Red Beads, Management Tools and the Elusive Quest for Strategic Advantage

Management tools do not automatically confer strategic advantage.  In principle any commercially available modern management tool from Total Quality Management to Lean Six Sigma, from Supply Chain Management to Price Optimization Models, is available to any and all paying customers on equal terms.  Two competitors in the same industry space may employ the exact same suite of management tools, but it is a good bet that their relative performance will vary considerably over time.  I don’t find this particularly surprising: generally speaking I subscribe to the view of competitive strategy vis a vis productivity enhancement tools eloquently expressed by Michael Porter in his 1996 Harvard Business Review article “What is Strategy?”  To wit: “Competitive strategy is about being different.  It means deliberately choosing a different set of activities to deliver a unique mix of value”.  That is to say, the act of hiring a Process Re-engineering implementation team or reinventing oneself overnight as a Learning Corporation will not automatically confer sustainable advantage.  Rather it is how (and if) those tools are integrated into a portfolio of aligned, mutually reinforcing organizational activities distinctive from those of competitors that will most likely make the advantage difference.

This makes sense to me.  Nonetheless I am often astonished by the frequent tendency among many corporate decision-makers to conflate the application of some management tool with a fabulous consultant-ese moniker into a “magic bullet” that will effortlessly change the organization overnight from a laggard to a market driving leader.  Then, as egregiously as they confer magic powers on the tools, after a few fiscal quarters the decision-makers realize they are not getting sustainable performance improvement, decide in their infinite wisdom that the inherent inadequacy of the tools is at fault, and consign them to the trash heap of unrealized expectations.

meaningful tools or random noise?

This misguided tendency – to ascribe awesome powers to something and then discard it for the wrong reasons – brings to mind one of my favorite management lessons: a timeless exercise developed by W. Edwards Deming called the Red Beads Experiment (actually, what I call “timeless” Deming himself calls “a stupid experiment you will never forget”).  Deming was one of the founding fathers of Statistical Process Control, itself a prototype of the management tools that abound in our age, and something of an iconic hero for several generations of Japanese business leaders dating back to the 1950s.  The phrase “you can’t improve what you can’t measure” is often attributed to Deming, though not always in the right context.  A more accurate reflection of his philosophy would perhaps be “measuring the wrong thing is much worse than not measuring at all”, and that brings us back to the Red Bead Experiment and its lessons for managers of today in the use and misuse of performance management tools.

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Fair Price, Optimal Price

Businesses seek to maximize the value they can obtain from their revenue models.  Price is the key lever decision-makers can operate to influence revenue, and in recent years a growing number of businesses have sought to implement strategies for actively managing the price lever – strategies such as demand management and revenue optimization.  However businesses are also highly sensitive to the perception by individual consumers and the society at large that their prices are fair, in other words that they do not violate widely held individual or societal norms.  Fair pricing matters – it matters to me, and to you, and perhaps ever more so in a climate characterized by economic uncertainty, downward pressure on demand and a perceptible decrease in the citizenry’s trust of public and private institutions.

Fortunately for business decision-makers, fair pricing and optimal pricing are not at odds with each other but can comfortably coexist.  Over the course of the coming weeks my colleagues at Sentrana and I will be approaching the rich topic of fair pricing in a series of exchanges on this blog.

debating the age-old question of fair price

What is a fair price?  This question has perplexed humanity throughout history.  Leading thought output of the ages, from Aristotle’s Nicomachean Ethics to the Summa Theologicae of  Thomas Aquinas, Pierre de Fermat’s probability proofs and Adam Smith’s classsical economics, have all weighed in with considered opinions on the fairness and justness of alternative ways to price economic goods and services, and the debate continues today.  A series of letters exchanged between Blaise Pascal and Pierre de Fermat in 1654 is often regarded as a primal cause of the development of modern probability theory: this exchange was actually an attempt to establish a scientific basis for the notion of fair price.  In his paper “The Unity and Diversity of Probability” Rutgers professor Glenn Shafer shows how these letters created hypothetical games of value that we today can recognize as the application of probability methods to defend a price as ‘fair’ under conditions of uncertainty. Read the rest of this entry »

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Why Pricing Must Be a Continuous Process (Part 1)

At some point, every homeowner learns an important lesson about how to save money on air conditioning during the hottest part of the summer. Generally speaking, it costs less to keep your house at a relatively even, tolerable temperature, then to turn off the unit entirely during the day and blast the A/C in the evening when you are home. The process of re-cooling the entire house each time wastes a lot of energy to get to a comfortable temperature again.

Multiple optimal prices can exist for a product, even in transparent markets. Note that all of the prices in this image apply to the exact same HP printer.

The lessons of efficiently cooling a home can be applied to many scenarios. In business, having a system in place for tweaking procedures continuously is easier to manage over time than are prolonged periods of stasis followed by dramatic transformations. Transformations are complicated. They are often expensive. If too much time passes between transformations, the organization’s inertia coefficient (a 100% made-up term) passes a critical threshold. After that point, two outcomes are the most likely, with a few shades of gray in between: (1) transformation projects mushroom from merely “expensive” to “expensive and painful”, or (2) the company is too lethargic to change, effectively dooming the business to eventual defeat or absorption by more innovative rivals. For the sake of comprehensiveness, I have to acknowledge that for a fortunate few, “federal bailout” must now be added to this list as a third possible outcome. However, in a few years we will see if my suspicion that outcome three eventually finds its way back to outcome two turns out to be correct. Read the rest of this entry »

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How Major League Baseball Can Steal Profits Back From Ticket Scalpers Using the Right Pricing Solution

The National Baseball Hall of Fame recently inducted Ricky Henderson, one of baseball’s most prolific base stealers with a record 1,406 bases stolen in his career – yet, Major League Baseball has failed to deal with scalpers who steal millions in profits from their franchises every year. Scalpers have seized the lost opportunity where Baseball franchises lock in their ticket prices months before the season starts and choose not to adjust prices throughout the season. A more efficient secondary market thrives due to the scalpers’ ability to factor in several game variables (e.g. strength of opponent, seat type, starting lineup, weather conditions, etc.), as well as buyer-specific factors (e.g. age, attitude, clothing, jewelry, etc.) to determine the maximum (and therefore optimal from the seller’s perspective) price that each person is willing to pay. Another advantage for scalpers is their ability to immediately negotiate if the buyer doesn’t accept the first price, carefully moving the price down until both the buyer and seller agree upon a satisfactory price. To help reclaim these lost profits, the San Francisco Giants are now testing dynamic pricing software to help adjust ticket prices based on the expected consumer demand for each game. So what exactly is dynamic pricing, and is it powerful enough to replace the individualized pricing, negotiation, and sales effectiveness of ticket scalpers? Read the rest of this entry »

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Missing the Ocean for the Stream: What We Can and Cannot Learn from IBM’s New Breakthrough

As part of its perpetual quest to reinvent and perfect its business model, IBM has made an aggressive push into the analytics market in the last half-dozen or so years. The company’s slick, though occasionally confusing ad campaigns (remember those ads with the mysterious red box being unveiled?) often announce its new initiatives, though it is not always clear that a new announcement is indeed a major one. In the analytics space, however, Big Blue does mean business. The announcement of its sizable new business analytics and optimization division is clearly intended to prove as much. Shortly after its announcement, IBM also unveiled a new stream computing platform called “System S” to much fanfare. The breathless enthusiasm of business journalists, technology bloggers and investment analysts has been palpable. But what exactly does this technological advancement do, and what does it mean for your business?

To answer this question, let’s begin briefly by dissecting what IBM has introduced. Imagine that you are receiving a continuous stream of data, such as stock prices on the Nasdaq. These figures must be quickly analyzed so that the proper buy and sell orders can be placed. Suppose that you also need to base your decisions not just on the Nasdaq prices but also the numbers figures coming in from dozens of other exchanges. Read the rest of this entry »

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Why Credit Doesn’t Matter to Maintain Competitive Advantage

Realizing I would be without a wireless connection on my train ride to NYC, I stopped to grab some light reading material at a kiosk in Union Station, where I found a plethora of headlines devoted to capital spending. I know that the loss of $50 Trillion in wealth in the last 18 months led to a severe credit crunch, but wasn’t that old news? Aren’t businesses starting to rebound with the distribution of the $700 Billion in TARP funds that helped prop up banks and car companies, along with another $2.5 Trillion spent to support the struggling financial system? I take a quick look through the daily business headlines, and they continue to reflect a particularly bleak outlook for businesses that are still struggling with low expectations for growth and profits, costly and scarce credit, weak consumer demand and a glut of production capacity. To compound matters, the current administration and Treasury Department will implement extensive financial regulations to curb future financial crises, and banks continue tightening their lending standards for all types of business loans. I hope these measures reduce the risk of another bubble market, but at what cost will these measures reduce the opportunity for many businesses to effectively compete in this economy? One thing is obvious: credit will no longer be a cheap commodity for businesses in the near future, period. But then again, is credit really necessary for businesses to stay competitive? Read the rest of this entry »

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Cheating Your Way into Business Visibility

Several weeks ago, I wrote a post about how the pace at which the world is accumulating information exceeds our ability to critically evaluate it. For companies that make thousands or millions of marketing decisions every day in the form of price offerings, advertising placements and so on, this translates into making decisions that perpetually involve a greater amount of uncertainty relative to the amount of information we have. The root cause of this problem is a technological one: we do not have the computing power to slice and dice massive datasets in order to glean insight in time to support decisions. An even deeper explanation is that the gap between the rate of information accumulation in businesses and the pace of information transfer improvements will continue to widen at an increasing rate. This poses serious challenges to the capabilities offered by Business Intelligence, not to mention our ability to determine optimal prices. Read the rest of this entry »

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Quantitative Intuition: It’s Not Counterintuitive (Nor an Oxymoron)

Think of the best salesperson you know: if you’re fortunate, perhaps someone in your company or, less happily, in a competitor’s firm.  What are the qualities that make this person excel at the job of sales?  In a classic Harvard Business Review article “What Makes a Great Salesperson” (July-August 1964) David Mayer and Herbert Greenberg likened a star salesperson to a heat-seeking missile: “Sensing what customers are feeling, they [the sales stars] are able to change pace, double back on the track, and make whatever creative modifications might be necessary to home in on the target and close the sale.”   Whereas most of us have intuitive abilities to a greater or lesser extent, excellent salespeople lever this intuition with strong empathy skills (sensing what the customer’s needs are) and the relentless personal drive necessary to cross the finish line.  If they could, managers would bottle this elusive elixir of talents and have all their salespeople drink it, every morning of every day. Read the rest of this entry »

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Finding Pricing Excellence on a Roulette Wheel

One of my recent posts, “You Are Not At the Mercy of the Market…”, attracted a rather thought-provoking response posted directly to the blog.  The crux of this response, and others sent directly to me, have all revolved around a similar theme:  With so much uncertainty surrounding consumer behavior, words such as “pinpoint” or “optimize” should not be uttered when it comes to the decisions that pricing and marketing managers must make.  This is indeed a compelling sentiment, and has stirred much discussion amongst my colleagues in industry and in academia (our research organization collaborates closely with professors within the University of Chicago and Carnegie Mellon University).  This discussion has taken on many twists and turns, which we hope to summarize in future posts.  But, there is one particular question that has resonated throughout our discussions:

What are the implications of the words “pinpoint” and “optimal” when market behavior is so uncertain?

In other words, is it possible to find a single decision that will maximize the odds of earning a handsome payoff when the outcome of any decision is uncertain?  In a rather extreme example, in the highly uncertain world of gambling, can I make some decisions that are clearly better than others in light of the uncertainty? Read the rest of this entry »

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You are Not at the Mercy of the Market: You Have All the Power to Make Your Price

If figuring out how to maximize your revenues by charging the right price is hard when people actually need your product, imagine how much harder it is when they don’t need your product or don’t necessarily even need to pay to enjoy your product.  The lessons learned from how to maximize revenue in this regard, which is a much more formidable challenge, can profoundly impact your ability to maximize earnings in the less difficult situation where people have no alternate choice but to pay for your product.  In a stroll down a busy street, we will once in a great while receive a good that can stir our soul yet require no payment.  We receive this good from the ubiquitous street musician who earns his income as a mendicant who lets you set the price (which is often nil), rather than setting his own price for “services tendered.”

And then there are those rare occasions where we encounter a street musician whose music soars so high that we are forced to refer to him simply as a “musician,” for using the adjective “street” would be nothing short of a criticism.  About 2 years ago, this is what I encountered at one of Washington D.C.’s busiest Metro (subway) stations during the morning rush hour.  It wasn’t until much later in the day that I discovered the musician in whose masterly hands the violin “sobbed and laughed and sang” was the great virtuoso Josh Bell.  In the middle of the morning rush hour, 1,097 commuters passed by and all heard soul-stirring music at a price of their own choosing that just a few days earlier fetched more than $100 a seat at Boston’s Symphony Hall.  Josh Bell played to a rush hour herd, and demanded no price for priceless music.

His income depended not on the value he provided to those 1,097 passersby, but the overwhelming value he provided – for, if he failed to stir, we listless commuters would feel no compunction to pause and forfeit even a meager fraction of our purse.  And stir he did, with a masterly performance of Bach’s Chaconne from Partita No.2 in D Minor.  Of the almost 2,000 pedestrians that filed by, only 27 gave money for a total of $32.  In other words, for a performance that was described by the Washington Post as “pearls before breakfast,” less than 3% of us offered any payment (for “a man whose talents can command $1,000 a minute”).  Did the service deserve such scant payment, or was there more to the revenue than just the greatness of the service itself.  This is a question that goes right to the root of just how complex the endeavor of pricing can be. Read the rest of this entry »

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