Management Insights
Authors: Gorman Michael F. 
Published: November 2011

Diwas Singh KC, Christian Terwiesch As health-care costs continue to skyrocket, could the inefficiencies arising from the traditional notion be to blame? In the 1970s, Wick Skinner espoused the idea that the “focused factory will out-produce, undersell, and quickly gain competitive edge over the complex factory.” In the case of health care, an example of such focus is Shouldice Hospital, a Canadian hospital that specializes in hernia operations. The authors evaluate the effect of focus on operational performance in the provision of health care through a study of more than 500,000 cardiac patients in California hospitals in 2007. They examine treatment focus at three distinct levels of the organization—at the firm level, at the operating unit level, and at the process flow level. They find that focus at each of these levels is associated with improved outcomes, namely, faster service at higher levels of quality, as indicated by shorter stays and reduced mortality rates. However, specialized hospitals such as Shouldice might have “efficient” operations only because they cherry-pick the easier cases, such as hernias. After controlling for selective patient admissions, focused hospitals no longer demonstrate a statistically significant reduction in length of stay or mortality rate. However, at more granular measures of focus within the hospital (e.g., operating unit level), they find that more focus leads to a shorter stay, even after controlling for selective admission effects. The insight for management: Hospitals might begin specializing to create operating efficiency.

Tanjim Hossain, Dylan Minor, John Morgan What do Microsoft Windows, the Nintendo Wii, Google, eBay, MasterCard, and the New York Stock Exchange have in common? They are all platforms. Platform competition is ubiquitous and has become increasingly important, but it is little understood. In some cases, multiple platforms coexist with stable market share; in others, a tipping point is reached and power shifts heavily, or entirely, to a single competitor. The authors use laboratory experiments to study platform competition. They find that when platforms are primarily vertically differentiated, even when platform coexistence is theoretically possible, markets inevitably tip to the more efficient platform. When platforms are primarily horizontally differentiated, so that there is no single efficient platform, the authors find strong evidence of equilibrium coexistence. The insight for management: Platforms are critical to competition and market structure for many products; the level of vertical and horizontal differentiation drives whether a competitive or monopolistic market results.

Ola Bengtsson How do venture capitalists (VCs) structure arrangements with entrepreneurs? Through empirical analysis of mandatory legal filings, the author studies how covenants are included in contracts between VCs and entrepreneurs. Commonly included covenants are protective provisions such as limitations on taking on new debt, selling assets, executive pay, and business model changes. The author finds that contracts with higher fixed payoffs include 1.6 more covenants than do contracts with lower fixed payoffs. Similarly, venture capital (VC) contracts with no VC board majority requirement include 0.6 more covenants than do contracts that require a VC board majority. Covenants are also more common with older companies and when fewer VCs invest in a round. The insight for management: Venture capitalists use covenants to maintain control of entrepreneurial ventures.

Yannis Bakos, Chrysanthos Dellarocas When it comes to buyer and seller contractual adherence, is an ounce of prevention worth a pound of cure? The authors compare market efficiency of markets with Internet-enabled reputation mechanisms with market efficiency of markets that use more litigation-like mechanisms for dispute resolution. They find that the popular view of reputation as an efficient and relatively costless way to induce seller effort under all circumstances is incorrect; reputation is less efficient than litigation in inducing any given level of effort. Thus, reputation improves efficiency only in settings where the high cost of litigation, insufficient damage levels, or low court accuracy induce suboptimal effort or cause market failure. The insight for management: Reputational effects alone are not enough; adding reputation to existing litigation mechanisms increases seller effort.

Rui J. P. de Figueiredo, Jr., Evan Rawley When managers require external investment to expand, higher-skilled firms will be more likely to diversify, even though less talented managers can exploit asymmetric information about their ability to raise capital from investors for personal rather than corporate gain. The authors examine more than 1,300 hedge funds from 1994 to 2006. They show that diversifying firms' excess returns are high relative to those of other firms prior to diversification and fall within firm after diversification, but are six basis points higher per month per unit of risk ex post compared to a matched sample of focused firms. The insight for management: Managers exploit asymmetric information about their own ability to time diversification decisions, but the discipline of markets ensures that better firms diversify, on average.

Zhe George Zhang, Hsing Paul Luh, Chia-Hung Wang When a country senses a threat to national security, travelers face the inconvenience of congested security checkpoints at international border crossing stations. Is there an effective security-check system that not only caters to the needs of nonrisk individuals but also sustains the efficiency of screening high-risk individuals? The authors investigate a security-check system with both security and customer service goals. In such a system, every customer has to be inspected by the first-stage inspector, but only a proportion of customers need to go through the second stage for further inspection. This “further inspection proportion,” affecting both security screening and system congestion, becomes a key decision variable for the security-check system. The authors show the optimal further inspection proportion can be determined to achieve the balance of the two goals and that the service capacities can be classified into “security-favorable,” “security-unfavorable,” or “security-infeasible” categories. The insight for management: Competing security and service objectives can be balanced with a smart approach to border crossing processing.

Michael Salinger, Miguel Ampudia The Lerner relationship links the profit-maximizing price to marginal cost and the elasticity of demand. The authors generalize this relationship to the price-setting seller of a short-lived product (e.g., a newspaper) with uncertain demand. There are two ways to specify uncertainty: multiplicative and additive. Multiplicative uncertainty increases the optimal price because it increases the marginal cost of a unit sold and does not affect the markup factor. Additive uncertainty has no effect on the marginal cost of a unit sold and lowers the markup factor because it increases the elasticity of the average quantity sold with respect to price. The insight for management: Pricing is affected only under certain conditions of uncertainty.

Thomas Åstebro, Jing Chen, Peter Thompson Who ends up being their own boss—stars of the market with high potential, or misfits who are hard-pressed to find traditional employment? Entrants into self-employment are disproportionately drawn from the tails of the earnings and ability distributions. Natural friction in the labor market creates mismatches between firms and workers and misassignment of workers to tasks. The authors use a Korean Labor and Income Panel Study data set to test their model. The insight for management: Prior work histories can be connected to the probability of entry into self-employment.

J. J. Po-An Hsieh, Arun Rai, Sean Xin Xu How can firms extract value from already-implemented information technologies (IT) that support the work processes of employees? One approach is to stimulate employees to learn and apply more of the available functions of the implemented technologies to support their work. Through study of the use of customer relationship management technologies at one of the world's largest telecommunications service providers, the authors find that such learning behavior of extending functions in use is ingrained in a process by which users make sense of the technologies in the context of their work system. The authors find that employees are more likely to figure it out in two ways: technology and work system. Employees' learning at the technology level is influenced by employees' assessment of technology quality, whereas employees' sensemaking at the work system level is influenced by customers' assessment of service quality. When technology is sub-par, employee feedback should be captured through employee participation at the technology level and through work system coordination at the work system level. Such alignment can mitigate the undesirable effect of low technology quality and low service quality, thereby facilitating extended use. The insight for management: The extended use of technology amplifies employees' service capacity, leading to better objective performance; understanding and aiding employees' sensemaking about the implemented technologies can promote their extended use of IT and improve their work performance.

Vish Krishnan, Karthik Ramachandran Consumers know that smartphones get better and more affordable each year and that the patient consumer who waits to adopt the latest technology can benefit. Firms face challenges in marketing such improving products to well-informed, forward-looking consumers who anticipate product improvements and seek to delay their purchase timing. The authors find that modular upgradable architecture (“Updates available for download!”), in which improving and stable subsystems of a product are separated and selectively upgraded, can be a valuable approach for marketers to alleviate consumer concerns about product obsolescence. However, such an architecture-based approach requires carefully coordinated cross-functional decision making by the firm. The authors find that “design inconsistency”—the firm's inability to commit to future product design architectures—lowers both firm profits and consumer well being when the firm cannot commit to future prices. The insight for management: A joint product architecture and pricing approach enables an innovating firm to optimally launch modular upgradable products in a time-consistent manner.

Hela Maafi Preference reversals have been widely studied using risky or riskless gambles. However, little is known about preference reversals under ambiguity (unknown probabilities). In experiments, subjects were asked to make a binary choice between a bet with a large but unknown likelihood of a small prize and a bet with a small but unknown likelihood of giving a large prize. They then repeated the choice where the probability of winning for a given risky bet is known with the same expected outcome as the ambiguous bet. The author finds that preference reversals are not only replicated under ambiguity but are even stronger than are those under risk. The insight for management: Advances are being made in the understanding of decision making under risk and ambiguity.

Ning Cai, S. G. Kou The Black–Scholes model created major advances in financial investing technology and strategy. The authors extend this model to include a more flexible distribution of jump diffusion, expanding its applicability, accuracy, and analytic tractability. The insight for management: Advances in financial research are expanding the applicability of the famous Black–Scholes model.