to charity in 2006. Is that not helping people in predicament?
5. From Kant's Universality principle, would a similar legislation be enacted to help everyone who gets into trouble with finances? Many of the uninsured families are just one medical disaster away from bankruptcy. Should they not be helped?
   

I tend to lean on the economic side. I am however confused about what is the minimum responsibility the society has. As Kant would ask, "What moral minimum or basic human rights am I duty bound to honor?"

Conflicting Interests - Environmentalists Oppose Clean Air Plan

There was an interesting story on multi-party negotiations in the WSJ, "Environmentalists Oppose Clean Air Plan". It is not that they are against clean air but object to a plan that disallowed big trucking companies and instead encouraged owner-operators. On the surface it would look like the environmentalists support the big trucking companies, but it is only because the workers of these companies are the members of the union that supports the environmentalists. The union is against the plan as well and favored the trucking companies.

The Mayor of the City, Villaraigosa, is for the trucking companies as well. He couches his argument with environmental concerns by saying, "Right now, the burden to clean up and retrofit the trucks is on an independent contractor who makes $11 an hour and has no benefits. They are never going to have the resources to do that."

Only the Port Officials seem to support the poor independent truck operators. That is again not out of the concern for them but from the fear that the union will end up unionizing the port workers.

Do environmentalists care more about the environment or union jobs? Why do the unions support the cause of environmentalists? Why do unions sometime side with management? Does the mayor of a city care about protecting jobs or the environment?

The answer is, it is a package. An individual issue matters only to the extent it adds to the total value of the package. If winning one issue would add more to the package than losing or compromising on another, the parties would do just that. Sometimes the issues are hidden and long term than what is currently at play. For example, the environmentalists want the union support in all their battles, port officials are afraid of unionization, etc.

This is a text book case of multi-party negotiations. Everyone is trying to maximizing their share of the pie and have more riding on this negotiation that it meets the eye. They all will be willing to trade one for the other as long their share keeps increasing.

Will the Oil Shock Lead to Unbundled Services?

When I was visiting Sweden I found it shocking that they charged me 4 Kroner for a 8oz glass of tap water. As I traveled a bit more in Europe I found this common practice of restaurants charging extra for things that in US we take for granted. Sitting at a table has a surcharge, bread has a surcharge, water too. I compare this to a sign that I saw outside a Hot Dog stand near UC Berkeley, "All toppings always free", this captures the characteristic of US restaurants.

These are not really free, restaurants here use bundled pricing. The problem with this bundling is some of the added items are valued below cost by the customers and hence the restaurants do not reap the advantages of bundling.

Now in US, as the food and fuel prices keep increasing, restaurants are finding it hard to keep their margins. All these free toppings and additions that are "always free" add to the cost with no relief through higher pricing. Until now they have not passed on much of the supplies cost increases to their customers in the form of higher prices. It is not that it is difficult to keep changing prices (economists call this the menu costs).

Restaurant owners are wary of customer reaction and competitor moves. There may also be lingering doubts on whether we are experiencing a temporary price shock or the higher prices are here to stay. If the businesses and the public are convinced that is is the latter, then the cost increases will flow into prices.

However, an acceptance of increased prices does not mean the demand will stay the same. There are substitutes, eating at home and packing lunch from home. So restaurants may still be reluctant to increase prices. That leads us to unbundled pricing. Should the US restaurants do costing right (do not price items below their cost)? Should they price the food items at its current levels and start charging for service, water, bread, toppings, paper napkins, plastic ware etc?

It is not clear to me.

Customers may not value some of the items included in the bundle but will consider these essential to support the main product they are buying. If customers do not value something by itself, they also will not be willing to pay it. So charging a quarter for toppings may find fewer takers. While the costs will go down, I am not certain if the demand for the main product will remain steady.

It is definitely worth experimenting at a smaller scale before unbundling the whole burrito.

Amazon Prime Numbers

amazon.com offers Prime, a shipping program that offers unlimited second day shipping for a cost of $79 a year. This plan, like Costco membership is considered to increase the sales, as customers enticed by the free second day shipping, shift more of their purchases to amazon and buy more often than they would normally.

How much revenue do these subscribers bring to amazon.com from their annual purchases to take advantage of free shipping? But we do not know how many subscribers are enrolled currently. amazon.com does not break out the number of subscribers to its $79 a year amazon.com Prime shipping program. amazon.com's 10-K does not spell out the exact revenue from the Prime program, the revenues streams are combined together in a line item "Shipping Revenue".

Here is an attempt to estimate the number of amazon.com Prime subscribers. The program was introduced in 2005. I computed the jump in shipping revenues year over year from 2002 to 2007. I cannot say much about the increase in revenue excluding Prime. The shipping revenue as a percentage of net sales is also decreasing, an indication of shift to Prime away from single unit shipping revenues. In the first year of introduction, the shipping revenue jumped by $91 million, in the previous year it jumped by $48 million. Since the uptake is bound to be lower in the first year, we can assume that the non-prime shipping revenue grew by the same $48 million in 2005 leaving $43 million to revenue from Prime.


In 2006 and 2007, if we assume the other shipping revenue remained the same, then we can attribute all the increase to Prime subscription growth. All this leads us to conclude that amazon.com has about 3.44 million Prime subscribers.

If we assume a $1000 revenue from each of them (based on shipping cost of 7.5% of total purchase), that is $3.44 billion just from these Prime subscribers. That is 25% of total sales.

Unlike an Economist

An economist is trained to assign value (in measurable units too) to every action we undertake and everything we buy. There are always trade-offs and costs including opportunity cost of not picking the next best option. If an option does not offer positive expected net present value it is not worth undertaking. If there are multiple options, then you pick the one that offers the maximum expected net present value.

We do not run our lives like an economist. Our decision making is flawed and is based on emotions than rational thinking. When looking at the decisions made by others, with the advantage of hindsight and emotional detachment, we make commentaries about the qualities of those decisions. The New York Times has an article by DAVID STREITFELD on the unfortunate homeowners who used storage to stash their belongings after foreclosure on their homes. David says,

"... some people cannot keep up with their storage bills any better than they could handle their mortgage payments and the storage companies are auctioning of their property for a pittance"

An economist would ask, have these people considered all options before choosing storage as the best option? David asks,

This is the eternal mystery of self-storage. If the material was worth
money, it was foolish to let it go to default. If it was not worth
much, why spend at least $50 a month to store it?

The problem is most people, and we can safely say all of these people who used storage only to lose the contents, do not have a formal decision process. One could argue that if they did, they would not have reached this stage in the first place. But if we give people the benefit of doubt, unexpected events and bad luck could easily be the reasons that drove them to foreclosure. Kirchler and Rodler of University of Vienna say in one of their cases on Consumer behavior,

"People in private households make decisions when they are still groggy in the morning or tired again in the evening after a day's work. Economics decision making is imbedded (sic) in the daily routine of a relationship, which is faced with a multitude of different decision topics which often do not present themselves one after the other but rather demand simultaneous solutions".

At the time of foreclosure they are already stressed and are trying to make a living and/or support their families. Their already sub-optimal decision making process is further weakened by their current state. They cannot make economic decisions on whether to sell the stuff right away or pay the rental charges to the self storage.

People tend to look at their property as a representation of their past, a life they once had and want to have back in the future. While it might make economic sense to sell these off rather than spend $600 a year to store them, only to lose them later, their emotional attachment makes them choose the option of storing instead of selling.

Unlike an economist people are not rational. Unlike a economist people are emotional. Unfortunately, this emotional decision process destroys private and public wealth.

This brings us to the questions,

1. Should people be making their own decisions?
2. Should there be professional decision makers, trained economists, who can take on the multitude of decision problems that require simultaneous solutions?
3. Just like people are not qualified to treat their own medical conditions, should they leave their economic decision making to professionals?

Principal-Cut is not attractive, yet

As I wrote in my last post about the housing-market legislation pushed by Rep. Barney Frank, the deal is not yet attractive to the mortgage firms. Today the WSJ says just that.

Mortgage companies are more likely to participate in the write-down program if they expect home prices to continue to decline steeply, he notes, increasing the chances of larger losses.

These firms have a variety of options and will evaluate the risk return on each before agreeing to the congressional plan. The risk however is if there are any loopholes in the plan that will allow the mortgage firms to selectively agree to high risk mortgages.

Bailing Out the Homeowner under water

Representative Barney Frank proposed a plan to the lenders to recover most of their mortgages and to help homeowners avoid foreclosures:

1. Agree to cut the mortgage to 90% of present value of the house
2. Pay additional 5% to FHA, for a total loss of 15%
   
3. FHA will take over the mortgage from the lender
4. If the homeowner sells the house at a later time for a higher price, they agree to pay "some profits".

This plan is not good in two ways. First, while Barney Frank says this helps the lender recover most of the mortgage that is under water, he is looking at this one mortgage at a time and not as the aggregate. The expected value of Mr. Frank's plan is lower than that of foreclosure. Say the median value of house is $250,000, and let us assume the mortgage is of the same size. If one such house goes under foreclosure, the lender would lose $250,000 (assume they lose substantial value in selling the foreclosed house) but if they accept Mr. Frank's plan, they would only lose 15% of 250,000, that is $37,500.

But according to the statistics quoted by Hank Paulson, the treasury secretary, only 2% of the homes go under foreclosure. That is, a lender will see this as 2% chance that a mortgage has to be written off. The expected loss is $5000, way below $37,500. Only at 15% foreclosure rate, will the two plans look identical and the lender will be indifferent to these options. There is a possibility that lenders may also try to sell selectively the high risk mortgages.

Second, it does not explain the implementation of profit recovery from the homeowner. Even if this is spelled out, due to political reasons this would never get implemented, there will be huge outcries about the FHA taking over people's wealth. If the homeowners think this is enforceable they will have no incentive to keep the house up to sell it at a price higher than their mortgage. This also incents people buying houses to take on larger mortgages, the very behavior that led us to the housing crisis.

So the bailout plan will result in spending tax payer dollars without adding value.

There is a risk that lenders may accept this. Some predictions by Economy.com say that the percentage of mortgages under water could reach 25% by early 2009. This may cause the lenders to reevaluate their risk models and selectively sell just the high risk ones to FHA, which will end up with a portfolio of all bad mortgages that have to be written off at the expense of taxpayers.

Why can't telecom providers be a house of brands?

Proctor and Gamble is a house of brands. Each brand is run like a business with its own P&L. There is no attempt to bring together all the brands nor is there a need to do so. When they acquired Gillette, a company by itself, it came as another brand under P&G. There were no integration hassles or costs. What can't a telecom company be like P&G?

When AT&T acquired Cingular Wireless, the network was completely integrated and the Cingular brand was quickly subsumed under at&t brand. When Sprint bought Nextel, they rebranded themselves as Sprint Nextel but attempted to integrate the two networks. Sprint Nextel expended considerable capital trying to integrate the two networks and is reported to be in the market to sell off Nextel, an admission that the merger did not work.

Why did Sprint try to integrate Nextel's networks and operations when the two technologies and customer segments were completely different? Why did they not attempt to let Nextel brand stand by itself and preserve the network as is? When a telecom company acquires another why can't they keep the separate companies as is without integrating the customers, the operations, the systems, the networks and the brand?

After all the positioning of the two companies and their customer segments have little overlap.
Sprint could have been the P&G of telecom, with multiple wireless offerings (like the Pantene and Head & Shoulders).

The answer lies in the valuation of the target at the time of acquisition and the strategic rationale. If we look at Sprint's reasoning in 2004,

1. Combination of Sprint Nextel will create America's premier communications company -- a leading wireless carrier augmented by a global IP network that will offer consumer business and government customers compelling new broadband wireless and integrated communications services.
   
2. Expected to deliver operating cost and capital investment synergies with an estimated net present value of more than $12 billion.

The answer lies in the synergy calculation, lot of things ride on the value of the combined operation. The value of Nextel depended on the $12 billion NPV of synergy which requires the complete integration of operations. Without the integration, there is no cost savings or spillover effect and the merger itself may be questionable.

So acquiring Nextel, just to run it as its own operation would have required Sprint to value the deal by at least $12 billion below the $71 billion price tag. Nextel shareholders would not have agreed to that price.

When Sprint Nextel wrote down $20 billion in goodwill it showed that the deal was overvalued. The rumors about Nextel spin-off show that synergy is easier said than realized.

Next up, Deutsch Telecom is reported to be looking to by Sprint Nextel. Once again there are multiple technologies, DT's T-Mobile USA uses GSM and its evolution while Sprint used CDMA and Nextel uses iDen. DT having seen the Sprint Nextel integration efforts will not attempt the same. If a deal has to happen then DT has to see Sprint Nextel by itself as a positive NPV acquisition and run Sprint Nextel brand in parallel with T-Mobile brand.

That will be an interesting experiment to watch and learn.

I am only taking the crumbs - Niche Strategy

How do you enter a market with large incumbents without being crushed by them? Market entry lesson from a hair stylist, Arrojo: (via WSJ)

WSJ: You sell and use P&G's Wella brand in your studio and represent the brand at beauty shows. Why isn't P&G upset about you launching your own competing brand of Arrojo product?

MR. ARROJO: I talked candidly with the P&G folks. They want market share of the beauty industry in the States, and Nick wants to keep building his business and brand. I'm a little dot compared to their business. If I sold to other salons tomorrow, [he sells primarily online, in his salon and through QVC] I'd get them upset perhaps. I'm not planning to go down that road at present. Sure I might make some more money selling shampoo, but I wouldn't get to travel and the exposure and to be visible on stage. Don't bite off the hand that fed you; don't think you can rule the world.

In the rest of the interview Arrojo talks about Branding, customer loyalty and retaining customers even when their regular stylist quits. Arrojo charges $500 for a haircut, but when I read this interview I think he can pass for one of those management gurus who charge $50,000 for a speech.

Just don't say the R word

There is really no useful definition for recession. It is decided by the economists at NBER by looking at the GDP numbers for the past two quarters. If the GDP shrank for two consecutive quarters, the NBER declares we were in recession. By this definition, we can only look back and say we were in recession, we cannot say whether we are in a recession or will enter into recession.

So what it means really does not matter for what is ahead of us.

But not to the policy makers from both sides, who either use it do label the current situation or produce every possible explanation for why we we are not in recession. Lazear, White House Economist, has this to say:

"I would be very surprised if the NBER, looking back at this period, would date this as a recession," Mr. Lazear said. There are even indications that revised first-quarter estimates would be slightly stronger than 0.6%. "The optimists seem to have been closer to right on that than the pessimists," he said.

While 0.6% is not much of a growth, by NBER's definition the economy was not in recession. But we should ask what contributed to this growth and how healthy is this growth?
As I wrote before, the growth came from inventory build up. Not a good sign. I believe Lazear realizes this as well as he predicted a flat growth for the next period.

The problem is not whether the economy will shrink or stay flat, the increased inventory is going to cause cut downs in production and will lead to hiring freeze. An increase in unemployment rate is a bigger problem than whether or not NBER should retrospectively label this period as recession.

Think! Don't Feel!

In the Star Wars Episode One, Liam Neeson character tells young Skywalker, just moments before the big pod race, " Feel, don't think!".

It is common sense that directing someone to feel makes no sense in business.

(Note: if you are doing Negotiations in your coursework the link below has the spoiler for the Texoil Case)

A new study done (link via The Economist) by Kelloggs School of Management on the unsuspecting MBA students confirms just this. In two party negotiations experiments, people who considered what the other side is thinking rather than what the other side is feeling ended up closing the deals more times than those "felt" or did not do either.

Perspective-taking is the cognitive power to consider the world from
someone else's viewpoint, whereas empathy is the power to connect with
them emotionally.

What this shows is that even with one negotiator having perspective-taking abilities it can produce a better overall outcome
for both sides. “You want to understand what the other side's interests
are, but you do not want to sacrifice your own interests,” says Dr
Galinksy. “A large amount of empathy can actually impair the ability of
people to reach a creative deal.”

Just as a side note the negotiation case discussed in this article is the very first case I had to solve in my Negotiations class at Haas School. I was the gas station guy trying to sell it to big oil before going on a trip.

The Long and the Short of Lifetime Value of Customer

Zappos takes pride in describing itself as a great customer service business that happens to sell shoes. I had to return a pair of shoes. As it had been said very eloquently by many, it was the easiest task I have ever done online. Zappos knows they have not lost me and that I sure will buy more shoes from them.

On the other hand, I went to the local UPS store to drop off the package. I asked the friendly associate to tape my box and affix my printed UPS shipping label. He did, but charged me $1 for a strip of tape. He explained that he makes no money from people dropping off packages and in my case he lost money because he spent time and material and hence had to recover that cost.

It was not a big deal to pay a dollar. But ...

Do businesses need to make money off of every customer interaction? The problem with most businesses, especially those run in franchise model with very low operating margin, is that they look for every opportunity to amortize the costs.

They look at customer interactions as transactional and not as a relationship.

The transactional model assumes every customer will visit your store exactly once (at least for the next few years). So the goal is to get the customer to pay. Even a small act you do for the customer needs to be charged.

The relationship model treats the customer visit as one of many opportunities to build a relationship with them. There is no concern about making money from every visit.

A customer who has bought other services in the past is not going to be happy for getting charged for every small thing. A new customer will form an opinion that will drive them away from the store for future services. The store should use every customer visit as an opportunity to build a stronger and better relationship.

The UPS stores are independently owned and operated by local business people. The franchisee, a local entrepreneur, pays a fixed fee and a percentage of revenues to UPS and takes as profit whatever is left after covering costs. Harvard Business School professors Campbell and Datar say in their working paper, "franchising imposes undiversified risks on the store manager and can create hold-up problems where franchisees may under invest in their stores". This may lead them to measures that are needed to stay afloat but does not help the brand.

We can't blame the franchisees for trying to stay afloat but customer experience is tied to the main brand. A customer will then relate the same experience to every UPS store and its offering rather than treat it as one off experience with an individual. UPS should incent the franchisees to build better relationships, and help reduce overhead costs by providing simple supplies to the stores to create better experience. This holds true for any business, franchised or not, big or small.

The high lifetime value of the customers in the relationship model requires businesses to look beyond profit from every visit and deliver above and beyond what is required.

If it isn't positive NPV

Southwest Airlines CEO Gary Kelley on acquiring other airlines (via NYTimes):

The thought of simply acquiring outright another airline that is
destined to lose money this year just doesn’t seem like a good
opportunity.

This is it! No consideration of possible synergies and savings from them. If the target is not generating positive cash flow it does not matter.

Economists Against Gas Tax Holiday

The economists are using social media to show their objection to the gas tax holiday. The Brookings Institution has created a simple blog gastax08.blogspot.com and published exactly one post, the open letter opposing the proposals for a Gas tax Holiday and the names of economists who oppose the gas tax. So far 248 scientists have signed the letter and counting.

There is not one economist available to support the gas tax holiday.

Why the current GDP growth is bad

US economy (measured by real GDP) grew by 0.6% in the Q1 of 2008. With all the dire predictions about slowing economy and recessions, the growth officially indicates that the economy is not in recession. (NBER defines recession as two successive quarters of negative growth).

But the current growth is not good news if you look at the components. My favorite book on Macroeconomics by Mankiw defines national income as
Y = C + I + G + NX
C is consumption
I is private investment
G is Government spending and investment
NX is Net exports

The U.S. Department of commerce report for Q1 2008 gives us the components of the 0.6% growth

Consumption grew 0.68%, Investments grew by -0.7%, Governmental component grew by 0.39% and Net exports grew by 0.22. On the surface it may look like a growth dominated by consumer spending but if you drill down the private Investment growth number, Inventories, an important component of private investments grew by 0.81%. This means manufacturers are storing more of what they produced in the shelves as the consumer demand weakened.

When excess supply over demand goes into inventory, manufacturers are bound to cut production and hiring. This means higher unemployment rate will follow that will lead to reduction in consumer spending and cause the national income to fall.

A growth caused by unexpected build up of inventory is not a good growth. If we take away private inventory growth component, the economy shrank by 0.4%. As the manufacturers readjust to cut production and reduce the inventory, brace yourself for a negative growth and unemployment.

Unbundling the Brand

In the CPG market the brands are unbundled from the corporation. You buy Pantene brand shampoo not P&G. There is some brand extension like using the Pantene brand for all hair care products. But most customers do not know or care about who makes Pantene. This level of unbundling was part of the strategy and not something forced on P&G or Lipton by the environment.

In the case of media companies NBC, ABC and HBO they are the brands and the product categories or the individual products to do not have a brand. The companies actively pursued bundling as the strategy like the Must See TV campaigns. The main brand is meant to evoke the same positive feelings across all the shows, from sitcoms to dramas. A successful show is used to position the main brand and leveraged to bundle with it other weaker and newer offerings. The shows are also very loosely tied to the media company because of the re-run market.

In the TiVo and Hulu world, an unbundling of the shows from the parent media company is unfolding and the companies can do nothing about it. Jason Fry of WSJ sees this as diminishing the role of a network to a bit pipe, like a cable company:

I don't know what network hosts most of the programs saved on my TiVo. (A rare exception is "John Adams, but that says more about what a strong brand HBO has become.) I don't have the faintest idea what time "John Adams" or most any other show airs. Why should I? Unless you're talking about a baseball game, all I need to know about a show is that it's on my TiVo screen when I want to watch it. As a result, I neither know nor care any more about the supposed qualities of NBC or the WB or any other network than I do about the supposed qualities of whatever company makes the coaxial cable Time Warner uses to bring a TV signal to my house. Content itself is becoming the brand -- and networks used to hitting me with commercials while I sat captive on the couch have to work much, much harder to get my attention.

The media companies can either let this happen and stay on the sideline or be a driver in developing the individual brands. This requires them to recognize the changes in business models from traditional Ads, DVD sales and re-runs. In addition to branding the content they need to unbundle them so each brand competes on its own.

This is not totally new to the networks. They already have branded morning shows like Good Morning America and news programs like 20/20. But the problem with entertainment shows is who owns the content and who should spend for brand development. The bigger question in an unbundled media world in which the content becomes the brand is, what value does a media company add?

Substitutions

Never underestimate the power of substitutions. FT.com reports

Farmers in the Indian state of Rajasthan are rediscovering the humble camel.

As the cost of running gas-guzzling tractors soars, even-toed ungulates are making a comeback, raising hopes that a
fall in the population of the desert state’s signature animal can be reversed.

Sizing up the Customer

Coke and Pepsi bottlers make the most margin from their sales at vending machines and convenience stores. These channels target the customers who are willing to trade in high price for convenience and immediacy in satisfying their want. The most common packaging option sold at convenience stores is the 20 Oz bottle sold at $1.29, more expensive that the 2 liter bottle pricing for the same brand in supermarkets.

WSJ reports that the bottlers are seeing a fall in sales in the convenience stores. The cited reasons include health concerns and softening economy. To stem falling sales, the bottlers have introduced multiple packaging, 12, 16 and 24 Oz bottles. The 16 oz Coke sells for $0.99 and 24 oz sells for $1.49.

The marginal cost per bottle is fairly independent of the size since the bigger cost component is packing and distribution. So the 30 cent pricing difference between 20 oz and 16 oz bottles is a bigger drop in margin to the bottler. Yet they chose to introduce new sizes instead of dropping the pricing on 20 oz bottles.

This indicates their understanding of consumer behavior and their reactions to economic weakness and health concerns. By replacing one size bottle with two new sizes and a large price differential ($0.99 vs $1.49), the Coca Cola bottlers are nudging the consumers to prefer the lower prices and smaller sized bottle. The price per oz for the consumer is the same on these two sizes and hence there is no rent to the consumer to pick the bigger size. They do not expect to sell many 24 oz bottle. The onl role of 24 oz bottle is to sell the 16 oz bottle.

Pepsi's tactic is slightly different from Coke's. Pepsi retained the 20 oz bottle and introduced 12 and 16 oz bottles. Between these two they cover the entire spectrum of packaging for studying market reaction. The two sure will be watching each other's sales results and will soon converge on the winning combination.

Results from the Business Plan

The results from the Berkeley Business Plan finals are in.

Congratulations to the winners of this year's UC Berkeley Business Plan Competition! Implicit Interfaces and Titan Medical tied for 1st place. Omniox won 3rd place. Glycometrix received the People's Choice Award.

I did place my bets on Ominox, Glycometrix and Titan Medical, the three non-internet startups.

I was wrong in predicting Implicit Interfaces had a slim chance.

Stick to the Narratives

Yet another example of the use of narratives in marketing, "Gas Tax Holiday". The hard numbers take time to explain and most people do not have the patience to understand. By repeating the story and by creating a strong, albeit non-existent, relation to the prices we pay at the pump, the two presidential candidates managed to grab attention.

The problem is that the Government needs to fund the infrastructure through other means and taxing oil companies, whose margin is 25 cent from a $3.50 retail price, will only result in them passing on this tax to the customers. Multiple other reasons like a weakening dollar, supply disruptions, or increased demand may push the gas price much more than current levels.

The reality is this will save utmost $30 for more than 95% of the people. But by framing it as "Holiday" and as a plan to "provide relief to people", by funding it by, "taxing the oil companies", the numbers get lost in the narratives.

It is surprising that narratives never fail.

Oreo by any other name

WSJ reports the reformulation of Oreo cookies in China:

So in China in 2006 Kraft remade the Oreo itself, introducing for the first time an Oreo that looked almost nothing like the original. The new Chinese Oreo consisted of four layers of crispy wafer filled with vanilla and chocolate cream, coated in chocolate.

When you create a new sub-category cookie it helps to differentiate by branding it and thereby owning the sub-category. Since the cookie is completely reinvented I wonder why Kraft chose to brand it as Oreo and not something new. Kraft has extended the Oreo brand in USA to 50 other products but none is as well known as the chocolate flavored sandwich cookies. I believe Kraft must have found that the brand Oreo, without association to a particular cookie type, carries a lot more equity in China than it would cost to rebuild a new brand.

There is an interesting data hidden in this. Brands have a significant influence on the first time purchase but cannot engender loyalty if the products do not match people's taste and expectations.

Corporations, Societies, Responsibilities

Milton Friedman said, "the business of business is business". He described the primary responsibility of the executive officers is to enrich the stakeholders by employing the capital in profitable ways. He further argued that the discussions on the need for social responsibility are "loose and lack the rigor".

I chose the case of Unocal (now part of Chevron) in Burma for my Ethics paper. I am struggling with this case, trying to reconcile my emotional side which believes CSR is a given vs. my business training which makes me want to agree with Friedman.

While I tend to agree with Friedman, I am siding with John Ruggie, Professor at Kennedy School of Government, that a corporation cannot be complicit with a despot and should not trample on human rights even indirectly.