Starbucks, Price Decreases, & Game Theory

Business Week has an interesting article about the recent decision by Starbucks to cut prices on its coffee sold in grocery stores by $1 per bag.  According to the article, "Last quarter the company collected about $380 million from sales outside its cafés at an operating margin of 25.5 percent. At that level, the coffee empire is making a profit of about $2.55 per bag. Take away $1 per, and Starbucks would have to sell 65 percent more bags to book the same amount of profit." 

Wow... could Starbucks really generate that many more sales to make up for the lost margin?  Unlikely.   The article tries to offer another explanation, citing Columbia Professor Rita McGrath.   Here's an excerpt:

It’s not clear Starbucks will sway that many customers quickly. But the company could be betting on widening income inequality—what academics call “the hourglass economy.” The theory is: Major retail growth has been—and will continue to be—at the low and the high ends of the socioeconomic scale. Starbucks already has plenty of $6 barista-brewed drinks to capture the top of that market, but a bag of $10 coffee is very much in the middle, according to Rita McGrath, a professor at Columbia Business School.

I respect McGrath's work a great deal.  She's a terrific strategy scholar.   However, I don't understand this point.  How is cutting the price of a bag from $10 to $9 enabling Starbucks to tackle the "low end of the market"?   That's some view of the low end!  The article continues by citing the fact that lower-end rivals such as Maxwell House, Folgers, and Dunkin' Donuts have cut prices this year as costs of coffee beans have fallen significantly.  Here's another excerpt:

And here’s where a little game theory comes into play...By committing to lower prices (and not using coupons or sales), Starbucks is sending a signal, McGrath says. It’s serious about the low end of the market; Dunkin’ Donuts, Folgers, and other competitors can either trim their margins further or give up volume. Either way, they lose. So does Starbucks, at least in the near term. But with savvy hedging and customers lining up for expensive lattes—including increasing crowds in China—it can stand the pain for a while. And it is betting it is more efficient than its competitors. As McGrath says: “If you can run economically enough to make money at the lower price, you’re simply taking money out of your competitors’ pockets.”

Again, I'm not sure that I understand or agree completely.    If Starbucks was clearly the low-cost competitor, I might understand this explanation.  It would be using its scale economies and cost efficiencies to attack its higher cost rivals.  However, do we really believe Starbucks is the low-cost player in this market?  That seems unlikely.   Perhaps another explanation is that, after Dunkin' and others cut prices this year, the gap between Starbucks and its lower-priced rivals became too large.  Starbucks' differentiated, high quality product could justify higher prices, but not that much higher.  The gap in price had simply exceeded the difference in perceived value (or willingness-to-pay) between Starbucks and other coffee rivals in the grocery aisle.  If it didn't address that issue, it would have ceded a great deal of volume to competitors.  Differentiated players always have to be careful that their price premium doesn't grow too high, exceeding the excess value that customers perceive in their product vs. rivals' products. 

If Starbucks, on the other hand, is truly just going for share at the low-end of the market, then I don't understand the logic of the strategy.  Why would a differentiated player cut its margins and try to compete directly with low-cost players?   Why compromise its premium positioning?  I don't think Starbucks is doing that... I don't see them getting into a price war in the grocery aisle just to inflict pain on their rivals.  The coffee industry is an attractive one, particularly at the higher end of the market.  Why would a market leader spoil that market by triggering an unnecessary price war?  That would be bad strategy. 

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A New Kind of Disney Princess

The Wall Street Journal reports today on Disney's development of a new type of princess for young girls.  Sofia the First is one of the new additions to Disney's family of characters.  She's "confident, resourceful and focused on being a good person. She should not be valued most of all for her beauty. Her royal family should include exactly zero evil stepmothers."    Nancy Kanter, a senior executive at Disney, explains: "We knew we didn't want it to be a young woman looking for a man."    The Sophia the First series debuted on Disney Junior on January 11th.   It has become the year's top-rated show among pre-school children.  Disney aimed to create a princess that would appeal to young girls, but that would provide an image and identity more acceptable to parents than some of the company's traditional princesses.   It appears that they have succeeded.

To me, this case provides another interesting development at Disney, besides the unique way that they are trying to reposition a key type of character.   Here we have a case of a key new animated character debuting on Disney's cable networks, rather than in an animated feature film.   The firm has begun to leverage the character in the theme parks and through its consumer products and retail divisions.  Historically, Disney launched key characters through animated feature films, and then leveraged them to other areas.  With Johnny Depp's Pirates of the Caribbean movies, we saw Disney take a theme park ride and build a popular series of feature films.  Now we have a character debuting on cable and then moving to the theme parks.  Could an animated feature film be next for Sophia the First?   Disney's ability to find different ways to originate content may be a key driver of growth for the future.  Relying only on feature films to launch a new franchise can be expensive and risky.  Having other ways of originating and leveraging characters could be key to the company's future... as important as some of the recent acquisitions have been in terms of adding to the stable of characters in the Disney family. 

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New Thoughts about Brand Extensions

For years, scholars and consultants have argued that companies should stick to brand extensions that fit closely with the core brand image and identity.   The logic goes as follows:  It's ok for Coke to make Diet Coke, but it does not make sense for the firm to offer Coke-branded laundry detergent. 

Researchers Tom Meyvis, Kelly Goldsmith and Ravi Dhar noticed something interesting though.  A few firms did extend their brands successfully in a way that seemed to fit much less closely with the core brand's image and positioning.   If these firms had succeeded, then perhaps the notion of fit needed more clarification.  

The scholars conducted an experiment, and in that study, they found that visual cues make a difference with consumers.  Seeing the physical product, as opposed to just hearing about it, can cause customers to genuinely consider a brand extension that appears to be low fit.  According to Kelly Goldsmith, “When you give people pictures, preferences shift because [people] are focused on quality—they are more interested in quality than fit.  Whereas when you show the brand concept without pictures … the reaction is more focused on fit than quality. Allowing product comparisons leads to the same results.”

Goldsmith explains the practical implications of the study: “If you get your brand-extension concept out of the lab and into the store, all of those [benefits from visual cues and brand comparison] are taken care of.  If you are a brand like Nike or Häagen-Dazs, or one of these very large national brands associated with quality, and you want to make money by extending that very successful brand even further—to new [but] lower-fitting categories—what our research shows is that you really need to show people what that product looks like and show it to them in the context of other brands in that category."

I find the research very interesting.  I still believe firms need to be very attentive to fit when it comes to brand extensions.  However, the notion of offering visual cues, sampling, and physical displays does seem to make sense.  Those tactics certainly do help a consumer understand and appreciate a new product offering that may not seem to fit with a brand's prior identity. 

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Innovation in Laundry Detergents

The Wall Street Journal reports today about how innovation is actually hurting laundry detergent sales.  Well, that's not quite what is happening.  Let's explore. P&G launched "pods" last year.  The product offered just the right amount of detergent for a load of laundry.  The product has been popular with customers.  However,  it appears that industry revenues are falling.  Has innovation been a bad thing?  I don't think so.  While revenues may be declining, margins for P&G are rising.  Their margins for pods are better than for jugs of laundry detergent.  Customers clearly like the pods.  Moreover, P&G seems to be gaining an upper hand on rivals, who are busy trying to copy them.

The bigger issue here is the obsession with revenues.  In the end, industry executives should be focused on profits rather than the top line.  Moreover, if customers prefer pods, then executives should be focused on delivering what customers want, rather than blaming P&G for "hurting" industry revenues.

One final thing... If P&G were escalating price rivalry in the industry, that could be problematic.  They would be damaging industry structure, making it less attractive.  However, that is not what they are doing.  They are actually bringing a differentiated product to a market which had experienced a great deal of price competition.  That's enhancing industry attractiveness.  Other firms should be seeking similar ways to innovate so that they are not just competing on price.

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Engaging Your High Performers

Forbes reported this week on a startling new study by Leadership IQ, a company that does a great deal of work on the assessment of employee engagement.   The firm examined data from 207 companies on employee performance as well as employee engagement.   According to Forbes,

"In 42% of the companies, the employees who do the worst job are the ones who feel the most “engaged.” At the same time, the middle and high performers in those firms feel disconnected from their jobs and not very motivated to come to work every day."

\The article, by Susan Adams, does a very nice job of explaining many of the reasons for this result.  Adams, drawing on a conversation with Mark Murphy (Leadership IQ CEO), argues that the lack of a true meritocracy causes disengagement among high performers.   Company leaders aren't having the difficult conversations with low performers, and they are not properly recognizing the best employees.  I cannot argue with that finding; it seems quite reasonable.

I would argue, however, that one other cause may exist for this alarming finding.  Many companies simply are not investing effectively in leadership development for their top performers.  Notice that I did NOT say that they are not investing ENOUGH.   Many companies are spending a great deal of money on leadership development programs and processes.  However, many organizations are not spending that money WISELY.   We see a litany of problems in many companies:  Too many one-off events exist.  Too many programs lack cohesion.   Too many leadership development events lack clear criteria for determining who should be involved or invited.   Far too little follow-up exists after programs are delivered.  Until firms start designing more effective leadership development activities, and begin spending their resources more effectively, we won't see engagement rise significantly for the highest performers. 

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Big Data Will Not Solve All Our Problems, May Mislead Us

Microsoft Research's Kate Crawford has a terrific blog for HBR about big data.  In the post, she discusses the hype regarding big data, and she talks about the hidden biases that we must be aware of when analyzing large data sets:

Data and data sets are not objective; they are creations of human design. We give numbers their voice, draw inferences from them, and define their meaning through our interpretations. Hidden biases in both the collection and analysis stages present considerable risks, and are as important to the big-data equation as the numbers themselves. 

Crawford has some terrific examples of biases in data sets.  For instance, she talks about how the Twitter data after Hurricane Sandy offers a distorted view of the storm.  Why?  As the storm progressed, people in the hardest hit areas ran out of battery power on their cellphones.  Thus, they stopped tweeting.  Folks in Manhattan, where the storm was significant, but not as devastating, engaged in much more Twitter activity.  Moreover, people in the lowest income groups are not as well represented on Twitter, because many do not own smartphones.  As she writes, "We can think of this as a "signal problem": Data are assumed to accurately reflect the social world, but there are significant gaps, with little or no signal coming from particular communities."

The lesson is clear.  Begin your big data project by asking:  How was the data collected?  What populations are overrepresented?  What populations are underrepresented?  Beyond that, you should ask:  Who collected and assembled the data set?  Do they have an agenda?  Are they biased in any way?  Often, the biggest bias in big data has nothing to do with access to technology or underrepresented populations.  Instead, the most significant bias lies inside the mind of the person assembling the data.  Their agenda clouds the process of data collection. 

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Do You Have a Mistake Diary?

The Wall Street Journal reports on an interesting new leadership phenomenon.  According to this article by
Rachel Silverman, "Some self-aware managers are trying out “mistake diaries” or “failure reports” to help minimize the chances that a problem happens twice – and to help foster an environment where it’s OK to try and fail."  

Silverman describes the efforts of Meebo co-founder Elaine Wherry, who has kept a mistake diary for a number of years.   Silverman writes that, "Using a series of sketchbooks, she started taking notes and making drawings to record her mistakes – such as time-management problems and hyper-perfectionism — as a personal way to remember them."   Wherry has even shared her "most common blunders" with her staff, since she noticed many young new employees making many of the mistakes that she had made earlier in her career.  (Take a look at a video created by Elaine Wherry by clicking here). 

Everyone should note the importance of reflection as a tool for improving as a leader.   We can't just focus on what's next, on the newest pressing problem.  We have to find a way to carve out some time for reflection if we are to improve and develop.   Of course, finding that time can be difficult in hectic schedules that many leaders keep.  So, before thinking about crafting a mistake diary, you have to take a hard look at your schedule.  Blocking out some time for reflection is hard, but necessary, if we are to identify and learn from our mistakes. 

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