JC Penney vs. Zara: How to Reduce Markdowns

Frequent markdowns can eat into a retailer's margins quite substantially.  No wonder, then, that Ron Johnson - the CEO of JC Penney has tried to wean the department store off of its reliance on discounts and sales.  We all know, however, that he has had limited success to date.  In fact, sales have plummeted as customers have revolted at the dramatic reduction in sales and markdowns. 

Let's compare JC Penney to Zara for a moment.  Zara is a Spanish apparel retailer that has done remarkably well over the past decade or so.   Zara manages to offer fewer markdowns than many rivals, and when it does discount its clothing, they price reductions are smaller than those offered by competitors.  How does Zara do it?  They pursue a "fast fashion" strategy, whereby they make smaller batches of fashion items - a substantial percentage of which they make in their own factories.  They change their product mix often, and they react quickly to changing trends and consumer tastes.  Customers know that many lines of clothing will have limited numbers of items, and that those items may not be on the shelf one month later.  As a result of this nimble strategy, Zara minimizes the downside of "fashion misses" in their product line.  Because they don't produce huge runs of some of these items, they have much less inventory left over if a new product is not a hit with consumers.  Therefore, they have less of a need to mark down those clothes.  

In short, Zara has reduced its dependency on markdowns, but they have not done it simply by declaring that there will be less discounts.  They have built an entire strategy that makes it much less likely that they will need to discount items.  JC Penney hasn't yet built that comprehensive strategy to support its  new pricing policy.  As a result, JC Penney has struggled. 

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Making Customers Wait Can Be a Costly Problem

Gad Allon, Awi Federgruen, and Margaret Pierson have conducted an interesting piece of applied research regarding the fast-food business, with implications for a wider range of industries.  They examined the fast-food drive-thru industry and took a look at the relationship between willingness-to-pay and wait time.   They found that, "Both the price and waiting time parameters have a significant impact on the consumer’s decision.  These results confirm … that in the fast-food drive-thru industry customers trade off price and waiting time. In particular, to overcome an additional second of waiting time, an outlet will need to compensate an average customer by as much as $0.05 in a meal whose typical price ranges from $2.25 to $6. This corresponds with an hourly cost rate of approximately ten times the (pre-tax) average wage of $18/hour and nearly 30 times the (pre-tax) minimum wage in Illinois in 2005.”

Most importantly, the scholars did not just show that people value their time, but that they value their time waiting in line VERY highly.  The research shows that people strongly dislike wait time while at the restaurant, and they value that time more heavily than they do the travel time to the restaurant.   As Allon notes, "The waiting time once in line is considered pure waste.”

Some firms should pay special attention to this study.  In particular, firms that do a fair bit of customization for customer orders need to be wary of wait time effects.  Take Starbucks, for instance.  They offer customers the opportunity to customize their drinks in many different ways.  One such customer with a highly specialized order can really lengthen wait times at their drive-thrus.  I always kid my wife about her tendency to use the Starbucks drive-thru. On numerous occasions, I've hopped out of the car, walked into the Starbucks, and come back into the car while she is still in line.   You might argue that a customer faces the same risk of being held up inside the Starbucks.  However, we have to remember that the customers inside the store are different in their wants and needs.  They have chosen to enter the store rather than go to the drive-thru. That decision suggests that they may not value speed as highly.  They may intend to sit down for a few moments, or they wish to use the restroom.  Therefore, the delay in wait time is not as problematic inside the store as it is in the drive-thru.  

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The Value of a University

Bob Sutton has an amazing post on his blog this week.  He writes about what struck him as he read an article from about a decade ago by the great organizational behavior scholar Karl Weick.  Sutton writes:

Karl started out his 2002 British Journal of Management on "Puzzles in Organizational Learning: An Exercise in Disciplined Imagination" this way: 

It is sometimes possible to explore basic questions in the university that are tough to raise in other settings. John Gardner (1968, p. 90) put it well when he said that the university stands for:

• things that are forgotten in the heat of battle

•values that get pushed aside in the rough and tumble of everyday living

• the goals we ought to be thinking about and never do

• the facts we don’t like to face

• the questions we lack the courage to ask

What an important reminder for us all... The thoughts of John Gardner don't just help a professor like me try to justify the existence (or cost) of universities. These thoughts remind me of what we are obligated to do as faculty members.  Sutton points out one small example, a Stanford study that finds "there is little or no documented health advantage to organic food."  Sutton argues that this study made him uncomfortable.  Frankly, it bums me out too... so much for spending all that money at Whole Foods!  Yet, who will make these types of contributions if not a professor? 

It is our obligation to ask these tough questions.  I would argue that it's also our obligation to train our students to ask these types of tough questions, and to teach them how to explore these questions.   That practice will help them not just in the scholarly arena, but also as leaders in various private enterprises or other organizations.  

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How Do Sexy Ads Affect Consumers' Desire for Immediate Rewards?

Wharton marketing professor Gal Zauberman and USC Professor B. Kyu Kim, have written a working paper called "Can Victoria's Secret Change the Future? A Subjective Time Perception Account of Sexual-cue Effects on Impatience."   The scholars conducted a series of experiments in which they showed "sexually suggestive and non-suggestive photographs to self-identified heterosexual male students."  The suggestive photos came from the Victoria's Secret catalog.  Geesh... I imagine that students flocked to sign up for this study!  

After seeing the images, subjects had to assess the value of items, such as a $65 Amazon gift card, that were received immediately versus a year later.  The research found that viewing the suggestive photos tended to enhance the value of the immediate reward and diminish the value of rewards provided a year later.  In other words, the subjects' discount rate rose substantially. 

Zauberman argues that, "Part of the reason why people discount future events, more or less, is their perception of duration [of time]."  The suggestive photos may "lengthen the perceived temporal distance to delayed rewards. That is, sexual cues make the wait seem subjectively longer, resulting in greater impatience."  In other words, consumers may not only be compelled to buy an item, but they may be much more likely to buy NOW even if it is not the most prudent financial decision. 

The scholars conducted other experiments as well.   They also showed subjects photos "designed to elicit physical symptoms similar to arousal -- increased heartbeat and respiration, for example -- that weren't actually sexual in nature."  Interestingly, people showed the same impatience that occurred when they had viewed the suggestive photographs.   In sum, "Sex may not be the only driver of this temporal response."

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Are Network Effects Over-rated?

Nir Eyal and Sangeet Paul Choudary have written an absolutely terrific column for TechCrunch about network effects.  The essay is titled, "The Network Effect Isn't Good Enough."  Network effects, of course, exist when the value per user rises as the number of users of a particular good or service rises.  When network effects are strong, one firm can become the standard in a market - think eBay in auctions, for instance.  In these situations, firms tend to try to "get big fast" so as to move up the curve and achieve a high value per user.  Then they hope that switching costs will lock users into their good or service.    Eyal and Choudary point out that many startups in Silicon Valley bank heavily on the notion of network effects.  They willingly run up huge losses in the early years, hoping to cover those losses with venture money.  Then they hope to reap the rewards when they have become the dominant player in their particular market. 

The authors point out, however, that network effects may not be the elixir that many startups believe they will be.  Why?  The authors make several key points.  Here is an excerpt from their argument:

For one, in the old days, consumers paid to access the network through their upfront investment in hardware. These upfront costs locked users into the network and once they were in, they were in for good, thus erecting barriers to entry for would-be competitors. However, the cost of providing access to the network has fallen precipitously. The days of customers buying expensive hardware to use a network are gone as is the correlating lock-in effect. In addition to access costs falling to zero, another key component of what once kept users locked into a network has vanished. Once, porting contacts onto a new network, like switching instant messaging services from Yahoo! to AIM, was a non-trivial task. Today however, customers use their Facebook, Twitter or Google profiles to join a new service in seconds. A burgeoning network, take Instagram or Pinterest, can leverage the single sign-on enabled by the social graph to reach critical mass faster than ever before.

In other words, switching costs may not be nearly as high as many startups believe them to be.  Thus, the lock-in effect doesn't materialize as hoped.  Consumers flock to a platform, but then they may just as quickly move on to a different product or service.   Think MySpace relative to Facebook.   This limitation on switching costs may explain why many startups have a hard time "monetizing" their eyeballs.  If they try to extract more value from their consumer, they face the startling possibility that people will simply switch to another product or service. 

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Iger's Long Term Strategy at Disney

As you know by now, Disney acquired Lucas Films last week. With that, Disney now owns the Star Wars and Indiana Jones franchises. I'm not surprised by the move. In fact, you can see a pattern emerging to Bob Iger's strategy at Disney, which is quite in contrast to the strategy during the second half of Eisner's tenure at the company. In Eisner's later years, he moved away from simply focusing on the characters as the central driver of synergy among Disney's businesses. He acquired ABC and Miramax, and he owned a baseball and hockey team for some time - among other moves. Now we see Iger refocusing on characters as the heart of Disney's corporate strategy. We see three major moves (Pixar, Marvel, and now Lucas) during his tenure that all involve expanding the universe of characters which Disney can leverage across its many businesses. I think the focus on characters makes a great deal of sense. Here's why...

When thinking about the characters at Disney, we should note those resources are quite valuable because they are highly durable and inimitable. Moreover, Disney can appropriate the value associated with those resources (as Buffett says, "the mouse has no agent"). How then can one think about leveraging such a valuable resource across multiple businesses? A strategist needs to think about how specialized vs. fungible/general the resource is. A highly fungible resource/capability would be something like “brand management expertise” or “innovation” or “risk management.” A highly specialized capability might be patented product formulas or engineering expertise in a very narrow discipline. Fungible capabilities can be easily transferred across lines of business. However, they are often too general/not unique enough to convey a substantial competitive advantage. On the other hand, highly specialized capabilities tend to provide powerful competitive advantage in a particular business, but they lose value very quickly when a firm tries to transfer them to a wide array of businesses. In other words, there are only so many areas in which you can grow based on a highly specialized set of capabilities.

In the 1980s, Disney’s core capabilities revolved around animated character development and deployment. Those tended to be highly specialized capabilities; Disney was able to leverage those capabilities to enter the hotel and cable television business, but ultimately, growth was constrained by the specialized nature of that capability. To move into even more diverse businesses, Disney had to be able to make the case that it had a broader/more general/more fungible capability such as “managing creativity.” That's the argument that Eisner used to move into a variety of businesses that did not have to do with characters (ABC, Miramax, etc.) There are two challenges associated with defining a firm’s capabilities so broadly. First, it is more difficult to make the case that the firm is truly unique and superior to all rivals in that set of capabilities. Second, it becomes rather difficult to discriminate among various options for diversification, i.e., how many businesses have something to do with managing creativity vs. developing and deploying unique characters?

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Sharing Bad News Uncovers Creative Solutions

Several weeks ago, I spoke with a group of senior executives about the importance of cultivating a climate of candor within their senior management team.  I argued that leaders need to encourage people to share bad news.  Put simply, bad news is not like cream; it often does not rise to the top.  Instead it remains quite hidden, often until problems mushroom and grow to a much riskier size and scope.  One executive noted that encouraging people to share bad news doesn't simply help the leader understand the key risks for the business.  Opening sharing among top team members also helps uncover creative solutions to tough problems.  Why?  The other top team members may never hear about a key problem in another division or functional area if that bad news is not shared openly.  If they do hear about it, they may be able to offer some ideas as to how to fix the problems.  Perhaps they have even experienced a similar problem in their own division.  In that way, a candid discussion of bad news isn't just about keeping the chief executive aware of key risks; it also provides an opportunity to get these problems fixed more quickly. 

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