FALL/WINTER 2004 STERNbusiness BRAND N E W S

Global Brand Managers Speak: Visa, MTV, J&J Stigmatized CEOs Martha’s Woes Rolex Rolls On Toyota Motors Ahead Paul Newman’s Salad Days Are Fannie and Freddie Too Big? Investors to CEOs: Ditch the G-IV! May I Help You? Customer Assistance Strategies That Work a letter fro m the dean

It’s rare to discuss are proud to offer strong programs in a range of branding in the context of disciplines: from economics to marketing, from a university, or of a busi- management to information systems. ness school. After all, we We strive constantly to invigorate Stern by don’t have customers or recruiting new faculty, by bringing a broad range of products. We don’t try to guest scholars and executives to share their experi- gain market share by ences with us, and by finding new ways to connect rolling out periodic mar- and re-connect with members of our far-flung com- keting campaigns. And munity. This September, we are welcoming 11 new yet, in one important way junior faculty to campus. We are also delighted that our efforts are inextricably linked to the process that Steve Florio, the former president and chief execu- companies go through when trying to build a brand. tive officer of Condé Nast Publications, is coming to We have a strategy in place to ensure that NYU teach at NYU Stern this fall. Our long-running CEO Stern signifies and embodies certain values and Series and the popular Author Lecture Series both attributes in the minds of all our stakeholders – continue, with the appearance of business leaders students, faculty, staff, colleagues, and our counter- such as Larry Bossidy and Robert Rubin, respective- parts in the private sector. Beyond that, we strive to ly. And in October, our Global Alumni Conference in communicate our values consistently and frequently Paris will feature presentations on topics ranging to our different constituencies. from the future of the European Union to the global What are the components of the NYU Stern luxury market. brand? A spirit of rigorous interdisciplinary inquiry; SternBusiness is an integral part of these efforts an openness to the city that is our home, and to the to explore, raise questions, and establish connections global context in which we live and work; a commit- in New York – and beyond. And this issue proves ment to excellence in teaching; and the ambition to that members of our community have significant grow, expand, and deepen our knowledge base intellectual contributions to make on the important through research. subject of branding. I hope you enjoy it. The Stern brand has been built over a century of sustained effort. We have deep roots in finance and accounting. But over the decades, as we have grown, and as our human and financial resources have Thomas F. Cooley grown, we have expanded our horizons. Today, we Dean contents FALL/WINTER 2004 Brand News

Stern ChiefExecutive Series

Interviews with 42 Tom Freston, Viacom, Page 2 Helping Carl Pascarella, Visa USA, Page 4 Hands William Weldon, Strategies for Assisting Shoppers Johnson & Johnson, Page 6 in Malls and Online by Eric A. Greenleaf, 18 Vicki G. Morwitz The Scarlet F and Russell S. Winer 12 Brand Equity When Good Executives Go Bad by Daniel Gross by Batia M. Wiesenfeld, Kurt Wurthmann and Donald C. Hambrick 48 Endpaper by Daniel Gross

24 What Makes Rolex Tick The Watch Maker’s Success Secrets by David Liebeskind

28 Car Talk NYU Stern Alumnus Tatsuro Toyoda of Toyota Motor Corporation Returns to Campus STERNbusiness 14 A Very Bad Thing A publication of the Stern School of Business, New York University Martha Stewart’s Meltdown 30 Flights of Fancy President, New York University by Peter N. Golder Do Stocks Suffer When CEOs John E. Sexton Use Private Jets? Dean, Stern School of Business Thomas F. Cooley by David Yermack Chairman, Board of Overseers William R. Berkley Chairman Emeritus, Board of Overseers Henry Kaufman Associate Dean, Marketing and External Relations Joanne Hvala 36 Editor, STERNbusiness Daniel Gross The Trouble with Fannie and Project Manager Lisette Zarnowski Freddie Design Esposite Graphics The Hazardous Growth of Two Mortgage Giants Letters to the Editor may be sent to: by Lawrence J. White NYU Stern School of Business Office of Public Affairs Illustrations by: Bryan Leister, Juliette Borda, 44 West Fourth Street, Suite 10-160 Jud Guitteau, Ken Orvidas, Steven Salerno, New York, NY 10012 Michael Caswell, Robert O’Hair www.stern.nyu.edu sternChiefExecutiveseries

Tom Freston co-president and co-chief operating officer of Viacom

Tom Freston, co-president and co-chief operating officer of Viacom, received his MBA from NYU Stern in 1969. He has been with the pioneering music channel MTV since its found- ing in 1981 and served as CEO of MTV from 1987 until last spring. MTV Networks, a division of Viacom, operates cable networks MTV, VH1, Nickelodeon, Country Music Television, Spike TV, Comedy Central and TV Land. The company also controls MTV films in association with Paramount Pictures and licenses consumer products. MTV currently broadcasts to 314 million of the world’s households in 136 countries and territo- ries. MTV has branched out from its original fare of music videos to offer original programming, such as Real World and Newlyweds, and has engaged young audiences with its “Rock the Vote” and “Choose or Lose” campaigns. In June 2004, Freston was promoted to co-president and co-chief operating officer of Viacom, and is now responsible for the company’s cable, publishing and theme park units.

RR: What television moments One was the notion that you Peter Drucker as one of my Then I decided I better get a influenced you growing up in should experience as many professors. job. I wanted to do something Connecticut? different things as you can, really creative. So I got a job at TF: I grew up in the '50s and that travel would be a very RR: Do you remember an ad agency, Benton & '60s, which must seem like important journey to take in anything that he specifically Bowles. They put me on a ancient history now, and I saw your life. taught you? Proctor & Gamble business. I those iconic moments: Elvis's TF: I always remember him was assigned to the Charmin first time on TV and the RR: So what motivated you to talking about innovation. toilet paper account. But I was Beatles and the Kennedy go to business school in the Invention is creating something very alienated at the time. So assassination. But I spent first place? totally new. But the real thing after a year and a half I quit, more time listening to the TF: I couldn't really see in life is innovation, which is and I spent a year traveling radio, and I was really touched myself being a doctor or a taking two things that already around the world. I ended up by the Beat movement of the lawyer or a dentist. If I went to exist and putting them together in Asia, and I was just so late '50s, early '60s, and the business school I thought I in a new way. That's where enthralled with everything I rise of the counterculture. I could find something that I most businesses come from. saw there. So I made up my wasn't a hippie, but I was right liked, although it was really mind that I would like to live here in Washington Square hard for me to figure out what RR: What did you do when there and work, and figured Park. And the late '60s was a that would be. It was also you left here? out a way to support myself. real interesting time to be helpful at the time to get a TF: I took off a year and a half I came back to the States going to business school in deferment and stay out of the and sort of bummed around. I and found a friend who had New York City. There are cer- war in Vietnam. But I was very was a bartender in Aspen. some money. And in 1973, tain themes from those move- pleased to get into NYU. I Then I went to Mexico and with the advent of air freight, it ments that resonated with me. was lucky enough to have worked around the Caribbean. was possible to make some-

2 Sternbusiness Mr. Freston was interviewed by Randall Rothenberg, editor-in-chief of the quarterly business magazine Strategy+Business and editor-at-large at Advertising Age. thing in a country like India or Networks as a real brand-ori- pany, make it work more effi- documentaries on sports fig- Afghanistan, and sell it 24 ented powerhouse. ciently, and get everyone to do ures. It's off to a good start. hours later in New York City. a slightly better job. If you're in We set up factories to design RR: You went from new a world that changes a lot like RR: Would you call that pri- and make clothes in India and recruit, to a company that the media, the organization marily a research-based Afghanistan. I had a house in didn't exist, to CEO in about really has to mutate and move process? each place. We sold our seven years. What were the quickly, and it requires strong TF: It was based on research clothes through a network of touchstones along the way leadership. That doesn't just and then looking at product showrooms here and in that led you to the point of mean leadership from me, but availability. But at the end of Europe and Australia. We did leading this company? a model where there is good the day it's about gut. There that for seven or eight years. TF: One of the good things leadership coming from a were one or two people stand- It was an excuse for me to live about being in a new company whole bunch of places. ing up, pounding the table, an adventurous life in Asia. in an industry that didn't exist saying this is a fabulous idea. is that no one knew what they RR: Why didn't you stay were doing. The people ahead “And I had this epiphany one day. there? of you often got fired because I was on a motorcycle in New Delhi. TF: Well, the U.S. put in place they usually did a few things It was 110 degrees, and some gas a system of quotas on textiles wrong. So it was easy to rise, and garments. Then the if you had your head up, if you from a diesel bus was blowing in my Russians invaded Afghanistan. were able to learn. In those face, and I said, ‘I’m out of here’.” And I had this epiphany one days, you'd go from a secre- day. I was on a motorcycle in tary to vice president in six New Delhi. It was 110 months. I was the marketing RR: How do you do that? You need people working for degrees, and some gas from a guy at MTV. Every time some- TF: There are five people who you who are passionate about diesel bus was blowing in my one would get fired, they'd give report to me, and there are the audience and have great face, and I said, “I'm out of me his job too. So then they maybe 15 people or so that instincts. here.” We had made and then put me in charge of affiliate report to them. And we talk a lost a lot of money, so I came sales, and I had never had a lot. I really believe we're a RR: Where do you find those back to New York with my tail sales job in my life. But we did bottom-up company. You kinds of people and how do between my legs. well, and then they moved me periodically will do a strategic you nurture them so they stay after a year of that to general plan that looks at how this around and don't move off and RR: So you get to Warner manager of MTV. Then VH1 world has changed, and to start their own companies? Amex Satellite Entertainment came along. And at this point, focus on, say, the Internet or TF: There is a sort of self- in 1980. That’s a pivotal year I’m only at the company four on international or on digital selecting process. You either for cable. USA Networks start- years. Then we were sold to services. find someone who is very obvi- ed, CNN debuts, Showtime Viacom and a lot of people left. ous, who is banging down your and The Movie Channel They made me co-president, RR: Can you give an example door. Or sometimes you just merge. What did you think this for no good reason. Then the of an idea that bubbled up find somebody you take a industry was going to be? guys who bought us got blown from below? Is Spike TV an chance on and you nurture TF: I was really lucky to get in out in a takeover battle with example of that? them; you allow them a certain when I did. There was a vision Sumner Redstone, and he TF: When Viacom merged amount of freedom. We have of an alternative television uni- came in and they made me the with CBS, they had two chan- 94 channels we run around the verse other than the three CEO. That was in 1987 and nels: TNN and CMT. TNN was world, so it's very decentral- broadcasters – based on cable I've just been there since. I the Nashville Network and the ized. Each is run by somebody rolling out across the country have a distinct lack of ambi- average age of those viewers who has a team under them, and the idea of narrowcasting. tion. When you have a good was 66. They wanted to make and they make most of their Almost all the incumbents said job, just keep it. it a general entertainment net- decisions. it would not work – the ad work like USA Network. That's agencies, the broadcasting RR: Reflecting back on the not what we do. So we decid- RR: I think a lot of people companies, producers. You almost 17 years now of being ed, look, there’s Lifetime and here are interested in how you had this melting pot of people, in charge of MTV, is there a Oxygen for women. It's under- manage a global company. none of whom had any experi- difference between running a standable to advertisers and What's the trick of globaliza- ence doing it. I was on the company and leading a cable operators. And there is tion in a cultural industry? development team of MTV and company? no channel for men. We TF: Coca-Cola can basically we all had a passion for music TF: If you were in a mature thought maybe we could make make the same bottle of soda and the belief that a network business, like you make the this a channel for men that and sell it everywhere. But in like this would work. We reflectors that go on stop would include everything from emerged at what became MTV signs, you could run the com- men's health and finance to continued page 8

Sternbusiness 3 sternChiefExecutiveseries

Carl Pascarella ceo of Visa USA

Carl Pascarella has been president and CEO of Visa USA since 1993. Mr. Pascarella attended the University of Buffalo and received a MS in Management from Stanford University. He worked at Bankers Trust and Crocker National Bank before joining Visa International in 1983, where he served as president of the Asia-Pacific region for a decade before being named CEO of Visa USA. With more than one billion Visa, Visa Electron Interlinked Plus, and Visa cash cards in the market today, Visa cards are the world’s most widely used form of plastic payment. In the past 10 years, Visa USA, owned by 14,000 U.S. financial institutions, and based in San Francisco, has seen its payments volume grow at a 17 percent annual rate, from $277 billion in 1993 to more than one trillion dollars today.

MCC: Visa is very different rules that we put in place. I making sure that Visa is avail- like American Express or First from most financial companies. report to a board of directors able 24 hours a day, seven Data. Those companies have Can you explain the Visa busi- that is composed of 14 mem- days a week, and that it never, to return funds to investors, in ness model? bers, representing 10 of the ever fails. For consumers, it’s the form of higher share price CP: One of the things that we major banks throughout the making sure we’re there any or dividends. never ever utter at Visa is the United States. At the same time they want to buy anything, word "association." We drive to time, our customers are these wherever they are, any way MCC: Who is your biggest a bottom line; we drive to same banks, and we regulate they want to buy it. And mak- competitor? Is it American make sure that our customers, them as well. It sometimes is a ing sure they have zero liabili- Express? MasterCard? whether they’re the banks or very, very complex arena to ty, so they don’t have to worry CP: At the risk of being the merchants or the con- operate in. about fraud. immodest, I don’t think so. sumers, are receiving value. One of the things that has We’ve moved market share for We are a for-profit. We’re made us successful is making MCC: How do you divide up the last five quarters against all responsible for, and are owned sure that we understand that the profits? competitors, against all product by, approximately 14,000 the needs of a bank like Chase CP: We take a majority of our lines. But since about 1994 or banks, and we’re all about are much different than the top-line income and reinvest it. 1995, we’ve really transcended delivering value to everyone needs of a smaller bank. And That’s why we’re able to bring being a credit card company. who is touching a Visa card, that the dynamics a merchant new products into the market; We’re going after cash and wherever they are. But the goes through are much differ- that’s why we’re able to look checks. And when you stop banks that govern us are also ent from those of a bank. over the horizon and perhaps and look at the way the pie is regulated by us. If you use our They’re interested in getting take a much more strategic divvied up today, we’re 54 per- brand or you use our systems, paid, and we’re guaranteeing look at the payments environ- cent of the payment systems you’ve got to abide by the that payment for them, and ment than other companies, market.

4 Sternbusiness Mr. Pascarella was interviewed by Michelle Caruso-Cabrera, co-anchor of CNBC’s Morning Call.

We’re 14 percent of the use this card because they in 2003 that allows companies MCC: You have a lot of expe- $12 trillion that American con- don’t take checks.” So it – instead of issuing paychecks rience in Asia. What are the sumers use to pay in cash and migrated from the education- – to issue Visa cards to their particular issues that you face checks every year. And that’s al side to a message of: employees and then just auto- in Asia in terms of Visa? the real market. We want to “Look how easy this is.” matically update them whenev- CP: The first time I went to displace cash and checks. er they’re paid. So many of the China in 1983, the Bank of Seven or eight years ago, the MCC: I want to take a step people in the United States China picked me up in what debit check card arena – debit forward. When you talk about that work don’t have a banking they called the red flag car – a cards that access your check- the revolution in the electronic relationship. These people black car with a red flag on it. ing account – was about 6 payments that you initiated have to stand in line, pay And there was one Chinese percent of our volume. Today and created, 10 years down user’s fees to get their checks hotel where I could stay. None they’re over 41 percent of our the road what does the land- cashed, and then have the of the Chinese could socialize total volume. So we’ve made scape look like? lack of security of walking with you individually. You significant inroads to make CP: If you go back 30 or 40 around with cash. Now they always had to be in a group. people aware that you can years ago, credit cards were get a card, the money is put And from the airport to down- access your checking account non-existent. Today you can’t onto their card, it’s safe, town Beijing, we never passed or your savings account rent a car, go into a hotel, or through a Visa card, and get buy an airline ticket without “But since about 1994 or 1995, that same level of service with- one. So it really is important we’ve really transcended being out having to write checks. for us to look at this $12 tril- a credit card company. We’re going lion and how it’s spent today, MCC: How do you teach a and how we can change the after cash and checks.” consumer to want something behavior to help the con- that didn’t exist before? sumers and the merchants secure, and they can use it a car. Now today, it’s gridlock. CP: The first thing we did was address this. We look at everywhere Visa is accepted, Then, everything was done at use the power of the Visa things today like automated or they can go to an ATM and the provincial level. We signed brand. There are two things payments and recurring pay- get cash, so they’ve got total an agreement with the Bank of that are sacrosanct at Visa – ments, we look at quick-serv- flexibility. China. Then we found out, our systems and our brand. ice restaurants. Those are the well, that’s good for Beijing, We had the capability to markets that we’re really MCC: How about the tech- but if you want to do any busi- expand our systems, to be going after very strongly right nology? ness in Guangzhou, you’d bet- able to offer a debit or a check now. And in 2003, the growth CP: About two years ago we ter sign the provincial leader, card product. Then the ques- rates were 100 percent plus employed Oracle and Sun because he runs the province. tion was: How to get folks to in terms of entry into that Microsystems to put in an IP There were no telephones change behavior? We started market. front end into our legacy sys- from province to province, so with educational advertising, tems. And so today, whether we had to put up a satellite to and it was two old men up on MCC: You’re talking about it’s a PDA or a cellphone, or do authorizations. The way we a porch in 1993, or ’94. One quick-service restaurants whatever the latest technology broke into China was to say says, “You know, I use this being willing to take the debit that Michael Dell wants to put “We can bring you a lot of for- card to access my checking cards? out, you can use that device eign income in terms of account.” And we walked CP: Yes, that’s right. And cred- and access your Visa account accepting Visa.” And they got through it. We wanted to make it cards, for that matter. And and exchange value. But we that right off the bat. The sure that everybody under- people being able to pay their are totally device-independent, Chinese are the most entre- stood that this was going to be utility bills, their mortgages, and we are able to route mes- preneurial people in the world, a universal product, that it was their health club and cable sages and information any- and I think we’re going to see safe and secure. Then there bills. It’s a great benefit for the where the parties want it to go. that as soon as the infrastruc- was a lot of collateral material consumer, because they don’t And that’s a significant break- ture is built. But you have to be that went out to the branches have to sit and write checks all through, because now we’re careful not to get too far ahead of the banks, and they did a lot the time. But the important only limited by our creativity. of the curve. of training at the branch level. thing from the standpoint of the We keep looking at this tag And then it got to be all merchant and the bank is that line all the time, “It’s every- MCC: How does it feel as a about the facility of the prod- it makes it a stickier relation- where you want to be.” We’re company to have essentially uct, and that’s when we ship. And today in the financial about ubiquity. People are changed the way monetary started doing the ads with services industry, the cost of more demanding today, they’re policy works around the Yao-Ming, Derek Jeter, and acquisition is so high, that smarter, they know much more world? I mean, have you Senator Bob Dole, who say, you’ve got to do everything to about technology. thought about that? “Hey, you know, they may retain every customer that you not know who I am, but I can have. We introduced a product continued page 9

Sternbusiness 5 sternChiefExecutiveseries

William Weldon chairman and ceo of Johnson & Johnson

William Weldon is chairman and CEO of Johnson & Johnson. Johnson & Johnson, founded in 1886 and based in New Brunswick, N.J., manufactures health care products, pharma- ceuticals, and medical devices. J&J, which has annual rev- enues of $42 billion, comprises more than 200 operating companies that employ more than 100,000 people and sell products in more than 175 countries. Born in Brooklyn, Bill Weldon graduated from Quinnipiac University, where he serves as a member of the Board of Trustees. He joined J&J as a sales representative in 1972 and, after a 30-year career at the company in the U.S., Asia, and Europe, rose to become the sixth chairman in the company’s history in 2002.

MCC: This is a wonderfully Scientific has another drug- and we lost a lot of the mar- There are literally thousands of timed opportunity. Johnson & alluding stent, which may get ket. Then we came out with products you have to synthe- Johnson was the lead story all approved shortly. Today the the drug-alluding stent, which size in the lab to do so, and day on CNBC, because it deal we signed was with has really taken the world by only one out of every three signed a big deal with Guidant. another maker of stents, storm. And it’s continuing with products that comes to market Tell us about the stent wars Guidant, which has excellent this acquisition. pays for the investment made and about your deal with delivery systems. Putting in it. You could argue it costs Guidant today. these two top companies MCC: Your entire industry has $800 million to a billion dollars WW: A stent is a small device together will be an advance for really been under siege. to bring a drug to market in 10 that is inserted into the aorta to patients. People ask why we can’t get years. And the actual time in keep it open. It was a huge cheaper drugs from Canada. which you can recoup your medical breakthrough about six MCC: All day long we’ve Do you feel drug companies investment is shortening every or seven years ago, and J&J talked about how Johnson & are being treated fairly? year. I think the investment is actually developed the technol- Johnson was moving higher. WW: I don’t think there is a really to help patients and to ogy. It’s a huge and growing What’s it like to be at work on really good understanding of bring these significant break- market, because stents really a day like that? the drug industry. At J&J, about throughs into the marketplace. help eliminate a lot of heart WW: It’s fun. Innovation is 50 percent of our volume is in You have to put it into per- attacks. Recently drugs have what it’s all about. Whether drugs, about 35 percent is in spective – namely that these been put on the stents, which it’s in devices, or drugs, or devices, and the rest is in con- drugs are having huge keep the aorta open longer. consumer products. We were sumer products and diagnos- impacts. If you take choles- For about the last nine or 10 the first company that came tics. I don’t think people appre- terol-lowering drugs, and you months, J&J had the first drug- out with stents, but very ciate the amount of time and look forward, you’re going to alluding stent, with a drug quickly other companies energy and cost that goes into eliminate a lot of open heart named Sirolimus on it. Boston came out with better stents, bringing a drug to market. surgery. With stents, you’re 6 Sternbusiness Mr. Weldon was interviewed by Michelle Caruso-Cabrera, co-anchor of CNBC’s Morning Call.

going to eliminate open heart broad breadth of businesses we just didn’t feel the cultures what we have today, as far into surgery, which is tens of thou- and such global opportunities. were compatible. You never the future as you can see. sands of dollars of cost that will I started as a sales rep, then get all 12 of them, but we go be taken out of the system. worked in New York City, then through them and then assess MCC: A lot of companies got went into the home office and the returns we expect to see rid of their consumer products MCC: What do you do as a worked through various jobs. I over time on a financial basis. divisions because they wanted CEO to try to deal with that? then went overseas, and I We don’t go in with the atti- to be pure-play pharmaceuti- WW: We try to talk to people spent time in Asia for about tude that we’ll buy a company cals or device companies. and try to explain the invest- four years working for groups and throw everybody out on Johnson & Johnson didn’t. ments that are necessary. We of companies. I went to the street. We bought a com- Why not? work with the government and Europe, then came back to the pany called DePuy in 1998 that WW: We see real value in we work with payers to help U.S., worked in a device busi- was a leading orthopedic com- being broadly based. If you them understand. And of ness and ended up back in pany. We took our orthopedic look back, there have been course we work with patient pharmaceuticals. Then I company and merged it with periods of time where con- groups. If someone is a dia- moved into the office of the DePuy. The reason you want sumer products are more high- betic, she doesn’t want us to ly valued and pharmaceuticals stop spending in research “I don’t think people appreciate are down, and then devices and development on new the amount of time and energy and come up. So having a mix of medicines. cost that goes into bringing a drug businesses provides some sta- bility. And if you fast forward MCC: You started as a sales to market. There are literally and look into the future, you’ll rep at McNeil Pharmaceuticals thousands of products you have to see a convergence of skills more than 30 years ago, and and technologies. We’ve got a now you’re the CEO of synthesize in the lab to do so, and stent called Cypher that really Johnson & Johnson. only one out of every three products came as a result of an engi- Essentially, you’ve been at the that comes to market pays for the neer working in our device same company for 30 years. business and a scientist work- Why do you think you got to investment made in it.” ing in our pharmaceutical busi- where you are now? ness. Even our consumer busi- WW: In every opportunity chairman. I think I’ve moved to acquire companies is ness is becoming so much you’re given, you do the best 13 times, and I’ve had I don’t because they’re great compa- more dependent upon science job you possibly can. I think too know how many jobs. You can nies. So why would you want and technology. We’ve moved many people have their sights do everything within a compa- to gut them and get rid of scientists from our pharmaceu- focused on what’s the next job, ny like J&J, or a company like them, other than to get cost tical business into our con- and they forget to do the best General Electric. synergies? sumer businesses. We have a job where they are. It’s doing a company called Aveeno, which little bit extra, it’s trying to look MCC: In the last 10 years J&J MCC: About half your profits is based upon natural ingredi- at new programs, new opportu- has bought 52 businesses. come from pharmaceuticals, ents. The scientific work on nities and capitalize on them, How do you determine compared with consumer natural ingredients has been and to take advantage of whether or not you’re going to products and devices. Is the able to expand that business. everything that’s put before buy a company? mix going to stay this way? you. WW: We have about 12 crite- WW: Ten years ago, consumer MCC: There are three CEOs ria. We’re in health care, and was the biggest piece and on trial this week in New MCC: Do you think being at we’re going to be in health pharmaceuticals were the York City: Martha Stewart, the same company for three care. We look at the products smallest. Because of the tech- John Rigas and Dennis decades is a good idea for the company has; are they nological advances and the Kozlowski. Any thoughts on Stern students? compatible with our products? growth of the market, pharma- that? WW: I think it’s a great idea, And is it going to take us into ceuticals have grown to WW: It’s unfortunate that a few and obviously I’m biased. To be areas of new technology, new become the biggest part. The people try to take advantage of able to go into a company and product opportunities? We ask pharmaceutical industry is situations and then it gets build your career within a com- if it will accelerate our growth, growing at 15 percent and the extrapolated out into the pany is really extraordinary. both short and long term. We consumer industry is growing broader industry. I think it’s our You build a network, you look at the management and at 3 percent. Right now I think responsibility to build the repu- understand the workings of the ask if it is compatible with the devices are the fastest growing tation of business executives organization. At J&J, there are values embodied in the J&J segment of the health care up again. People who tried to lots of opportunities to move Credo. We’ve walked away industry, not just at J&J. I think abuse the system should be from company to company. from very good companies, we will probably have a mix punished, and I really feel for Few companies have such a with very good people, where that will be somewhat similar to continued page 10

Sternbusiness 7 continued from page 3 the entertainment world you really can't do that because most culture is local. When we went into Europe in 1987 we had a pan-regional signal. We didn't have the amount of homes to develop the scale to have specialized services in each country. The VJs were people who spoke English as a second language. That worked pretty well for a while because it was a novelty. But the local competitors really said we had to change our model. So we decided to regionalize and now we have 45 different feeds of MTV around the world.

RR: Do you have programming business than bringing in niche, there are a lot of great put in place in a bunch of other and leadership flowing some expatriates, except in online applications where you countries. Having a strong between or among these the early days when you want have more control over your brand in a world of endless units? Do you find great execu- to do what I call the DNA destiny and you can get start- choices becomes even more tives in France? transfer. ed with a lower base of capital. valuable. TF: Every general manager can pick and choose for MTV Audience Questions Q: I am employed at MTV Q: How about another technol- or Nickelodeon or VH1 whatev- Q: I’m a part-time MBA stu- Networks and have been there ogy trend: music downloading er they want on the worldwide dent and a full-time employee for five years now and am a and Napster? part-time student. I’m curious TF: We believe that that busi- “We have 94 channels we run around to hear your thoughts on some ness is about to rationalize and the world, so it’s very decentralized. of the threats that we currently become a viable pay business. Each is run by somebody who has a face with the emergence of The turning point was with team under them and they make digital cable? iPod. We didn't want to be the TF: On digital cable, we're try- first one in there because for most of their decisions.” ing to be at the forefront. I look the last several years there to the U.K., which is the testing have been so many failed feed. In doing so, they get to of your sister network, ground. There are 28 music technologies. I didn't want to know each other. On the man- Showtime Networks. When we channels in the U.K., if you can attach our brands to one of agement side, outside the look at the consolidation in imagine that, and we have them early. In the next few United States, there is a great both programming and distri- about 11 of them. What we've months, we are probably going interchange of people moving bution, what advice would you done is basically do brand to announce a music subscrip- from region to region. I've been give to your 26-or 30-year-old extensions or bring in new tion/downloading service. disappointed continually in the MBA student who would like to brands. And they capture States by the number of people start their own MTV one day? about 65 percent of the viewer- Q: It seems the record indus- who are here who don't have TF: Most of the good ideas ship and the lion's share of the try is not really signing and any interest to leave. I always are taken for television net- money. Despite all this compe- willing to promote new artists. think, God, I'd be banging on works where the economics tition, we’ve been able to Where do you see the music the door. Send me to are such that you could actual- increase our market share, industry and MTV headed in Singapore or somewhere. What ly make money from advertis- increase our overall ratings, breaking in and promoting new I do find is you're probably bet- ers and distribution. If you and increase our business. artists? ter off having locals run your have great ideas for a real That's a strategy we're set to TF: There is all this talk that

8 Sternbusiness “In those days you’d go from a secre- sleeve in the overseas environ- win in the market, or win at tary to vice president in six months. ment, and come back and run what you're doing, or enjoy the a bank. I went over there for people that you're working I was the marketing guy at MTV. Visa, and it was in disarray. with, I think you're missing the Every time someone would get fired, We had markets where Diners boat, because life isn't a dress they’d give me his job too.” Card had more market share rehearsal. That's very, very than we did. When I look back, important. the music industry is down at the same place for so I have got to be one of the When I was at Stanford a because of downloading and long? most fortunate individuals in professor of organizational file sharing. I think it's fair to TF: I guess I traveled around the world, because you are behavior told a bunch of us, say one of the reasons the for a long time because I able to change the way people “You folks kill me. You've spent music industry is down is never really – and this live. With that comes such a all your time on economics, on because the willingness of sounds like a real cliché – “Today in the financial services labels to take chances and found myself. I came into this nurture artists isn't what it company and all the things I industry the cost of acquisition should be. Bob Dylan had six love are here. Just when it's is so high, that you’ve got to do albums out before he had a hit getting boring, there is a new everything to retain every single. That wouldn't happen thing that keeps your interest customer that you have.” today. You'd be dropped after – new services or going inter- two albums if you don't have a national or starting a huge hit single, and that's unfortu- online operation. I just think huge responsibility, not just statistics, on policy, on nate. I see the record industry I'm still in the middle of the personal, but also corporate as accounting. Those of you that as mutating, surviving, and things I love. I work with a well. Because if you misstep, are going to end up running actually I see good days great team of people. And I and if you just try to get num- businesses, you're going to ahead for it. It’s going to be get all these free CDs all the bers, and if you get egotistical hire economists and CFOs and easier in many ways for inde- time. about this thing, it can blow up IT people and statisticians. But pendent labels to get started in your face at any time. what it's all about is motivating online and to market and mer- people; it's getting to know chandise and promote their MCC: How about one piece of people.” That was one of the continued from page 5 artists to consumers. advice for these folks to close? best pieces of advice that I CP: I have. And you know, I CP: I think the most important ever got. Don't lose the human Q: You went from exploring the joined Visa for all the wrong thing is to be passionate, and side of business, don't lose the world to 17 years in the same reasons. I had been with to really and truly love what organizational side. Because if position at the same company. banks, and I wanted to get a you do. And if you don't really you do, you're only going to get What makes you want to stay couple of chevrons on my want to get up every day and so far.

Sternbusiness 9 “And if you don’t really want to does Visa assist its member me all the time: “We've got get up every day and win in the banks with securitization 112,000 people. It's the size of market or win at what you’re efforts? a city, and there's crime in the CP: With securitization, you’re city.” At J&J it really does tie doing, or enjoy the people that selling the risk. And it's done a back to our Credo and the val- you’re working with, I think great deal in order to grow the ues embodied in that. you’re missing the boat, because business. But there are a lot of MCC: One of the results of life isn’t a dress rehearsal.” contingencies that go along the scandals has been the with this. The quality of the Sarbanes-Oxley law, which Audience Questions people that load their Pay-Pal portfolio has got to be main- creates more regulations and Q: I would assume that credit account load it with a Visa tained at a certain level. If you mandates that CEOs sign off cards are a terrific target for card, and so that's volume have a downturn in your credit on corporate earnings reports. counterfeiters and criminals, that we get on the front end. quality in your portfolio, you've Does it make you nervous? given the high value associated With our relationship with got to replace those accounts, WW: No. We go through half with them. What's Visa doing to Yahoo! and Amazon and all of or you're going to have a capi- a day with internal auditors stay ahead of the curve in secu- the leaders in the Net, we tal call. So we help in terms of and our legal people to make rity? certainly are aware of what's making sure that a portfolio is sure that what we're signing CP: We've spent hundreds of going on. Is it essential that up to speed. is as accurate as it can be. millions of dollars in terms of we look at the $2 or the 20 You have to have confidence what we call “neural network- cent transaction? It isn't. But Q: In terms of emerging in the people that work for ing.” Today, we can recognize what is essential is that the markets, how do you balance you. I keep going back to the aberrant behavior at the point consumer is protected, and the decision to go into these Credo. It's been around for 60 of transaction. So if you have that we work with these markets when you know that years. It's an extraordinary never come to New York or aggregators to make sure that risk exists? document. And we do prac- you've never gone to a jewelry they are protecting the con- CP: You make sure that the tice it. J&J holds that the ante store, we'll at least stop that sumers. systems infrastructure is there to play in the game is the transaction and ask the mer- before you do anything. value system that we have. chant to do a little bit more Q: You talked a lot about Because if you can't handle We have to deliver results, checking. And the consumer business, but you didn't mention an authorization, and you but never at the cost of the response to that is very, very what kind of person you are. can't clear and settle the values. positive. We're launching, as What were the personality account to get the payment, we speak, the advanced traits that made you what you it's not going to work. And Audience Questions authorization system, which is are now? then you've got to work with Q: I have a small Internet going to let banks put further CP: You know, you look back the regulatory agencies that company called E-Health- information into the authoriza- on your childhood and early are there. You might go in Care Solutions. How do you tion. In terms of hacking, we've jobs, but I think the most with a debit card, or a secured think the Internet is going to got very, very strict rules in important thing is to have card first. You don't go in and impact marketing and adver- terms of who has our data and confidence. To be sure you give lines of credit to people tising going forward? And how whether or not it's encrypted. know who you are and what that don't understand how to many hours a week do you And we always make sure, you want. You've got to be use them. personally spend on the above anything else, that the able to make that tough call. Internet? fire walls are up and that we’re You know, it was a tough call WW: Consumers are using always ahead of the curve in going to Asia in 1983. I had the Internet to learn things continued from page 7 terms of fraud risk and credit been to Asia three times in about our products, and I risk. my life. And I had enough the people who were secre- think they need to be confidence at that point in taries and janitors – people informed. We don’t want to Q: What kind of threat do you time to say “That’s an oppor- whose whole lives were usurp the professional's see from companies like Pay- tunity, I want to do that, and I dependent upon these organi- responsibilities but we want Pal, which are doing electron- will succeed.” zations. I think that we have a consumers to be able to have ic payments? moral and ethical responsibility an intelligent dialogue. My CP: Pay-Pal and other aggre- Q: Can you talk about how to try to do what's right. I'm not own personal use is very min- gators are certainly interesting securitization has affected the saying J&J's perfect, because imal. I have a 26-year-old to us. In a lot of cases, the credit card industry? And how as our general counsel says to son, who spends an extraordi-

10 Sternbusiness people came to J&J because of the values. Our reputation is the most important thing that we have.

Q: I’m an employee of J&J and a first-year student. In our first class on ethics, I find that a lot of what I add to the discussion is the Credo-based decision- making. I wonder if you can articulate or discuss some examples where you resolved that conflict between fiduciary responsibility to the sharehold- ers and making Credo-based decisions. WW: I think the best example is Tylenol. The Credo of J&J says first and foremost, patients, people use your products. That's who you take care of. Second are the employees and making sure that employees are treated nary amount of time on the best deals. As every company WW: Motivation is personal. I with dignity and respect. Third Internet. When I want to find does, we've got a whole organ- think it comes down to treating is the environment we work in. something, I just either ask ization down in Bentonville, people fairly. And you need to The fourth thing is, if you do him or my secretary. But I have Arkansas working with Wal- have a sense of urgency. It's those three things, then to admit, I'm Internet illiterate Mart. In 2003, our consumer by and large. business had its best year in “I keep going back to the Credo. the past decade. And I think a It’s been around for 60 years. Q: I'm a first-year student at lot of it has been this move- It’s an extraordinary document. Stern, and I'm going to be ment away from consumer ori- And we do practice it.” interning in your personal ented products that don’t differ- products company. What are entiate themselves in the mar- not the old management style there's a fair payback to the some of the main challenges ketplace. Neutrogena, one of of beating people over the shareholder. When we had the you see in the consumer our companies, is making huge head. You have to support Tylenol poisonings, we pulled products business? advances in the area of them. You've got to give them all the Tylenol off the market. healthy skin and healthy hair. I the tools to be able to do their We'd never even discussed “I think I’ve think Neutrogena is the most job. You've got to make sure the financial implications. The moved 13 times, highly recommended product that there is fair recognition. I Credo actually allowed us to and I’ve had I by dermatologists, and that's think the other thing that is crit- make that decision very clear- because we have a profession- ical, and it is embodied in our ly, to see that this was in the don’t know how al group going to dermatolo- Credo, is treating people with best interests of the people many jobs. You gists who are recommending respect and dignity. I recently that consumed our products. can do everything these products and are creat- asked our public relations peo- Obviously, Tylenol has come within a company ing value in the market place. ple to get together people back, and it's a huge brand, like J&J.” under the age of 30 who have probably one of the biggest Q: How do you motivate all been with the company for less brands out there today. WW: There's a lot of consolida- of your employees across than five years. I was tion. Companies like Wal-Mart the different divisions and impressed at their commitment are pushing, looking to get the companies? to the Credo and how many

Sternbusiness 11 BRAND

here are comparatively few global brands, utive’s resume. But you words that in a syllable or two can evoke a don’t have to be a crimi- symbol, a product, or a feeling for billions of nal to get branded nega- consumers. One of those is Visa. Plastic may tively. Serving as an have symbolized something artificial and executive or a director Teven boring to a prior generation. (Remember the scene at a failed public com- from The Graduate in which Mr. Robinson advises the pany can stigmatize a young Benjamin to go into plastics? He recoiled in horror.) mature professional for But today, when money is as likely to change hands in the life. But not all are form of bits and bytes as it is in bills and coins, plastic branded equally, say means real business, and growth. And Visa, whose logo is Batia M. Wiesenfeld, recognizable the world over (it helps that it’s seen on stick- Kurt Wurthmann, and ers on pretty much every retail outlet from Bangkok to Donald C. Hambrick in Bangor, Maine) has played a significant role in this evolu- “The Scarlet F” (p. 18). tion. “We want to displace cash and checks,” declared Visa The comeuppance boss- USA CEO Carl Pascarella (p. 4). “There are two sacrosanct es suffer after being things at Visa – our systems and our brand.” involved in business MTV is another one of those brands that functions as a debacles is a function of sort of global shorthand. And even in a universe of hun- many factors – ranging dreds of channels, Tom Freston, co-president and co-chief from the severity of the operating officer of Viacom (p. 2), sees opportunities. mishap to the number of “There are 28 music channels in the U.K., if you can imag- friends and connections ine that, and we have about 11 of them,” said the Stern an executive possesses. alumnus, who had been with MTV since its inception. “The greater the social capital of an elite associated “What we’ve done is basically do brand extensions or bring with a failed firm, the less the stigmatization he or she in new brands.” will experience,” they conclude. Brands can get hurt by a range of external factors – vig- or investors, it would be great to know orous competitors and technological breakthroughs, which executives are going to fail and be malevolent vandals or unfortunate accidents. But no blow stigmatized in advance. It would have been is so damaging as a self-inflicted one. Exhibit A: Martha F great to know that Enron’s top brass would Stewart. The domestic doyenne hurt her reputation – and be indicted. But how are shareholders to know? that of her eponymous company – by getting caught up in Analysts haven’t yet developed stock-picking tools an insider-trading investigation. Convicted in March of that screen for possible fiascos. However, David lying to investigators, both Stewart and her company face Yermack has identified one aspect of CEO behavior an uncertain future. But it didn’t have to be that way, says that points to potential underperformance of their Peter N. Golder, in “A Very Bad Thing” (p. 14). By seek- stocks. In his article, “Flights of Fancy” (p. 30), ing to become more than the sum of Martha’s many parts, Yermack examined the frequent flying habits of CEOs the company could have “developed an impersonal brand over a 10-year period. He found that “shareholders that was synonymous with a certain lifestyle – stylish, aspi- react negatively to the news that CEOs are using cor- rational, and up-scale.” Instead, the name is synonymous porate jets.” And with good reason, it turns out. “The with an altogether different lifestyle: prison inmate. And, shares of companies whose CEOs use private aircraft no, there’s no truth to the matter that her next magazine underperform the market by more than 400 basis will be entitled, This Old Big House. points a year.” A felony conviction stands as a black mark on any exec- One of the sectors where brands matter most –

12 Sternbusiness EQUITY

where people pay the highest place that isn’t going to treat you right, especially when premium for goods that have there are so many options – online and offline. But a positive image in the con- there’s a trick. There are different ways retailers can sumers’ mind – is in luxury offer help to shoppers, and the relative effectiveness of goods. What makes one pair “different” has to do with psychology, expectations, and of shoes worth $500 while feelings. Eric A. Greenleaf, Vicki G. Morwitz, and another, with many of the Russell S. Winer investigated the varieties of help online same components, costs and offline and conclude which are most effective in $39.99? Brands help explain their article, “Helping Hands” (p. 42). Their conclu- a lot of the difference. In sion: Customers don’t always want to hear the words: “What Makes Rolex Tick?” “Can I Help You?” Like Greta Garbo, some prefer to be (p. 24), David Liebeskind left alone. And online and bricks-and-mortar shopping tells the story of how one are two different worlds. “Since web shopping involves Swiss watchmaker manages consumer experiences that are very different from store to hold onto its position with shopping, it is not clear that help strategies that work the regularity of, well, a fine- well in face-to-face retail encounters will work well on ly made timepiece. The the web.” “largest single luxury watch or most brands, success means avoiding brand” has pursued a strate- controversy. Nobody wishes to offend a gy of continuity, limiting potential customer, after all. But two of the production, and zealously biggest brand names in financial services – keeping watch not just on Fannie Mae and Freddie Mac – are quite how the watches are made, controversial.F The two companies, which occupy the but on how they are sold. “The crystal prism that indi- not-so-neutral ground between the government and pri- cates a store is an ’Official Rolex Dealer’ is highly vate sector, have grown into massive forces in the hous- prized,” Liebeskind notes. ing markets – and in the House and Senate in olex has been careful not to dilute its brand Washington. But they have faced questions about their by branching out into unrelated areas. (You accounting, influence, and relationship to the govern- won’t find Rolex shoes and socks in ment. Lawrence J. White, in “The Trouble With Fannie Bloomingdale’s.) And for many brands, a and Freddie” (p. 36), thinks some reform is necessary, singular focus on a single product or group and that the companies would thrive as purely private of products is the key to success. But entities. “Given their substantial brand names and their RJohnson & Johnson – which houses as many great brands impressive collection of human and intellectual capital, as the Yankees’ dugout houses all-stars – has followed a they would likely continue to innovate and prosper,” he different tack. Over the years, J&J has built up three writes. broad lines of business: consumer products, pharmaceu- One of the great things about a magazine is that it ticals, and medical devices. William Weldon, the CEO of offers readers the opportunity to dip into the content at Johnson & Johnson, argues that the diversification pro- their own leisure, and on their own terms. And this issue vides ballast for a giant ship. “We see real value in being of Sternbusiness is full of unconventional wisdom about broadly based,” said Weldon, who has spent his entire the use and misuse of brands. All readers will find 30-year career at J&J. “Having a mix of businesses pro- plenty to sample. vides some stability.” (p. 6). One of the components of a brand, especially for retailers, is service. After all, why spend your money in a DANIEL GROSS is editor of STERNbusiness.

Sternbusiness 13 A Very Bad Thing By Peter N. Golder

After Martha Stewart’s conviction, the prospects of the company she founded

and built, Martha Stewart Living Omnimedia, looked bleak. By tying her per-

sonality so closely to that of the company’s many lines of business, Stewart and

her management team left the whole enterprise vulnerable. There’s plenty we

can learn from the rise and potentially avoidable fall of this brand icon.

14 Sternbusiness n March 5, 2004, Martha Stewart was convicted of conspiracy, obstruction of justice, and lying to investigatorsO who had been probing her stock sales in biotechnology company Imclone. Earlier that day, amid speculation she would be acquitted, stock in Martha Stewart Living Omnimedia (MSO) traded as high as $17. Soon after her con- viction, the stock sank as low as $9.25. The damage to the Martha Stewart brand cost her company 46 percent of its total value – or $433 million. Martha’s legal travails have been thoroughly dissected. But their impact on the company’s brand has received less attention. Did the company have to lose 46 percent of its peak value that day based on a single conviction? No. Did the company have a sound branding strategy in place at the time? No. Was there something the com- pany could have – and should have – done differently to avoid suffering such a huge impact as a result of Martha’s guilty verdicts? Yes.

Sternbusiness 15 A VERY BAD THING

In the Beginning nished.” As a result, management felt the company had developed an Martha Stewart’s ascent to there was a need to “evolve our impersonal brand that was synony- lifestyle impresario began with the brands – and reduce dependence on mous with a certain lifestyle – stylish, publication of her 1982 book our founder.” aspirational, and up-scale. The Entertaining. In 1991, she launched Unfortunately, there was never a Disney brand thrives today, nearly 40 Martha Stewart Living with the sup- serious attempt to implement such a years after its founder’s death, port of Time Publishing Ventures. strategy. The company continued to because it came to mean so much Throughout the 1990s, the indefati- practice the easy strategy of “All more than the person Walt Disney. gable lifestyle expert expanded into Martha, All the Time.” And so when Martha Stewart should have had several other businesses as she the guilty verdicts came in, the com- her company develop brands and dis- became a television star and syndi- pany was seriously wounded. And in tinctive values that transcended her cated columnist. In 1997, she bought the wake of the verdict, many openly alone. It’s likely that the astonishing her freedom and the rights to all of wondered about its long-term sur- success of MSO’s personal-brand her businesses from Time Publishing vival. approach blinded the company to the Ventures for $53 million. In short longer-term potential of the imper- order, she launched a website, a radio “The company continued sonal-brand approach, in which the program, and more television pro- to practice the easy company is tied more closely to key gramming. Most important, she strategy of ’All Martha, attributes than a single person. The began selling licensed merchandise All the Time.’ value of these key attributes would through K-Mart. When her company And so when the guilty likely have stood the test of time went public in 1999, its assets were much better than the value of one verdicts came in, impressive: two magazines, Martha individual. Even if Martha Stewart Stewart Living and Martha Stewart the company was had not committed crimes, it’s likely Weddings; two television programs, seriously wounded.” that her personal appeal would have the syndicated “Martha Stewart fallen out of fashion eventually. Living” television show, available in Developing Long-term So, what prevented MSO from 90 percent of U.S. homes, and “From Brands implementing an impersonal brand- Martha’s Kitchen” on the Food Branding is primarily about own- ing strategy, when the company Network; Martha Stewart’s 27 books; ing a distinctive and valuable spot in acknowledged that it was important the askMartha radio program, reach- your customer’s thought. One simple to do so? Perhaps the early success of ing 1.5 million listeners each week- approach to achieve such distinctive- the company fed the hubris of its day; the askMartha syndicated news- ness is to develop a personal brand. founder and fostered a cult of per- paper column, reaching 43 million Essentially, a unique individual sonality within the company. Or per- readers each week; a website, imbues the brand with all of her per- haps Stewart and her management MarthaStewart.com; and licensed sonal characteristics. Yet, as MSO team simply didn’t know how to shift merchandise, including bed and bath acknowledged back in 1999, this easy towards a less personal branding products, paint, furniture, and gar- strategy risks sudden demise if that strategy. den tools. person’s reputation is damaged. By From the beginning, MSO was contrast, the harder yet more endur- Missed Opportunities always about Martha Stewart. All of ing way to develop a distinctive brand There are a series of integrated the key assets of the company depend is to start by identifying the attributes steps that MSO – or any other com- on her persona and her brand name. that your customers value. Then, if pany – could take to build an imper- Early on, the company recognized the company can perform on those sonal brand portfolio. this singular focus as a potential lia- attributes and communicate that per- First, determine the attributes bility. The prospectus for its 1999 formance, customers begin to associ- that deliver value to your customers. initial public offering filing noted ate your brand with those attributes. Then, based on the company’s cur- that the “business would be adverse- Differentiating Martha Stewart as rent strengths and strategy, decide ly affected if Martha Stewart’s public a personal brand was relatively easy. which attributes you want to own, image or reputation were to be tar- But it would have been much better if and devote resources to capture

16 Sternbusiness them. Just as FedEx is tied to reliable “The best future oppor- television program would take a hia- overnight delivery, and Disney is tied tunities to diversify are tus for the 2004-2005 season. to family entertainment, MSO could likely to be with The impact on magazines is sub- have tied itself primarily to stylish, licensed merchandise, stantial, but not quite as bad as tele- aspirational, up-scale living – much vision. Earlier this year, Martha as Ralph Lauren has done. Then, its because the appeal Stewart Living reduced its guaran- efforts could have been directed of these products has teed circulation from 2.3 million to toward reinforcing associations with relatively more to do 1.8 million. Even more important, these attributes, rather than associa- with the products them- advertisers fled. Total ad pages tions with Martha Stewart. This selves than with Martha dropped from 1,887 in 2002 to 1,234 approach creates value in a company, Stewart the person.” in 2003. While the impact on mer- rather than value in a personal chandise has been minimal thus far, brand. sented another opportunity for devel- it’s likely that a reduced media pres- Second, adapt brand names over oping sub-brands. With such a wide ence will eventually lead to lower rev- time. As one example, the magazine variety of licensed merchandise, dif- enue here too. Martha Stewart Living could have ferent attributes are relevant for dif- MSO has to hope that eventually been re-titled Living by Martha ferent products. Therefore, the com- its branding strategy can take prece- Stewart, and eventually just Living. pany could have developed brands dence over Martha’s legal strategy. Over time, Living could have been for different groups of products: one Even now, the Martha Stewart brand tied to those attributes the company brand for kitchen products and a sec- is likely the most valuable asset of the wanted to own. Then, should Martha ond brand for bed and bath products. company. Thus, it has to hope that Stewart “the person” encounter Over time, these sub-brands could Martha Stewart the person can help problems, Living “the brand” could have been converted to primary to revive Martha Stewart the brand. live on. Advertisers wouldn’t have brands. Whether or not her convictions are run from a magazine called Living as upheld, Martha Stewart must find a quickly as they ran from a magazine Now What? way to re-connect with her customers named for a convicted felon. From the time it went public in in a way that incorporates and sub- Third, introduce sub-brands (part 1999, MSO realized the importance sumes these legal events into the 1). In MSO’s magazines and televi- of moving away from Martha Stewart public’s broader perception of her. sion shows, it would have been very the person. Unfortunately, it now For Martha Stewart herself, the easy to introduce guest experts in a faces the task of doing so, out of optimal strategy is to continue to variety of areas – gardening, cooking, necessity, and with a dramatically fight the legal battle. Yet, this person- decorating, etc. The best guest weakened brand. The best future al strategy is at odds with the best experts could then have been turned opportunities to diversify are likely to brand strategy. The right brand into regular features. In the best-case be with licensed merchandise, strategy will likely incorporate scenario, some could have even been because the appeal of these products acknowledgment of her conviction, spun off into their own television has relatively more to do with the contrition, and an appeal for forgive- shows and magazines. And MSO products themselves than with ness. The sooner this strategy is could have owned the rights to these Martha Stewart the person. In con- implemented the better. Then MSO new properties. Of course, such a trast, the media properties, especially can begin to diversify its brand port- strategy would have been a big diver- television, are much more closely tied folio from the strongest possible base. gence from “All Martha, All the to Martha Stewart herself. After the People may be willing to wait to for- Time.” In contrast, Oprah Winfrey’s verdict, stations dropped her televi- give the person, but they won’t wait success in launching the Dr. Phil tel- sion shows and newspapers dropped to forgive the brand. evision show demonstrates how such her columns. The flagship television a strategy could have been imple- PETER N. GOLDER is associate professor program went from reaching 90 per- of marketing at NYU Stern. He wishes to mented. cent of U.S. households to only 50 thank Alina Dijur, MBA ’04 and Cecilia Fourth, introduce sub-brands percent. More recently, the company Dones ’04, for their research assistance (part 2). Licensed merchandise pre- announced that her main syndicated in preparing this article.

Sternbusiness 17 THE SCARLET

18 Sternbusiness Executives and directors associated with corporate failures can get branded for life. But the stigmatization process is not always rational or efficient. Why are some executives tarred with failure while others seem to be Teflon-coated?

By Batia M. Wiesenfeld, Kurt Wurthmann and Donald C. Hambrick

When companies fail – because of misjudgment, misdeeds, or even bad luck – leaders’ names and rep- utations stand to be indelibly smeared. They get fired and have a hard time finding work elsewhere. Those who do get rehired tend to do so in lesser capacities or at smaller firms. It is difficult to imagine Dennis Kozlowski of Tyco or Jeffrey Skilling of Enron ever working again. Even executives who have been labeled as simply bad managers, such as Jill Barad of Mattel, become marginalized. For CEOs who get branded with the Scarlet F – for failure – it’s all part of the “settling-up” process. Settling-up is an essential, but often overlooked, premise of agency theory developed by University of Chicago finance professor Eugene Fama. Corporate owners (principals) can rely on the fact that managers and directors (agents) will be motivated to do their very best by the prospect of future adjustments to their compensation – adjustments, or settling-up, that will be based on prior performance. Executives who perform well build good reputations and get better jobs and higher pay in the future. Meanwhile, the markets dis- seminate word about the failings of those who perform poorly, and their prospects are accordingly diminished. But the settling-up process for corporate elites can be exceedingly imprecise. Peter Lynch, the investment guru and vice-chairman of Fidelity Management and Research Company, was a director of two of the most visible corporate collapses of the 1990s – Morrison Knudsen and W.R. Grace. Yet his name was rarely invoked in conjunction with these failures, and he went on to enjoy great acclaim after their occurrence. And sometimes corporate leaders are penalized far out of proportion to their culpability. Lloyd Ward served as CEO of Maytag for only 15 months. He was replaced in November 2000, after being blamed for the 59 per- cent drop in Maytag’s share value; he lost prestigious corporate directorships and has not found a compara- ble position. But Ward served at Maytag during very difficult times for the appliance industry. And Maytag’s performance was worse under some other CEOs who somehow avoided stigmatization. ILLUSTRATIONS BY KEN ORVIDAS ILLUSTRATIONS

Sternbusiness 19 THE SCARLET F

ow is it that some elites ure. This loss may be abrupt or The stigmatization of leaders can be who are associated with gradual. It may be attributed to driven by other voices: investor failures avoid paying business misjudgment or to ethical advisory services and newsletters; H much professional price, misdeeds that impair the firm’s watchdog groups, such as the while others – who, on the surface, legitimacy. It may be large enough Council of Institutional Investors; seem no more or less blameworthy – to send the firm into bankruptcy or and academics, who often focus face the end of their career? simply enough to wipe out a signifi- their attention on a company’s lead- It turns out there are many fac- cant percentage of its value. ers when performance declines. tors – economic, social, and psycho- When a company fails, those The business community may logical – that influence the amount whose professional identities are join in the stigmatization process as of professional devaluation that a closely tied to the organization are well. Peers and business acquain- affected – particularly its tances may withdraw their contact officers and directors. because of the negative portrayals Professional identities are from other quarters. Company “When a company fails, achieved through a social employees may speak vigorously to those whose professional negotiation process where- the press about the deficiencies of by the person and audi- the firm’s leaders in order to deflect identities are closely tied ence (or interaction part- blame and to reassure outsiders that to the organization are ners) interactively claim the source of the firm’s problems is and grant identity through gone. affected – particularly its words and actions both officers and directors.” symbolic and substantive. Professional Devaluation Ultimately, however an Stigmatization is emotionally elite’s claim to an identity painful, but it can be financially may be either supported painful as well. And the greater the corporate director or executive will or rejected by others, including the stigmatization of a corporate elite, face. We have constructed a model press, employees, business peers, the greater will be his or her subse- to describe the process. In this and others. quent professional devaluation. model, failure evokes a stigmatiza- hen a firm experiences Stigmatization leads to substantive tion process, whereby opinion- failure, a social negoti- devaluation through three interre- shapers discredit the professional ation process is mobi- lated conduits. First, the presence of identities of corporate elites. The lized through which a stigma is a signal of a person’s discrediting, in turn, triggers tangi- Welites’ professional identities are inferior abilities. Since labor mar- ble economic loss. The greater the revised. The elites leading the firm kets consider all available informa- stigmatization of corporate elites, are often themselves branded as fail- tion about candidates in arriving at the more unwilling companies will ures. This process bears the hall- appropriate wages, public informa- be to associate with them and the marks of stigmatization, whereby an tion about inadequacy would have a greater the professional devaluation individual is discredited and deni- negative effect on the elite’s employ- they will encounter. But the amount grated because a negative attribute ability and compensation. Second, of stigmatization the person is associated with his or her social firms tend to feel social pressure not encounters is shaped by a host of identity. to hire the stigmatized – especially factors. These include indicators of The media plays a particularly for leadership positions. Third, stig- a person’s responsibility for failure, substantial role in the stigmatization matized individuals are likely to cognitive biases that amplify or process. The business press fre- anticipate the reluctance of compa- diminish the assignment of blame, quently glorifies leaders whose com- nies to make them favorable offers, emotional biases, and the amount of panies are performing well, but then and so they may be unwilling to social capital the person possesses. disparages the same leaders if their present themselves as candidates for companies stumble. It is common future leadership positions. How Stigma Starts for press accounts of company fail- Stigmatization will be tempered The process starts after a precip- ures to emphasize the role of the by referent comparisons that shape itating event, a major corporate fail- firm’s leaders in corporate fiascos. observers’ expectations. Failures in

20 Sternbusiness healthy industries are And it’s better to be unexpected. As a result, incompetent than corrupt. they provide strong signals Elites accused of ethical of leader ineffectiveness misdeeds that lead to firm and contribute to greater failure will experience stigmatization. In con- greater stigmatization than trast, failures that occur in will those accused of busi- hostile contexts can be ness misjudgment. Ethical largely assigned to envi- misdeeds – insider trading, ronmental factors and fraud, misleading and dis- therefore result in less honest actions, sexual mis- leader blame. conduct, and abuse of Social psychological power – will be even more research suggests that stigmatizing than simple stigmatization is greater to lack of ability, because a the extent that observers willful misdirection of effort perceive that the individ- is far more controllable than ual was able to control or is a mere lack of skill. prevent the offending attribute. And so individ- ual-level factors such as Cognitive Biases an elite member’s position, Observers are not fully tenure, and actions will rational in how they view influence attributions of the influence of leaders on control and blameworthi- organizational outcomes. ness. Observers frequently engage For example, execu- in a “romance of leader- tives at failed firms experi- ship.” Even though corpo- ence greater stigmatization than do mation are better able to foresee the rate failures may stem from any outside directors. Outside directors’ consequences of their decisions and number of factors – including envi- professional identities are not actions. And those with greater ronmental jolts, long-institutional- strongly invested in the company on authority and individual power have ized structures and systems, even whose board they serve. Because greater control and ability to over- accidents – observers tend to blame their contact with the organization come resistance by less powerful leaders. and their access to information is opponents within the organization. he assignment of blame is limited, outside directors are not Tenure matters, too. The longer an interpretive process held to the same standard of in- an elite’s tenure at a failed firm, the rather than a black-and- depth understanding about compa- greater the stigmatization he or she white calculation. And ny affairs as executives. will experience. When executives likeT other stigmatizing stereotypes, Among executives, the higher you and directors are relatively new to a the act of blaming leaders is subject are, the harder you fall. Senior-most firm, the degree of control they are to bias. We anticipate that there are executives (CEOs, COOs, and able to exert over organizational two prevalent mental short-cuts, or CFOs) who are associated with outcomes is constrained. With time, heuristics, that shape observers’ failed firms experience greater executives and directors accumulate stigmatization of elites. stigmatization than do lower-level the information they need to The first is the availability executives of the firms. Increasing empower them to make important heuristic. People tend to view infor- hierarchical position in an organiza- decisions. Greater tenure also puts mation that comes most easily to tion brings increasing access to them at the helm over an extended mind, such as vivid and recent infor- information, formal decision-mak- decision-making period, giving mation, as the most reliable and rel- ing authority, and individual power. them more influence over both evant. As a result, it will be more Leaders with greater access to infor- strategy and performance. available in the sensemaking

Sternbusiness 21 THE SCARLET F

process. Social psychologists, for In addition to timing, size mat- firm failure. If a failed company is instance, have observed that people ters. Failures of large firms affect accused of using dubious accounting may be stigmatized merely by their many people – employees, cus- stratagems that resemble (even proximity to a negatively evaluated tomers, and suppliers. Large corpo- somewhat) the accounting strata- object or person – even if there is no rate failures are vivid because they gems of already notoriously failed apparent relationship between them. are relatively rare and surprising. firms – like Enron – then the focal nd so elites who are pres- When big companies fail, observers company and its leaders are readily ent at the firm during the are likely to conclude that serious placed in the same category as the visible phase of a failure errors in leadership must have earlier offenders. will experience greater occurred. And that increases In addition to the cognitive bias- stigmatizationA than those who observers’ tendency to attribute es, there are critical emotional departed earlier. Since these leaders blame to corporate elites. For exam- processes that cause stigmatization have to explain the failure event in ple, both Xerox and its much small- of elites to deviate from what might speeches, on television, in newspa- er competitor, Global Imaging rationally be expected. For corpo- per articles and formal announce- Systems, Inc., lost 52 percent of rate leaders, we can expect that ments, and sometimes even in for- their market value between May of schadenfreude – or pleasure in oth- mal testimony, they will be per- 1999 and May of 2000. The losses ers’ misfortune – will exert an emo- ceived to be much more closely asso- at Global Imaging received relative- tional influence on stigmatization. ciated with the failing firm than ly little attention. But Xerox CEO After all, schadenfreude is motivat- leaders who have already departed. Richard Thoman was widely and ed by observers’ desires to feel better By contrast, leaders who depart vehemently criticized in the press about themselves by comparing prior to a perceived failure do not and forced to resign after only a year themselves to less fortunate others. in office. And observers may obtain a feeling of justice in seeing the lofty brought Representativeness down to earth. “Elites who are present Bias he more that an elite’s Another heuristic asso- previous success and at the firm during the ciated with stereotypes status is viewed as visible phase of a failure is representativeness. undeserved, the more will experience greater Observers make judg- likely his or her pain ments, in part, by taking willT trigger schadenfreude. And so stigmatization than those into account the degree to the more an elite leader has been who departed earlier.” which a specific event cor- portrayed as ruthless or arrogant, responds to a broader cat- the greater the stigmatization he or egory of occurrences in she will experience upon firm fail- their minds. Instances that ure. For example, Al Dunlap openly serve as the human face of the firm in are representative of a broader cate- acknowledged his take-no-prisoners public forums in which the failure is gory of events will lead observers to style of leadership, including drastic examined, making them less avail- perceive that all of the features of layoffs at Scott Paper and at able in observers’ minds. For exam- the broad category apply to the new Sunbeam; he wrote a book about his ple, Gerald Levin, the CEO of Time instance, far out of proportion to the experiences entitled Mean Business. Warner, engineered the eventually actual degree of correspondence. Once Sunbeam’s performance began discredited merger with AOL. But he As a result, elites who have been to decline, those who observed the announced his resignation seven previously associated with other indifference he seemed to have months before a 59 percent collapse failed firms will experience greater about firing people were eager to of the combined company’s market stigmatization upon a firm failure help speed his fall from grace. value, and thus received far less crit- than will those without such prior Additionally, corporate elites who icism and stigmatization than did the associations. Observers will perceive are seen as selfish and greedy are other top executives who were pres- leaders who have been associated likely to inspire resentment. The ent at the collapse, notably former with past failures to be representa- greater an elite’s compensation, rel- AOL CEO Steven Case. tive of the category of causes for ative to peers and to others in the

22 Sternbusiness focal firm, the greater the stigmati- their minds that might zation he or she will experience justifiably absorb their upon firm failure. Observers may attention. What’s more, grudgingly tolerate high executive fellow elite members “High-status leaders will compensation when firm perform- often make the deci- be more likely to be excused ance is good. However, once per- sions through which for having many important formance falters, the appearance of tangible devaluation unfairness will inspire anger and occurs. When they feel things on their minds that indignation. Observers will take bound by the bonds of might justifiably absorb great pleasure in seeing such elites loyalty and friendship, their attention.” cut down to size. these elites will be moti- Elites who are associated with vated not to ostracize failed firms during periods of failed elites; and they macroeconomic malaise will experi- may be unwilling to ence greater stigmatization than impose the devaluation that other- style of humility, and even carry those associated with failed firms wise seems warranted. this philosophy over to his or her during periods of macroeconomic ndividuals who possess social pay package. vitality. In periods of widespread capital are also able to grant Ultimately, however, the fact economic trouble, many social favors to those upon whom that cognitive and affective biases actors will be dissatisfied with their they depend. These favors cre- play such an important role in the own lot, and comparing themselves Iate a diffuse, generalized commit- stigmatization and devaluations to less fortunate others may be ment among individuals through process throws into question the among the few available ways for norms of reciprocity. Such obliga- market efficiency of settling up. If people to derive a (perverse) form of tions may be “called in” when an some elites are not sanctioned to happiness. As the old adage goes, individual with social capital the full extent they should be – say, “misery loves company.” requires them, such as when his or simply because they are associated her career is at risk – thus providing with relatively obscure companies, Social Capital another countervailing force against or because they have a lot of social Some corporate executives and the effects of stigmatization. capital – other elites in similar situ- directors possess much more social Our elaborated model of settling- ations will implicitly be allowed to capital than do others. They may sit up has widespread practical impli- engage in unsound behaviors. On on multiple, influential boards, or cations. People need to be aware the other hand, if some elites are maintain close personal friendships that they are likely to face consider- punished more harshly than their with lots of influential people, or able career loss if associated with a behaviors warrant, then some tal- have prestigious educational and company failure. And they will seek ented individuals may be unwilling military credentials. These aspects either compensation or insurance for to become executives and directors of social capital can also function as this risk. Thus, some portion of the of companies. If leaders are unduly a stigma buffer. The greater the high pay that executives and direc- timid and risk-averse because they social capital of an elite associated tors receive can be thought of as fear failure and the stigmatization with a failed firm, the less the compensation for bearing extreme it brings, then investors and society stigmatization he or she will experi- career risk. Similarly, the fact that will ultimately pay the price. ence. elites may seek some form of insur- Executives and directors who ance for the event of their stigmati- BATIA M. WEISENFELD is associate have high levels of prestige tend to zation helps to explain the large sev- professor of management at NYU Stern. be perceived as competent, credible, erance agreements that executives KURT WURTHMANN i s a doctoral and trustworthy. Observers are have been seeking in recent years. student at Columbia University reluctant to view such individuals as Beyond building social capital, Business School. inept, careless, or self-serving. there are things an executive can do DONALD C. HAMBRICK is profes- Furthermore, high-status leaders to mitigate his or her eventual risk sor of management at the Smeal will be more likely to be excused for of stigmatization and devaluation. A College of Business Administration at having many important things on person may intentionally adopt a Pennsylvania State University.

Sternbusiness 23 What Makes Rolex Tick?

By David Liebeskind

he market for luxury Rolex has built and defended a Naples to be worn on the wrist. At goods is booming – strong position in the high-end London’s 1861 Crystal Palace locally and globally. In watch market. And it has remained Exhibition, Patek Philippe featured the U.S. alone, 2.2 independent even as many com- a watch with a diameter of only million individuals petitors have sought the shelter of 8.46 millimeters. have liquid portfolios conglomerates. Today, Rolex is the In the 19th century, England, ofT over $1 million. And tens of mil- largest single luxury watch brand, Germany, and France became early lions of less well-heeled consumers with revenues of about $3 billion centers for wristwatch manufacture. routinely splurge on high-end prod- and annual production of between The United States also played a vital ucts. But the market relies more on 650,000 and 800,000 watches. The role in the evolution of the industry. psychology than sheer consumer secret to its success: a strategy that The Waterbury Clock Co., founded utility. In order for luxury goods eschewed fashion and emphasized in 1857, brought mass production to makers to crack the market and performance, brand purity, and the industry, and drove the price of maintain a hold on finicky con- continuity. pocket watches down sharply. sumers, they have to convince people By the standards of the time- Switzerland, however, was the source to pay far more for something – a keeping industry, Rolex is a relative of the highest quality watches. pair of shoes, a bottle of wine, or a newcomer. The pocket watch first French Huguenots, who settled in watch – than they need to. After all, emerged in the early 1600s. In the Switzerland in the late 16th century, why would otherwise economically 18th century, innovators incorpo- formed the nucleus of the Swiss rational people spend thousands on a rated jewels into the design to industry. The Swiss concentrated watch when one that costs only $10 reduce the friction of turning their efforts on watches rather than tells time just as accurately? points and thus improve accuracy clocks. And by the early 20th centu- Rolex, the Swiss watch company and reduce wear. According to ry, the label “Swiss Made” began to that will celebrate its 100th Frank Edwards’ Wristwatches: A indicate quality, and Swiss firms anniversary next year, knows the Connoisseur’s Guide, Berguet in began to dominate the middle and answer. Over the past century, 1810 made a watch for the Queen of high-end of the market.

24 Sternbusiness Luxury brands can rise and fall quickly. But by following a strategy of brand purity, continuity, and performance, the leading Swiss high-end watch maker has withstood the test of time.

Sternbusiness 25 “Today, Rolex is the pilots wrote to the company describ- would be inexpensive to produce. largest single luxury ing their experiences, Rolex replaced The new quartz technology allowed the watches free of charge. American for both analog and digital readouts, watch brand, with rev- servicemen learned of Rolex while and opened the door to new func- enues of about $3 billion stationed in Europe, thus helping to tions like calculators. By the end of open the lucrative U.S. market to the the 1970s, about half of the watches and annual production of company. sold worldwide were based on quartz between 650,000 and In the post-war era, as the com- technology, and Hong Kong had 800,000 watches.” pany set its sights on expansion, emerged as a major center for watch Rolex continued to build its high- production. performance reputation. In 1945, Rolex was reluctant to join the High Performance Rolex introduced the Datejust model, quartz wave, but did come out with The company that would eventu- the first chronometer with an auto- a limited number of models. In spite ally become Rolex was founded in matic date changing mechanism. of threatening new technologies, a London in 1905 by a 24-year old Eight years later came the proliferation of low-cost producers in Bavarian who was orphaned at age Submariner, which was both water- the Far East, and economic ups and 12. Hans Wilsdorf founded the com- resistant and pressure-resistant to a downs, most of the luxury brands pany with his brother-in-law, depth of 330 feet. And Rolex contin- survived in one way or another. But William Davis, and coined the brand ued to find even more dramatic Rolex thrived in the face of disrup- name Rolex. He felt the name sound- opportunities to demonstrate its tive technologies. In an era when ed like the noise a watch made when unique performance characteristics. accuracy and dependability were no it was being wound. It was also easi- Sir Edmund Hillary wore a Rolex longer the exclusive province of pre- ly pronounceable in different lan- when he climbed Mt. Everest in mium products, Rolex developed a guages and short enough to fit on the 1953. The watch became the key series of attitudes toward defending face of his watches. Wilsdorf ulti- instrument to measure time at sport- and building its position in the high- mately moved his company to ing events. end market. Geneva in 1919. Even as watches became mass- The period between the two Continuity Amid Change produced commodities, Rolex con- World Wars was a difficult one for Before his death in 1960, Hans tinued to emphasize craftsmanship Swiss watchmakers, as they had to Wilsdorf placed ownership of Rolex and quality. It used materials such as contend with successive economic in the hands of the Wilsdorf gold, platinum, and jewels. And it and political crises. But in this peri- Foundation, which would assure the continually improved its movements od, Rolex began to build its reputa- company’s independence. In 1962, and added new functions to its tion for performance. In 1914, a Rolex’s board appointed 41-year-old watches: the ability to tell the date, Rolex watch was awarded a Class A André Heiniger, who had worked for the day of the week, and the time in precision certificate from the British Wilsdorf for 12 years, as managing different time zones. As a result of Kew Observatory, an honor previ- director. In 1992, Patrick Heiniger, this greater complexity, Rolex’s ously reserved exclusively for marine a 32-year-old lawyer, who had watches were made with a greater chronometers. In 1926, Wilsdorf served the company for six years as sense of old-fashioned craft. An inex- developed and patented the first marketing director, succeeded his pensive quartz watch produced with truly water-resistant watch, the father. André stayed on as chairman a great deal of automation has Oyster. The watch was strapped to until 1997, when he became chair- between 50 and 100 parts; a Rolex the wrist of Mercedes Gleitze as she man emeritus. In Rolex history, Oyster chronometer has 220 parts. made her pioneering 15-hour swim there have been only three managing across the English Channel. Rolex directors. Maintaining Demand capitalized on the event by using it in In the post-war years, watches Rolex also maintained its brand advertisements, and by building dis- became both cheaper and more reli- image by limiting production, even plays in jewelers’ windows that fea- able. In 1950, a Norwegian born as demand rose. For luxury goods, tured a watch submerged in a small engineer, Joakim Lehmkuhl devised scarcity in the marketplace can tank of water. a more dependable inexpensive influence value, spur demand, and By World War II, the Rolex brand watch by making significant contribute to collectibility and long- had gained such prestige that British improvements to pin-lever technolo- term appreciation. And a company Royal Air Force pilots bought them gy. It was marketed under the brand that can pitch its product as an to replace the inferior watches that name Timex. In 1968, prototype investment can frequently charge were issued to them. Pilots captured quartz crystal watches were intro- a premium. Finely-made luxury as prisoners of war frequently had duced. These time pieces were watches tend to appreciate in value their Rolexes confiscated, but when extremely accurate and eventually over time. The Complete Price Guide 26 Sternbusiness to Watches (2004 edition) lists the Watches. Compagnie value of a 1936 Patek Philippe Financière Richemont, ROLEX TIMELINE Calatrava in 18-karat gold at the world’s third largest $700,000. Rolex watches have held luxury goods maker, their value well, too. Price guides for owns watch brands collectors indicate that almost all such as Cartier, Baume 1905 – Hans Wilsdorf and his brother-in-law, William Davis, older Rolex models are valued above & Mercier, Piaget, found watchmaking firm in London their initial selling price. Most col- Jaeger-LeCoultre, and 1908 – Rolex brand created lectible Rolexes sell in a range of Officine Panerai. Well- between $1,500 and $20,000. known brands Movado, 1910 – Rolex obtains first official chronometer certification in Rolex has also taken pains to Patek Philippe, and Switzerland for a wristwatch ensure that its watches are sold Breitling remain essen- only in appropriate venues. The tially independent. By 1919 – Wilsdorf forms Montres Rolex SA in Geneva, Switzerland crystal prism that indicates a store placing control of the to be close to Bienne, where his precision movements is an “Official Rolex Dealer” is company in the hands are crafted highly prized. Rolex looks for of a foundation, 1926 – Rolex patents Oyster design for a waterproof watch dealers with high-end images, rel- Wilsdorf guaranteed atively large stores, and attractive that Rolex would have 1931 – Rolex introduces the Oyster Perpetual, the first waterproof locations that can provide out- the means to withstand & self-winding watch standing service – such as the pressure to affiliate Tourneau. At one point, Rolex got with a larger company 1945 – Rolex introduces their first Datejust model, the first into a dispute with Tiffany that has a range of chronometer with an automatic date changing mechanism because the venerable retailer was interests and markets. 1950 – Rolex creates the "Turn-O-Graph" imprinting its name on the Rolex Rolex also maintains watches it was selling. When its brand purity by 1953 – Rolex introduces the Submariner, the first automatic Tiffany refused to stop, Rolex combating counterfeit- diving watch that is water resistant to 100 meters dropped Tiffany as an official jew- ers. Today, many copies eler. In the 1990s, as part of an are so good that only an 1956 – Rolex launches the Day-Date model effort to control sales of their expert can tell the dif- 1960 – Rolex founder Hans Wilsdorf dies goods in the so-called gray market, ference. And while con- Rolex cancelled agreements with noisseurs will certainly 1963 – André J. Heiniger succeeds Hans Wilsdorf as head of Rolex about 100 dealers. note the difference Rolex has also focused on main- between a $5,000 Rolex 1978 – The Oyster Perpetual Date Sea Dweller is introduced, taining the purity of its brand. Many and a $25 knock-off, waterproof to a depth of 1,220 meters luxury-goods makers have used their the existence of large original product as a springboard. number of counterfeits 1992 – Patrick Heininger becomes managing director Cartier and Mont Blanc, for example, inevitably affects have bet that the equity of their demand at some level. brand built on a single product will Rolex likely spends more money But as it approaches its 100th pull sales for a variety of luxury policing fakes than any other brand. anniversary, Rolex is sticking to its goods. And some brands have In the future Rolex will no doubt core strategy of independence, conti- licensed their brand to other manu- face stiffer competition as innovative nuity, and brand purity. The compa- facturers, thus ceding some control entrepreneurs search for new ways to ny’s attitude has allowed it not just to over the products appearing under attack its markets. And the large lux- survive decades of technological and their name. But Rolex makes only ury goods conglomerates enjoy cer- economic upheavals, but to thrive watches, and it has never licensed its tain advantages over an independent amid them. Even in today’s massive, name. firm like Rolex. They have restruc- global luxury-goods market, an What’s more, many watch tured operations to take advantage independent company that clearly brands have responded to compe- of size and significantly reduce cost, defines its market niche and relent- tition by merging into conglomer- enjoy synergies in advertising and lessly sticks to its strategy can rise to ates over the last few decades. marketing, and are more willing to the top. LVMH Moët Hennessy Louis engage in open discussions in trade Vuitton, the world’s largest luxury associations to learn from the com- goods company, with annual sales petition. The conglomerates may DAVID LIEBESKIND is an adjunct of more than $15 billion, includes also be more willing to source from professor of management at NYU Stern. venerable watch brands such as Tag Asia, where labor costs are consider- Heuer, Zenith, and Dior ably lower than Switzerland. Sternbusiness 27 CAR TALK Tatsuro Toyoda, a 1958 alumnus of NYU Stern, knows what it Dean Thomas Cooley hosted a celebratory lunch- eon at NYU Stern in honor of Tatsuro Toyoda, a 1958 Stern alumnus who received an honorary takes to build a global auto brand. He has worked in the family Doctor of Commercial Science degree at NYU’s business — Toyota Motor Corporation — for more than a half Commencement Ceremony on May 13, 2004. Pictured from left to right are Professor Eitan Zemel, W. Edwards Deming Professor of Quality & century, and served as president from 1992 to 1995. Throughout Productivity and chairman, Department of Information, Operations & Management Sciences; his long, eventful career, Mr. Toyoda carried with him lessons William R. Berkley, NYU Trustee, chairman of the Stern Board of Overseers and chairman and CEO, learned at NYU Stern from Professor W. Edwards Deming. As an W.R. Berkley Corporation; Mr. Toyoda; Dean Cooley; Mrs. Toyoda; Diana Deming Cahill, founding trustee apostle of quality control, Professor Deming worked with many of the W. Edwards Deming Institute and daughter of W. Edwards Deming; Professor Ernest Kurnow, Mr. Japanese companies in the 1950s and 1960s, including Toyota. Toyoda’s former Statistics teacher at Stern and a former colleague of W. Edwards Deming; and Yi Lu, By following his statistical quality control techniques, a doctoral candidate in Statistics who currently holds the W. Edwards Deming Fellowship. Japanese manufacturers like Toyota built up a reputation for quality that Tatsuro Toyoda enabled them to penetrate distant 1928 Born in Nogoya, Japan, the son of Kiichiro Toyoda, founder, Toyota Motor Corporation markets. 1953 Joins Toyota after earning a degree in mechanical engineering from At NYU’s Commencement Ceremony the University of Tokyo 1956-1958 Attends NYU Stern, studying statistical inference with Professor on May 13, 2004, Mr. Toyoda received Ernest Kurnow and statistical analysis with Prof W. Edwards Deming an honorary Doctor of Commercial 1958-1974 Works in domestic and international marketing at Toyota Motor Corporation 1974 Named director of Toyota Motor Corporation Science degree. At a dinner with NYU 1984-1986 Heads joint venture with General Motors in California Trustees on the evening of May 12, Mr. 1992 Succeeds brother Shoichiro as company president Toyoda reflected on his career, and on 1995 Named vice chairman of Toyota Motor Corporation 1998-present Senior advisor to the board of Toyota Motor Corporation his experience at NYU Stern.

28 Sternbusiness Thank you, President Sexton, and good evening. I am honored to be here tonight with NYU Board Chair Martin Lipton, the NYU W. Edwards Deming Trustees, fellow honorary degree recipients, and other distinguished guests. It is a great honor to receive the honorary degree of Doctor of Commercial Science. Born in Iowa, and educated at the University of When I came to the United States for the first time in 1955, we didn’t sell any vehicles Wyoming in Cheyenne, W. Edwards Deming received here. It was two years later, in 1957, when our first vehicle – the Crown – was shipped to graduate degrees in physics and mathematics from the the United States. University of Colorado and Yale University. Unfortunately, at that time, Toyota vehicles were not comparable to the "Big Three" in But the scientist would make his mark in a different terms of quality and driving performance. Since then, we worked hard to produce a bet- field: Statistics. In the 1940s, Deming was an adviser to ter car for this great country. the Bureau of the Census, which was starting to use sam- I had the fortune to attend a class taught by Dr. W. Edwards Deming during my days pling techniques to count the U.S. population. In 1946, at the NYU Stern School of Business. Many Japanese companies followed Professor Deming joined the faculty of what is now the NYU Stern Deming’s advice, and substantially improved their quality control in manufacturing and School of Business as a professor of Statistics, and start- other areas. His landmark work is widely acknowledged among Japanese companies – ed a consulting practice to advise companies and institu- and one of the most prestigious awards in Japan is the Deming Prize. tions on the use of statistical quality control. While he did- When I was a student at NYU, our annual new car sales were less than 300 units. Last n’t find many clients among American businesses, year, thanks to American customers, we sold over two million cars and trucks in the North Deming quickly learned that Japanese companies were American market, and our four assembly plants in North America built more than 60 eager for his expertise. percent of those vehicles. He was convinced that the use of statistical methods From the beginning of our operations, we have sought to contribute to society through could help Japanese companies rebuild, improve quality, our investment, employment, and corporate citizenship activities. In recent years, we have and compete in global markets. In 1950, he delivered a focused on safety and environmental initiatives. For example, our advanced technology series of eight day-long lectures, which were attended by hybrid gas-electric vehicles achieve high mileage and reduce emissions. many top Japanese business and industry leaders. He told I, and my colleagues at Toyota, owe a debt of gratitude to America. And we will work them that "Japanese quality could be the best in the world, hard to repay it by continuing to provide jobs and investments here, and by building safer instead of the worst." Deming returned to Japan several and more environmentally friendly vehicles. times in the 1950s, ultimately helping to train some My time at NYU taught me about American consumers and their tastes. This knowl- 20,000 engineers in statistical methods and directly influ- edge came in handy 20 years ago when I was asked to head Toyota’s first vehicle assem- encing Japan’s remarkable postwar recovery. Almost bly plant in the United States, New United Motor Manufacturing, Inc., or NUMMI as we call it. Located in Fremont, California, this joint venture plant with General Motors is still instantly, Deming became something of a folk hero in a thriving success some two decades later. Japan. And in 1960, Emperor Hirohito bestowed on When I returned to Japan after NUMMI, I was named president of Toyota Motor Deming the Second Order Medal of the Sacred Treasure. Corporation – and I continued to pursue my dream of making a positive contribution to Even as Japan continued to rise as a global manufac- society. turing power, Deming’s teachings on the need for worker I want to thank NYU for giving me a good foundation in business and in my personal cooperation and continuous quality improvement were life – that served me well in my career with Toyota. largely ignored in the U.S. It wasn’t until the 1980s, when It is a sincere privilege to have been chosen to receive the honorary degree of Doctor U.S. industry aimed to recapture ground lost to Japanese of Commercial Science from this great university. firms, that Deming’s ideas were discovered in his home I am deeply touched. country. The author of several books and more than 150 Thank you. papers, Deming died in 1993 at the age of 93. Sternbusiness 29 30 Sternbusiness FLIGHTS OF FANCY A top of the line corporate jet can cost a company up to $35 million. But a new study shows that when chief executive officers trade in first-class commercial tickets for private planes, the cost to shareholders can be far greater.

By David Yermack

ersonal aircraft use ize corporate cultures of excess. At to shareholders. I set out to deter- represents by far the Adelphia Communications, the mine if there was, in fact, an empir- most costly and fastest bankrupt cable company whose top ical link between CEOs’ use of cor- growing fringe benefit executives have been convicted of porate jets and corporate perform- enjoyed by chief exec- fraud, prosecutors charged that the ance. The results were striking. In utive officers of major company jet was used to ferry cor- the short-term, shareholders react Pcorporations. In 2002, more than 30 porate founder John Rigas to Kenya negatively to the news that CEOs percent of Fortune 500 CEOs are using corporate jets. While were permitted to use company “Corporate jets regularly CEOs who fly on such aircraft planes for personal travel, up inspire criticisms of managerial may arrive at their destination from less than 10 percent a excess by journalists and quickly, their stocks lag. The decade earlier. shareholder activists, and they shares of companies whose Several factors have con- frequently seem to symbolize CEOs use private aircraft under- tributed to this growth. The rise corporate cultures of excess.” perform the market by more of fractional aircraft ownership than 400 basis points per year. has dramatically reduced the up- on a safari and to deliver a front costs of access to corporate Christmas tree to one of Rigas’ Perks and Compensation jets. And in the wake of the daughters. At Enron, according to In a sense, this effort was a mat- September 11, 2001 terrorist Bethany McLean and Peter Elkind, ter of putting two theories of execu- attacks, many executives have authors of The Smartest Guys in the tive behavior and compensation to chosen to escape the hassles and Room, members of CEO Kenneth the test. In their classic 1976 study, perceived danger of flying on major Lay’s family were known to use the Theory of the Firm: Managerial airlines by using private jets. company’s jet fleet as a sort of per- Behavior, Agency Costs and Corporate jets regularly inspire sonal taxi service. Ownership Structure, Michael C. TIONS BY JUD GUITTEAU criticisms of managerial excess by But Adelphia and Enron provide Jensen and William Meckling, of the journalists and shareholder activists, only anecdotal connections between University of Rochester, used

ILLUSTRA and they frequently seem to symbol- the use of jets and potential damage perquisite consumption by man-

Sternbusiness 31 FLIGHTS OF FANCY agers as the basis for their formal exceeds the subsequent Table 1 model of the agency costs of outside consequences to the equity in a public corporation. manager from ex-post CEO Variables Mean When an owner-manager sells stock settling up wage revi- Age 57.4 to the public and reduces his owner- sions. Fama’s theory, ship below 100 percent, incentives then, appears to predict Years as CEO 6.9 increase for the manager to expend an inverse association Ownership fraction 1.48% corporate resources for personal between perk consump- Founding family member 15% benefit. Jensen and Meckling’s tion and compensation, Salary $870,000 model seems to predict that perk controlling for other Annual bonus $1.24 million consumption by a CEO should vary attributes that affect inversely with his fractional owner- compensation such as Stock option award $4.48 million ship of the company (that it would industry, performance, Restricted stock award $710,000 rise as a CEO’s stake in the publicly- and experience. In other held company he runs falls). They words, perk consump- Political Affiliation Percentage also suggest a manager’s personal tion would fall as com- Donor to Republicans 55 tastes and the difficulty of monitor- pensation rises. Donor to Democrats 19 ing the manager’s actions would I tested both theories Donor to both parties 19 influence perk consumption. by investigating the In his 1980 paper, Agency prevalence of a major Education Level Percentage Problems and the Theory of the perk – the use of corpo- Firm, University of Chicago Finance rate jets – and then No college degree 6 Professor Eugene Fama took a more measuring its relation- College only 37 benign view of perquisites. ship to other factors such MBA graduate degree 38 “Consumption on the job” by man- as overall compensation, JD or LLB 10 agers amounts to a form of compen- CEO characteristics, and Ph.D. 5 shareholder return. Data Other graduate degree 10 “...aircraft use is by far for this study was drawn from a panel of 237 the largest disclosed Fortune 500 companies CEO perk, appearing between 1993 and 2002. The final annual income from stock option more than twice as sample had 2,340 observations, and restricted stock awards. Stock often as the next most with most firms appearing in the options delivered a large, skewed popular item, financial sample for 10 full years. Those distribution of compensation, with a observations covered 485 individual mean of $4.5 million and a median counseling...” CEOs, a small handful of whom of $1.6 million. served more than one term with the t is impossible to measure sation that can be offset through same company. The sample firms the tastes and performance adjustments in salary or other forms had median annual sales of close to of CEOs directly. However, I of pay. Fama described the interac- $7 billion, median total assets above was able to collect two vari- tion between managers and their $10 billion, and a median market ables about the backgrounds boards of directors in terms of a capitalization close to $8 billion. ofI my sample’s 485 CEOs that one dynamic of “ex post settling up,” in Table 1 contains data on the might expect to exhibit correlations which the manager’s wage is regu- characteristics of the CEOs in the with their perk preferences: political larly revised to account for his per- study. The typical CEO was about affiliation and education. First, I formance and his personal con- 58 years old, with a mean ownership chose CEOs’ political affiliations, sumption of company resources. of about 1.5 percent of the firm’s which can be observed from data- Fama’s model implies that perk con- shares. CEOs received mean cash bases of donations maintained by sumption represents an agency cost salary and bonus compensation of the Federal Election Commission. only to the extent that its value about $2.1 million, and additional I classified CEOs as either

32 Sternbusiness Republicans or Democrats if a clear majority of their donations were Table 2 directed to one party’s candidates or Perquisites Required for CEOs organizations. Fifty-five percent of the CEOs appeared to be Category Observations Frequency Republicans and 19 percent, Democrats. An additional 19 per- Personal use of company aircraft 346 14.6% cent donated fairly evenly to both parties, and the rest had no record of Financial counseling 161 6.8% political donations. Second, I chose Company car and local transportation 94 4. 0% CEOs’ educational backgrounds, which were provided by Forbes Relocation and housing expenses 54 2.3% magazine’s annual executive com- Country club dues 46 1.9% pensation surveys and supplement- ed when necessary by online news Medical care exceeding company plans 20 0.8% searches. Six percent of the sample Personal or home security 6 0.3% CEOs had no college degree, but a majority had attained a graduate degree of some type. below $12,500 (equal to 25 percent disclosed, is a little more than of the $50,000 overall threshold). $50,000. While costs of operating Measuring Perk From reading a large number of different aircraft vary greatly, The Consumption proxy statements, it is evident that New York Times, using data from Next, I measured CEO perk con- several disclosure loopholes limit the Executive Jet Inc., the leading time- sumption – a complex and occasion- transparency of perk consumption share company, in 2001 estimated ally difficult task. The primary data. the hourly cost of leasing an eight- source of information was the com- ven so, I was able to person Cessna Citation V aircraft panies’ annual proxy statements. amass a large amount was $10,000 – or $2,500 per person Data on perks usually appear in of data on CEO perks, if the CEO on average travels with proxies as a footnote to column (a) which is described in three other passengers. A CEO with of the Summary Compensation Table 2. Perks are $50,000 in reportable aircraft use Table, headed “Other Annual rank-orderedE according to the fre- would therefore spend about 20 Compensation.” The total value of quency of their disclosure. hours per year in the sky, enough perks must be disclosed based upon Companies use certain euphemisms for perhaps three round-trips their “aggregate incremental cost” to describe personal aircraft use, between New York and Florida, for to the company, but only if the total such as “travel expense” and “cor- example. exceeds the lesser of $50,000 or 10 porate transportation.” I generally What determines whether a CEO percent of the executive’s salary plus assumed that such language refers has a higher propensity to use cor- bonus. Companies must itemize the to airplane or helicopter travel porate aircraft? I used a Tobit cost of any individual perk, such as rather than limousines, trains, or regression model to analyze how the personal aircraft use, if it exceeds 25 boats, unless disclosures indicate cost of CEO aircraft use in each percent of the overall perk total, otherwise. As Table 2 indicates, air- firm-year is related to a range of assuming that the total exceeds the craft use is by far the largest dis- explanatory variables. Among the $50,000 threshold. The structure closed CEO perk, appearing more variables I chose were CEO stock of the Securities and Exchange than twice as often as the next most ownership, compensation, the age Commission’s disclosure rules causes popular item, financial counseling, of the CEO, whether or not he was data for CEOs’ personal aircraft use which includes tax preparation, a member of the firm’s founding to be censored. For example, assum- estate planning, and the cost of rep- family, education level, and political ing the CEO earns at least $500,000 resentation in contract negotiations. affiliation. The regression model salary plus bonus, firms never have The median cost to the company includes control variables for size to disclose aircraft use if its cost lies of CEO’s personal aircraft use, when and capital structure.

Sternbusiness 33 FLIGHTS OF FANCY

hen I ran the mod- els, the estimates for the excess compensation residual were neg- Wative. That provided some support for Fama’s theory about perk con- sumption, since it implies that a CEO’s compensation is adjusted downward when his perk consump- tion increases. But the effect was very small. The result implied that an additional $1,000 in perks con- sumed by the CEO leads to a reduc- tion in compensation of 10 cents, an economically negligible amount. The Jensen-Meckling theory of perks predicts that CEOs trade off the value of perk consumption against the reduction in personal ownership value entailed by that same consumption. When I estimated the model, the CEO ownership vari- able provided evidence of the pre- dicted negative association with perk consumption. The estimates imply that increases in ownership act as a $5,030 reduction in perk consump- sions will permanently impact curb against perk consumption at tion, which seems quite small com- their compensation. both low and high ownership levels, pared to the cost of the additional CEOs from founding families but that greater ownership provides equity investment – $201 million in also use corporate aircraft with protective cover that CEOs use to the mean sample firm. abnormally high frequency, perhaps extract greater perks over a middle indicating that founders do not rec- ownership range. The overwhelming Older Frequent Fliers ognize boundaries between personal majority of CEOs in this sample lay Variables associated with CEO and corporate property as clearly as tastes and preferences non-founders. Political affiliation “While CEOs who fly on have clear impacts has some impact upon perk con- upon patterns of corpo- sumption, but in a non-partisan such aircraft may arrive at rate aircraft use. Older way. CEOs who make no political their destination quickly, their CEOs are more likely donations are the heaviest users of stocks lag. The shares of than younger ones to corporate jets, while CEOs who companies whose CEOs use make personal use of make donations to both parties are company aircraft. This the lightest users. CEOs who clearly private aircraft under-perform pattern may arise due are Democrats or Republicans fall the market by more than to increasing frailty of somewhere in the middle. 400 basis points per year.” CEOs as they age, or it Finally, the education variable may represent oppor- results were striking. CEOs with the in the low ownership range. Again, tunism by CEOs who consume least education (no college degree) the effect was very small. The mar- perks heavily near the end of are the heaviest aircraft users, while ginal effect implies that a 1 percent their careers with reduced fears those with the highest advanced rise in CEO ownership leads to a that ex post settling up wage revi- degrees (Ph.D.s) are the lightest.

34 Sternbusiness CEOs who hold MBAs or other mas- both business and personal travel. agers who use jets frequently also ters degrees are somewhere in The CAR results indicate that run their firms inefficiently, tolerat- between, and CEO-lawyers have shareholders do not welcome the ing waste, excess overhead, or significantly higher aircraft use than news that firms permit CEOs to use uncompetitive cost structures. When normal, though not as high as non- corporate aircraft for personal trav- I ran regressions of firms’ return on college graduates. el. When I ran regressions that took assets against the aircraft use into account compensation and dummy variable, as well as dummy Shareholder Returns ownership levels, I found that share- variables for industries and years, I How does aircraft use affect stock holder reactions to CEOs’ corporate found a negative association prices? In my 1993-2002 sample of jet use are mitigated if the CEO between profitability and the air- 237 firms, 63 companies disclosed earns lower compensation. This pat- craft use variable, and a strong, sig- no CEO aircraft use for either of the tern is consistent with Fama’s per- nificant negative association first two years and then began dis- spective, that perks are benign if off- between the aircraft variable and closing it for some future year or set by reductions in other forms of sales per employee. These regres- years. I calculated the mean cumu- compensation. sions indicate that firms with high lative abnormal stock “CEOs from founding families also CEO perk consumption returns (CAR) for these 63 also tend to be over- firms beginning two weeks – use corporate aircraft with staffed relative to the com- or 10 trading days – prior to abnormally high frequency, perhaps petition, as they achieve the statement date of the indicating that founders do not $30,000 to $40,000 less in proxy in which corporate recognize boundaries between sales per employee. aircraft use was first dis- The inverse relation- closed. I extended the event personal and corporate property ship between CEO aircraft window until one day after as clearly as non-founders.” use and company per- the filing day because some formance appears surpris- firms may post their documents ingly strong and much larger than after the market closes. The results: Long Term Losses could be explained by the direct cost stock prices exhibit essentially zero Short-term, stockholders plainly of the resources consumed. It could change until one week before the view the use of a corporate jet as a be that CEOs who consume exces- event day, at which point they begin negative. Next, I assessed the ongo- sive perks may be less likely to work to trend downward, with the mean ing market performance of firms hard, less protective of the compa- showing a CAR of -1.99 percent. that permit their CEOs to have per- ny’s assets, or more likely to tolerate loss of 2 percent in mar- sonal use of corporate aircraft. bloated or inefficient cost structures. ket capitalization was Again, the results were negative. High executive perks might also worth about $150 million The results indicate that firms with occur due to weak corporate gover- for the median firm in the CEO aircraft use under-perform the nance. Asample, far in excess of the disclosed market by more than 400 basis For many in the world of busi- incremental cost to the company of a points per year, equal to a shortfall ness, the corporate jet is the ultimate CEO’s personal aircraft use. If of about $300 million in market sign of arrival. When they’re able to shareholders view the entire corpo- capitalization each year for the fly in a Gulfstream IV out of rate aviation activity of a firm as a median sample firm. Teterboro Airport in New Jersey deadweight cost that yields no com- Given that these performance instead of having to wait in line to pensating benefits, and if one factors shortfalls equal hundreds of millions board a Boeing 737 at La Guardia, in additional costs for storage, main- of dollars per company per year, it many executives feel as if they have tenance, fuel, and operation of the would be difficult to argue that the finally made it. For shareholders, plane, then the dollar loss in share- direct costs of perk consumption ironically, this moment frequently holder wealth could approximate alone could explain the gap. Even signals it’s time to head for the exits. the true present value cost to the the most expensive jets don’t cost firm of acquiring an aircraft and several hundred million dollars. One DAVID YERMACK is associate professor making it available to the CEO for clear possibility is that these man- of finance at NYU Stern.

Sternbusiness 35 The Trouble with Fannie and Freddie

Fannie Mae and Freddie Mac have parlayed the advantages they enjoy as government-sponsored enterprises to grow into massive financial power- houses in the market for residential mortgages in the U.S. Have they grown too big? And do the bene- fits that they deliver to the public fall short of the potential costs they hold for taxpayers? By Lawrence J. White

n the past year, there has been a great deal of debate about the special status, accounting policies, and the influence of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan IMortgage Corporation (Freddie Mac). The two entities, which enjoy federal government charters and an array of implicit and explicit privileges, have grown into gigantic, publicly traded firms that wield enormous influence on the U.S. capital markets and housing market – and hence on the American economy and the political system. Many national leaders, from Federal Reserve Chairman Alan Greenspan to the heads of large commercial banks, have raised questions about Fannie and Freddie. Have they grown too large and unwieldy? Are they disrupting housing and capital markets? Might they be a future source of systemic risk? And if so, what can be done about them? Answering these questions requires a care- ful consideration of the companies’ roles and net effects, and some speculation as to what the world would look like if the two were to lose their special status. Fannie Mae, created in 1938, and Freddie Mac, created in 1970, are federally chartered cor- porations, or government-sponsored enterprises (GSEs). They share narrow federal mandates: to provide finance for single- and multi-family housing. And while they are both publicly traded companies, at each company, five of the 18 direc- tors have been chosen by the President, and the two companies enjoy an array of special privi- leges. Fannie and Freddie are the only two enter- prises that have received this special housing finance charter from the federal government. Both companies have grown rapidly in the past two decades, as the data in Table 1 indicate. As of year-end 2003, Fannie and Freddie had $1,010 billion and $803 billion in assets, respec- tively. Ranked by assets, they were the second- Sternbusiness 37 The Trouble with Fannie and Freddie

Table 1: Balance Sheet and MBS Data, Fannie Mae and Freddie Mac, 1980-2003 (in billions of dollars) Fannie Mae Freddie Mac

Retained MBSs Retained MBSs Total mortgage outstanding Total mortgage outstanding assets portfolioa portfoliob assets portfolioa portfoliob

1980 $57.9 $55.6 $0.0 1980 $5.5 $5.0 $17.0

1985 99.1 94.1 54.6 1985 16.6 13.5 99.9

1990 133.1 114.1 288.1 1990 40.6 21.5 316.4

1995 316.6 252.9 513.2 1995 137.2 107.7 459.0

2000 675.2 607.7 706.7 2000 459.3 385.5 576.1

2003 1,009.6 901.9 1,300.2 2003 803.4 660.4 768.9

a Includes repurchased MBSs. b Excludes MBSs that are held in portfolio. Source: OFHEO. and third-largest “private” enterprises mortgages in their portfolios than are insurance. The U.S. Department of in the U.S. In addition, there are banks and thrifts, and are exempt Housing and Urban Development about $1,300 billion outstanding from state and local taxes. Their secu- (HUD), as well as HUD’s Office of pass-through mortgage-backed secu- rities are exempt from the Securities Federal Housing Enterprise Oversight rities (MBSs) that carry Fannie’s guar- and Exchange Commission’s registra- (OFHEO), regulates the companies. antee, and $769 billion guaranteed by tion requirements and fees. They can The GSE status of Fannie and Freddie. With market capitalizations borrow from the U.S. Treasury and Freddie gives them clear advantages of $75 billion and $43 billion, respec- use the Federal Reserve as their fiscal over non-GSEs. Because of their tively, as of early 2004, Fannie and agent. Their MBSs, when held by U.S. “agency” status, Fannie and Freddie Freddie ranked among the 60 largest banks and thrifts, carry a capital (net can issue debt at interest rates that publicly traded companies. worth) requirement of only 1.6 per- are about 35-40 basis points less than he companies have been cent, rather than the capital require- could an otherwise similar non-GSE. able to grow so rapidly ment of 4 percent that the underlying Their MBSs similarly carry a yield in part due to their sta- mortgages themselves would require that is about 30 basis points lower tus as GSEs, which con- if held by a bank or thrift. than non-GSE MBSs. On the other fers several advantages Fannie and Freddie are also sub- side of the ledger, Freddie and Tthat rivals don’t enjoy. Although their ject to major limitations. They are Fannie’s mortgage purchase activities prospectuses explicitly note that the restricted to the business of providing appear to have reduced conforming government does not guarantee the residential mortgage finance; they mortgage interest rates by about 25 securities they issue, the securities cannot originate mortgages. They can basis points. markets act as if the firms’ directly only finance mortgages that are at or issued debt and MBSs may well carry below a specified maximum (“con- Pioneering New Markets a federal guarantee. Fannie and forming”) loan size that adjusts annu- The companies’ participation in Freddie thereby enjoy lower financing ally with an index of housing prices the residential mortgage markets costs than do AAA-rated corporations (in 2004 that limit is $333,700 for a takes two forms. First, they buy and – but not quite as low as the U.S. gov- single-family home), and the mort- hold residential mortgage assets in ernment itself. The two firms are gages must have a 20 percent down their own portfolios; they fund these subject to lower capital (net worth) payment or have a third-party credit purchases overwhelmingly with debt. requirements for holding residential enhancement, such as mortgage Of Fannie’s $1,010 billion in assets at 38 Sternbusiness year-end 2003, $902 billion (89 per- for the following percentages of the ing and especially home ownership, cent) was invested in mortgage assets; various categories of residential mort- the ethos of public policy has been of Freddie’s $803 billion in assets, gages: 39 percent of the $5.6 billion (and continues to be) “too much is $660 billion (82 percent) was in total of all residential mortgages; 40 never enough.” mortgage assets. Their liabilities were percent of the $5.2 billion total of composed of 96-97 percent debt and all single-family (one-to-four units) A Contingent Liability only 3-4 percent equity. mortgages; 48 percent of the $4.4 bil- Fannie and Freddie are exposed to econd, they purchase resi- lion total of all single-family “conven- at least three types of risks. First is dential mortgages from tional” mortgages (that were not credit risk. On all of the mortgages originators, create securi- insured by the Federal Housing that they hold in their portfolios and ties (MBSs) from bundles Authority or the Veterans on all of their MBSs, Fannie and of the mortgages, and Administration); 60 percent of the Freddie are exposed to the risks of Sswap the securities back to the origi- $3.5 billion total of all single-family default by the mortgage borrower. nators or sell the securities to conforming mortgages; 71 percent of Second is interest rate risk. On all of investors, with guarantees on the the fixed interest rate mortgages that MBSs as to the timely payment of “Although their they hold in their portfolios, Fannie interest and principal. By doing so, prospectuses explicitly and Freddie are exposed to the risk Fannie and Freddie have created a note that the govern- that interest rates will rise, which will large national secondary market in ment does not guaran- decrease the value of their assets. residential mortgages and revolution- tee the securities they Further, the risks are asymmetric: ized the mortgage market. issue, the securities Since all mortgage holders have the A few decades ago, mortgage markets act as if the option to pre-pay, interest rate finance was largely a vertically inte- decreases are often accompanied by grated process. Banks and thrifts firms’ directly issued waves of pre-pays and refinancings at originated residential mortgages, debt and MBSs may lower interest rates. As a result, which were financed almost entirely well carry a federal Freddie and Fannie do not experience by deposits, and kept the mortgages guarantee.” comparable capital gains. Third is in their portfolios. Federal deposit operational risk. This is the risk of insurance, provided by the Federal the $2.8 billion total of all fixed-rate poor management, bad judgments, Deposit Insurance Corporation single-family conforming mortgages. and employee fraud. (FDIC) to banks and the Federal The special status that Fannie and As would be true for any well- Savings and Loan Insurance Freddie enjoy is part of a much larger managed company, Fannie and Corporation (FSLIC) to thrifts, pro- mosaic of long-standing public poli- Freddie take extensive measures to vided guarantees to the depositor/lia- cies to encourage residential housing. contain these risks. But if the capital bility holders. Owner-occupied housing is largely markets are correct in their belief that The activities of Fannie and exempt from capital gains taxes. the federal government would stand Freddie have created a second, verti- Owner-occupiers can deduct mort- behind Fannie and Freddie’s obliga- cally disintegrated process. Banks still gage interest and real estate taxes on tions in the event that either were in make mortgages, but they frequently their income tax returns. Rental hous- financial difficulties, then creditors sell them to Fannie and Freddie. ing enjoys accelerated depreciation. A need not worry about suffering huge Banks and thrifts also purchase MBSs host of federal, state, and local subsi- losses. Instead, the federal govern- and hold them in their portfolios, dies and tax advantages exist that are ment is at risk. In essence, then, the thereby gaining a more liquid mort- intended to spur construction of implicit guarantees that Fannie and gage asset with a credit guarantee and rental housing. The government also Freddie enjoy comprise a contingent lower capital requirements, and the directly provides rental (“public”) liability, or implicit cost, for the feder- potential for greater geographical housing. Thrifts and other deposito- al government – for 2003 the annual- diversification than could be achieved ries that focus on residential lending ized figure was around $13 billion. from local mortgage originations. receive favorable funding through the The size of this contingent liability As of year-end 2000, Fannie and Federal Home Loan Bank System. It depends on external factors, such as Freddie’s mortgages-in-portfolio plus is perhaps only a slight exaggeration the volatility of interest rates and MBSs outstanding together accounted to claim that when it comes to hous- homeowner defaults, and partially on Sternbusiness 39 The Trouble with Fannie and Freddie internal factors, such as the size of the of a home as an investment, home lower – about 10 percent – than it companies’ securities issuance and the ownership may well be inappropriate otherwise could be. More recent stud- quality of their hedging. But the gov- for households with high mobility, ies have supported that finding. ernment only recognized the need to unstable employment, and irregular limit its exposure through heightened incomes. Reforming Housing Finance regulation of the companies in 1992, “Freddie and Fannie’s Fannie and Freddie borrow for less when Congress established core capi- than would otherwise be the case. tal requirements for Fannie and mortgage purchase They cause conforming mortgages to Freddie and created OFHEO within activities appear to have cost/yield less than would otherwise HUD to set capital requirements and reduced conforming be the case, thereby increasing the conduct formal examinations of mortgage interest demand for residential housing. And Fannie and Freddie. rates by about 25 they create a contingent liability for basis points.” the federal government. The Larger Context Is it worth the price? We should The evaluation of the net or bal- s a result, it would start by assuming a zero-sum world ance of Fannie’s and Freddie’s roles seem that the best and then look for positive externali- must be made in the larger context of program would be a ties that would justify the special gov- housing policy in the U.S. The govern- focused one that ernment treatment that Fannie and ment puts great store in boosting the encourages those Freddie receive. While GSEs do lower percentage of households that own households who the cost of home ownership modestly, their own home. That figure is seen as would not other- most of the encouragement they pro- an important social indicator. In the wise buy (but for whom it is a close vide must be to induce households fourth quarter of 2003, it stood at a call)A to purchase a home. This focus who would be owner-occupiers any- record 68.8 percent. In the 1990s, should be on would-be first-time low- way to buy a bigger/better appointed the goal of extending home owner- and moderate-income household buy- house and/or to buy a second house. ship deeper into the ranks of “low- ers. But virtually all of the policy tools In 2002, when the Fannie/Freddie and moderate-income” households used to encourage home ownership, conforming mortgage limit was became more important. And so in including the basic Fannie/Freddie $300,700, the median sales price for 1992, Congress gave HUD the power program, are quite broad and blunt. a new home was $187,600 and the to set goals for Fannie and Freddie to So our society effectively spends a median sales price for an existing extend their mortgage purchase efforts great deal of time and resources sub- home was $158,100. The median 80 to encompass more low-and moder- sidizing home ownership for house- percent mortgages would have been ate-income households. holds – especially middle-and high- $150,080 and $126,400. Thus, There are serious theoretical argu- income households – who would buy Fannie and Freddie are financing ments to support the claim that home and own anyway but who are thereby many homes that are far above medi- ownership provides positive externali- encouraged to buy larger and better an levels. ties (spillover effects) for society and appointed homes and to buy second As a result of legislation passed in thus to support the encouragement of homes. 1992, HUD was instructed to set spe- home ownership, and a recent body of That the panoply of encourage- cific goals for Fannie and Freddie to empirical research has begun to vali- ments causes the stock of housing to help create more affordable housing. date those arguments. Owners tend to be inefficiently larger than would oth- The GSEs were to focus on low-and maintain their homes better than do erwise be the case is evident. moderate-income borrowers, house- renters, and are more likely to become Northwestern University professor holds with less-than-median incomes, more involved in their communities. Edwin S. Mills in 1987 estimated that and to focus geographically on under- Also, home ownership has traditional- the U.S. housing stock was about 30 served areas such as low-income and ly been an important vehicle for percent larger than if the encourage- high-minority census tracts. household saving and asset accumu- ments were not present. With an Over the course of the 1990s, lation. But there clearly are limits. excessively large housing stock (and Fannie and Freddie met these goals. Because of the substantial transac- insufficiently large stock of other pro- But the extent to which these efforts tions costs in buying and selling a ductive capital), he found that U.S. have induced Fannie and Freddie to home, as well as the inherent riskiness aggregate income was substantially expand home ownership, beyond 40 Sternbusiness what otherwise would have occurred, sist even without the favored status of moderate-income households. This is unclear. Detailed studies indicate the GSEs, the assumed inherent supe- would be a far more direct way of that the targets may be sufficiently rior efficiency of Fannie and Freddie addressing the positive externality of broad so that meeting them is not a may not be valid. Thrifts are likely home ownership. The encouragement strain, and that these GSEs’ efforts holding more MBSs today because the should apply both to reducing down with respect to low-income house- MBSs enjoy regulatory advantages payments and interest costs. The costs holds and areas tended to lag behind when it comes to meeting capital of the program would, and should, be those of local portfolio lenders. What’s requirements. explicit. Further, as a way of reducing more, such efforts to lean on Fannie the costs of housing more generally, and Freddie to make loans involve Modest Benefits governments at all levels ought to placing pressure on an organization to In sum, the positive externalities focus on supply-side considerations take actions that are believed to be and thus true social benefits provided such as modifying restrictive land unprofitable, and that thereby rasp by Fannie and Freddie are surely pos- zoning (which reduces housing supply against the grain of a profit-seeking itive but modest. If the status of by limiting the ability to build single- enterprise. Fannie and Freddie could be consid- family houses on small lots and limits Observers have noticed two other ered in isolation, the policy recom- the building of multi-family units), potential advantages from the govern- mendation to privatize them – i.e., modifying building codes that unnec- ment chartering of Fannie and remove all explicit/formal and implic- essarily raise housing costs without Freddie. First, Susan E. Woodward of it government support – would be an adding to housing safety, and avoiding Sand Hill Econometrics has argued easy one. Given their substantial restrictive international trade policies that the (implicit) government guar- that raise the prices of important antee permits Fannie and Freddie to “The special status that inputs into housing, such as lumber. issue a blanket guarantee on all their Fannie and Freddie general rationalization of MBSs that removes issues of credit enjoy is part of a much U.S. housing policy may risk from the minds of MBS investors. larger mosaic of well be a quixotic goal, And that eliminates the transactions however. Public and costs of credit/information research in long-standing public political sentiment shows which MBS investors would otherwise policies to encourage fewA signs of turning away from the engage. While this argument is surely residential housing.” notion that more housing is always a correct, the gains are likely offset by good thing, even if middle-and high- the contingent liability of the federal brand-names and their impressive income households are the primary government, as well as the monitoring collection of human and intellectual beneficiaries. If privatization of costs of OFHEO. capital, they would likely continue to Fannie and Freddie is not a realistic he other potential posi- innovate and prosper, with their rela- political option, then rigorous and tive advantage arises in tive funding costs a bit higher than is vigorous safety-and-soundness regu- the context of Robert Van currently the case, their MBSs yield- lation must be pursued, so as to min- Order’s model of “dueling ing a bit more, and the costs for home imize the federal government’s con- charters.” Van Order, the buyers of obtaining a residential tingent liability. But so long as the Tformer chief economist at Freddie mortgage rising a bit. Freed of the GSEs exist in their current form, the Mac, reminds us that depositories that restrictions that accompany their cur- goal of expanding home ownership fund residential mortgages and hold rent status, Fannie and Freddie would will be pursued only indirectly as part them in portfolio also have a govern- likely vertically integrate into related of a larger mosaic of programs, subsi- ment guarantee, in the form of federal areas, such as mortgage and title dies, and tax breaks. Disentangling deposit insurance. If the depositories insurance, and expand horizontally Fannie and Freddie from that larger are inherently a less (socially) efficient into related areas of finance, such as framework will not be easy. But it is a means of financing mortgages than auto loans and jumbo mortgage loans. task that is worth attempting. are the GSEs, then the expansion of And in turn, the government’s contin- the GSEs at the depositories’ expense gent liability would disappear. LAWRENCE J. WHITE is Arthur E. Imperatore Professor of Economics at reduces social inefficiency. However, In their place, the federal govern- NYU Stern, and was a board member of though the innovation of mortgage ment should institute a targeted pro- the Federal Home Loan Bank Board securitization has clearly revolution- gram to encourage home ownership from 1986 to 1989, in which capacity he ized mortgage finance and would per- for first-time buyers among low-and was also a director of Freddie Mac. Sternbusiness 41 Helping Hands

Whether they are selling clothes in a mall or books on a website, retailers have to walk a fine line. They must offer help to customers who want assistance, while taking pains not to intrude on their privacy.

By Eric A. Greenleaf, Vicki G. Morwitz and Russell S. Winer

etailers face a chal- click to request help by start- lenge in developing the ing an instant messaging appropriate approach chat with an Internet sales- to offering customers person. Companies such as help. Salespeople can LivePerson and LiveOffice wait until approached provide web retailers with by customers. Or, software that allows cus- upon spotting a customer browsing tomers to initiate help Rat a bookshelf, a salesperson can requests. This software also approach and ask if the customer allows web retailers to use needs help. Or, the salesperson can more aggressive help strate- grab a book and suggest the cus- gies, such as popping open a tomer might like it. There are pit- “May I help you?” window in falls to each approach. And of the consumer’s browser. But course, offering help does not Internet help is a fairly recent always benefit retailers. When innovation. Since web shop- Safeway, the supermarket chain, ping involves consumer expe- encouraged employees to offer help riences that are very different to indecisive consumers without from store shopping it is not waiting to be asked, the program clear that help strategies that backfired. Many consumers viewed work well in face-to-face it as an invasion of their privacy, retail encounters will work while many Safeway employees felt well on the web. uneasy about observing customers. Marketing researchers Online retailers face a similar have found that making recom- computerized “smart” agents to challenge. They have to make sure mendations that are consistent estimate consumers’ preferences that customer help efforts increase with consumers’ prior preferences based on their characteristics and sales and satisfy consumers rather can increase consumer satisfac- past behavior, and recommend than alienate them. Many websites tion. Marketers have also suggest- products. But consumer help differs feature icons that consumers can ed that Internet retailers can use from consumer recommendations.

42 Sternbusiness TIONS BY JULIETTE BORDA

Sternbusiness 43 ILLUSTRA HELPING HANDS

Recommendations often involve tinguished three types of help: help People have both positive and providing information impersonally, requested by the person being negative reactions to receiving help. and do not necessarily involve per- helped; help offered by the helper, And consumers’ decisions on sonal or Internet contact. By con- while allowing the recipient to whether or not to seek help, and trast, we define consumer help as an accept or decline the help; and help their reaction to help, can be viewed encounter where a retailer represen- imposed by the helper without first as the result of the relative weight tative explicitly provides aid to a asking for permission. given to the perceived costs and consumer regarding a consumer benefits. Requested help has a need, product attribute or attribute Help Strategies potential advantage over offered or importance, or a purchase decision. It is fairly simple to create strate- imposed help since it allows the And while help-seeking and help- gies for each of the three help types, helped person to maintain autono- giving have been investigated exten- both online and offline. Consumers my and control. But past help sively in the fields of psychology, can request help in a store from research has shown that in face-to- education, child development, for- salespeople, while Internet con- face help encounters, people are eign aid policy, and organizational sumers can request help by sending more likely to have a more positive performance, the existing marketing an e-mail or clicking a help icon to reaction when help is offered than literature has given relatively little start a help “chat.” Store salespeo- when it is requested, because other attention to the question of con- ple can offer help by asking con- factors outweigh the potential posi- sumer help. sumers whether they would like to tive aspects of requested help. Consequently, we set out to be helped, while online retail per- Requesting help may increase feel- investigate which types of consumer sonnel can pop open a window in ing of indebtedness to the help help affect consumer satisfaction – the consumer’s browser and offer provider, and it can reduce self- in stores and online – how these help. Store salespeople can impose esteem. People are also less likely to strategies affect actual sales, and help by giving consumers help with- request help if their request is whether the best online strategies out first asking for permission, while observed by other people. differ from the best in-store strate- web retailers can impose help using These factors, which have been gies. Researchers have generally dis- an instant message window. identified in contexts outside of the

44 Sternbusiness consumer realm, are also likely to have long accepted that employees Barnes & Noble, one of the largest increase consumers’ perceived in most kinds of stores, which are retail booksellers, or on Barnes & “cost” of requested help in face-to- public spaces, may observe their Noble.com. The description of the face encounters. And so our first actions as a prelude to offering or help encounter with the salesperson hypothesis holds that in stores, a imposing help, people usually use involved either requested, offered, help encounter that uses imposed or the web in the privacy of their home or imposed help. The scenarios for offered help will lead to higher con- or office. Many consumers are con- all three types of help contained the sumer satisfaction than an cerned that web monitoring invades same help from the Barnes & Noble encounter that uses requested help. their privacy. And so our fourth employee. Our second hypothesis holds that hypothesis holds that the impact of Participants were asked to report customers will have more satisfac- imposed help on satisfaction will their satisfaction, on a numerical tion with a retailer when they depend on the extent to which the rating scale. Participants also request help during Internet shop- imposed help leads consumers to be reported how many books they had ping than during shopping in a concerned about their privacy. purchased for themselves or others store. Computer contact omits many e tested these during the past month. They were of the visual elements that can form hypotheses with a also asked whether during the shop- an important part of interactions in study involving 135 ping experience they were “worried face-to-face encounters and makes undergraduates at a about your privacy” and whether requested help less attractive to con- university in the they “thought your privacy was sumers. Other consumers cannot northeastern U.S. being invaded.” observe consumers who make help WParticipants read one version of a requests over the Internet, and peo- help encounter with a salesperson in The Results ple are more likely to request help if a bookstore or bookseller website. Comparisons among participants they remain anonymous to the They were asked to “imagine that showed that when shopping in a helper. The lower level of personal you are actually in this shopping sit- store, satisfaction with the retailer contact in Internet help also increas- uation” and then asked how they was higher when help was imposed es the psychological and social dis- would react. In all scenarios, the than when it was requested (see tance between the consumer and the participant was shopping for a Figure 1). The comparison between help provider. At the same time, friend’s birthday present and was requested and imposed help is sta- consumers are likely to still appreci- trying to choose between books by tistically significant, while the com- ate the greater autonomy, freedom, two of the friend’s favorite authors. parison between imposed and and control that requested help Participants were either told they offered help is not significant, gives them. were shopping in a store operated by although in the correct direction. Our third hypothesis holds that imposed help will gener- Figure 1 ate greater satisfaction in stores than on the web. Satisfaction with Retailer (Adjusted Means from ANCOVA) Imposed help generally 5.6 requires the greatest level of 5.47 monitoring of consumers by 5.4 5.36 retailers. Retailers of either 5.2 5.05 Help requested kind cannot make a reason- 5 4.97 able attempt to impose help 4.8 4.65 without first observing 4.61 Help offered customers. This need for 4.6 monitoring may signal to Satisfaction 4.4 consumers that they are Help imposed being observed. If con- 4.2 sumers believe that this mon- 4 itoring invades their privacy, Retail Store Web this can lower their satisfac- tion – particularly in online settings. While consumers

Sternbusiness 45 HELPING HANDS

Advance page mentions that their sales agents “Requesting help may Notification might flash a message on your Why is that the screen to help you with your pur- increase feeling of indebtedness case? Consumers’ chase decision,” while the conditions to the help provider, and it can expectations for without advance notice did not con- reduce self-esteem. retail shopping may tain this sentence. include help, but n examination of compar- People are also less likely to their expectations isons between satisfaction request help if their request is for web shopping with and without notifi- observed by other people.” may not. If con- cation, for each type of sumers are offered help showed that, as pre- help during web dicted,A advance notification had the Thus, our first hypothesis was par- shopping, this creates a discrepancy greatest positive impact on satisfac- tially supported. We also found that with their expectations that leads to tion for imposed help, and a lesser, satisfaction in the requested help surprise. Unpleasant surprises can but still marginally significant, condition was higher for the website lower consumer satisfaction. As a impact for offered help. But con- than the store, supporting our sec- result, we set out to examine trary to our expectations, advance ond hypothesis. By comparison, sat- whether providing web shoppers notification actually decreased satis- isfaction with imposed help was with advance notice that help may faction in the requested help condi- higher for store than for web shop- be provided would reduce privacy tion, although not significantly. One ping, supporting our third hypothe- concerns, and in turn increase cus- possible explanation: notifying con- sis. It is interesting to note that the tomer satisfaction. Doing so might sumers that they might receive help rank order of satisfaction for the tend to reduce feelings of unpleasant creates an expectation that they def- three types of help in web shopping surprise and invasion of privacy at initely will receive help. When they was precisely the reverse of their the time the consumer is helped. need help, but have to request it, rank order in store shopping. For in- However, we expect that the this expectation is not met, resulting store, the rank was: imposed, impact of advance notification on in lower satisfaction. offered, and requested. For online, satisfaction will vary across the the order was requested, offered, three types of help. If consumers Influencing Sales and imposed. perceive a type of help as unusual, Marketers must also consider hen we tested novel, and opposite to their expecta- whether providing help has a direct the hypothesis tions, advance notification can be influence on sales. In a third study that privacy expected to have greater impact. we analyzed actual data from a well- concerns affect Specifically, we hypothesized that known, general merchandise retailer the relationship consumers will perceive imposed with both store and web operations. between shop- help as the least normative, and The retailer’s website includes an ping context and most unusual type of retailer help on online help facility that lets con- satisfaction for the web; offered help as more nor- sumers request help by initiating a imposedW help, we found, as expect- mative; and requested help as the live, instant messaging conversation ed, that the average satisfaction for most normative. Thus, we expect with a retailer representative, by web shoppers was significantly that advance notification will have clicking on a live “chat” icon. This lower than the average for in-store the greatest impact on satisfaction falls under our classification of shoppers. The concern score when for imposed help and the least requested, online help. So we imposed help was received in web impact for requested help. hypothesized that the higher satis- shopping was significantly greater To test these hypotheses, we faction associated with requested than when this help was received in designed a second study, with 132 online help would make consumers store shopping. These results sug- undergraduates at a university in who requested help using the online gest that, in general, web help gen- the northeastern U.S. who had not chat facility more likely to purchase erates higher privacy concerns than participated in the first study. This from the web retailer than con- in-store help, and that imposed help study used the same book-shopping sumers who did not. on the web generated the highest scenario, but included the following The data were provided by a privacy concerns of all. advance notice condition as a vari- market research firm that recorded able: “The Barnes & Noble home the web usage of a large panel of

46 Sternbusiness consumers from August 2002 to consumers to still request help if dicting those ads, and have higher June 2003. During this time, pan- they need it, so that they are not dis- purchase intentions, compared to elists made 60,057 site visits to the appointed if they decide to request shoppers who were not allowed to retailer’s website, and purchased help. choose among ads. Similarly, reac- during 815 of these visits. We deter- Since consumers who request tions to help might become more mined that panelists had requested help tend to look at more web pages positive if consumers are allowed to help during 363 site visits. And we than those who do not, it is impor- choose from a menu of help types. found there was a signifi- While most consumer help cant connection between in stores and on the Internet is help and sales. The propor- “Comparisons among partici- provided by human beings, tion of consumers who pur- pants showed that when shop- automated help systems for chased during a site visit if ping in a store, satisfaction with Internet retailers exist that do they requested help during not require human interven- the same visit was 38.3 per- the retailer was higher when tion, such as ActiveBuddy. cent. That was significantly help was imposed than when it Given that peoples’ propensi- higher than the proportion was requested.” ty to seek help is affected by that purchased when not whether they believe a com- requesting help during the puter is providing the help, site visit – only 1.13 percent. We tant that the web representatives there is a need to examine the poten- note that we can’t infer causality providing help be knowledgeable tial advantages and disadvantages from this test. It is possible that con- about the product line and the site of such help systems, and identify sumers who request help are already itself, so that consumers can obtain contexts where automated help is more likely to purchase. The mean the information they seek to expand most effective. number of the retail site’s web pages their web shopping. Just as companies have combined viewed by panelists who requested online and off-line retail strategies – help (46.8) was also significantly Other Factors so-called clicks and mortar – there greater than the mean number A number of factors not investi- are signs that retailers are taking viewed by those who did not request gated in this paper might also affect both approaches. Liveperson has help (13.5). The results suggest that consumer reactions to help or their developed software that allows consumers use requested help to willingness to request help, and are retailers to use decision rules or broaden, rather than narrow, the areas for future research on con- intelligent agents to decide whether amount of information they obtain. sumer help. For example, willing- and when to provide offered or ur studies have shown ness to seek help can be affected by imposed help to web shoppers, but that the effectiveness how the person in need of help per- then connects consumers who con- of consumer help ceives the physical attractiveness of sent to help to a real person for fur- strategies in increasing the potential helper, and whether ther assistance. Consumers may also consumer satisfaction the two have the same or different be less likely to feel that their priva- depend, in part, on the genders. Males are often less willing cy is invaded by offered or imposed shopping context. to seek help than females, but are online help if they know that the Firms can use these results to help more willing to help. This behavior web retailer’s decision to contact designO their help strategies. For has implications not only for retail- them is the result of a computer example, retail stores can encourage er’s in-store help strategies, but also applying an automated rule, and not salespeople to offer or impose help for the picture and name of the because a human being was moni- rather than waiting for consumers to helper that consumers see in an toring their behavior. request it. Internet firms, by com- online-help facility. parison, should rely more on Web retailers might also develop ERIC A. GREENLEAF is associate pro- requested help. If they do wish to use capabilities for asking shoppers, at fessor of marketing at NYU Stern, imposed or offered help, web retail- the beginning of a site visit, which VICKI G. MORWITZ is associate professor ers should give consumers advance type of help they would prefer to of marketing at NYU Stern, and notification that they may be helped, receive. For example, web shoppers RUSSELL S. WINER is the Deputy to alleviate their privacy concerns. who are allowed to choose which ad Dean and William H. Joyce Professor of This notification, however, should be message they will view are more Marketing at NYU Stern. phrased in a way that encourages resistant to later information contra-

Sternbusiness 47 endpaper Salad Course By Daniel Gross

an you make a ton of money and build a brand that racks up a quarter of billion dollars Cannually in sales if you know than Paul Newman’s blue eyes. absolutely nothing about business From the outset, the founders and management? In their occa- agreed to give all profits to charity. sionally hysterical new book, Sales caught on, fueled by the rapid Shameless Exploitation in introduction of spaghetti sauce. Pursuit of the Common Good, Newman’s Own grew steadily Paul Newman and A. E. and, um, organically – adding Hotchner, say you can – but only popcorn, lemonade, and cookies if you give the profits away. to the product mix, which now The tale of how two middle-aged numbers 77. men whipped up the $250-million- In its first 20 years, Newman’s a-year Newman’s Own food empire Own has earned – and given away – from scratch starts in 1980, in $150 million. The biggest benefici- Westport, Connecticut. Newman was aries of the empire of lemonade, somewhat obsessed with salad dress- popcorn, and vinaigrette have been ing. He took an oil-and-vinegar a string of camps created by cocktail of his own design every- ILLUSTRATION BY STEVEN SALERNO Newman’s Own that serve children where he went, “not just as a taste with cancer. preference, but also as a defense response: “Maybe we should call it “There are three rules for run- against those insufferable artificial Redford’s Own.” ning a business; fortunately, we additives.” But Newman’s star status helped don’t know any of them,” the co- Newman and A.E. Hotchner, a out. They held – and won – a tasting authors protest. But they knew at novelist and biographer of Ernest test at the kitchen of “a local caterer least one. A company competing in a Hemingway, wanted to market a mix we knew named Martha Stewart.” In market dominated by giant, deep- they had stirred up in Newman’s September 1982, when the all-natu- pocketed brands – Kraft, Ragu, and basement. But they knew that ral salad dressing was formally intro- Orville Reddenbacher – needs an celebrity-related products frequently duced at a bar in New York – with edge. And the goal of any successful failed at the consumer box office. Newman and his wife, Joanne brand manager is to have the target And so did industry professionals. Woodward, providing the entertain- audience develop positive associa- “No offense, Mr. Newman,” one ment – film reviewer Gene Shalit tions with the brand. What better marketing consultant said, “but just showed up. The bushy-mustached way to do so than to give away your because they liked you as Butch critic raved. profits to a good cause? Cassidy doesn’t mean they’ll like Newman’s Own had another sell- your salad dressing.” His droll ing point that proved more powerful DANIEL GROSS is editor of STERNbusiness.

48 Sternbusiness

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