Knowledge that Transforms

Xiaofang Wang, Laurens G. Debo, Alan Scheller-Wolf, Stephen F. Smith How can phone-in diagnostic service centers improve service and reduce costs in health care? According to the Centers for Disease Control and Prevention, of an estimated 113.9 million emergency room visits during 2003, 13% were nonurgent. At an estimated average cost of $300 per emergency room visit, a cost of $4.4 billion can be managed more efficiently by directing patients to the appropriate care center. To help with this problem, diagnostic service centers provide advice to patients over the phone about what the most appropriate course of action is based on their symptoms. Managers of such centers must strike a balance among accuracy of advice, callers' waiting time, and staffing costs by setting the appropriate staffing levels, skills sets, and service depth. Patients decide whether to use such a diagnostic based on their expectation of accuracy of advice and wait time due to call congestion. The authors find that the dual concerns of accuracy and congestion lead to a counterintuitive impact of capacity: Increasing capacity might increase congestion. The insight for management: Staffing, quality, and depth of service considerations require careful consideration in health care. Teck-Hua Ho, Noah Lim, Tony Haitao Cui How many newspapers should a newsvendor stock, given that demand each day is uncertain? On one hand, the newsvendor likes to stock enough to provide a high service level. On the other hand, overstocking newspapers will lead to wasteful excess inventory. Researchers have found that there are psychological costs of leftovers and stockouts, tending to result in a “pull-to-center” bias. The authors confirm this result and further find that the psychological aversion to leftovers is greater than the disutility for stockouts; the pull-to-center is greater from the right. They test their hypothesis with both the centralized and decentralized inventory structures using experimental subjects motivated by substantial financial incentives. They find that the degree of bias is greater in the high-profit margin than in the low-profit margin condition, which is counterintuitive, given that with high profit margins there is greater economic incentive to overstock and have leftovers. The insight for management: Managers may exhibit a bias toward stocking for the mean demand, which may inhibit their ability to achieve a level that optimally balances its costs and benefits. Benjamin Van Roy, Xiang Yan Netflix, Amazon, and the like allow customers to get recommendations from other customers with similar tastes through a “collaborative filtering system.” Perhaps because of their success, collaborative filtering systems influence purchase decisions and hence have become targets of manipulation by unscrupulous vendors. The authors demonstrate that the algorithms used in these services are highly susceptible to manipulation and introduce new collaborative filtering algorithms that help to reduce this unwanted tampering. The insight for management: Providing a service like a collaborative filtering system is an advantage for customers only if they can trust its content; advanced methods may help to better prevent misleading information. Prabuddha De, Yu (Jeffrey) Hu, Mohammad S. Rahman How do online consumers use search and recommendation technologies on the Internet? Does consumers' technology usage have an effect on their purchasing habits? The authors study the relationship between shopper technology usage and online sales and find a significant relationship, but this effect varies for different technologies and across different products. In particular, the use of directed search has a positive effect on the sales of promoted products, whereas it has a negative effect on the sales of nonpromoted products. In contrast, the use of a recommendation system has a positive effect on the sales of both promoted and nonpromoted products. Surprisingly, the use of nondirected search has an insignificant effect on online sales. The insight for management: Careful consideration of how different online technologies affect customer behavior is critical to achieving desired sales. Ram D. Gopal, Alok Gupta Approximately $50 billion per year are lost to software piracy, which is widely regarded as one of the biggest problems facing the software industry. As a result, the industry has adopted a number of technical, legal, and economic strategies to curb piracy and stem the resulting losses. At the same time, the software industry has made increasing use of product bundling, which enables sellers to extract higher profits from buyers. The authors find that the practice of product bundling can increase the presence of piracy but that, despite this, bundling can be profitable even when the act of bundling increases the piracy level of one of the products in the bundle. With such “phantom piracy,” sellers trade higher piracy for one product in favor of lower piracy for the other product while deriving overall higher profits. The use of price discounting of bundles deters piracy. The insight for management: Bundling coupled with steep price discounts can be an effective deterrent to piracy, while consumers also benefit from higher surplus. Rustam Ibragimov, Johan Walden The authors develop a framework for the optimal bundling problem of a seller who provides goods to consumers who value the products differently. When there are “heavy tails”—an exceptionally high number of customers who assign extreme valuations to the products—buyers prefer unbundled products. For products with low marginal costs, the seller's optimal strategy is consistent with consumer preferences: to provide goods separately when consumers' valuations are heavy tailed and in a single bundle when valuations are thin tailed. These conclusions are reversed for goods with high marginal costs. The insight for management: Seller and buyer bundling preferences can diverge as the cost structure of the product increases. Paul J. Healy, Sera Linardi, J. Richard Lowery, John O. Ledyard Double auction prediction markets have proven successful in applications such as elections and sporting events. Consequently, several large corporations such as Google and Intel have adopted these markets for smaller-scale internal applications like revenue forecasting where information may be complex and the number of traders is small. The authors find that when information is complex, an iterated poll (or Delphi method) outperforms the double auction mechanism. The insight for management: More traditional forecasting methods may be more appropriate in small-scale situations with complex information. David B. Brown, Bruce Ian Carlin, Miguel Sousa Lobo How should large holders of equities liquidate large holdings? The authors analyze the problem of an investor who needs to unwind a portfolio in the face of recurring and uncertain liquidity needs while accounting for both permanent and temporary price impacts of their trading. They show that a risk-neutral investor who myopically deleverages his position to meet an immediate need for cash always prefers to sell more liquid assets. But if the investor faces the possibility of a sizable downstream shock, the nonmyopic investor unwinds positions more quickly and retains more of the assets with low temporary price impact in order to hedge against possible distress. Generally, optimal liquidation involves selling more of the assets with a more temporary and less permanent impact, even if these assets are relatively illiquid. The insight for management: Properly accounting for the possibility of future shocks should play a role in liquidating large positions in portfolios. Arthur E. Attema, Han Bleichrodt, Kirsten I. M. Rohde, Peter P. Wakker Are preferences dependent on the passage of time? The authors develop a general tool to analyze intertemporal choice. The authors suggest that currently popular discount functions used in the literature do not account well for this possibility and suggest new measures that do. The insight for management: To appropriately model consumer choice, it may be advisable to reconsider intertemporal effects in consumer choice. Conditional Coskewness in Stock and Bond Markets: Time-Series Evidence (p. 2031) Jian Yang, Yinggang Zhou, Zijun Wang How are risks of stock related to the returns of bonds, and vice versa? Coskewness is the return of one asset relative to the volatility of the other. The authors evaluate U.S. stock coskewness (the relation between stock return and bond volatility) and bond coskewness (the relation between bond return and stock volatility). They find that the relationship is statistically and economically significant and confirm these results with data from the United Kingdom. The insight for management: When evaluating risk and reward of portfolios, coskewness might be a factor to consider. Pavlo R. Blavatskyy The Nobel-Prize-winning work of Dr. Harry Markowitz in the 1950s on portfolio theory proposes a mean-variance approach to balancing risk and return from a portfolio. The risk measure used, variance, although popular, is unduly subject to outlier observations because errors are squared. The author proposes “mean absolute semideviation,” which weights errors linearly rather than quadratically. The insight for management: Improved risk measures may lead to recommended optimal portfolio strategies that do not exhibit behavioral irr

Jasjit Singh, Morten T. Hansen, Joel M. Podolny The “small-world” argument emphasizes that people are, on average, only a few connections away from the information they seek. The authors explore why some employees may be at a disadvantage in searching for information in organizations. It is understood that, if an employee is positioned far from the network center, then the employee may have longer search paths in locating knowledge in an organization; thus, they are less likely to find the information they seek quickly and efficiently. These researchers conducted a network field experiment in a large multinational professional services firm and found that searchers are also likely to seek information from people similar to themselves, which exacerbates the problem. Because their connections are similar to them, they are less likely to conduct a quick and successful search. The insight for management: Encourage network connections among heterogeneous employees to improve the efficiency of information search. Waverly W. Ding, Sharon G. Levin, Paula E. Stephan, Anne E. Winkler Does information technology (IT) increase research productivity and collaboration? The authors investigate the impact of information technology on productivity and collaboration patterns in academe. They analyzed data from 3,114 active research scientists from 314 U.S. institutions over a 25-year period. They found that early adoption of Internet technology (BITNET and a domain name) on a scientist's campus had a positive effect on his or her research productivity and collaborative network. The technology effect is greater for researchers and those at nonelite institutions, suggesting that IT is an equalizing force, providing a greater boost to productivity and more collaboration opportunities for scientists who are more marginally positioned in academe. The insight for management: Academic administrators can boost researchers' output with appropriate IT investment such as online database subscriptions and collaboration tools. Maurice Levi, Kai Li, Feng Zhang Would a woman CEO be more likely to lead two companies though a cooperative merger or acquisition? The authors argue that a combative nature among CEOs is a result of testosterone levels that are higher in young males. Young male CEOs appear to be combative: They are 4% more likely to be acquisitive, and, having initiated an acquisition, they are more than 20% more likely to withdraw an offer. Furthermore, a young target male CEO is 2% more likely to force a bidder to resort to a tender offer. Specifically, high-testosterone responders tend to reject low offers even though this is against their interest. The act of attempting or resisting an acquisition can be viewed as striving to achieve dominance. The insight for management: There seems to be a significant hormone effect in mergers and acquisitions. Ramon Casadesus-Masanell, Feng Zhu How should Apple iTunes respond to Pandora, an ad-sponsored, free music service? Similarly, what should AOL have done with its subscription rates when NetZero, a free, ad-sponsored service, came about? The authors analyze the optimal strategy of a high-quality incumbent that faces a low-quality ad-sponsored competitor. Apple might first compete through adjustments of tactical variables such as price or the number of ads a product carries. But the authors show that the optimal response to an ad-sponsored rival often entails more strategic business model reconfigurations. These researchers suggest that the incumbent might consider using an ad-sponsored model like the competitor; a mixed model in which the incumbent offers a product that is both subscription based and ad sponsored; or a dual model in which the incumbent offers two products, one based on the ad-sponsored model and the other based on the mixed business model. They also find that, when there is an ad-sponsored entrant, the incumbent is more likely to prefer to compete through the subscription-based model or the ad-sponsored model, rather than the mixed or the dual model, because of cannibalization and endogenous vertical differentiation concerns. The insight for management: An optimal response to a new competitor might require strategic business model changes. Cheol S. Eun, Sandy Lai, Frans A. de Roon, Zhe Zhang Can improved investment strategies break through previously identified risk–reward trade-offs? The authors propose a new investment strategy employing “factor funds” to systematically enhance the mean-variance efficiency of international diversification. They use data from 10 developed countries during the period 1981–2008 and show that their augmented optimal portfolio involving local factor funds substantially outperforms the benchmark optimal portfolio comprising only country market indices as measured by their portfolio risk/return ratios. Their results are robust for a number of time periods and investment costs. The insight for management: Adding factor funds into a portfolio can improve the risk/return trade-offs of indexed funds. Saravanan Kesavan, Vishal Gaur, Ananth Raman The authors suggest that firm-level sales forecasts for retailers can be improved if cost of goods sold, inventory, and gross margin (defined as the ratio of sales to cost of goods sold) are incorporated as three endogenous variables. They construct a simultaneous equations model, estimated by using public financial and nonfinancial data, to provide joint forecasts of annual cost of goods sold, inventory, and gross margin for retailers using historical data. The authors show that sales forecasts from this model are more accurate than consensus forecasts from equity analysts. The insight for management: Equity analysts seem not to fully utilize historical inventory and gross margin data that contain information useful to forecast sales. Evan Rawley, Timothy S. Simcoe The authors study how firms reorganize after diversification, proposing that firms use outsourcing, or vertical disintegration, to manage diseconomies of scope. They explore the origins of scope diseconomies, showing how different underlying mechanisms generate contrasting predictions about the link between within-firm task heterogeneity and the incentive to outsource after diversification. Using microdata from the Economic Census on taxicab and limousine fleets, they find that taxicab firms outsource, by shifting the composition of their fleets toward owner-operator drivers, when they diversify into the limousine business. The magnitude of the shift toward driver ownership is larger in less urban markets, where the tasks performed by taxicab and limousine drivers are more similar. The insights for management: Firms use outsourcing to manage diseconomies of scope, and interagent conflicts can be an important source of scope diseconomies. Sang-Hyun Kim, Morris A. Cohen, Serguei Netessine, Senthil Veeraraghavan How should a company structure supplier equipment service contracts when the equipment is too important to fail? On one hand, the supplier has to respond to these infrequent outages because firms that rely on functioning mission-critical equipment for their businesses cannot afford significant operational downtime due to system disruptions. On the other hand, because the equipment is so critical, disruptions occur infrequently, making it very expensive for a supplier to commit the necessary resources for recovery because they will be idle most of the time. A widely adopted incentive mechanism is performance-based contracting (PBC), in which suppliers receive compensation based on realized system uptime. The authors show that designing a successful PBC creates nontrivial challenges that are unique to this environment. Namely, because of the infrequent and random nature of disruptions, a seemingly innocuous choice of performance measures used in contracts may create unexpected incentives, resulting in counterintuitive optimal behavior. They compare the efficiencies of two widely used contracts, one based on average downtime and the other based on cumulative downtime, and they identify the supplier's ability to influence the frequency of disruptions as an important factor in determining which contract performs better. The insight for management: A company must devise a proper incentive mechanism for the rare outage of mission-critical equipment so that the suppliers provide prompt restoration and recovery services to the customer. Jun Yang Could a different contract structure have prevented the recent mortgage banking debacle? In the mortgage banking industry, the loan originator screens borrowers, and the rating agency evaluates the creditworthiness of the mortgage-backed securities (MBS) at the outset, whereas the servicer collects mortgage payments and detects or prevents potential defaults over time. The author studies the three-sided moral hazard problem with one agent exerting up-front effort and two agents exerting ongoing effort. The author finds that, in the optimal contract, the timing of payments reflects the timing of effort: Payments for up-front effort should precede payments for ongoing effort. The insight for management: Careful contract structuring can help create the required incentives for success. Terry A. Taylor, Wenqiang Xiao Better forecasts would seem to create better outcomes. This may not be so for all supply chain members, according to the authors, who consider a manufacturer selling to a retailer with a perishable

Some luxury goods manufacturers offer limited editions of their products, whereas some others market multiple product lines. Researchers have found that reference groups shape consumer evaluations of these product categories. Yet little empirical research has examined how reference groups affect the product line decisions of firms. Indeed, in a field setting it is quite a challenge to isolate reference group effects from contextual effects and correlated effects. In this paper, we propose a parsimonious model that allows us to study how reference groups influence firm behavior and that lends itself to experimental analysis. With the aid of the model, we investigate the behavior of consumers in a laboratory setting where we can focus on the reference group effects after controlling for the contextual and correlated effects. The experimental results show that in the presence of strong reference group effects, limited editions and multiple products can help improve firms' profits. Furthermore, the trends in the purchase decisions of our participants point to the possibility that they are capable of introspecting close to two steps of thinking at the outset of the game and then learning through reinforcement mechanisms.

This paper studies how firms reorganize following diversification, proposing that firms use outsourcing, or vertical disintegration, to manage diseconomies of scope. We also consider the origins of scope diseconomies, showing how different underlying mechanisms generate contrasting predictions about the link between within-firm task heterogeneity and the incentive to outsource following diversification. We test these propositions using microdata on taxicab and limousine fleets from the Economic Census. The results show that taxicab firms outsource, by shifting the composition of their fleets toward owner-operator drivers, when they diversify into the limousine business. The magnitude of the shift toward driver ownership is larger in less urban markets, where the tasks performed by taxicab and limousine drivers are more similar. These findings suggest that (1) firms use outsourcing to manage diseconomies of scope at a particular point in the value chain and (2) interagent conflicts can be an important source of scope diseconomies.

Monetary incentives, such as subsidies or bonuses, are often considered as a way to foster contributions to public goods in society and firms. This paper investigates experimentally the effect of private contribution incentives in the presence of a norm enforcement mechanism. Norm enforcement through peer punishment has been shown to be effective in raising contributions by itself. We test whether and how (centrally provided) private incentives interact with (decentralized) punishment, both of which affect subjects' monetary payoffs. The results of our experiment show that private incentives for contributors can reduce the effectiveness of the norm enforcement mechanism: Free riders are punished less harshly in the treatment with incentives, and as a consequence, average contributions to the public good are no higher than without incentives. This finding ties to and extends previous research on settings in which monetary incentives may fail to have the desired effect.

Economists studying innovation and technological change have made significant progress toward understanding firms' profit incentives as drivers of innovation. However, innovative performance in firms should also depend heavily on the pecuniary and nonpecuniary motives of the employees actually working in research and development. Using data on more than 1,700 Ph.D. scientists and engineers, we examine the relationships between individuals' motives (e.g., desire for intellectual challenge, income, or responsibility) and their innovative performance. We find that motives matter, but different motives have very different effects: Motives regarding intellectual challenge, independence, and money have a strong positive relationship with innovative output, whereas motives regarding job security and responsibility tend to have a negative relationship. We also explore possible mechanisms underlying the observed relationships between motives and performance. Although hours worked (quantity of effort) have a strong positive effect on performance, motives appear to affect innovative performance primarily via other dimensions of effort (character of effort). Finally, we find some evidence that the role of motives differs in upstream research versus downstream development.

Retail store managers may not follow order advices generated by an automated inventory replenishment system if their incentives differ from the cost-minimization objective of the system or if they perceive the system to be suboptimal. We study the ordering behavior of retail store managers in a supermarket chain to characterize such deviations in ordering behavior, investigate their potential drivers, and thereby devise a method to improve automated replenishment systems. Using orders, shipments, and point-of-sale data for 19,417 item–store combinations over five stores, we show that (i) store managers consistently modify automated order advices by advancing orders from peak to nonpeak days, and (ii) this behavior is explained significantly by product characteristics such as case pack size relative to average demand per item, net shelf space, product variety, demand uncertainty, and seasonality error. Our regression results suggest that store managers improve upon the automated replenishment system by incorporating two ignored factors: in-store handling costs and sales improvement potential through better in-stock. Based on these results, we construct a method to modify automated order advices by learning from the behavior of store managers. Motivated by the management coefficients theory, our method is efficient to implement and outperforms store managers by achieving a more balanced handling workload with similar average days of inventory.

The study of risky decision making has long used monetary gambles to study choice, but many everyday decisions do not involve the prospect of winning or losing money. Monetary gambles, as it turns out, may be processed and evaluated differently than gambles with nonmonetary outcomes. Whereas monetary gambles involve numeric amounts that can be straightforwardly combined with probabilities to yield at least an approximate “expectation” of value, nonmonetary outcomes are typically not numeric and do not lend themselves to easy combination with the associated probabilities. Compared with monetary gambles, the evaluation of nonmonetary prospects typically proves less sensitive to changes in the probability range (inside the extremes of certainty and impossibility), which, among other things, can yield preference reversals. Generalizing on earlier work that attributed similar findings to the role of affect in the evaluation process (Rottenstreich, Y., C. K. Hsee. 2001. Money, kisses, and electric shocks: An affective psychology of risk. Psych. Sci. 12(3) 185–190), we attribute the observed patterns to a fundamental difference in the evaluation of monetary versus nonmonetary outcomes. Potential pitfalls in the use of monetary gambles to study choice are highlighted, and implications and future directions are discussed.