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Château Margaux- Launching the Third Wine.pdf

9-513-107

R E V : J A N U A R Y 4 , 2 0 1 6

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Professor Elie Ofek and Research Associate Eric E. Vogt prepared this case. It was reviewed and approved before publication by a company designate. Funding for the development of this case was provided by Harvard Business School, and not by the company. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2013, 2014, 2015 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1- 800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/educators. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

E L I E O F E K

E R I C E . V O G T

Château Margaux: Launching the Third Wine

“Down, Zorba!” “Come here, Souvlaki!” Corinne Mentzelopoulos commanded lovingly to her two beagles as she strode briskly across the raked white gravel in front of her château. It was mid- February, 2013. The ground fog from the nearby Gironde estuary still lingered over the legendary terroir of Château Margaux. Mentzelopoulos was on her way to the tasting room, located just beside the wine cellars, to take part in some critical decisions regarding the 2012 vintage.

Upon her arrival, she was greeted by General Manager Paul Pontallier, Technical Director Thomas Dô Chi Nam, Cellar Master Philippe Berrier, Commercial Director Aurélien Valance, Chief Financial Officer Olivier Pinon, and their consulting oenologists Jacques and Eric Boissenot. Her eyes quickly turned to the 20 glasses neatly arranged along a table in the middle of the room. “With some luck, I think we can settle on the assemblage of the Grand Vin today. Shall we begin tasting?” Pontallier asked. Mentzelopoulos nodded as she lifted her first glass.

The vineyards on the estate were divided into distinct plots, and the grapes harvested from each during the fall were processed separately. The resulting wines were kept in carefully labeled barrels. After four months of cooling, Pontallier and his team mixed samples of the young wines in an effort to determine the “perfect” blend, or assemblage, which balanced exquisite taste and quantity. As weather conditions differed from year to year, with each plot’s unique soil, elevation, and drainage affecting how the grapes developed, so did the selection for blending. It took three or four iterations to arrive at the final composition of the château’s first wine, the Grand Vin du Château Margaux.

The gravity of making the right call on the assemblage of the first wine weighed heavily on Mentzelopoulos. She felt as though the reputation of Château Margaux was at stake anew each year. Yet she also knew that the Grand Vin’s final composition had additional implications. The decision today would determine which of the château’s 80 hectares would remain for making the second red wine, Pavillon Rouge du Château Margaux. And following a similar process of blending and tasting, what was left, anywhere from 0–35% of the total production, would constitute the third red wine.

Historically, management had not bothered much with this “leftover” wine, leaving it in barrels and selling it in bulk to local merchants who mixed it with other bulk wine from the Margaux region. But the 2009 vintage had changed things considerably. That year’s third wine tasted so good that Mentzelopoulos decided to retain it all, giving her the option of selling it as a Château Margaux wine when it was deemed “pleasurable to drink.” In the subsequent two years, she and her team sampled the 2009 third wine and were not disappointed, which led them to keep a portion of what was left after the first and second wine assemblages of the 2010 and 2011 vintages for similar purposes.

For the exclusive use of M. Dagstanyan, 2016.

This document is authorized for use only by Marie Dagstanyan in Marketing Concepts & Strategies - SPRING '17 taught by Tony Stovall, Woodbury University from December 2016 to June 2017.

513-107 Château Margaux: Launching the Third Wine

When the 2009 third wine was tasted in early 2013, it was quite obvious that it would be ready for commercial sale by early fall. What was less obvious was how best to market it. Mentzelopoulos, Pontallier, and Valance had engaged in heated debates for several weeks on the matter. One straightforward option they contemplated was to sell the third wine to the Bordeaux merchants, called négociants, and entrust them with maximizing the market opportunity. Early conversations with a number of prominent négociants suggested that they would be delighted to do so. A different option was for Château Margaux to develop a complete marketing plan for the new offering. Although this option seemed attractive at first, the more they dug into it, the more questions began to surface. Who should be the target market for the third wine? What should be its brand image relative to the château’s first and second wines? What were the best channel and communication approaches? What price should the consumer expect to pay for a bottle? Even seemingly simple issues, like what name to give it and what color to select for the label, proved difficult to resolve.

Unlike reaching consensus on the assemblage for the château’s traditional wines, a process she had been overseeing annually for over 30 years, reaching consensus on the launch strategy of an entirely new wine was something Mentzelopoulos had never done before.

The Global Wine Industry

As of 2013, the global wine industry was estimated at about $110 billion in revenues annually, with hundreds of thousands of wineries worldwide producing over 30 billion bottles.1

Supply

Few barriers existed to making wine, as virtually anyone between the latitudes of 30 and 50 degrees in both hemispheres, with a reasonably warm and dry summer, could plant a varietal of the common grapevine in their backyard. Yet until recently, almost all wine was made in Europe, with France and Italy as the main “Old World” producers. This pattern changed in the second half of the 20th century, as winemaking dramatically increased in the New World, which primarily consisted of the U.S. and Southern Hemisphere countries. Names like André Tchelistcheff and Robert Mondavi shaped the fine wines of Napa Valley, while Ernesto and Julio Gallo built up volumes of table wines in the Central California Valley region. In the 1980s, Argentina became one of the largest producers of wine in the Americas, and Chile began building sizable domestic and export wine businesses. In the 1990s, Australia harnessed large tracts of land in the south and declared wine an export imperative. New Zealand followed suit, leading with its Sauvignon Blanc from the Marlborough region. By the turn of the 21st century, New World producers began taking meaningful market share of global wine exports from Old World producers. (See Exhibit 1 for data on worldwide wine production.)

The increased number of wine-producing locations resulted in excessive quantities supplied to market, forcing many winemakers to lower prices, curb yields, or exit the business altogether. In several countries, such as France and Australia, the government actively stepped in. Measures ranged from subsidies to help clear excess capacity to imposing restrictions on the planting of vines. Indeed, between 2008 and 2011, tougher EU policies led to 269,000 hectares of vines being dug up.2

Global wine exporting was dominated by EU countries, with Italy, France, and Spain accounting for 55% of all wine traded by volume, while Argentina, Chile, Australia, and New Zealand made up roughly 33% combined; the U.S. accounted for 8% of exports. As for wine importing, the U.K. and Germany were the largest by volume, followed by the U.S. Fine wine tended to be exported in bottles to those areas of high willingness to pay for them, whereas low-end wines were often shipped in bulk containers. Large U.K. retail chains commonly imported bulk wine and then bottled and sold it under

For the exclusive use of M. Dagstanyan, 2016.

This document is authorized for use only by Marie Dagstanyan in Marketing Concepts & Strategies - SPRING '17 taught by Tony Stovall, Woodbury University from December 2016 to June 2017.

Château Margaux: Launching the Third Wine 513-107

their own private labels, a trend that was growing in other countries as well.3

Demand

Global demand for wine was highly uneven. Annual per capita consumption in 2012 was still the highest in Old World countries, such as France, Italy, and Spain, yet was gaining momentum in other places, such as Australia, the U.S., and China. In 2011, for the first time, the total volume of wine consumed was higher in the U.S. than it was in France. (See Exhibit 2 for trends.)

In many European countries, wine was tied to a tradition that incorporated it into everyday life and was a common part of family meals. However, the erosion of typical family structures and a movement away from alcoholic beverages were undermining this tradition, leading to a decline in wine consumption in recent years. By contrast, in many New World countries, wine consumption was more occasion-driven and took place away from home. There was also a marked correlation between the tendency to drink wine and various demographics. In countries like the U.S., U.K., and Australia, wine drinkers tended to be older, have higher disposable income and education levels, and be female.4 Consumption location affected spending. In the U.S., for example, about 50% of wine purchases by dollar amount occurred in bars and restaurants (called “on-premise”). But because of the high markup at these venues, these purchases represented only 20% of the volume sold.5 The 80% of wine volume purchased “off-premise” was through liquor stores, grocery stores, fine-wine shops, domestic wineries that sold direct, and, increasingly, Internet retailers, such as Wine.com and Lot18.

Although per capita wine consumption in China was considered low by Western standards, its pace of growth since 2008 had been impressive—more than triple that in the U.S. In the past decade, wealthy Chinese developed a taste for fine wine, and in 2008, Hong Kong eliminated all taxes and restrictions on wine imports. These factors created a surge in demand, and by 2012, China displaced the U.K. as the fifth-largest market by volume, with nearly 2 billion bottles consumed. Affluent Chinese commonly bought an expensive wine for a special occasion or for gifting. For example, business deals were often sealed by opening a first-growth Bordeaux wine. There was also a very active aftermarket in China, with prices of leading wines often quadrupling over a three year span. For instance, a 12-bottle case of Château Lafite Rothschild 2009 recently sold for £43,000 in a Hong Kong auction, and counterfeiters were paying up to $450 for an empty bottle of a high-end wine, refilling it with cheap wine, and reselling it as an original at market prices. As one wine dealer put it, “This is always going to be a danger when people are drinking not out of passion but because they think that fine wine is what they should be seen drinking.”6

Buyer Behavior and Influencers

The vast range of wine prices—from under €3 at a local French supermarket to upwards of $3000 at a high-end Chinese restaurant—suggested considerable heterogeneity in consumer wine-buying patterns. Several criteria seemed relevant for segmenting wine buyers: drinking frequency, information sources, consumption setting (private vs. social), purchase channel, and price sensitivity. A recent study partitioned wine consumers into six segments: Traditionalists, Enthusiasts, Image Seekers, Savvy Shoppers, Satisfied Sippers, and Overwhelmeds. (See Exhibit 3 for segment details.)

Fine-wine buyers were often categorized as either “connoisseurs” or “luxury” consumers. The former tended to be knowledgeable about wines and able to discern between different regions and vintages; their sophistication and appreciation for quality were a source of pride. Luxury consumers, on the other hand, typically lacked deep knowledge of wines, and their choices were intended to portray an image of wealth and stature. Many attributed the run-up in prices of fine wines to luxury buyers in emerging markets, such as China and Russia. A third, but growing, segment of premium

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513-107 Château Margaux: Launching the Third Wine

buyers were willing to spend more on wines that fit their desire to be perceived as distinctive, trendy, and adventurous; as one blogger put it: “A fashionable wine from a faraway region that allows them to stand apart, will get this group reaching for your bottle (and their wallet).”7

Taste and quality were important criteria in wine selection. However, because wine was an “experience good,” the ability to assess these attributes prior to purchase was limited. Although sampling was sometimes possible (for example, on a visit to a winery), for the majority of purchases, consumers used extrinsic cues. Some relied on previous consumption experiences, while others held preconceived notions of where and when good wines were made. Many trusted the advice of others to learn about wines they might like and to reduce the risk of buying an unsavory bottle, especially since the relationship between wine quality and price was often seen as distorted. Recommendations could come from friends, retail sales associates, sommeliers, or wine journalists. Critics were yet another group with a strong voice, and the one with perhaps the most influence was Robert Parker.

Robert Parker Jr. had worked as an attorney at a bank in Baltimore, Maryland. In 1978, his passion for wine led him to start a newsletter called the Wine Advocate. In 1983, Parker had the opportunity to taste the 1982 vintage in the trade tastings held in Bordeaux. The established critics were unimpressed with the new vintage, commenting that the wines lacked acidity and tannic structure, were not age-worthy, and were unlikely to hold their fruit flavors over time. Parker disagreed. His descriptions and ratings of the vintage captured the enthusiasm of the emerging U.S. market for Bordeaux. By the time the 1982 vintage was bottled and tasted by consumers in 1984, the world sided with Parker, and prices were reset to a much higher level than a year earlier. His newsletter jumped in circulation, and he decided to quit his job at the bank to work full-time on his passion.8

Each year, Parker sampled around 10,000 wines and published his comments and rating scores in his newsletter. He assigned each wine a number between 50 and 100, awarding 50 points for “just showing up,” up to 5 for color and appearance, 15 for aroma, 20 for flavor and finish, and 10 for overall quality or aging potential.9 When asked how he was able to apply a seemingly objective standard for the many wines he tasted, he replied, “A wine goes in my mouth, and I just see it. . . . The textures, the flavors, the smells, they just jump out at me.”10 From the U.S. to Hong Kong, Parker’s impact was felt throughout the wine ecosystem; a wine’s price could tumble on a bad rating or skyrocket on an especially good score. Winemakers commonly believed that “if my Parker rating is under 90, I cannot sell it; if it is over 90, my traditional customers cannot buy it!” Other well-known critics included James Molesworth of the Wine Spectator and Jancis Robinson of the Financial Times. The Wine Advocate and Wine Spectator ratings, which did not always agree, were often displayed in retail stores or restaurants (“WA 90/WS 92”).11 Some in the industry didn’t approve of these single- number ratings and felt they treated wine like a basketball game. They believed critics like Parker wielded too much power and pushed the industry in the direction of their particular preferences.

The Bordeaux Wine Region

In French, bord d’eaux meant “beside the waters.” Bounded by the Bay of Biscayne on the west and the Gironde estuary on the east, much of the Bordeaux wine region was a large peninsula surrounded by water, which served to mediate temperature fluctuations, thus improving conditions for growing grapes. (See Exhibit 4 for a map of the region.) The area north of the city of Bordeaux and west of the Gironde was referred to as the “left bank.” Here the soil was mainly gravel and sand, a combination well suited to develop the tannins of the Cabernet Sauvignon grape. The region to the east of the Gironde was referred to as the “right bank.” The soil there contained more clay and limestone deposits, favoring the nourishment of Merlot and Cabernet Franc grapes. Bordeaux was the largest “origin-controlled” wine region in France and had about 60 “appellations,” or named sub-regions, in

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Château Margaux: Launching the Third Wine 513-107

which wine was produced. It contained over 11,000 châteaux and 118,000 hectares of vineyards, and produced on average 730 million bottles of wine a year.12 The vast majority of Bordeaux wine was sold in supermarkets for less than €10 a bottle. But the leading wines were sold in specialized shops and upscale restaurants around the world at prices that often exceeded €1,000 per bottle. Bordeaux fine wines were typically blended from different grape types, a process believed to add complexity in texture and flavor, and tended to improve with age, sometimes for several decades.

The 1855 Classification

In 1855, Napoleon III decided to hold a World’s Fair. He asked the Bordeaux wine merchants, or négociants, to send “the finest Médoc wines to Paris, and to classify them so the very best could be easily distinguished.”13 Faced with this task, the Négociants Council invoked a trusted metric: market prices. They reviewed prices that had been recorded since the 17th century and created a five-tier ranking or classification scheme: Premier Cru, Deuxième Cru, Troisième Cru, and so on. They declared the wines from the châteaux of Lafite, Latour, Margaux, and Haut-Brion as Premier Cru, or first- growths.

Although wine critics voiced reservations from time to time as to whether this ranking was still valid over 150 years later, often proposing alternative rankings, the general opinion was that the 1855 classification got it right—the superiority of the “terroir” at the first-growth estates would always come through. This French term referred to the combination of the soil, the sub-soil structure, the tilt of the vineyard, the drainage properties, and the position of the water table. Vineyards that made their vines “work hard,” to send out roots through difficult soil to find water and nutrients for their grapes, tended to make more concentrated juice. Vineyards that sloped toward the river but were not beside it tended to drain well and keep the grapes from getting bloated with water after a rainstorm. All of these factors combined to favor some parcels of land over others. The vineyards of the first- growth estates were believed to be blessed with respect to these characteristics.

Common belief was that terroir trumped technique. Yet viticulture experience, grape selection during harvest, and careful winemaking all contributed to great wines. And several châteaux had consistently achieved more than their allotted “growth ranking” indicated. For example, Léoville-Las Cases, Palmer, Lynch-Bages, Pontet-Canet, Cos d’Estournel, and Ducru-Beaucaillou were often referred to as “Super Seconds” for their outstanding wines. Nevertheless, there had been only one change to the 1855 classification. In 1973, Château Mouton Rothschild was elevated from second to first-growth, in a complex and political process. (See Exhibit 5 for information on first-growths.)

The Sale and Distribution of Fine Bordeaux Wine

In keeping with a time-honored tradition, the leading Bordeaux châteaux distributed their wines through the négociants. And although most wineries sold their wines after bottling, the top 50 or so châteaux in Bordeaux sold the majority of their wine while still in barrels in an en primeur, or futures, market system. For example, the wine produced from grapes harvested in the fall of 2012 would only be delivered by the châteaux in late 2014 or early 2015, but Bordeaux négociants were given the opportunity to purchase allocations of it during the spring of 2013. The sale of wine futures to these merchants came on the heels of an annual tasting ritual. In early April, the leading châteaux hosted a weeklong event, informally called “en primeurs week,” where journalists, critics, importers, and merchants were invited to taste samples of the newest vintage still in barrels. The industry waited anxiously for the top critics to place a score on each of the hundreds of wines they tasted. Mentzelopoulos described the scene and its pricing implications: “We do our best during en primeurs week to feel the excitement level for our wines. We pay close attention to the chatter of the négociants

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513-107 Château Margaux: Launching the Third Wine

and wine critics. We also factor in our yields and assessment of consumer trends and global economic conditions. This helps us set the price.” Valance added, “Once we have all this information, we also check which of our past vintages received a similar critic evaluation. The release prices for those wines were set in expectation of future demand, but the popularity and willingness to pay for them could differ considerably once consumers tasted them. Hence, we look to see what those previous vintages sell for at retail now. Then, given typical markups by the various channel members, we back out what price makes sense for us to charge négociants for the new vintage.” From year to year, the opening en primeur release prices could vary wildly, from a low of €60 all the way up to €500 per bottle. (See Exhibit 6 for Parker scores and en primeur and retail prices for Château Margaux wines.)

The new vintage was sold in several offerings, called “tranches,” during the late spring. Hundreds of négociants were eager to buy classified growth wines. The châteaux had to decide which merchants to sell to; what quantity to allocate; how much quantity, if any, to keep for the second and third tranches; and whether to hold back some wine in their own cellars to sell in future years. With a good vintage, the châteaux would release a limited quantity at a first-tranche price. Reactions, if enthusiastic, usually resulted in successive offerings at much higher second- and third-tranche prices. In average-quality years, there would be only one tranche. The châteaux dealt with a limited number of négociants, and relationships mattered. A chateau favored those merchants that had shown commitment to its image, sold to reputable importers in a number of important markets, and came through in good as well as bad years. The first-growth châteaux typically held back some of their first and second wine production each year, usually in the range of 10%–20%, and sold it to the merchants after bottling. Mentzelopoulos summed up the process: “Because market and weather conditions varied so much from year to year, every vintage is like the IPO of a new company, and the négociants are in a position to invest in its shares. We have to decide how many shares to put up and at what price.”

After agreeing to purchase allocations from the châteaux, négociants quickly turned to large importers and distributors around the world and resold part of their futures. In turn, these channel members sold to smaller distributors and retailers in their local markets. Valance estimated that each player in the chain sold about 80% of its allocation. Négociants marked up futures by about 15%–20%, while other players in the chain marked them up by 10%–15%, depending on the tranche. (See Exhibit 7 for channel pricing of Château Margaux wines.) Mentzelopoulos declared, “Because the market value of first-growths can climb so much over time, each player stashes away some to make more money than in the en primeur market. Many people wonder whether these margins truly reflect their costs of doing business.” Indeed, on the quantities held back, négociants’ profits could more than double for the same vintage, depending on when they sold it.

The use of négociants dated back to the 18th century. The practice spared châteaux owners from the commercial aspects of the business and let them focus on winemaking. Owners remained behind the scenes and were thus not held accountable for final price fluctuations or product availability. Some defended the négociants’ role, observing that they had the scale economies to maintain a global sales force, develop new markets quickly, and deal with hundreds of importers, some of whom might not pay on time or be of dubious reputation. Moreover, the leading châteaux were often able to sell their entire production in one day and collect the cash almost two years before shipping a single bottle. However, many regarded the négociants as an anachronistic phenomenon, arguing that the highly profitable châteaux had less need today for a financial buffer and personally knew many of the importers and key global purchasers. Moreover, due to global warming and advanced viticultural and oenological practices, truly “bad” vintages were rare. “The négociants’ job has gotten easier, yet their profits have increased,” Valance quipped. Lastly, the Internet had emerged as an efficient vehicle for direct communication and sales, which could replace many functions of the négociant.

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Château Margaux: Launching the Third Wine 513-107

Château Margaux

The Château Margaux estate was located on the left bank of the Gironde estuary, in the heart of the Médoc region (see Exhibit 4). Although ownership records of the land date back to the 12th century, the estate’s reputation for great wine was established in the 16th century by the Lestonnac family. Future owners continued the tradition of exceptional winemaking, and, fueled by strong demand for Bordeaux wines by the British, Château Margaux experienced a golden age during the 18th century. The estate changed hands several times; in 1810, a new owner, the Marquis de la Colonilla, redesigned the estate’s buildings. The result, which constitutes the current property, was considered an architectural masterpiece. The estate’s palace, nicknamed the “Versailles of the Médoc,” was placed at the center of a small “viticulture city.” (See Exhibit 8 for a photo.) On one side was the tradesmen’s yard, and on the other, the cellars and vat room.

In 1977, André Mentzelopoulos, owner of a successful French supermarket chain, purchased Château Margaux for about $16 million. At the time, Bordeaux wines were experiencing a decline in popularity. The estate had been up for sale for over two years, with little interest. But André immediately fell in love with the property and believed he could restore its glory. The conservative Bordeaux community was taken aback that one of the most prestigious châteaux in France had fallen into the hands of a Greek. However, their skepticism was soon put to rest as he orchestrated a complete overhaul of the vineyards, improved drainage, built the first underground cellar, and initiated new plantings. He reintroduced the château’s second wine, Pavillon Rouge, which was created in 1906 but had been forgotten for years, and redefined the Pavillon Blanc white wine. The estate’s 1978 vintage, the first he had overseen, was recognized as exceptional and one of the best that year. André’s vision, attention to quality, and innovation inspired many Bordeaux winemakers.

A Dynamic Duo Takes Control

Unfortunately, André Mentzelopoulos died abruptly of a brain aneurism in 1980. Corinne, his 27- year-old daughter, inherited the estate. She felt compelled to follow in her father’s footsteps. “We continued my father’s work out of love for Margaux; we simply didn’t have the right to let it fall.” In 1983, she hired Paul Pontallier to succeed the retiring general manager, Philippe Barre. Pontallier, who was 27 years old at the time, had received a doctorate degree from the prestigious Talence Institute of Oenology. Mentzelopoulos recalled, “The other leading châteaux would have dismissed Pontallier’s application, as he had no experience. But I was impressed by his entrepreneurial spirit, his passion for Bordeaux wines, and his commitment to improvement. I did not hesitate to hire him.”

Fairly quickly, the Mentzelopoulos-Pontallier combination proved to be a winning one. Practices that would become commonplace only in the 1990s were ushered into Château Margaux in the 1980s. Ideas such as waiting beyond sugar ripeness before harvesting, strict temperature control during fermentation, and novel techniques for extracting softer tannins led to finer wines. Mentzelopoulos reflected, “Paul and I always believed in the potential for increasing first-growth wine quality. One of

my proudest moments was when our picture made the Wine Spectator cover in 1984.”

Buoyed by Parker’s highly favorable reviews, Americans’ newly found enthusiasm for classified first-growths, and the rekindled interest of connoisseurs in the U.K. and Germany, the leading Bordeaux châteaux saw an explosive rise in demand from the early 1980s onward. The enthusiasm in the West for these wines was but a precursor to the astonishing fascination in the East in subsequent decades. Mentzelopoulos commented, “Our wine, even though it had been appreciated for centuries, had never known such success; enthusiasts from all over the world were coming to visit, taste, and compare.” Among the many distinguished visitors were the president of China, Hu Jintao; the king

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513-107 Château Margaux: Launching the Third Wine

of Sweden, Carl XVI Gustaf; and Bono. “After a few bottles of Château Margaux 1982, we were all singing U2 songs at the top of our voices,” Mentzelopoulos recounted with a wide smile.

Making Château Margaux Wine

Although the estate grounds comprised some 250 hectares, the terroir suitable for growing grapes was limited. Specifically, 80 carefully chosen hectares were devoted to vines for red wine and 12 hectares for white wine. In 2013, the estate employed about 100 people, mainly in production. Other expenses included equipment and maintenance. An industry expert estimated that a bottle of first- growth wine cost between €25 and €50 to produce, depending on weather, yield, and selectivity. Dô Chi Nam explained, “In a vintage like 2009, things went smoothly. Spring rains came in time for vine flowering to occur in May, summer was warm but not oppressive, the grapes ripened on schedule in September, and the harvest was completed before fall rains began. Costs were on the low side that year. But with the 2008 vintage, early fall rains delayed ripening. Had we not reduced the number of grape clusters per vine, we might have lost the harvest altogether. Costs were higher that year.”

Over the past 30 years, management was inclined to put less of the production in the first and second wines and also to reduce yields overall in the vineyard, concentrating the flavors in the remaining grapes. Thus, while 51 hectoliters of wine were produced per hectare in the 1980s, this number had dropped to 35 by 2012. These decisions had led to fewer bottles, but with increasing quality. Pontallier expounded, “In responding to the market, we found ourselves in a vicious cycle. The more consumers were willing to pay for a Bordeaux first-growth, the more incentive we had to increase our quality by being more selective, which resulted in stronger reviews and hence even higher willingness to pay, which prompted us to be even more selective, and so on.”

Marketing Château Margaux Wine

Until recently, if management had been asked about marketing practices, it would have simply replied, “We don’t do marketing.” Mentzelopoulos believed the 1855 classification, along with the quality and scarcity of the product, created the allure for wine aficionados. The château relied on the channel to serve as the distribution and marketing arms for its wines. Yet Mentzelopoulos noted demand shifts: “Twenty years ago, 100% of our wines were bought by connoisseurs. Ten years ago, that changed to 80% connoisseurs and 20% luxury buyers. Today the split is 60% vs. 40%, and those 40% luxury buyers are mainly from China.” Valance estimated that in 2005, Mainland China and Hong Kong accounted for 4% of sales, but by 2012, that number had climbed to 35%. Conversely, sales in Japan and the U.S. had dropped by about 10%; sales in France remained relatively flat.

Dealing exclusively with the négociants simplified life, but it meant that Mentzelopoulos and her team were far removed from the market. Valance outlined some recent steps taken to change this situation: “We began organizing events in key markets and invited journalists, wine experts, and channel members. We made sure a representative from Château Margaux was present, and we staged wine tastings. We engaged with the media and hired a PR person.” Valance estimated that 2,000 bottles of Château Margaux wines were allocated to these events every year. Perhaps the biggest marketing initiative was in China. In 2010, the château appointed a dedicated person, which it referred to as an “ambassador.” Pontallier elaborated, “China is a large country with many distributors and retailers. We wanted to make sure they were aware of the quality of our wines, and we needed to better communicate the value of our brand.” The ambassador in China met with channel members, wine professionals, and journalists to build relationships. He also organized events—the most spectacular to date was a gala dinner on the Great Wall of China. In 2012, Château Margaux expanded the ambassador program to the U.K. and the U.S.

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Château Margaux: Launching the Third Wine 513-107

The Third Wine Opportunity

The idea to sell a third wine was planted in Mentzelopoulos’s mind in 2008 by a young Chinese visitor, frustrated at how difficult it was to obtain first-growths in China. Mentzelopoulos dismissed the idea at the time. “We didn’t think the quality of what was left after making our first two wines was good enough. Moving ‘downstream’ also went against everything we had done since my father acquired the château—to relentlessly increase quality and build a reputation for spectacular wines.”

But then came the 2009 vintage. Pontallier described the sequence of events: “We were working on the assemblage of that vintage, which was one of the best we could remember, and realized that by being more selective, we could bring our first and second wines to a truly exceptional level, which we believed was something the market wanted. A by-product of that decision was that the volume of the third wine was more than 20% of the entire production. When I tasted it, I was pleasantly surprised. It was so good that in some past mediocre years, it could have easily qualified as our second wine. It seemed a shame to sell it as bulk, so we decided to keep it and see in a year if it was worth bottling.”

As they thought about the prospects of the third wine, various trends struck management as noteworthy. Pontallier elaborated, “We had no control over final prices, and in the past few years, our second wine’s price had tripled. In talking to several merchants and experts, it seemed that Pavillon Rouge went from being perceived as ‘the Grand Vin’s little brother,’ made from grapes that weren’t good enough for the first wine, to having a reputation as a high-quality wine on its own.” Mentzelopoulos added, “Our core markets were shocked by the recent price escalation and believed they were unduly inflated by luxury consumers. Our second wine began disappearing from retail stores and restaurant wine lists, similar to what had happened to our first wine a few years ago.”

A big moment of truth came in early 2011 when two tastings had to go well in order for the third- wine concept to be further pursued: the 2009 vintage had to show it was aging well in the barrels and the recent 2010 vintage third wine had to be of sufficient quality. Both passed with flying colors. There was no doubt about what to do with the 2009 third wine, as Pontallier announced, “Bottle it!”

The Future Marketing of the Third Wine

Mentzelopoulos and her team brainstormed about what to do when the third wine was ready to hit the market. The simplest option was to sell the bottled third wine to a select set of négociants, in exactly the same way the château gradually sold the 10%–20% of first and second wine production that it held back from the en primeur process. Valance explained the appeal: “We have a good sense of these merchants and what drives them. They will accept a high price for the third wine because they want allocations of our first and second wines. They would likely pay us up to 50% of what they pay for Pavillon Rouge.” Mentzelopoulos added, “I don’t think they will have a hard time selling this wine. This option can maximize profits, but most of the wine will probably end up in China.”

As the team thought more about the négociant option, they debated what it was they hoped to achieve with the third wine. Pontallier voiced his opinion, “Our wines have become inaccessible to our core customers in traditional markets, like the U.S., U.K., Japan, and France, who used to buy our wines regularly. We need to bring them back; a third wine can do that.” Valance expressed a different view, “We do need more presence in traditional markets, but we should reach consumers new to the wine-loving world and introduce them to our brand.” Mentzelopoulos weighed in:

I see the merits of going after each of these segments. I would like to regain the hearts of the loyals who have been “priced out.” They admired our wine because of its uniqueness and excellence. But we need to think hard about how to position a third wine to them, as they

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513-107 Château Margaux: Launching the Third Wine

“grew up” on our first and second wines. We can’t allow a perception that this is an inferior product. It is also important to breed the next generation. These are consumers with a certain profile and may in the future want to buy our top wines, despite the high prices; the third wine should let them understand what the magic of Château Margaux is all about.

Place To target specific consumers, management believed it would have to bypass the

négociants. This meant contacting importers or large distributors directly to try to reach the desired end consumers at the right time and place. Valance believed one such promising “place” could be restaurants, particularly high-end or trendy ones. He elaborated, “We would canvas the metropolitan cities we decided to go into and find the right venues for our wine. Sommeliers would be critical here by featuring our third wine on lists and promoting it to guests.” An alternative would be to focus on wine shops, primarily boutique ones. Sales associates could bring the third wine to the attention of customers, particularly those they knew intimately and who would find such an offering attractive.

In France, Château Margaux could sell directly to consumer-facing outlets, but management felt it should work with a large distributor who would sell to restaurants or stores. Selling in other EU countries would also involve two steps. In the U.S., imported wine had to go through a three-step distribution scheme that involved an importer and state distributor before reaching retailers or restaurants. Management assessed the margin each player expected to earn as follows: importers or large distributors 25%, retailers 30%, restaurants 60%, and U.S. state distributors 28%.

Price Management had to select a price to charge the channel partner buying the wine from the château—be it négociants, importers, or large distributors. If bypassing négociants, the team felt they should approach this task by working in reverse, that is, determine the price end consumers should pay and then back out the price to charge based on typical channel margins. Valance remarked, “We think the price consumers pay should fall somewhere between $100 and $150 per bottle. If we lean toward $100, say, in the U.S., we are perhaps sending a message of affordability or ‘value for your money.’ At closer to $150, we are perhaps preserving the upscale image of our wines.” He continued, “Although we don’t have immediate control, we could select channel partners that shared our vision. We would explicitly articulate our strategy and monitor where our third wine ended up and at what price. If things didn’t go according to plan, we would consider switching partners the next year.”

One benchmark was Latour’s third wine, Pauillac de Château Latour, which Latour had offered consistently since 1990. Its price had steadily climbed, and a strong vintage bottle cost between $100 and $150 at retail, with much higher prices at restaurants. As far as Valance could tell, Latour used two négociants: one sold exclusively to the French market and the other to importers and large distributors abroad. Mentzelopoulos asserted, “The quality of our third wine should not be below that of Latour’s and our price should not be above theirs.”

Promotion Proactively marketing the third wine meant influencing key decision makers. For example, having the wine offered at prestige restaurants required convincing sommeliers to order it. But leading sommeliers’ attitude toward Bordeaux wines seemed to have soured in recent years. Such was the case at the sleek Manhattan restaurant Rouge Tomate, where many Bordeaux wines had been taken off the list. In an article titled “Bored of Bordeaux,” the beverage and wine director of the restaurant noted that authenticity in winemaking “is what Bordeaux used to be before it became a brand,” and that the traditional Bordeaux châteaux from Pauillac and Margaux could benefit from less “snob appeal.” In explaining the backlash against Bordeaux first-growths, Eric Asimov, the New York Times wine critic, cited “monstrous prices” and complacency toward the U.S. market, adding, “They perhaps imagined that they would always sell all the wine they could want through the enthusiasm of Parker, not realizing that a generational shift was occurring.”14

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Château Margaux: Launching the Third Wine 513-107

Mentzelopoulos acknowledged the negative attitude among sommeliers: “We became too expensive for them, and it got harder and harder to get supply. They are better off telling a story that first-growths are overpriced, not trendy and boring.” She believed sommeliers would welcome a reasonably priced third wine from Château Margaux: “I wouldn’t put my hand in the fire, as we have not done formal market research, but I think they will love it. Our third wine will give them a new and better story to tell; it will allow them to surprise and delight their clients.” Valance added, “If we handpick a select set of restaurants in each major city we wish to reach and commit to sommeliers through our distributors that they will get consistent supply of the third wine, they will feel special.”

Brand name Mentzelopoulos asked her team to carefully consider what name to give the new

wine. “How we call it will create expectations in the marketplace, including for those buying our first two wines,” she said, and argued for a name that conveyed simplicity and authenticity. Pontallier advocated for a name signaling that this was, after all, the third wine. One proposal was Margaux du Château Margaux; other names that had been floated were Petit Margaux du Château Margaux and Esprit du Château Margaux (petit means small or little; esprit means spirit). Suggestions also included finding a way to leverage the Pavillon name or crafting an entirely new moniker.

Product and production Château Margaux was blessed with the 2009 vintage in terms of

both the quality and quantity of the third wine. With the 2010 vintage, management decided to be more selective; hence less than half of what was left after blending the first two wines was deemed of high enough quality for the third wine, while the rest, now constituting a fourth wine, was sold in bulk. The overall lower quality of the 2011 vintage resulted in even less bottled third wine. (See Exhibit 9 for wine production.) This fluctuation in quantity raised several issues. In the short term, as there were fewer third-wine bottles from the 2010 and 2011 vintages, the château faced a decision on how many 2009 vintage bottles to release in the upcoming launch. Valance proposed an approach: “If we want a consistent supply every year, perhaps we should not sell all the 2009 third-wine bottles in 2013 and wait to release some of them with the 2010 vintage.” But what was the “right” amount to sell to smooth out the supply across robust and scanty years? And what if there were years when practically none of the wine left after blending the first two was of sufficient quality?

In the long term, what if the third wine was so well received that there was demand for more of it? How could supply be increased? Pontallier knew he could be even more selective in making the first and second wines, which would result in a greater “pool” from which to make the third wine. But was that wise? Increasing the yield of the existing plots was another option, but Mentzelopoulos was concerned about jeopardizing quality. She urged her team to think “outside the château box.” One possibility was to buy grapes or bulk wine from other estates within the appellation. Some second and third classified growth châteaux sold good-quality bulk wine. (See Exhibit 10 for bulk wine prices.) This would allow retaining the “Margaux” appellation designation on the label. A more radical route would be to purchase land or even an entire estate. For instance, between 2005 and 2012, Latour had purchased individual plots within the Pauillac appellation to add 20 hectares and boost its third-wine production. In 2011, second-growth Château Lascombes (118 hectares) sold for €200 million, and in 2012, third-growth Château Calon Ségur (74 hectares) sold for €170 million.15 Because

French regulations allowed classified growths to add hectares from within their appellation and sell

the wines under their own name, an industry insider recommended that Château Margaux consider

buying an estate in the Margaux region. For example, although the terroir at Château Malescot St.

Exupéry was not considered as good, some plots of its first wine were comparable to Château

Margaux’s second wine, and other plots to the third wine. He believed that even if Château Margaux

reduced yields at Malescot and was more selective, with bottled production going down by 10%,

such an acquisition could make sense. (See Exhibit 11 for details on Malescot St. Exupéry.)

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513-107 Château Margaux: Launching the Third Wine

Pondering Other Moves

Every morning I wake up and think—what am I missing? What can go wrong? — Corinne Mentzelopoulos

Selling Wine to the “Masses”

A number of first-growth châteaux had introduced wines targeted at a broad consumer base. The most prominent was Mouton Cadet. Disappointed in the quality of the 1930 vintage, Baron Philippe de Rothschild decided to sell Château Mouton Rothschild’s first wine of the vintage under a different name, Mouton Cadet, and at a lower price.16 The strong demand for the wine led him to offer it in subsequent years using grapes from all over the Bordeaux region to ensure supply. Demand kept increasing, and by 2012, the wine sold between 12 million and 15 million bottles a year in over 150 countries at an average price of $15 or less a bottle.17 The brand was aggressively promoted by associating it with well-known events: Mouton Cadet was the official sponsor of a Winter Olympic Games, famous tennis and golf tournaments (e.g., Roland Garros), and entertainment occasions (e.g., the Cannes film festival). The bottle’s label noted in bold font that it was made by “Baron Philippe de Rothschild.”

Another example was Clarendelle, introduced in 2005 by Prince Robert of Luxembourg, owner of Château Haut-Brion. He commented, “[Consumers] might be overwhelmed by the number of wines coming from France or the so-called Old World but they want something that they can recognize. . . . [O]ur background and history will give the consumer confidence and a promise of regularity of quality.”18 Haut-Brion blended bulk wines from Bordeaux to create Clarendelle, which was named after Clarence Dillon, the prince’s great-grandfather, who bought the estate in 1935. A bottle sold for about $20 at retail. Mentzelopoulos said, “I have heard that Clarendelle has not been a big success. Few consumers know who Clarence Dillon was, so the distribution pressured them to add ‘Inspired by Haut-Brion’ on the label; they also ran newspaper ads.” Valance noted, “I am not sure about the economics. They sell close to 1 million bottles a year. It probably costs them €3–€4 to make each bottle and they flip it to the distribution for about €7–€8. In the past, we might have considered a similar launch, but now it may be too late, as there are so many brands on the market.”

First-Growths Go Global

Château Mouton Rothschild was among the first to play in the global arena. In 1979, it formed a joint venture with Californian winemaker Mondavi to produce the premium wine Opus One. The label featured the signatures of Robert Mondavi and Baron Philippe de Rothschild and selling prices were typically $250–$300 per bottle, depending on the vintage. Domaines Baron de Rothschild (DBR), which managed the famed Château Lafite Rothschild, was probably the most entrepreneurial among first-growths when it came to pursuing interests outside of Bordeaux. Under the direction of Baron Eric de Rothschild, DBR acquired the Los Vascos estate in Chile in 1988, partnered with Argentine winemaker Catena starting in 1998 to coproduce CARO wine (CA for Catena and RO for Rothschild) and later the Amancaya and ARUMA wines, and bought Château Aussieres in the south of France in 1999. Perhaps DBR’s boldest move was to partner with a Chinese investment company to produce a fine wine in China’s Shandong province. Planting had begun by the summer of 2012, and the first wine production was expected in 2015.19 DBR had created a logo, which appeared on all its wines regardless of where they were produced. (See Exhibit 12 for label and logo images.) The wines sold at various price tiers. For example, one could buy a Los Vascos Cabernet Sauvignon for under $10 at a local U.S. wine store. A web of global distributors helped DBR bring its wines to market.

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Château Margaux: Launching the Third Wine 513-107

Pontallier stated, “Our skills and expertise are similar to Lafite’s. We could bring our know-how and successfully run an estate in, say, South America. And I must admit it would be an intriguing challenge for our team.” But Mentzelopoulos cautioned, “I worry about spreading ourselves too thin. I can see why Mondavi wanted the Opus partnership, but what does it bring to Mouton Rothschild? As for Lafite, is selling cheap wines, which are directly associated with the Rothschild and Lafite names, good for their brand? There is a fine line between leveraging a brand and diluting it.”

Latour Shakes the Fine-Wine World

In April 2012, immediately after the 2011 vintage futures market, Château Latour announced that it would no longer sell its wines en primeur. A Latour source said, “We want to kill the speculation side of the market.”20 Many in the industry, such as James Miles, founder of Liv-Ex, reacted with bewilderment. “The decision is impossible to fathom. Not because it is bad for the market and the consumer, which it is, but because it makes no sense for the owners. When you can sell your wine for €500 per bottle in a single phone call . . . with minimal distribution or marketing cost . . . why would you want to change a thing? It is a high risk, low return strategy.”21

Valance believed that for Latour, which was owned by one of the richest men in France, the motivation to get paid early to fund work on next year’s vintage was not strong, “and why settle for a lower price en primeur when a good vintage appreciates in value considerably over time?” Pontallier pointed out that Latour’s decision did not mean that it would not use the négociants to sell the wine after bottling. Mentzelopoulos commented, “We have seen prices come down to levels below the en primeur release price, for example, when the economy slows. In addition, if a new vintage is hailed as exceptional, everyone wants to get their hands on it. This can cause a previous vintage with a similar Parker rating to ‘get trumped’ and lose value. Latour wants to sit on their wine till they feel demand for it peaks. But what happens if they find themselves sitting on hundreds of thousands of bottles because the price isn’t ‘right’? Will they come crawling back to the négociants to take it?” Notwithstanding, Mentzelopoulos was intrigued by Latour’s move. “Every year we wonder about the merits of a distribution system that has not changed in 300 years and debate whether we should hold back more wine from the futures market than we currently do. Latour is serving as a guinea pig for us by in effect holding back 100% of their wine. I am dying to see how this experiment turns out.”

Moving Forward

Mentzelopoulos reflected on whether Château Margaux should follow in the footsteps of its peers. “My father left me with a jewel in the rough. We have tried to polish that jewel and we hope we have been a devoted steward of this precious terroir. People who drink our wines use words such as ‘soft power,’ ‘perfume,’ and ‘harmony’ to describe their complex and subtle virtues. We bought the estate for $16 million and could sell it for much more today. Maybe that is what an MBA student would advise, given the uncertainty on weather patterns, consumption trends, and shifts in critics’ opinions. Many in Bordeaux worry about the region’s popularity when Parker retires.” She concluded, “It boils down to whether I see myself in the wine business or in the Château Margaux business.”

Mentzelopoulos had much on her mind as she pressed the first glass of wine she lifted from the assemblage table to her lips. She and her team had to carefully navigate the next few years. Although the destination was not altogether clear, it was becoming obvious to her that the marketing of the third wine fed into the complex mosaic of the château’s future. It was time to taste.

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513-107 Château Margaux: Launching the Third Wine

Exhibit 1 Worldwide Wine Production: Top-10 Producing Countries (thousands of hectoliters)

Source: Adapted from International Organization of Vine and Wine, “Statistical report on world vitiviniculture 2012,” http://www.oiv.int/oiv/info/enstatistiquessecteurvitivinicole#secteur, accessed March 27, 2013.

Exhibit 2 Per Capita Wine Consumption in Liters (2007 vs. 2011) and Total Cases Sold (2011)

Source: Adapted from “Grape expectations,” The Economist online, March 22, 2012, http://www.economist.com/blogs/ graphicdetail/2012/03/daily-chart-15, accessed May 15, 2013.

10000

20000

30000

40000

50000

60000

70000

2000

2005

2011

300

307

282

116

141

311

156

Total 2011

consumption in

millions of

12-bottle cases

2007

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This document is authorized for use only by Marie Dagstanyan in Marketing Concepts & Strategies - SPRING '17 taught by Tony Stovall, Woodbury University from December 2016 to June 2017.

http://www.economist.com/blogs/%20graphicdetail/2012/03/daily-chart-15

Château Margaux: Launching the Third Wine 513-107

Exhibit 3 U.S. Wine Consumer Segments; % of Total Consumers (% of category spending)

Enthusiasts: 12% (25%)

 Consider themselves to be passionate and knowledgeable about the total wine experience.

 Entertain at home often and enjoy wine with friends.

 Constantly seek additional knowledge and appreciate sophisticated wine information.

 At retail, read labels and enjoy lingering in the wine section. Like to be offered both well-known as well as unique wine selections. On-premise (i.e., at restaurants), typically buy wine by the bottle.

Image Seekers: 20% (24%)

 For them, wine is a status symbol. They only have basic wine knowledge and are driven by awareness of the latest trends. They often use the Internet as a key source of information.

 When not sure about what to buy, they will typically go for the one that’s more expensive.

 When going out to a nice restaurant, they will typically check out the wine list ahead of time online so they can impress their friends.

Savvy Shoppers: 15% (15%)

 Enjoy shopping for wine and discovering new brands and varietals on their own. Get a lot of personal satisfaction when they buy a great $15–$20 bottle of wine and only pay $10 for it.

 Shop in a variety of stores to find the best deals. Heavy users of coupons and rebates.

 On-premise, typically buy a glass of the house wine as it’s a better value for the money.

Traditionalists: 16% (15%)

 Enjoy wines from established wineries that they feel have perfected the art of winemaking.

 Like to be offered a wide variety of well-known brands; influenced by marketing efforts.

 Don’t try new brands often and shop at retail places that make it easy to find their preferred brands.

 On-premise, always order wine brands with which they are familiar.

Satisfied Sippers: 14% (8%)

 Not very knowledgeable about wine. Usually buy the same brand, preferably domestic wine.

 Don’t enjoy the experience of buying wine. Tend to shop at places that make it easy to find their preferred brands. Not interested in learning more about wine.

 When dining out, typically order house wine and don’t worry about wine and food pairing.

Overwhelmeds: 23% (13%)

 Perceive that there are too many wines on the shelves.

 Look for wine information at retail that’s simple and easy to understand. They are very open to advice, so it’s frustrating when they go to a store where there is no one in the wine section to help.

 If it’s too confusing or there’s not any information, they won’t buy anything.

 On-premise, they are easily intimidated. Sometimes it’s safer not to order wine to avoid getting stuck with something that doesn’t taste good.

Source: Adapted from Mike Vesath, “What are wine enthusiasts looking for,” Wine Economist, April 5, 2008.

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513-107 Château Margaux: Launching the Third Wine

Exhibit 4 Map of the Bordeaux Wine Region

Source: Map copyright of Berry Bros. & Rudd, http://bbrblog.com/wp-content/uploads/2012/03/bordeaux-map.jpg, accessed May 13, 2013.

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This document is authorized for use only by Marie Dagstanyan in Marketing Concepts & Strategies - SPRING '17 taught by Tony Stovall, Woodbury University from December 2016 to June 2017.

http://bbrblog.com/wp-content/uploads/2012/03/bordeaux-map.jpg

Château Margaux: Launching the Third Wine 513-107

Exhibit 5 Comparison of Bordeaux First-Growths

Château Lafite Rothschild

Latour Margaux Haut-Brion Mouton Rothschild

Owner Baron Eric de Rothschild (and other family members)

Francois Pinault, owner of Gucci, YSL, and Christie’s auction house

Corinne Mentzelopoulos

Prince Robert of Luxembourg (and other family members)

Baronne Philippine de Rothschild

Appellation Pauillac Pauillac Margaux Pessac-Leognan Pauillac

Red Wine

Vineyard areaa

103 hectares 80 hectares 80 hectares 49 hectares 80 hectares

Grape Varietals Planted

70% Cabernet Sauvignon, 25% Merlot, 3% Cabernet Franc, 2% Petit Verdot

75% Cabernet Sauvignon, 20% Merlot, 4% Cabernet Franc, 1% Petit Verdot

75% Cabernet Sauvignon, 20% Merlot, 3% Cabernet Franc, 2% Petit Verdot

50% Cabernet Sauvignon, 40% Merlot, 9% Cabernet Franc, 1% Petit Verdot

83% Cabernet Sauvignon, 14% Merlot, 3% Cabernet Franc

Red Wines Produced: Name and Quantity (average ranges)

First wine: Château Lafite Rothschild, 18–20,000 cases

Second wine: Carruades de Lafite, 15–20,000 cases

First wine: Grand Vin de Château Latour, 15–16,000 cases

Second wine: Le Forts de Latour, 18,000 cases

Third wine: Pauillac de Latour, 6–9,000 cases

First wine: Château Margaux, 12–14,000 cases

Second wine: Pavillon Rouge du Château Margaux, 14–16,000 cases

First wine: Château Haut- Brion, 10–12,000 cases

Second wine: Le Clarence de Haut-Brion, 5–7,000 cases

First wine: Château Mouton Rothschild, 16–18,000 cases

Second wine: Le Petit Mouton de Mouton Rothschild, 5–6,000 cases

2009 Vintageb

First wine:

Parker Score

Price per bottle

$1,530

100

$1,745

$1,280

$1,200

$1,100

Second wine:

Parker Score

Price per bottle

Third wine:

Parker Score

Price per bottle

$335

$280

$97

$185

$160

$195

Source: Jane Anson, Decanter.com, accessed May 15, 2013; company data; and 90plusWines, http://www.90pluswines.com/ Wine/1655E875/Latour/Pauillac-de-Latour-,-Third-wine-of-Chateau-Latour.aspx, accessed May 22, 2013.

a A hectare is a unit of area equal to 10,000 square meters (roughly the equivalent of 2.5 acres).

b All prices are average U.S. retail per bottle. The 2010 Latour third wine scored higher and was selling for $140.

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This document is authorized for use only by Marie Dagstanyan in Marketing Concepts & Strategies - SPRING '17 taught by Tony Stovall, Woodbury University from December 2016 to June 2017.

513-107 Château Margaux: Launching the Third Wine

Exhibit 6 Parker Scores, En Primeur Prices, and Current Retail Prices for Château Margaux Wines

Parker Rating by Vintage

En Primeur Prices and Current Retail Prices per Bottle (in euros; €1 = $1.32)

Château Margaux

Vintage 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

1st Tranche en

primeur price (€)

120

350

270

200

110

450

500

300

Current price (€) 800 385 350 520 350 760 350 335 400 850 695 380

% increase 567 353 483 333 338 117 30 68 264 89 39 27

Pavillon Rouge

Vintage 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

1st Tranche en

primeur price (€)

Current price (€) 150 115 125 160 98 120 95 107 90 94 130 90

% increase 582 539 681 596 444 300 217 257 309 88 44 20

Notes: The estate also produced 12,000 bottles a year of the white wine Pavillon Blanc, and its current retail prices were similar to those of Pavillon Rouge. Current prices listed are average worldwide at retail. During 1991–1998, for a number of Pavillon Rouge vintages, Parker ratings were not available; data for those years compiled from other critics.

Source: eRobertParker.com, wine-searcher.com, accessed May 13, 2013; and company documents.

100

19 78

19 79

19 80

19 81

19 82

19 83

19 84

19 85

19 86

19 87

19 88

19 89

19 90

19 91

19 92

19 93

19 94

19 95

19 96

19 97

19 98

19 99

20 00

20 01

20 02

20 03

20 04

20 05

20 06

20 07

20 08

20 09

20 10

20 11

Château Margaux

Pavillon Rouge

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Château Margaux: Launching the Third Wine 513-107

Exhibit 7 Channel En Primeur Pricing of Château Margaux (Grand Vin) Wine

Average-Quality Vintage (2007)

Exceptional Quality Vintage (2009)

Notes: 1. Formally, the châteaux had to work through a “Courtier” or broker who facilitated the sale to négociants and took a 2% fee.

2. In the U.S., an importer brought the wine into the country and sold it to distributors licensed to operate in each state. The state distributors sold to retailers.

3. Once bottles were delivered, actual retail prices could fluctuate over time depending on market conditions. In general, channel margins were higher when wine was not sold as futures.

Source: Company data and estimates.

Exhibit 8 The Château Margaux Palace

Source: Casewriters.

Château €200 (first tranche)

Bordeaux Merchant €240

Importer/Distributor €260

Retailer €280

Château

€450 (first tranche) €600 (second tranche) €750 (third tranche)

Bordeaux Merchant €540 (first tranche) €660 (second tranche) €830 (third tranche)

Importer/Distributor €620 (first tranche) €725 (second tranche) €915 (third tranche)

Retailer €715 (first tranche) €800 (second tranche) €1000 (third tranche)

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513-107 Château Margaux: Launching the Third Wine

Exhibit 9 Wine Production at Château Margaux (% of the yield used to make each wine)

Year % Château Margaux % Pavillon Rouge % Third Wine % Bulk Wine

2011 38 28 7-11 23-27

2010 38 38 8-12 12-16

2009 36 41 18-23 0-5

2008 36 53 - 11

Average 06-07 33 56 - 11

Average 03-05 39 56 - 5

Average 00-02 37 51 - 12

Average 97-99 41 49 - 11

Average 94-96 46 54 - 0

Notes: Average red wine production in hectoliters per hectare was: 51 in the 1980s, 48 in the 1990s, 44 in the 2000s, and 35 since 2009 (1 hectoliter = 100 liters and the common bottle size contained 0.75 liters of wine). Storing and bottling the third wine instead of selling it in bulk bore an extra cost of €3–€5 per bottle.

Source: Company documents.

Exhibit 10 Château Margaux Selling Price (€) per Hectoliter to the Bulk Wine Merchants

Vintage 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Price

(€/hectoliter)

712 677 600 723 723 777 777 833 723 723 833 889

Notes: 1. If Château Margaux wanted to buy bulk wine from within the appellation, it could coordinate with a broker to purchase from specific estates (at a 2% broker’s fee).

2. If Château Margaux bought grapes or bulk wine from within the appellation, it could use the “Margaux” appellation designation on the label but could not use its classified château as part of the name, i.e., it could not say “du Château Margaux.”

3. If Château Margaux bought bulk wine from other regions in Bordeaux, the designation would be “Appellation Bordeaux Controlee.”

4. Among first-growths, Château Margaux was the only one where the name of the estate contained the name of the appellation. This complicated copying peers’ naming strategies. For example, if wine was externally sourced, it would be illegal to call the wine “Margaux Cadet,” though it might be possible to use a different name altogether and note on the label “Inspired by Château Margaux.”

Source: Company documents.

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Château Margaux: Launching the Third Wine 513-107

Exhibit 11 Malescot St. Exupéry: Parker Ratings, Prices, and Estimated Production

1855 Classification

Vineyard Area

Average Yield

Third-Growth (Troisième Cru)

23.5 hectares

50–55 hectoliters/hectare

1st Wine 60%

2nd Wine 30%

Bulk Wine 10%

Vintage Parker Rating First Wine Current Retail Price ($)

1994 87 78

1995 90 96

1996 90 93

1997 82 52

1998 90 81

1999 90 87

2000 95 138

2001 88 70

2002 92 73

2003 92 89

2004 90 64

2005 97 155

2006 91 66

2007 89 58

2008 93 64

2009 96 118

2010 95 104

2011 92 52

Notes: The average retail price for Malescot St. Exupéry’s second wine was about $30–$35. An industry expert estimated average production costs of €15 per bottle at Malescot St. Exupéry, which could increase in proportion to greater selectivity.

Source: Data compiled from Stephen Brook, The Complete Bordeaux: The Wines, The Châteaux, The People (Mitchell Beazley, 2012); Robert M. Parker, Bordeaux: A Consumer’s Guide to the World’s Finest Wines, 4th ed. (New York: Simon & Schuster, 2003); eRobertParker.com; Wine-Searcher.com, accessed May 13, 2013; and company and casewriter estimates.

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513-107 Château Margaux: Launching the Third Wine

Exhibit 12 Domaines Baron de Rothschild Logo and Back Label on a Los Vascos Bottle of Wine

Source: Casewriters; and Pasternak Wines, http://www.pasternakwine.com/pdfs/Los%20Vascos%20Packet% 202013.pdf, accessed June 9, 2013.

Notes: The logo also appeared on the cork, the seal, and the back label of the wine. Los Vascos produced upwards of 500,000 cases of wine each year.

The back label said:

“Los Vascos, one of Chile’s oldest wine estates, is managed by Domaines Baron de Rothschild (Lafite), who began a comprehensive modernization and investment program in 1988. The 560 hectare vineyard is located in the Caneten valley of the Colchagua province which offers a healthy microclimate for its ungrafted pre-phylloxera Bordeaux rootstock. Under the direct technical supervision of the Domaines, Los Vascos is committed to producing the finest consistent and balanced wines whose elegance and harmony are to be shared with discriminating connaisseurs around the world.”

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Château Margaux: Launching the Third Wine 513-107

Endnotes

1 IBISWorld, Industry Report C1123-GL, Global Wine Manufacturing, February 2014.

2 Sybille de La Hamaide, “World wine output down, hit by weather and EU curbs,” Reuters, March 21, 2013.

3 IBISWorld, Industry Report C1123-GL, Global Wine Manufacturing, December 2012.

4 Ibid.

5 Vins de Provence, “The U.S. Wine Market: Facts & Figures,” January 2012, http://res.franceguide.com/us/ press_2012/weblinks/vin_de_provence_facts_figures.pdf, accessed June 12, 2013; and Mary-Colleen Tinney, “Survey of Top On-Premise Wines Released,” Wine Business.com, http://www.winebusiness.com/news/ ?go=getArticle&dataId=44085, accessed June 12, 2013.

6 Malcolm Moore, “Empty wine bottles sell for £300 in China,” The Telegraph, January 7, 2011.

7 Bruce McGechan, May 31, 2011, http://www.mylocalwinestore.com/winery-marketing/wine-research/,

accessed April 4, 2013.

8 William Langewiesche, “The Million Dollar Nose,” Atlantic Monthly, December 2000.

9 The Wine Advocate Rating System, https://www.erobertparker.com/info/legend.asp, accessed June 8, 2013.

10 Langewiesche, “The Million Dollar Nose.”

11 “Wine Ratings Don’t Tell the Whole Story,” New Orleans Times-Picayune, May 20, 2005.

12 Julia Pittam, “Chinese connoisseurs buy up Bordeaux’s wines,” BBC News, February 17 2013, http://www.bbc.co.uk/news/business-21292824, accessed June 8, 2013; and the Office de Tourisme de Bordeaux, http://www.bordeaux-tourisme.com/pl/coup_coeur.pl?lg=uk&id=239, accessed June 8, 2013.

13 Dewey Markham, 1855: A History of the Bordeaux Classification (New York: John Wiley & Sons, 1988).

14 Alice Feiring, “Bored of Bordeaux,” Out & About, January 2013.

15 Rebecca Gibb and AFP, “Insurance Giant Buys Top Bordeaux Château,” Wine Searcher, July 4, 2012, http://www.wine-searcher.com/m/2012/07/insurance-firm-buys-top-bordeaux-property-saint-estephe, accessed June 9, 2013.

16 Wikipedia, “Mouton Cadet,” http://en.wikipedia.org/wiki/Mouton_Cadet, accessed June 9, 2013.

17 Ibid., and wine-searcher.com, http://www.wine-searcher.com/find/mouton+cadet/2009/-/-/u, accessed June 10, 2013.

18 Will Lyons, “The case of Clarendelle,” Wall Street Journal, July 2, 2010.

19 DBR, “Gerad Colin reports on DBR-Citic vineyard,” news release, March 2012, http://www.lafite.com/ eng/News/Gerad-Colin-reports-on-DBR-Citic-vineyard, accessed June 9, 2013.

20 Victoria Moore and James Hall, “Good news for Wine Buyers as Château Latour exits decades-old ‘en primeur’ system,” The Telegraph, April 16, 2012, http://www.telegraph.co.uk/foodanddrink/wine/9207836/ Good-news-for-wine-buyers-as-Chateau-Latour-exits-decades-old-en-primeur-system.html, accessed June 9, 2013.

21 Jeff Leve, “Liv-ex (London International Vintners Exchange) Wants to Change How Fine Wine is Bought Sold and Exchanged,” Wine Cellar Insider, February 20, 2013, http://www.thewinecellarinsider.com/2013/ 02/liv-ex-wants-to-change-how-fine-wine-is-bought-sold-and-exchanged/, accessed June 9, 2013.

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August 1, 2009

CHAPTER TWO

Cultural Knowledge

From Cultural Intelligence: Living and Working Globally,

Second Edition, by David C. Thomas and Kerr Inkson

Published by Berrett-Koehler Publishers, Inc.

Harvard Business Publishing distributes in digital form the individual chapters from a wide selection of books on business from publishers including Harvard Business Press and numerous other companies. To order copies or request permission to reproduce materials, call 1-800-545-7685 or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means – electronic, mechanical, photocopying, recording, or otherwise – without the permission of Harvard Business Publishing, which is an affiliate of Harvard Business School.

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CHAPTER 2

Cultural Knowledge

WE CAN MAKE THE BEST OF IT

Chan Yuk Fai ushered his British guest into the crowded Shanghai restaurant. Around them, the atmosphere was busy with the quiet babble of a dozen conversations. Mr. Chan bowed slightly, then leaned forward and smiled. “I think,” he said in excellent English, “I think the food is not the very best in this restaurant.”

Jeffrey Thomson stiffened slightly. He found it hard to conceal his surprise. What was he to make of Mr. Chan’s remark? Mr. Chan had chosen the restaurant. Did he really think the food was poor? If he thought so, why had be chosen this restaurant? Perhaps criticiz- ing the food was just a Chinese custom — something everyone did that had nothing to do with the real quality of the food. Perhaps it was a joke — Mr. Chan was smiling broadly. After all, what did Jeffrey know about the Chinese sense of humor? Or perhaps it was an affectation of modesty. He had read somewhere that Chinese were self-effacing. But he had also read that they were indirect. Maybe criticizing the restaurant was Mr. Chan’s way of saying he did not have a lot of interest in Jeffrey or what he had to say. Maybe it was even some form of veiled insult!

He realized that Mr. Chan was politely waiting for him to re- spond and that he had no idea what to say. He felt very confused.

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Cultural Knowledge 21

Best to be noncommittal, he thought. What would I say if someone said that to me in London? He smiled back at Mr. Chan. “I’m sure we can make the best of it,” he replied.

Was it his imagination, or did he see a minuscule reduction in Mr. Chan’s beaming smile?1

On the surface Jeffrey Thomson’s worries about Chinese cul- ture have to do with Chinese customs, the habitual ways in which people go about day-to-day activities. The Chinese custom is to show respect for a guest by disparaging one’s own accomplishments, even the selection of a restaurant. And the expectation is that the guest will return this respect with a compliment. By not doing so, Jeffrey has made a cultural blunder. This custom is specific to the cultural situation, but the general predicament in which Jeffrey finds himself is one that he has in common with thousands of other travelers from all continents and countries. Jeffrey does have some understanding of the notion that important cultural differ- ences exist between himself and Mr. Chan. There is some truth in his inner reflections on Chinese people tending to be self-effacing and inscrutable. And he is trying to use his powers of observation to draw an appropriate conclusion and behave in an appropriate way. But his knowledge, his insight, and his experience are simply insufficient for the task. He lacks cultural intelligence.

Components of Cultural Intelligence

Jeffrey’s problem can be divided into three linked components. First, he lacks detailed knowledge. He understands that

there are such things as cross-cultural differences. His mind has retained a few ideas (from where, who knows?) about characteristics of Chinese people like the man he is dealing with. But these are crude stereotypes that leave open multiple interpretations and are of little help in enabling him to under- stand the situation.

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22 c u l t u r a l i n t e l l i g e n c e

Second, he lacks mindfulness. Not only does he not know what Mr. Chan’s remark means, but he lacks the ability to observe and interpret the remark in the context of other cues — prior conversations, his dealings with other Chinese, the visible quality of the restaurant he is standing in, Mr. Chan’s smile, and so on. Because of this, he is unable to read the situation as it develops. Whatever the outcome, he is likely to learn little from the experience that will assist him with further interactions. Mindfulness is a means of continually observing and understanding cultural meanings and using that understanding as a basis for immediate action and long- term learning.

Third, he lacks the skill to adapt his behavior. He would love to be able to respond confidently, in both his words and his physical actions, in a way that would be authentic but also sensitive to his host. He realizes that being able to respond appropriately to Mr. Chan’s remark would not only put both of them more at ease but would also help their conversation. But the only action he is capable of — because of his lack of both knowledge and interpretive skills — is to respond as he would “at home.” Jeffrey needs to develop a repertoire of behaviors that will enable him to act appropriately and suc- cessfully in any cross-cultural situation.

The three components combined provide a template for intercultural flexibility and competence. In brief, culturally intelligent people have:

■ the knowledge to understand cross-cultural phenomena ■ the mindfulness to observe and interpret particular

situations ■ the skills required to adapt behavior to act appropriately

and successfully in a range of situations

These three components are connected to each other and build on each other. Because culturally intelligent people have good background understanding, their interpretation is assisted — they know what to look for. But each competency

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Cultural Knowledge 23

is also based on wider characteristics that we all have to dif- ferent degrees: those who find cultural intelligence easiest to acquire are people who are interested in novel learning and social interaction and who already have good communication skills. For those who are unsure of themselves in these areas, acquiring cultural intelligence is also likely to increase compe- tence and confidence in all interpersonal situations.2

In this chapter we focus on the information base — or knowledge — that is the first component of cultural intelli- gence. In the case study, a culturally intelligent Jeffrey would have been mindfully aware of Mr. Chan’s remarks and would have adapted his behavior by choosing from a number of more appropriate responses. But in order to do this Jeffrey would have needed a basic understanding of culture.

What Culture Is

Culture is a word that is familiar to everyone, but its precise meaning can be elusive. A useful definition by noted social scientist Geert Hofstede is that culture consists of shared mental programs that condition individuals’ responses to their environment.3 This simple definition neatly summarizes the idea that we see culture in everyday behavior — individu- als’ responses to their environment, such as Chan Yuk Fai’s and Jeffrey Thomson’s efforts at conversation — but that such behavior is controlled by deeply embedded mental programs. Culture is not just a set of surface behaviors; it is deeply embedded in each of us. The surface features of our social behavior — for example, our mannerisms, our ways of speak- ing to each other, the way we dress — are often manifestations of deep culturally based values and principles.

A key feature of culture is that these mental programs are shared — Chan Yuk Fai and Jeffrey Thomson share theirs with many other people from their own ethnic or national communities. Hofstede talks about three levels of mental programming, as shown in figure 2.1.

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24 c u l t u r a l i n t e l l i g e n c e

■ The deepest level — human nature — is based on common biological reactions, such as hunger, sex drive, territorial- ity, and nurturing of the young, that all members of the human race have in common. Because of human nature, there are many behaviors and understandings that all peo- ple share, even though they come from different cultures.

■ The shallowest level — personality — is based on the spe- cific genetic makeup and personal experiences that make each of us a unique individual. For example, we may be sociable or introverted, aggressive or submissive, emo- tional or stable, or perhaps, as a result of learning, have a deep interest in fashionable clothing or a love of good wine. Because of personality, each of us has many behav- iors and understandings that are quite different from those of others, even though they come from the same culture.

■ The middle level — culture — is based on common experi- ences that we share with a particular group of our fellow human beings. Cultural values, attitudes, and assumptions about proper behavior give us something in common with a definable group of others, but not with all of them. The group may be a very large one, such as a national popula-

BiologicalUniversal

Personality

Culture

Human Nature

LearnedSpecific to groups

Inherited and learned

Specific to individuals

FIGURE 2.1. Three levels of mental programming

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Cultural Knowledge 25

tion, for example, Japanese culture; or a very small one, for example, the culture of the committee of a local PTA. In recent years, many business, government, and not-for- profit organizations have recognized the power of culture to shape individual values and actions and have worked hard to establish “organization cultures” that will bond the activities of diverse members to common values and themes such as customer service or conservation.4

In this book, we are concerned mostly with national or ethnic cultures. But the notion of smaller cultures — some- times referred to as subcultures — and the idea of individual personality remind us that huge variation exists within any given culture and that one of the biggest barriers to effective intercultural interaction is basing our behavior on stereo- types, which assume that all members of a given culture are identical.

Characteristics of Culture

Culture has some basic characteristics that are worth keeping in mind.

C u lt u r e I s S h a r e d

By definition, culture is something that a group has in com- mon that is not normally available to people outside the group. It is mental programming held in common that enables insiders to interact with each other with a special intimacy denied to outsiders.

For example, Scottish people all over the world share an understanding of history that is rooted in conflict with, and oppression by, the English. Even though the two groups now- adays coexist relatively harmoniously, this simple fact creates a bond among Scots and an attitude toward the English that is hard to put into words but is immediately recognized by Scottish people when they meet anywhere in the world.

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26 c u l t u r a l i n t e l l i g e n c e

C u lt u r e I s L e a r n e d a n d I s E n d u r i n g

The example of the Scots and the English tells us that culture does not arise by accident but builds up systematically over time based on sequences of historical events. The mental programming of a group is learned by its members over long periods as they interact with their environment and with each other. Some aspects of culture, such as religious beliefs, systems of land ownership, and forms of marriage, are built into institutions. Other aspects are passed on through the generations in the form of parental role modeling and advice to the young.

C u lt u r e I s a P ow e r f u l I n f l u e n c e

o n B e h av io r

We have a hard time escaping our culture, even when we want to. The mental programming involved is strong. Even when we mentally question the rationality of some aspects of our culture or seek to adopt cultural flexibility by doing things in line with a different culture, we have a natural tendency to revert to our cultural roots.

For example, one young man was brought up in a strict Christian culture that taught him that the theater is the house of the devil. When he went to university and mixed with more liberal people, he decided that from a rational point of view there was nothing wrong with going to the theater. But on his first visit, he became nauseous and had to leave to be sick. His culture had programmed him extremely powerfully. To some extent this book, in encouraging cultural flexibility in cross- cultural situations, is asking readers to try to do something that may not come naturally.

Nevertheless, the experience of migrants, who deliberately and often successfully move from one cultural setting to another, suggests that individuals can learn, and even identify with, aspects of a new culture. In some cases, the require- ments of a dominant culture may even cause them to suppress

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Cultural Knowledge 27

aspects of their original culture. These changes take place through a process known as acculturation.5 Being embedded in an unfamiliar setting causes some to learn actively about the new culture, while others attempt to avoid it, often by trying to re-create their old culture in the new situation.6 The best adaptation is done by those who learn the new culture while still retaining valuable elements of their original cul- ture. By so doing, they cultivate cultural intelligence.7

C u lt u r e I s S y s t e m a t i c a n d O rg a n i z e d

Culture is not random. It is an organized system of values, attitudes, beliefs, and meanings that are related to each other and to the context. When Chan Yuk Fai says, “I think the food is not the very best in this restaurant,” understanding that Chinese people often deprecate themselves is not enough. We need to understand that such deprecation is but one tiny expression of a complex system of values and ideas. It is a sur- face representation of Mr. Chan’s deepest values and under- standing of the world — a mental program based on centuries of survival and cooperation by Mr. Chan’s Chinese ancestors in their largely agricultural economy and culture. As another example, the practice of polygamy, which is frowned on in most cultures, makes good historical sense in some African cultures where it is still practiced. Acceptance of polygamy depends on such factors as family status, economic security, and religious commitment, all of which are based on having more children, and particularly more sons, per family.

Because of the mental programming imposed by our own culture, the cultures of other people often seem strange and illogical. Deeper scrutiny can reveal that each culture has its own, often exquisite, logic and coherence.

C u lt u r e I s L a rg e ly I n v i s i bl e

What we see of culture is expressed in living artifacts, which include communicated messages such as that of Mr. Chan concerning the food. But they also include human activities

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28 c u l t u r a l i n t e l l i g e n c e

such as language, customs, and dress, as well as physical artifacts such as architecture, art, and decoration.

Because much of culture is hidden, these obvious and visible elements of culture may be likened to the tip of an iceberg.8 Icebergs have as much as 90 percent of their mass below the surface of the water, leaving only a small percent- age visible. The important part of the iceberg that is culture is not the obvious physical symbols that are above the surface but the deep underlying values and assumptions that they express. So understanding cultures involves a lot more than just understanding immediate surface behavior such as bows, handshakes, invitations, ceremonies, and body language. The invisible elements of culture — the underlying values, social structures, and ways of thinking — are the most important.

C u lt u r e M ay B e “ T ig h t ” o r “L o o s e ”

Cultures differ from each other not just in their details but also in their pervasiveness.9 Some societies are character- ized by virtually 100 percent agreement as to the form of correct behavior; other societies may have greater diversity and tolerance of difference. “Tight” cultures have uniformity and agreement and are often based on homogeneous popula- tions or the dominance of particular religious beliefs. Japan is a good example. Countries such as Canada with diverse populations have relatively “loose” cultures, which in some cases are made even looser by the encouragement of freedom of thought and action.

National and Global Culture

As we have mentioned, nation and culture are not identical. Many ethnic cultures, organization cultures, minority cul- tures, and subcultures may influence different people within the same country. For example, the indigenous peoples of North America have cultural characteristics very different

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Cultural Knowledge 29

from those of the majority of Canadians and Americans, and both the United States and Canada have many distinctive cultural groupings within their populations. The main focus of this book, however, is on national culture.

Nations are often formed because of cultural similarities among different population groups, and over time they rein- force their adherence to a national culture by means of shared institutions, legal and educational systems, and, of course, nowadays, the mass media. National cultures are particularly important in international business because of the concept of national sovereignty and the need to conduct business affairs within a nation’s legal and political frameworks.

Another issue relating to national culture concerns the apparent growth of “global culture.” Some people argue that as travel, business, and the media become more international, all countries converge toward a single culture, ironing out all the special differences that make each national culture unique. Because of the economic dominance of Western coun- tries, particularly the United States and the larger European democracies, some people think that these countries’ cultural forms will gradually submerge other cultures around the world. Thus, the international proliferation of organizations such as McDonald’s and Starbucks is often welcomed as a sign of economic success, while also being criticized as an intrusion of American culture.

If the convergence theory were correct, it might be a reason to downplay the notion of cultural intelligence. If this were the case, it could be best to work with people from all nations to help them to get away from their own cultural habits and instead to understand and practice values and customs that are becoming standard around the world.

We think that this is a bad strategy for several reasons:

1. While some evidence supports the convergence theory, other evidence opposes it.10 Many cultures may be becom-

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30 c u l t u r a l i n t e l l i g e n c e

ing “modern,” but they are doing so in different ways. Cultures tend to accept some aspects of other societies and reject others. In Hong Kong, for example, people have retained their traditional Chinese respect for authority while rejecting its fatalism and have adopted modern com- petitiveness but rejected modern attitudes toward sexual freedom. Across the world, probably the only real con- vergence that is taking place is in surface matters such as basic business structures and consumer preferences, rather than in fundamental ways of thinking and behaving.

2. A society may also appear to accept change, but in fact the change is often recontextualized to fit preexisting cul- tural patterns.11 For example, even though a McDonald’s restaurant may look very much the same in any part of the world, the experience of visiting a McDonald’s is very different for Japanese or Chinese or French or U.S. people. That is, people from many Western countries see McDonald’s as the place one goes to for fast food, but many Chinese people visit McDonald’s as a means of having an “American experience.”

3. Even if convergence is taking place, the pace of change is very slow. The evolution of culture in any society is not easily predicted.12 Traditional cultural patterns tend to be deeply embedded. Those who intend to sit back and wait for the rest of the world to catch up with the West in terms of culture will have to wait for a very long time.

4. Societies worldwide are recognizing the value of diversity in human affairs. Just as biodiversity has a value in allowing ecosystems to deal with major change, so too does cultural diversity offer us a wider range of viewpoints and ways of doing things. Many societies nowadays go out of their way to ensure that cultures under threat are protected from sub- mergence by majority cultures.

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Cultural Knowledge 31

Key Cultural Values In chapter 1, we rejected the laundry-list approach to under- standing cultures — learning everything one needs to know about every culture one is likely to deal with — on the basis that cultures are so diverse and so complex that the task is impossible.

Nevertheless, we can “unpackage” cultures by describing their essential features to aid understanding. It is a bit like the language we use to describe people. Sally may be a unique individual with specific qualities and quirks of character that would take a long time to describe. But if we say Sally is intel- ligent, extroverted, emotionally stable, and unassertive, we have in a few words conveyed a lot of information that might differentiate Sally from other people.

Just as we can summarize people’s individual character- istics, we can summarize the characteristics of a culture. An important way to describe both the similarities and differ- ences among cultures is by their underlying values. These cultural values are fundamental shared beliefs about how things should be or how one should behave.

Consider the case below.

HOW ARE YOUR JOB INTERVIEWS GOING?

Barry and Miguel, students approaching graduation at the Uni- versity of Nevada, are close friends — roommates from their fresh- man days and keen rivals on the racquetball court. On graduation, each seeks a position in a major company, Barry hopefully on the West Coast of the United States and Miguel in his native Mexico. But their strategies for finding work are quite different.

All the time he has been at university, Barry has focused on de- veloping himself as a unique individual, consciously improving his skills — particularly communication skills — his initiative, his personal goals, and his own identity. He has been powerfully influenced by books that tell him: “You are unique, you are a brand, develop

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32 c u l t u r a l i n t e l l i g e n c e

yourself as a product and market yourself and what you bring, to get the highest price and best prospects you can for your services.” At corporate interviews, Barry aims to shine. He does not expect to have any particular loyalty to the company that hires him. In a dog-eat-dog world, Barry will, at each stage, move to the best deal he can get: if his initial company continues to offer the best deal, then he will be loyal.

Miguel attends no corporate interviews, not even with compa- nies that he knows have big operations in his native Mexico. When people ask him and Barry, “How are your interviews going?” Barry can answer, but he can’t. It is not for him to fix up interviews; it is for his family, particularly his father and his uncles, who own their own small business in Mexico City and have lots of business contacts they will use to secure him openings after graduation. Miguel knows that for him to arrange interviews on his own without his family’s blessing would be to commit an unforgivable offense against his parents and the wider family that has always looked after him. He is confident that after he returns to Mexico, he will have interviews, opportunities, and potential jobs, almost certainly arranged through other family members and friends. He knows that he will be expected to take family advice on which opportunities to take, and that long-term loyalty both to the family and to his new employers will be expected. He wants to give that loyalty: it’s the way things should be.

One night, Barry and Miguel discuss their rapidly approaching careers after a racquetball game. They have difficulty in under- standing each other. “How can you let yourself be so dependent on others?” says Barry. “Some people would see it as nepotistic and corrupt.” “How can you live your life as a man apart?” says Miguel. “Don’t you care about the people who help you? Some people would see you as selfish and ungrateful.”

The explanation for the cross-cultural misunderstanding in the case of Barry and Miguel is based on an important dimen- sion of variation between cultures. Latin Americans have a much more group-oriented culture than Americans. Many activities, ranging from the kind of job seeking referred to

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Cultural Knowledge 33

above to methods of decision making, are based on groups —

extended families, organization departments, volunteer groups. This results because of differentiating factors called individualism and collectivism.

■ In individualist cultures people are most concerned about the consequences of action for themselves, not others. They prefer activities conducted on one’s own or in relatively private interactions with friends. Decisions are made by the individual according to his or her own judgment as to what is appropriate and on the individual rewards that will accrue.

■ In collectivist cultures, people primarily view themselves as members of groups and collectives rather than as autonomous individuals. They are concerned about the effects of actions on these groups and the approval of other people in their groups. Their activities are more likely to be undertaken in groups on a more public basis. Decisions are made on a consensual or consultative basis, and the effects of the decision on everyone in the social group are taken into account.

Individualism and collectivism are not either/or. They provide dimensions along which different cultures can be understood. Of all measures of cultural variation, individualism and col- lectivism are the most useful and powerful.13 However, it is important not to simplify these dimensions by, for example, equating individualism with selfishness or introversion, or collectivism with socialism. Both individualists and collectiv- ists have relationships and groups, but the type of relationship is different: collectivists actually tend to have fewer groups with which they identify, but these are wide, diverse groups such as tribes or extended families, and the bonds of loyalty are strong. Individualists often identify with many different groups, but the bonds are superficial.

Individualism–collectivism potentially provides a basis for

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34 c u l t u r a l i n t e l l i g e n c e

describing national culture in terms of its position on the dimension between them, and for comparing any two national cultures on the same basis. When other dimensions or aspects of culture are added to the picture, somewhat more detailed assessments and comparisons can be made.

H o f s t e d e ’s S t u dy

For example, in Geert Hofstede’s well-known survey of over 100,000 employees of a large multinational corporation spread across fifty countries, each country, on the basis of its employees’ responses, was assigned an individualism score between 1 and 100.14 The most individualist countries on this measure were Australia, Belgium, Canada, Great Britain, Israel, Italy, New Zealand, South Korea, and the United States, all of which had scores of over 75. Collectivist countries that scored less than 20 included Chile, Colombia, Costa Rica, El Salvador, Guatemala, Indonesia, Pakistan, Panama, Peru, Taiwan, and Venezuela. The countries with high scores were all North American, European, or former colonies of the United Kingdom. The lower scores were found in countries in South America and East Asia. Among countries that came out around the average for individualism-collectivism were Argentina, India, Japan, and Spain.

I n d i v i d ua l i s m a n d C ol l e c t i v i s m

As we have shown, individualism is most common in devel- oped Western countries. A strong relationship exists between a country’s individualism and its wealth (gross national product, or GNP).15 The recent political fashion of free mar- kets and the encouragement of entrepreneurship plays to individualism, and developed countries have seen a marked international trend in this direction, leading, for example, to a general decline in individuals’ loyalty to their employing organizations. Try the exercise in the appendix to see the extent to which you think of yourself in individualist or col- lectivist terms.

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Cultural Knowledge 35

S c h wa r t z Va l u e S u r v e y

Individualism and collectivism, while perhaps the most important dimensions of cultural variation, are not the only dimensions that researchers have been able to identify. For example, Israeli psychologist Shalom Schwartz and his col- leagues did a more recent and more sophisticated mapping of cultures according to their value orientations.16 They identi- fied three universal requirements that every culture has of itself: the need to specify how individuals should relate to the wider society, the need for society to preserve itself, and the need to define how society should relate to the natural world. Schwartz’s idea was that while all societies have to address these requirements, they do so in different ways. In each society this leads to a shared set of fundamental beliefs about how things should be or how one should behave. By examin- ing fifty-seven national cultures, Schwartz and colleagues derived seven fundamental value dimensions:

■ Egalitarianism — recognition of people as moral equals ■ Harmony — fitting in harmoniously with the environment ■ Embeddedness — people as part of a collective ■ Hierarchy — unequal distribution of power ■ Mastery — exploitation of the natural or social

environment ■ Affective autonomy — pursuit of positive experiences ■ Intellectual autonomy — independent pursuit of one’s own

ideas

Figure 2.2 shows the relative positions of countries along the seven dimensions.

It is impossible to represent perfectly the relative position of countries on seven dimensions in the two-dimensional space of the printed page. However, by using a technique called a co- plot, Schwartz and his colleagues were able to present the rela- tionships quite accurately. The position of each country along

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36 c u l t u r a l i n t e l l i g e n c e

the vector of each cultural dimension indicates how similar or different each country is on that dimension. For example, Canada and New Zealand are very similar on all seven dimen- sions. However, the United States, which is similar to these two countries on other dimensions, ranks higher on the mastery dimension (more like Japan). By examining the position of your own country and that of others on this map, or by reading Schwartz’s books and papers — or indeed Hofstede’s — you can increase your knowledge about the areas of potential cultural harmony or conflict with members of another culture.

T h e G L O B E S t u dy

Another way of understanding similarities and differences across cultures is to examine which countries cluster together

EMBEDDEDNESS HARMONY

EGALITARIANISM

INTELLECTUAL AUTONOMY

AFFECTIVE AUTONOMY MASTERY

HIERARCHY

CyprusChile

Norway

Macedonia

Bulgaria

Mexico

Turkey

Italy

Finland

Spain France Sweden

Denmark

Austria

Switzerland

Greece England

China

India

Zimbabwe

Namibia Nigeria

UgandaHong Kong

Thailand Ghana

Nepal

Indonesia

Singapore

Bolivia

Philippines Russia

Hungary Australia

Netherlands

Canada

New Zealand

USA

Japan

FIGURE 2.2. Co-plot of value dimensions across national cultures Source: Adapted from Sagiv & Schwartz (2000)

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Cultural Knowledge 37

in their positions on various measures of cultural values. Based on a large-scale study of cultural differences in values, researchers who conducted the Global Leadership and Orga- nizational Behaviour Effectiveness (GLOBE) study grouped the sixty-two societies they studied into ten clusters.17 These clusters, shown in figure 2.3, are based on overall similarity of countries based on nine value orientations:

■ Institutional Collectivism: The degree to which organiza- tional and societal institutional practices encourage and reward collective distribution of resources and collective action

■ In-Group Collectivism: The degree to which individuals express pride, loyalty, and cohesiveness in their organiza- tions or families

■ Power Distance: The degree to which members of a col- lective expect power to be distributed unequally

■ Uncertainty Avoidance: The extent to which a society, organization, or group relies on social norms, rules, and procedures to alleviate unpredictability of future events

■ Gender Egalitarianism: The degree to which a collective minimizes gender inequality

■ Assertiveness: The degree to which individuals are asser- tive, confrontational, and aggressive in their relationships with others

■ Humane Orientation: The degree to which a collective rewards individuals for being fair, altruistic, generous, caring, and kind to others

■ Future Orientation: The extent to which individuals en- gage in future-oriented behaviors such as delayed gratifi- cation, planning, and investing in the future

■ Performance Orientation: The degree to which a collec- tive encourages and rewards group members for perfor- mance improvement and excellence

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38 c u l t u r a l i n t e l l i g e n c e

As shown in figure 2.3, the clusters of countries reflect such fac- tors as common language, common religion, common climate, geographic proximity, common economic system, and shared political boundaries — all of which can be shown to contribute to national cultural variation.18 This typology underscores the historical basis of cultural variation. For example, the composi- tion of the Anglo cluster indicates that as a result of migration this culture was diffused from England to Ireland, the United States, Canada, South Africa, Australia, and New Zealand, and its position relative to other clusters indicates its own roots in Saxony (Germany) and Jutland (northern Denmark). Likewise

Ecuador EI Salvador

Colombia BoliviaBrazil

Guatemala Argentina

Costa Rica

Venezuela Mexico

D enm

ark

Finland

Sw eden

C an

ad a

U .S

.A .

A us

tr al

ia Ir

el an

d E

ng la

nd So

ut h

A fr

ic a

(W hi

te S

am pl

e) N

ew Z

ea la

Austri a

The N eth

erl ands

Switze rla

Germ any

Zimbabwe NamibiaZambiaNigeria

South Africa

(Black Sample)

G reece

H ungary

A lbania

Slovenia

Poland

R ussia

G eorgia

K azakhstan

T ur

ke y

K uw

ai t

E gy

pt M

or oc

co Q

at ar

Singapore

Hong Kong

Taiw an

China

South Korea

Jap an

Latin America

Southern Asia

Con fucia

n Asia M

id dl

e E

as t

Philippiness Indonesia Malaysia

India Thailand

Iran

Israel Italy

Switzerland (French Speaking)

Spain Portugal France

N ordic

E urope

Germ anic

Europe

A ng

Latin Europe Sub-Sahara Africa

E astern

E urope

FIGURE 2.3. Country clusters according to GLOBE

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Cultural Knowledge 39

the Confucian Asian cultural cluster reflects the strong historical influence of China and Confucian ideology. Even Japan with its physical isolation shared significant cultural interactions with China over time. As with the mapping of the Schwartz value orientations, by referring to the GLOBE cultural clusters, you can get a first approximation of the extent to which you might share cultural values with people from other societies.

Effects of Culture: The “In-Group” and the “Out-Group”

An important aspect of culture is the way we use it to define ourselves. If we state that we are “American,” “Thai,” “Mus- lim,” or that we “work for IBM,” our assertion places us inside a boundary that excludes a lot of other people. It dif- ferentiates us. It sets up expectations — intentional or uninten- tional — as to the kinds of attitudes and behavior that others can expect from us.

This tendency is important in terms of bias — typically bias is in favor of our own group or culture (the “in-group”), and against others (the “out-group”) external to our own. Therefore, we typically discriminate in our own group’s favor.

Most importantly, we tend to identify everything about the in-group as being normal (i.e., the way things ought to be done). Consequently, whenever we encounter people doing things a different way, we tend to see their action as not just different but as deviant, even as wrong. We are particularly likely to do this when operating on our own turf, yet even when we are overseas we tend to take our own common expe- riences at home as the norm for how others ought to behave.

For example, although the United States and Mexico are geographically close to each other, the GLOBE clusters sug- gest that they are separated by a significant cultural distance. The GLOBE value scores for the two countries and the aver- age for the entire worldwide sample (on a scale of 1 to 7) are as follows:19

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40 c u l t u r a l i n t e l l i g e n c e

The table shows that the United States has a very high level of assertiveness, performance orientation, and gender egali- tarianism as compared to the world average and to Mexico. Mexico, on the other hand, has very high uncertainty avoid- ance compared to the world average and the United States. It is easy to see how it might be difficult for individuals from one country to know how to behave socially in another coun- try or to understand the process of making decisions in still another when those countries are from different groups.

As in the case of Barry and Miguel presented previously in the chapter, consider how an American and a Mexican with no prior cross-cultural experience might perceive each other from the standpoint of their own cultures. Despite some very different scores in both countries, individuals from each are likely to judge the other as though his or her own country represents the norm. Each will take “the way we do things at home” as a starting point. The American may find irritat- ing Mexicans’ emphasis on social activity, the slowness of

GLOBE D IMENSION

UNITED

STATES MEXICO

WORLD

AVERAGE

Assertiveness 4.36 3.67 3.82

Institutional Collectivism 4.20 4.77 4.73

In-Group Collectivism 5.79 5.78 5.66

Future Orientation 5.35 5.74 5.49

Gender Egalitarianism 5.03 4.57 4.51

Humane Orientation 5.51 5.10 5.42

Performance Orientation 6.14 6.00 5.94

Power Distance 2.88 2.75 2.75

Uncertainty Avoidance 3.99 5.18 4.62

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Cultural Knowledge 41

their consultative decision making, their comfort with status differences between men and women, and their discomfort with any sort of ambiguity or with taking decisive action on their own initiative. For their part, the Mexican might see Americans as being self-centered, aggressive, and single- mindedly focused on performance.

The first step to cultural flexibility is to understand your own culture and how it affects your interpretation of the behavior of others. This is an important part — though far from the only part — of the cultural makeup and stereotyping that you most likely bring to each new cross-cultural situation you face. We have already suggested that you locate your own culture in terms of the Schwartz map or the GLOBE clusters. Think about your culture again in terms of all its special features and idiosyncrasies. Try to look at it through the eyes of people from contrasting cultures.

Summary

This chapter describes how knowledge of what culture is and how it varies and affects behavior is the first stage of develop- ing cultural intelligence. Culture is not a random assortment of customs and behaviors. It is the values, attitudes, and assumptions about behavior that are shared by people in specific groups. It is systematic and organized and has devel- oped over time as a result of societies learning to deal with their common problems. Cultures can be defined according to their values — the fundamental beliefs that people within the culture share about how things should be and how one should behave. Culture is shared; it is passed on from one generation to the next. While it has a profound influence on behavior, the most important aspects of culture are invisible. A key feature of culture is that it categorizes others and us into in-groups and out-groups. This categorization of people into “them and us” underlies much cross-cultural behavior. There are several important dimensions along which cultures

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42 c u l t u r a l i n t e l l i g e n c e

can be defined, the most important being individualism and collectivism. By understanding our own culture we can then make initial comparisons with others to understand areas of possible agreement or disagreement. The knowledge gained in this way is a necessary first step to becoming culturally intel- ligent. In subsequent chapters we link this knowledge with the important elements of mindfulness and cross-cultural skills.

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Denver Museum of Nature & Science.pdf

9-315-081

R E V : O C T O B E R 5 , 2 0 1 6

Senior Lecturer Jill Avery and independent researcher Jim Rosenberg (National Arts Strategies) prepared this case. It was reviewed and approved before publication by a company designate. Funding for the development of this case was provided by Harvard Business School and not by the company. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2015, 2016 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545- 7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

J I L L A V E R Y

J I M R O S E N B E R G

Denver Museum of Nature & Science

As Bridget Coughlin, Vice President of Strategic Partnerships and Programs, strolled through the new wing of the Denver Museum of Nature & Science (DMNS), she was thrilled to see it brimming with energy and activity. It was school vacation week, one of the busiest weeks of the year, and the museum was packed with schoolchildren and their parents. They spilled out from the galleries and classrooms into the hallways, chattering happily with each other.

Digital was on Coughlin’s mind these days. DMNS had been dabbling in digital for the past few years, but had never fully committed to it. The time had come to establish a strategic vision, and to decide whether to designate serious human and financial resources. She lamented, “I know we need to commit one way or the other because right now we’re spread so thin that it’s not meaningful. Right now, digital is an institutional distraction and a financial distraction.” It was time to make some decisions about the DMNS’s digital future. How big a role digital should play at DMNS, if any, was unclear to Coughlin:

Whenever I ask the “Why digital?” question, people think it is heretical. I have never received a satisfying answer to it, other than “it’s the new way people live their lives; every industry is going digital.” That reply is for lemmings. Maybe digital is not the business we should be in. Maybe our core competency is based in the physical experience. Maybe not going digital is the blue ocean strategy. It scares me to say that. But if everyone else rushes into digital, then there is this big void, this blue ocean that recognizes the value of face-to-face interaction in the saturated world of digital.

The digital discussion was taking place within a larger strategic conversation about the primacy of the onsite experience of the museum and the need to get outside of its walls to reach new constituents. Coughlin had to decide how to allocate the human and financial resources of the organization to ensure that the museum was financially sound and sustainable for generations to come. How should she balance on-site, off-site, and online programming to maximize attendance and deliver against the museum’s mission? Was digital the magic pill that would allow the museum to reach new audiences? Or was DMNS better off delivering a face-to-face museum experience within its own four walls or out on the streets of the Denver community? What did the Denver community want from a museum experience?

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315-081 Denver Museum of Nature & Science

Inspiring Curiosity and Exciting Minds through Scientific Discovery

In the late 1800s, Edwin Carter, a Colorado naturalist, began amassing a collection of objects that documented the animals and natural history of the Rocky Mountains. His log cabin home, nestled in the mountains west of Denver in a small town called Breckenridge, became known as the home of the Carter Museum. Its mission sprung from its founder’s commitment to public education. To Carter, an enlightened public was critical to preserving the world’s natural wonders. The founders of the museum believed that knowledge was power and that education about the natural world should be available to all, not just to a select few. Over 100 years later, the museum’s stated mission remained true to this ideal: “To inspire curiosity and excite minds of all ages through scientific discovery and the presentation and preservation of the world’s unique treasures.” The museum saw itself as a catalyst for igniting the public’s passion for nature and science. It strove to create an empowered community that loved, understood, and protected the natural world, and which was equipped to think critically about the lessons of the past and act as responsible stewards of the future.

By 1908, the growing collection instigated a move to a new building within the confines of Denver’s City Park. At the opening of the new building, John F. Campion, one of the museum’s founders and the donor of an esteemed collection of crystallized gold, proclaimed that “a museum of natural history is never finished,” and the DMNS team took that to heart. Over the years, the museum expanded to make room for a planetarium, IMAX theater, classroom spaces, and additional galleries. In 2014, the museum opened the $56.6 million Morgridge Family Exploration Center, a three-level education and collections facility that included a Discovery Zone for young children, temporary exhibition galleries, classroom spaces, and the Rocky Mountain Collections Center, an underground storage facility for the museum’s specimens that was the size of two football fields.

The museum was a dynamic place, with new objects entering the collection in a constant flow. One of the most exciting developments in the recent past was the discovery and excavation of 32,000 Ice Age fossils, including the bones of mammoths, mastodons, ground sloths, and giant bison. The objects were discovered in 2010 by a bulldozer operator who was digging in the area of Ziegler Reservoir to make room for further development of Snowmass Village, a Colorado mountain resort. DMNS staff conducted an enormous fossil excavation of the surrounding area over the next 10 months, while PBS/NOVA and National Geographic Television produced an episode dedicated to the effort.

By 2014, DMNS housed and cared for 1.5 million objects and enjoyed a reputation as one of the world’s leading natural history and science museums (see Exhibit 1). In its halls, one could find a profusion of objects and experiences related to all of the branches of science, including exhibitions on gems and minerals, dinosaur excavations, insects and butterflies, natural wildlife, North American Indian culture, space exploration, human biology, and Egyptian mummies. It showcased some of the world’s greatest natural treasures, delved into the lives of legendary historical figures, and brought science, nature, and human culture to life for millions in the Rocky Mountain region. The museum’s permanent collection was augmented by periodic special exhibitions that helped drive attendance.

Much of the museum’s success could be attributed to its funding model, which relied on private donations, volunteer labor, and public funding from the Denver Scientific & Cultural Facilities District (SCFD) to supplement its operating revenues and offset its costs. To spur the cultural development of Denver in an effort to make the city a more desirable place to live, legislators established a special district containing seven counties in the surrounding metropolitan area. For every $10 consumers spent on purchases in the special district, one penny was donated to more than 300 of Denver’s scientific and cultural organizations, accounting for $40 million in annual support.

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Denver Museum of Nature & Science 315-081

This provided a stable source of funding for all of Denver’s major museums, including the DMNS. Over 1,750 volunteers donated their time to work in the museum, accounting for over 210,000 hours of service, the equivalent of about 100 full-time employees. Private donations came from a wide family of supporters; in 2012, the youngest donor was four and the oldest was 110. (Exhibit 2 contains DMNS’s financial and operating statistics and Exhibit 3 shows revenue trends over time.)

Visitor Science Attendance had been relatively constant over the past several years; in 2013, 1.35 million visitors

came to DMNS (see Exhibits 4, 5, and 6 for visitor statistics). Attendance was driven by school field trips, special exhibitions, and community free days sponsored by the SCFD. Over 315,000 children and teens visited in 2013, with 85% of them coming for free or at a reduced cost. The museum offered free admission to all pre-K to grade 12 school groups and youth groups. Two special exhibitions, Mammoths and Mastodons: Titans of the Ice Age and MythBusters: The Explosive Exhibition, drew 258,000 visitors. Twelve community free days brought in 94,470 visitors, contributing to a 5% increase in Hispanic visitors. Overall, 34% of the 2013 visitors came for free.

The museum encouraged frequent visitors to purchase a membership. Memberships started at $55 for an individual and $90 for a family, so a membership generally paid for itself within two visits, making it an attractive value. (Exhibit 7 provides details about the museum’s admission pricing structure.) In 2013, the museum had 61,500 member households, up from 49,532 in 2005. But, as Coughlin explained, the museum was not keeping up: “We’ve been between 60,000 and 65,000 member households for many years, but at the same time, the population of the Denver metro area grows 4%–7% each year. We’re losing market share because we are losing relevancy.”

Denver was home to a host of growing technology and telecommunications businesses and was rated by Forbes magazine as one of the best places in the U.S. for business and careers. This was driving population growth, which was up 8% since 2000. Many Denver area residents were transplants, moving to the city from other places. Denver’s demographic profile was shifting rapidly and the city was becoming more multicultural: 52% of the population identified as white, 10% as black, and 32% as Hispanic. This increasingly posed a problem for DMNS, as many visits were initiated by nostalgic parents who had visited when they were children. New Coloradans were underrepresented in attendance because they didn’t have this emotional connection to DMNS.

DMNS segmented its visitors based on demographics, such as age and gender, or on behavioral characteristics, such as first-time visitors and repeat visitors. Visitors valued different things (see Exhibit 8). Non-visitors perceived significant barriers, including the cost of attendance and limited hours of the museum. However, research showed that people who were visiting the museum did not perceive cost or hours to be a significant barrier.

DMNS faced significant competition for visitors’ leisure time. Denver, located at the base of the Rocky Mountains, boasted a healthy, active population drawn to the area by its natural beauty, and offered countless opportunities for outdoor sports and adventures. A thriving nightlife, abundant microbreweries, and four professional sports teams provided other entertainment opportunities. DMNS’s frequent visitors, infrequent visitors, and non-visitors all cited outdoor activities as their top leisure activity, at a rate three times higher than any other activity. However, museums and cultural institutions were also popular leisure activities for all groups (see Exhibit 9 for the top five leisure activities).

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Even within the museum space, Denver residents had lots of choices. The Denver Zoo attracted over 2 million visitors per year, the Denver Children’s Museum was growing rapidly and served over 300,000 visitors, and many other museums, including the Denver Botanic Gardens and History Colorado Center, served up similar content and experiences to those found at DMNS. Dave Allison, DMNS’s Onsite Programs Manager, commented on the competition:

Museums are more and more being seen as one option among many different leisure time options. So the challenge is to make sure that whatever we have is such a high quality and matches or exceeds other options on pure entertainment value. If not, they are going to go somewhere else, they are going to do something else that’s more entertaining, that’s more fun. So it is incumbent on museums to make sure that what we have is so compelling, so fun, that when people are here, they have a great time.

DMNS had recently adopted a visitor segmentation approach that focused on the differential identity motivations of visitors, adopted from the work of John Falk, founder of the Institute for Learning Innovation. Falk’s work identified five different segments of museum visitors:

• Explorers are curiosity driven, with a generic interest in the content of the museum. They expect to find something that will grab their attention, fuel their learning, and inspire them to investigate.

• Facilitators’ visits are socially motivated, focused primarily on enabling the experiences and learning of others in their accompanying social or family group.

• Professional/Hobbyists feel a close tie between museum content and their vocation or hobby. Visits are typically motivated by a desire to satisfy a content-related objective.

• Experience Seekers perceive the museum as an important, “must see” destination. Their satisfaction primarily derives from having “been there and done that.”

• Rechargers seek a contemplative, spiritual, and/or restorative experience within their visit. They see the museum as a refuge.

In 2010, DMNS conducted a pilot study to ascertain how the DMNS audience mapped onto these customer segments. They found that 20% of visitors were Explorers, 36% were Facilitators, 11% were Professional/Hobbyists, 15% were Experience Seekers, and 4% were Rechargers. The remaining 14% didn’t fit neatly into any motivational segmentation. Kathleen Tinsworth, Director of Visitor Research and Program Evaluation, believed that this new way of segmenting the audience was powerful:

Motivations underlying visitation are expected to influence key outcomes, such as how visitors interact with the setting, satisfaction levels with programs and exhibitions, interest in returning, and importantly, how visitors make meaning of their Museum experience. Understanding motivation types allows DMNS to provide more customized, engaging, and ultimately satisfying experiences for visitors now and as we grow.

O2: Moving Outside the Museum’s Walls

Coughlin had recently launched a new initiative that combined the museum’s off-site activities with its online activities, which she dubbed O2 (Offsite and Online), a play on the chemical symbol for oxygen. This group was charged with exploring whether and how to deliver the experience of the

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museum outside of the building in an effort to build a more diverse constituency. Coughlin explained the challenge:

Do we have to be space-based? These four walls are brick and mortar, but can we deliver the museum experience virtually or in other physical locations? Our two strategic objectives are to see more people and to see a bigger swath of the community so that our museum represents the diversity of the community. How can we use off-site and online to help us achieve these objectives?

To launch the O2 effort, Coughlin reoriented the organizational structure, bringing together three diverse customer-facing groups: museum educators, museum enactors, and technology specialists. The idea behind the reorganization was to infuse the strengths of each group across all three to enhance how the museum related to all of its customers. The museum educators were classroom teachers who were excellent at forging strong and deep human connections through extended face- to-face interactions with their students. The museum enactors were professional actors who were excellent at engaging and exciting crowds through their dramatic enactments in the galleries, which often lasted only minutes. The technology specialists understood how to use technology to communicate and engage with audiences online. Bringing the groups together allowed the museum to brainstorm how to bring more drama and technology into the physical classrooms of the museum, as well as how to forge strong, deep connections with people outside the classroom, either online or in more fleeting interactions.

Much of the group’s activity had focused on building relationships in the various communities represented in the Denver area. Allison explained:

Our primary driver has traditionally been reaching underserved audiences, trying to go to places where audiences that don’t come to the museum are, so that we can make connections with the community. Part of it is building relationships and part of it is being a constant presence at festivals. We set up a booth, participate in parades, etc. It’s about showing up and being there, being a part of that community and showing that we really care about what they care about. That’s something we can’t necessarily do in our own building.

However, the O2 group had limited resources, according to Coughlin: “There is a trade-off in O2— do we do more digital or do we do more out of the museum events, things like Cinco de Mayo festivals, Black Arts film festivals, and other community events?” The organization could handle only so much. Coughlin wondered how to best combine O2 strategy with the visitor segmentation data. Which visitors were well served by the physical museum and which might benefit from off-site and online activity?

Digital Experimentation

Social Media Marketing

DMNS had been experimenting with digital efforts across the organization. One of the most promising areas was the use of social media for marketing upcoming special exhibitions. Tara Hubner, the museum’s Digital Marketing Manager, struggled to execute digital programming with a limited budget. “We don’t really have a huge blowout social media campaign; instead, we have a lot of smaller things happening along the way to hopefully keep people’s interest up and keep the awareness there for the six months that a special exhibition is here,” she noted. Hubner had

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successfully leveraged social media to generate buzz about previous exhibitions, using innovative programming to capture the public’s attention, and was lucky enough to have captured the attention of one of the world’s leading advertising agencies, Carmichael Lynch, who offered her its pro bono services to produce some groundbreaking social media campaigns. Some of the programs included:

• A Twitter account for Pliny the Elder (@Elder_Pliny), a historical figure who provided one of the few firsthand accounts of the eruption of the volcano Mount Vesuvius that buried the city of Pompeii, to promote a special exhibition about Pompeii. More than 6,000 followers followed 24 hours of “live” Tweets as he reported from the scene, and traced his journey to Pompeii on an interactive Google Earth map.

• The “Talk to a Plant” experiment was used to promote the MythBusters exhibition. This experiment tested the accuracy of the myth that plants that are spoken to grow better. Two identical plants were chosen. One was put into an isolation room, while the other was set up in a room with speakers. The speakers were connected to a Twitter hashtag. When people tweeted a message using the hashtag, a computerized voice would read their tweet to the plant. A website tracked both plants’ statistics.

• The “Tweetaconda” campaign was used to promote an exhibition about reptiles, which sent people to a website that featured a digital snake. The length of the snake was determined by social media users; it grew a little bit with each tweet, revealing snake factoids along the way. The goal was to create the world’s longest snake, outpacing the current record holder of 32.75 feet found in Indonesia.

Although the social media campaigns garnered a lot of press and many won social media awards, their results were mixed, according to Hubner:

Pliny the Elder was hugely successful from a public relations standpoint; the number of press clips we had was great. It wasn’t necessarily so successful in terms of exhibition ticket sales. It definitely worked in terms of awareness, though. We soon started getting emails from teachers asking if we could keep it live; they were using it as a teaching tool, which was an unanticipated side effect for us. It had a much larger educational reach than we intended. We thought it was just going to be a marketing tool.

Pliny gained 6,000 followers in less than 24 hours, which for us was a big deal; we are not Kim Kardashian or anything. But it would have been nice if it was actually the museum itself getting those followers. Unfortunately, when Pliny died, all of those followers kind of died with him. I wish we could have kept those folks and engaged with them in another way. It was kind of like, “Oh dang, 6,000 people are gone.”

The price of social media campaigns was increasing. “It used to be that you could pull it off pretty cheaply, but not anymore. And you still have to do all of the traditional print and radio advertising you’ve always done. You have to be everywhere all of the time, and there is just not any more money to do that with,” proclaimed Hubner.

Hubner also struggled to find the appropriate balance between a centralized social media presence for DMNS and individual curators’ and departments’ desires to build their own social media following. It seemed to Hubner like everyone at the museum wanted to be in social media:

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It is hard to explain to people, “No, you can’t have your own Facebook page just for zoology bug people.” How far is too far? How segmented do we want to get, and when do those segments make sense and when do they not make sense? Everyone in research and collections wants to get into social media, but they get really caught up in the tactics, and they are not really thinking about what it is that they are trying to achieve. I try to get them to figure out what their goals are and who they want to talk to first, before they just start doing tactics.

Digital in the Galleries

Digital screens populated every gallery in two permanent exhibitions. In the Mayan exhibition, videos with archaeologists and linguists were intercut with images of digs and cultural artifacts. Visitors could use interactive activities to calculate their age using Mayan math or create their own Mayan name. In a digital archaeology dig, visitors could uncover their own artifacts.

The Expedition Health exhibition allowed visitors to use technology to observe and analyze their own physical health, creating a personal profile that measured their target and resting heart rates, height, arm span, stride length, and energy score as they engaged with several interactive exhibits. The technology allowed visitors to see their pupils dilate in response to light, to see themselves age, and to simulate the physical effects of oxygen deprivation from hiking at a high altitude.

Coughlin explained, “In Expedition Health, we really wanted to use the technology in a fanciful way, not in a technical way, so that the technology really just enables play. We wanted there to be physical specimen collections in that exhibit combined with technology, but the technology is really exploratory and very playful.”

While she was proud of the technology in the exhibitions, Coughlin worried that it might be compromising the museum experience. As she strolled through the special exhibition Maya: The Hidden Worlds Revealed, she noticed the flurry of activity around the exhibition’s digital programming elements. Visitors were sitting in front of screens, watching videos of curators and scientists on location in Mexico and playing with interactive video games and activities that brought aspects of the exhibition to life. While these activities seemed to be engaging visitors, Coughlin couldn’t help but notice that the archaeological objects from the collection were getting short shrift as visitors pushed past them to get to the next screen. As an adjunct curator and a scientist with a PhD in biochemistry, she felt a twinge of uneasiness as she saw the collection of objects so carefully curated by seasoned experts playing second fiddle to digital experiences. She also worried that technology might interfere with the museum’s educational and social experience:

Museums are highly social. No one comes alone. Recently, I was talking to the staff at another science museum. Samsung provided them with free tablets and they created incredibly rich tablet experiences to tie in with their exhibitions. But they are shocked that no one is taking the tablets out. I am not shocked at all. It makes people look down and not around them and not have the use of their hands. It’s unacceptable from a social interaction standpoint . . . You are taking away one of the key drivers for coming, which was to socialize with the people they came with. Technology is hijacking the experience and not yet really augmenting it . . . When they are on their screens, they’re not talking to each other, they’re looking down so you see the top of their head, not their face.

The reason parents take their kids here instead of to see a Colorado Avalanche hockey game or to go to Six Flags amusement park is because they feel like they are giving their child an educational and cognitive advantage, that they are going to be

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smarter if they come here. Parents don’t see screens as educational . . . a screen is a euphemism for entertainment and not for education . . . . Screens are seen as anti- learning, at least by some adults.

Hubner continued:

We want to get more involved with technology, but we’ve seen a lot of resistance from people; they don’t want their kids coming to a museum to look down at a screen. They want them to be experiencing the museum and the exhibits. So, how do you incorporate technology in a way that doesn’t affect people’s sensitivities about kids being too connected? People are sensitive about screen time; they don’t want their kids’ eyes on a screen all of the time. At the same time, screens can be strong educational tools, so that’s an interesting challenge.

The education team had been experimenting with iPad applications for teachers to use while leading school groups. The Animal Adaptations app brought school children along on a tour guided by their own digital superhero, an animal with a unique evolutionary adaptation. The app also guided students through activities and challenges in each gallery. The initial testing had gone well and the team was wondering whether to roll out the app for use with the general public. Allison touted the social nature of the app, which made it ideal for visiting families: “This iPad app is meant to be a communal or shared experience. We know that families are our biggest audience and so it’s a really important thing to have a shared family experience where people can work together on something.” Still, developing iPad apps proved expensive and needed a budget commitment.

Digital Engagement

DMNS strove to deliver its extensive collection of objects to a virtual audience by offering 700,000 images of its specimens online in its Image Archives. Its goal was to photographically document every object in its collection and make all of them available to the public for free online.

Social media played a crucial role in building engagement with the museum’s many fans. On Facebook, DMNS had 43,000 likes, stemming from a fan base built mostly through contests that enabled visitors to receive discounts or prizes for liking DMNS. Sixteen thousand people followed DMNS’s Twitter feed, 196 subscribed to its YouTube channel, and many pinned or posted photos of DMNS to Pinterest and Flickr. Hubner explained:

The majority of our fan base is made up of people who know us and love us already. They are our biggest source of digital word of mouth. They are the ones that are spreading the cool things that we have to offer to their family and friends. They are museum geeks for sure, and they are geeks for this museum in particular.

The museum’s social media sites provided virtual meeting spaces and information exchanges for people who were into science. DMNS’s comment policy outlined its mission for these sites:

Science—we dig it—and we’re guessing that since you’re here, you do too. We’re also guessing that you’ve got lots of questions . . . It’s questions like these that caused us to create the Denver Museum of Nature & Science social media networks and blog. We’d like to start a conversation with you—a conversation about science that’s easy and available to anyone who’s ever asked the question, “Why?” It’s a conversation that’s already begun in some cases—visitors talking with docents, students talking with teachers, or people just talking with one another while walking around in the exhibit

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halls. Our goal is to extend those chats onto the Web, so that even more people can be included in the discussion, and even more knowledge can be gathered and gained. The main thing is we want to hear from you . . . All we need from you is what you think, what you know, and what you dig about science. In other words, we’re glad you’re here. Now the conversation can really get started. Welcome, and happy posting!

However, most of the content on DMNS’s social media sites had been authored and submitted by museum staff or volunteers. The museum’s blog featured 316 articles, most with no comments from readers. An interactive conversation appeared to be difficult to get started.

Return on investment on online content was a significant hurdle, given the high cost of producing high-quality content in keeping with the museum’s image. Coughlin wondered whether co-creation or co-curation of content might provide a solution:

Maybe our role as curators and as scientists is evolving to sous-chef. We can provide all of the right ingredients, we provide the raw data, we frame the questions, we pose the problems based on known assumptions, and then we step away from the kitchen. And, God knows what people are going to make with that, but we know that these ingredients taste good together.

Yet the DMNS culture was not quite ready to hand over the reins for content production to the public and encourage the co-curation of its online science information. Explained Coughlin:

Curator means guard, and you’re guarding and controlling the stuff and the story of the stuff. By allowing people to co-create the narrative of the stuff, you’re taking away 50% of the job of a curator. That takes a big mind shift for someone to say to our curators, “OK, half of the definition of your professional life goes away.”

Still, according to Coughlin, audience co-creation was happening whether curators liked it or not:

Whether or not the curators or the content experts or the educators want to relinquish control, it has already been relinquished. I will always remember the lecture I gave when someone just whipped out their phone and fact checked me. Or the times when someone asks a question and you answer that you’re not sure, and then 45 seconds later someone says, “I’ve got the answer,” and then they read from their device.

Distance Learning

Distance learning infused with digital at DMNS began with Scientists in Action (SIA), a program that used two-way videoconferencing technology to connect scientists working in labs, in the field, or in the museum with students in schools around the country. Students had the opportunity to speak live with the scientists and ask them a variety of questions. SIA was broadcast to thousands of students across the U.S. on a monthly basis. Its success encouraged the museum to offer eight virtual classes that could be broadcast directly to classrooms. For example, in the Virtual Heart class, students had the opportunity to explore heart anatomy as they observed a sheep heart dissection. A DMNS educator, Mark Widdifield, proclaimed, “Through the museum’s distance learning we have the opportunity to spread the love of science, scientific thinking, and our scientist’s research around the world. It’s a mechanism to take the best regional museum to people across the country.”1

These online classes were beginning to take the place of physical visits to schools by museum educators, who previously would come to classrooms equipped with a rolling duffle bag of materials from the collection. As the team moved further into digital, Allison wondered whether digital

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interactions could supplant physical visits: “What can distance learning enabled by technology do differently or even better than if we were to be physically there?” With distance learning, DMNS could now serve schools across the U.S., eliminating geography as a limiting factor.

For a time, DMNS also produced Science Bytes! a two- to three-minute video series that explained the how and why behind current news in science. This moved distance learning out of the classroom and targeted it toward all people interested in science. Offering great content, the series was popular with viewers, but cost a lot to produce, and was canceled due to a lack of funding after museum managers struggled to provide a strategic rationale for its existence. Coughlin noted:

One of the problems with digital is it’s not as traceable or auditable. You can say that lots of people downloaded it, so that it met a need, but to get large gifts and grants, I’m going to need to show that it reached a specific group. When we do human-facilitated education, we know exactly who is coming to use it and can track it. With technology- facilitated education, we know how many people downloaded it, but we don’t really know who they are and how they used it. In a classic philanthropy environment, that is not sufficient to underwrite it through contributed income. So it has to be self-sustaining from an earned income point of view.

Science Bytes! struggled from a lack of interactivity, as DMNS did not allow comment boards to accompany the videos, shutting down two-way communication opportunities. Explained Coughlin:

The fear was that people would post inaccurate things, inappropriate things. For example, on the Earth Science one, we were worried about people who don’t believe in the age of the earth, and we were not confident that there would be enough people who would deflate their arguments and invalidate the crazy comments that would appear. We were afraid of exposing ourselves to inappropriate or inaccurate content, and we didn’t want to put the resources behind policing it. We were uncomfortable giving control away and saying that the community would police it for us. We were insecure.

She cited the example of the online series Brain Scoops, which featured scientist and museum educator, Emily Graslie. Coughlin lamented:

She is a collections manager at the Chicago Field Museum. She has a huge following. She started making these videos about cool stuff behind the scenes. And they have very high production value, they are very funny, they are very, very tongue in cheek. And she is young and attractive and smart as gunk and clever. Sure enough, there was a community that started posting things like “I would totally date her” and then some more inappropriate things. The crazies really hijacked the conversation.

A Strategic Plan for Digital

The key to answering the digital question lay in developing a strategic plan for digital at DMNS, something that was currently lacking, according to Coughlin:

A lot of museums have a technology plan, but it is a plan for plan’s sake. It’s not designed to enable any strategic objectives . . . What we do now at DMNS is an illusion. We do a little here and a little there; it is like the buffet version of experimenting with technology. I think to really make an impact, we need to go from the buffet of digital experimentation to a full menu—commit to one thing in particular and go much deeper.

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Although the museum had experienced some success, going digital appeared to raise more questions than it answered. Digital programs were often perceived as “nice-to-haves,” but because it was often impossible to prove their return on investment, it was difficult to find funding for them in the budget-constrained environment of a nonprofit organization like DMNS. Was digital expendable? Or was digital actually a “must-have”? Should Coughlin divert funding from other programs to fund digital efforts?

On the one hand, many within the museum felt that digital was critical to the museum’s future viability. DMNS CEO George Sparks proclaimed:

Museums, institutions and businesses are all under the threat of becoming irrelevant . . . museumgoers of the future—drawn from an increasingly ethnically and racially diverse community—will expect interactive and experiential learning opportunities. Younger generations, the so-called “children of the screen,” will expect information to be provided digitally, so smartphones will someday become a fundamental part of the museum experience.2

Allison continued:

Tech is definitely something people expect when they come to museums or any other kind of attraction or entertainment venue. They want to have the option to enter into the experience in a multiplicity of ways. The first, the traditional way, is talking with a volunteer or staff member and having a mediated experience that way. The second is reading or looking at things and physically interacting with objects in the collection. I think that the other primary way is through technology, which can deliver a very self- directed experience where you can enter into it at whatever place you feel comfortable with and then dive into whatever level you want.

Coughlin worried that not going digital would reflect poorly on the museum’s brand image: “There might be some perceived value in going digital. If we don’t have any presence online it might just reinforce the stodgy museum brand, even though, ironically, only a fraction of people will actually use the online content. There’s cachet from being in the digital space.”

On the other hand, digital was hard to track and DMNS’s internal and external metrics were not set up to measure its success. Externally, “the SCFD funding totally disincentivizes us to do anything O2 off-line or off-site because this activity doesn’t count in the SCFD’s audited count of audiences,” explained Coughlin. DMNS and its sister organizations throughout Denver were working to create new audience measurement systems to include online activity in audience counts and to convince the SCFD to include them. But the conversations were proving difficult, according to Coughlin:

The problem with reporting on online activity in your attendance figures is that there is no consensus on how to count it. Is it unique visits, completed online visits, significant online engagement? I find we have these perverse conversations when it comes to the online experience about what is meaningful and rich. We don’t have the same perverse conversation about our physical visitors—did they stay for 30 minutes or two hours, did they see only one exhibit or three? The digital is under greater scrutiny, there is a bigger spotlight on the quality of the experience. Whereas if you physically come, we assume that you have a quality experience and there is no threshold you have to achieve.

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Coughlin was wary of using digital to drive physical attendance to the museum. The physical plant of the museum constrained how many people the organization could serve. The museum was feeling the effects of its rapid growth. Coughlin explained:

We say we want to drive attendance and at the same time we say we have a parking lot problem, we have a capacity problem, people are complaining because it’s really busy. We have two conflicting objectives, because we say we need to drive attendance, but what we are really saying is that we want to drive attendance during slow times—in September and on Monday mornings. We don’t have an attendance problem; we have a peak load problem.

Coughlin worried that building out the museum’s digital presence might exacerbate the DMNS’s physical space problems: “Until we build a big expansion and figure out our physical capacity issues, we actually don’t want digital users to physically come to our space. And if that’s the case, you are setting up two separate groups of users—the physical users and the digital users. We want some cross-pollination, but if we do a good job enticing digital users to come to the museum, we’ll compound our physical problems.”

Coughlin also was concerned that the DMNS did not have the resources and competencies to compete well in the digital space. While she felt confident the museum could produce online content, she had less conviction that they could make money from it.

The conundrum is the following: The virtual space is highly competitive. There are lots of discussions of ”boy, we could make a 99-cent app, or we could do games online . . .” But once you start to try to digitize content and produce value online, you quickly realize that there is a glut of good content online and it is particularly hard to monetize. How do we as newcomers without big budgets do something that is so incredible that we could actually monetize it so that people would pay for it when there is a wealth of free information already out there?

Coughlin wondered if digital could bring the diverse community of DMNS members together to establish a more meaningful connection to the museum and to each other. Membership today was more of an economic transaction—members joined just to buy a season pass and save money when they came to the museum. Coughlin wondered if it could be more of a relationship.

Research showed that building a community wouldn’t be easy, given the heterogeneity of DMNS’s fan base. Hubner explained: “One of the challenges is that our audience is made up of a lot of smaller niches. We’ve got people who are into bugs, people who are into dinosaurs, people who are into space. It is hard to figure out a way to get them all together and find something that is interesting to everybody. How far do you go before you start segmenting your brand so much that everything is diluted?”

Do Social Deal Sites Really Work.pdf

HBR.ORG May 2012 reprinT r1205X

HBR Case study

Do Social Deal Sites Really Work? a theme park operator considers whether the boost in ticket sales is worth the trouble. by Marco Bertini, Luc Wathieu, Betsy Page Sigman, and Michael I. Norton

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http://hbr.org

http://hbr.org/search/R1205X

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Case Study

The sales reps from DailyDilly had just finished their rollicking video presentation, and the laughter in

the meeting room was starting to subside. Ruth Davison, the marketing director of Flanagan Theme Parks, was still smiling when she finally spoke. “I’m thoroughly impressed,” she said. “This would give us the marketing capabilities we’ve always wanted.”

Will Eastman, Flanagan’s operations director, was beaming. He had suggested doing the promotion with DailyDilly, a fast-growing Australian social-couponing company similar to Groupon and Living- Social. “Then I think we’re ready to make a decision,” he said.

Everyone looked at Allie James, a consultant decades younger than Will and Ruth. Allie had been working with Flanagan for just over a month. She knew she had to kill the DailyDilly initiative but was reluctant to do it with the reps present.

“Let’s discuss this off-line,” she said. Will slapped the table. “Come on,” he

demanded. “We’re here now.” The Daily- Dilly reps became wide-eyed.

Allie took a deep breath. If Will was go- ing to push her, she’d be blunt. “No, then,” Allie said. “It’s not on.”

Will pushed his chair back and walked out of the room. The reps started to review their presentation, but Allie stopped them with a wave of her hand. Ruth, no longer smiling, told them all she was sorry and stood up to escort everyone out.

Allie knew she had just made some enemies.

Half an hour later, Ruth stopped her in the corridor. “So you’re still not convinced?”

“Roddy asked me to weigh in on Daily- Dilly for a reason,” Allie said. Roddy Bren- nan, Flanagan’s managing director, had retained her from Gold Coast Partners, one of Australia’s top management-consulting firms, with a mandate to improve the

Do Social Deal Sites really Work?

A theme park operator considers whether the boost in ticket sales is worth the trouble. by Marco Bertini, Luc Wathieu, Betsy Page Sigman, and Michael I. Norton

HBR’s fictionalized case studies present dilemmas faced by leaders in real compa-

nies and offer solutions from experts. This one is based on the HBS Case Study “What’s the Deal with LivingSocial?” (case no. 512-065), by Marco Bertini, Luc Wathieu, Betsy Page Sigman, and Michael I. Norton. It is available at hbr.org.

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customer experience at the company’s six theme parks in Australia and New Zealand.

Ruth glared, and Allie had to summon all her strength to muster a defense. She began: “I know everyone’s getting caught up in the group-buying mania. DailyDilly sounds fun, but a promotion like that would hurt the customer experience at the parks and damage your company in the long run.”

“Are you hungry?” Ruth suddenly interrupted.

Allie was startled. “Why?” “I am. Let’s get lunch.” “I brought a sandwich—” Allie said. “Never mind your sandwich,” Ruth said.

“I’ll treat.”

Buckle In Ruth’s was a forceful personality, and Allie soon found herself in the car park. “Buckle in,” Ruth said. Allie felt a little as though she were strapping into Flanagan’s signa- ture zero-gravity ride. What was it called? Ah, yes—the Great White Shark.

She and Roddy had ridden the Great White Shark together a few weeks back, when he was showing her around Mermaid Landing, the company’s flagship park. He had screamed and laughed the whole time, and that tickled Allie. Roddy obviously had the heart of a kid and a real love for his product.

But Flanagan was struggling. The lines were shorter than those at competing parks. The problem wasn’t the rides and attractions—they were state-of-the-art. In Allie’s opinion, customers were being turned off by careless service, crowded conditions at the eateries, poorly managed traffic flow into and out of the parks, and awkward scheduling of shows. Roddy had brought her in to fix all that. “I want customers to leave here raving about it— raving,” he had said.

Allie knew she could make Flanagan better. She had already helped an in- ternational hotel chain turn around its service reputation and improve guest satisfaction—she was becoming her firm’s go-to person for that kind of thing. Allie

was painstakingly attentive to detail and preternaturally decisive, which is exactly what Roddy wanted. “Rule with an iron fist,” he’d told her.

Ruth pulled onto the highway. “I noticed you weren’t laughing during the video this morning,” she said. “Didn’t you think that senior citizen group on our zip line was funny?”

“The video glossed over the pitfalls of daily deals,” Allie replied, knowing she sounded humorless. “There are ample case studies showing that people who buy from sites like DailyDilly are the worst kind of customers: ones with no loyalty. They’re like a flash mob of coupon clippers. They overburden merchants, create shortages, annoy the staff, and erode the experience for other customers.” She paused. “Where are we going, by the way?”

Just then Ruth exited at the sign for Coral Wonderland, another Flanagan park. She pulled up to a service entrance, showed her ID, and parked next to a high wall that separated this area from the one that customers see. “Did you notice the river in this park on your tour?” she asked, lowering her window. Allie nodded. “Well, there’s a little canal down there,” Ruth said, pointing to a glimmer of water under a mass of pipes and machinery. “That’s where the river starts. It runs through the whole park.”

“I remember ducks,” Allie said vaguely. “The ducks love it,” Ruth said. “So do

the mosquitoes. That’s because it doesn’t flow—it’s blocked by all of this.” She mo- tioned to the machinery. “I’m told this may be the biggest plumbing mess in eastern Australia. The circulation system wasn’t built properly, and for years we’ve been patching it up because we don’t have the cash flow to replace it. We can’t budget for this kind of thing because revenues are so unpredictable.” Satisfied that she’d made her point, she restarted the car.

But Allie didn’t get it. “And?” “I’m talking about DailyDilly. Think

about it. If we work with them, our cash flow gets easier to predict—because people pay when the deal is posted, not when

they come through our gates, if they ever do. That’s why Will was upset when you said no. He needs to make operations more predictable. I suppose you could argue that cash flows don’t affect customer experi- ence, but mozzies breeding in our plumb- ing cesspool certainly do.”

One of those mozzies had apparently gotten into the car. Allie slapped it away.

“But how many deals could you do in a year?” she asked. “Three? That’s hardly steady cash.”

50% off Back on the road, Ruth pulled up to a fast- food restaurant.

“Here?” Allie gasped. “Don’t worry, we’re not eating at this

place. I just want to show you something.” Inside, they observed customers getting their orders. “Notice the tray mats?” Ruth said. They all carried an ad for Flanagan Parks—a cartoon image of the Great White Shark, along with a coupon offer.

“This is a typical comarketing effort for us, and it’s typically bland,” Ruth said.

“With comarketing we don’t control our message. We’re limited by our partners’ requirements. We can’t use sophisticated humor or striking images to differentiate ourselves. We spend many thousands of dollars on this junk, and the return is pathetic.” She looked around in disgust.

“We’re done here,” she said. “And DailyDilly would solve the prob-

lem?” Allie asked back in the car. “We would have more control over pric-

ing,” Ruth said. “Right now we’re giving away so many coupons that hardly anyone pays full price to get into a Flanagan theme park.”

“I’d say that’s what’s wrong with DailyDilly, not what’s right about it,” Allie replied. “You saw the discounts the reps mentioned this morning: 50%. It creates the same pricing problem as the coupons. We’d be encouraging customers to wait for the next dirt-cheap deal. And no customer values an experience that’s 50% off!”

Ruth shook her head. “True, we would take a hit for certain customers at certain

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times. And, yes, we’d get only 25% of the ticket price because DailyDilly keeps half of the promotional price. But overall we’d be better able to maintain our list price, given that we’d eliminate all those other coupons. And we’d be targeting our kind of customer: people hungry for a thrill, which is what we sell. Traditional marketing inevitably—invariably—means throw- ing money at people who aren’t really potential customers. With DailyDilly we’d be hitting exactly the right audience—and that’s worth a lot.”

She turned into another parking area. “Here we are,” she said.

“This place?” “It’s a hoot,” Ruth said.

a Long Queue Everything in the restaurant appeared to be in constant motion, like sea grass in the waves. That’s because each table was suspended from the ceiling, and every seat was a swing. Even more surprising was how many of the seats were occupied.

“I’m getting the point that this lunch excursion is a theme-park ride devoted to daily deals,” Allie said. “So what’s the angle here?”

Ruth grinned. “You’re right. The ride is over. This is our final destination. The DailyDilly reps told me that this restaurant just ran a very successful group buy, offering 50%-off lunch coupons. They sold thousands of them. That’s what you’re looking at. Can you think of any other type of marketing initiative that could target so many people predisposed to a quirky expe- rience like this? Forget it. There isn’t one.”

Allie looked around at the dozens of people gently swinging as they talked and ate. The clink of dishes and the buzz of conversation mingled with the creaking of ropes. But Allie knew that if these were DailyDilly customers, they weren’t the good ones every merchant wanted. She’d heard enough from her hotel clients about how badly deal seekers behaved. They were rude, left holes in walls, and, most important, never came back to pay full price.

“Let’s talk to them,” Allie said. “Who, the owners?” “No, the customers.” Picking a table of

four women in their twenties, she asked if they’d bought into the DailyDilly deal, and indeed they had. “So how much are you going to spend beyond the coupon?”

They giggled. “As little as possible,” one said.

“Would you come back and pay full price?” Allie asked.

“Doubt it,” another answered. “Who wants to get seasick while you eat?” More laughter.

Allie turned to Ruth. “Ask any table. I’m sure you’ll get the same answers. Now imagine these people at Mermaid Landing or one of the other parks. Would they pay for photos or buy stuffed animals? Never. They probably wouldn’t even buy food. They’d get sandwiches through some other DailyDilly deal, smuggle them in, and eat lunch on a bench.”

Allie pointed toward the door, where another group of young women had just lined up at the hostess stand—more DailyDilly people, no doubt. “Do you see? They’re queuing up for tables, just as they’d queue up for the Great White, mak- ing the experience that much worse for the good customers, the ones who pay.”

“I just see a lot of eager customers, all acquired very efficiently at a relatively low

cost,” Ruth replied. “If short queues are Flanagan’s goal, we’re already a screaming success. I want to see longer queues. Not so long that people get fed up, but long enough to make them feel they’re waiting for something special—and to make Flana- gan money.

“And if you want to interview a deal seeker, talk to me,” Ruth continued. “I use DailyDilly for all kinds of things, and I do buy more than the coupon value, and I do go back to places I like. I’m one of those

‘good’ customers you’re talking about.” She paused and looked around again. “This could really help Flanagan,” Ruth said.

“That’s why I’m asking you to reconsider your decision.” Reprint Case only R1205X

QShould allie approve the DailyDilly promotion?

Marco Bertini is an assistant professor at London Business School. Luc Wathieu is an

associate professor and Betsy Page sigman is a distinguished teaching professor at george- town university’s McDonough School of Business. Michael I. Norton is an associate professor at Harvard Business School.

“eternal damnation? Do you realize how this will look on my résumé?”

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HATSUNE MIKU- JAPANESE VIRTUAL IDOL IGNITES GLOBAL VALUE CO-CREATION.pdf

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HATSUNE MIKU: JAPANESE VIRTUAL IDOL IGNITES GLOBAL VALUE CO-CREATION Timothy Craig, Philip Sugai and Lukman Aroean wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) [email protected]; www.iveycases.com. Copyright © 2014, Richard Ivey School of Business Foundation Version: 2014-12-18

In March 2014, Hiroyuki Itoh, chief executive officer (CEO) of Crypton Future Media, Inc. (Crypton), looked out his office window at the still snow-covered cityscape of late-afternoon Sapporo and reflected on the journey that had taken him from founder of a music technology start-up in 1995 to creator and “manager” of the world’s best-known virtual idol, Hatsune Miku. Crypton was already a leading company in its core business of music software development and sales when, in August 2007, it released Hatsune Miku, a singing synthesizer application based on Yamaha’s second-generation speech synthesis engine Vocaloid 2. Users of the Hatsune Miku application could create songs by entering the melody and lyrics into the program, after which the songs would be “sung” by Miku, whose picture was featured on the software packaging.

Originally targeting professional music producers, the release of Hatsune Miku set off an unexpected burst of creative activity by amateurs, who produced Hatsune Miku-based music, lyrics, artwork and videos. And the users inspired each other. One user might create a song and post it on a site such as YouTube or Nico Nico Douga. Another would then listen to the song and draw an illustration to accompany it — typically of the Miku character. Another might build on these works by producing a short animated video. The result was a hurricane of creation, re-creation and co-creation that showed no signs of slowing down. Miku had over 110,000 released songs, 170,000 uploaded YouTube videos, 1,000,000 created artworks and nearly two million Facebook “likes.”1 This had made Hatsune Miku a household name in Japan and, increasingly, abroad. A 2013 survey conducted in Tokyo of people between the ages 12 and 39 found that she had a name recognition rate of 95 per cent.2 Overseas, Miku outfits outnumbered those of any other character at cosplay events.3 She had 175,000 followers on Sina Weibo and 270,000 followers on Tencent Weibo, Chinese versions of Twitter.4 In a “The Top Tens” opinion poll that asked “Who is the best singer for the London Olympics Opening Ceremony,” Miku ranked first, ahead of Lady Gaga and Justin Bieber.5 Miku herself, in her live-performance hologram form, was slated to be the opening act for a month of shows in Lady Gaga’s Artpop tour starting in May 2014.6 Miku’s exploding popularity brought with it new business opportunities for the company that created her. As of January 2014, 100,000 copies of the Hatsune Miku software had been sold.7 In addition, Crypton licensed the rights to use Miku’s name and image to publishers, game makers, character goods producers and advertisers. In March 2012, Nomura Research Institute estimated that sales for Hatsune Miku-related

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Page 2 9B14M110 business (not counting software sales) since her release in 2007 totalled 10 billion yen (approximately US$100 million).8 Until this point, Crypton had “gone with the flow.” Aware that it was fan power and the creativity of amateur users of the software that had made Miku who she was, Itoh viewed fans and users as “partners” to consult and work with and not simply as consumers to sell a product to. But as Hatsune Miku had become big business with the potential to grow even bigger, he wondered whether it was time to take a more proactive approach to maximize the revenue-earning potential of his singing star. And if so, what was the best way to do that? WHAT IS HATSUNE MIKU? Hatsune Miku was a piece of software, a Vocaloid (a singing voice synthesizer), a hologram, a 16-year- old female singer, the world’s best-known virtual idol and the sum of hundreds of thousands of songs, illustrations and animated videos that were created by her fans.

Released on August 31, 2007, Hatsune Miku was the third Vocaloid released by Crypton, following Meiko (2004) and Kaito (2006). She was the first to use Yamaha’s Vocaloid 2 speech synthesizer, an improved version of the original Vocaloid engine on which Meiko and Kaito were based. But Miku turned out to be different from her predecessors. She took off, and did so in ways that her creators never expected. Crypton Future Media, Inc. Crypton Future Media was established in 1995 in Sapporo, the largest city in Japan’s northern island of Hokkaido, as a music software company. Founder Hiroyuki Itoh grew up in Hokkaido, listening to new music on the radio — his hometown had no music store. He studied economics at university and created electronic music as a hobby.9

Crypton started out by importing audio products but soon established itself as a leading distributor of sampling CDs and DVDs, sound effect and background music libraries and musical synthesizer applications. The company achieved a 60 per cent share of the Japanese market for sound effects for games, anime and TV shows; a top share in the market for ringtone sounds for cell phones; and a top share overall (16.6 per cent in 2012) in Japan’s market for sound-related software.10

Crypton licensed software to video game companies, musical instrument makers, broadcast media, computer companies, local and national government institutions and educational institutions. It also operated several Japanese mobile websites that distributed sound effects and ringtones.11 In 2014, the company had 70 employees and over 100 business partners in the United States, Europe and other countries around the world.12 Its motto was “Expressing ideas with sound.”13 Yamaha’s “Vocaloid” Voice Synthesizer Application As a developer and seller of musical synthesizer applications, or “virtual instruments,” Itoh had long been intrigued by the idea of a “virtual singing voice.” He explained:

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Page 3 9B14M110

The human voice is an instrument too, right? But a human singing voice is very difficult to synthesize. I knew that if we could make a computer software human voice instrument, it would sell well. Because there’s a big need among music creators for the human singing voice. Just like there was a need for many other kinds of musical sounds, which have sold a lot. But the technology didn’t exist for this.

When Yamaha developed the Vocaloid technology to synthesize the human singing voice, that created the connecting point. We said to Yamaha, “Let’s do a project together,” and the result is our company’s product: software that sings songs, a virtual instrument that synthesizes the human singing voice.

Yamaha’s Vocaloid software allowed users to create songs and have them “sung” by the software by entering the lyrics and melody into the program. Specially recorded vocals of singers or voice actors were used to create the singing. The result of Crypton’s collaboration with Yamaha was the company’s first Vocaloid, Meiko, released in 2004, followed by Kaito in 2006. Both found moderate success, targeting amateur musicians and music producers. The Hatsune Miku Phenomenon and Collaborative Creation In 2007, Yamaha released Vocaloid 2. This was an improved version of the original Vocaloid, with a revamped synthesis engine and user interface and the capability to produce more realistic-sounding vocals. Hatsune Miku was the first Crypton Vocaloid to be based on the Vocaloid 2 engine, so her vocals, which were sampled from Japanese voice actress Saki Fujita, sounded better than the previous Vocaloids. But Hatsune Miku was different in other ways as well, starting with the packaging. Itoh explained:

When we developed our first Vocaloid, this kind of software was new to the world, so we started thinking about how we should package it. You could just make an ordinary package—call it “vocal” or “Hatsune Miku.” But that doesn’t tell the customer what’s inside the box. You would have no idea what this software does. So we decided to give the product the name of a person, and put an illustrated character on the package. The idea was to communicate that “you install this character inside your computer and she sings songs for you.” We weren’t thinking at all about creating an animation character. We develop software and music technology. We have no interest at all in things like anime — we know nothing about it. The only reason we put an illustrated character on the package was to communicate to the people who buy it, in an easy-to-understand way, what the product does.

While Meiko and Kaito also had human names and illustrated characters on the package, character development was taken further with Miku. After deciding on the name — “Hatsune Miku” came from the Japanese words hatsu (first), ne (sound) and miku (future) — Itoh and his team searched the Internet for an illustrator who could create the image they had in mind. Itoh explained, “We didn’t want a childlike, typical Akihabara type character. We wanted something more like a robot, or an android — it’s a Vocaloid. We wanted an illustrator whose drawings feel like ‘technology’ or ‘future.’ We found just such a person, Kei, so we asked him to do it.”

The specs Kei were given were sparse: Miku was to be a 16-year-old girl, dressed like a high school student and some part of her was to have some kind of technology. The latter turned out to be the

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Page 4 9B14M110 computer-like panel on her arm, which was modeled after the legendary Yamaha DX7 synthesizer, widely used by musicians in the 1980s. Itoh said, “I respect Yamaha’s technology so I wanted to put some motif of their technology on our character.”

The Hatsune Miku software was an immediate success. In a software category where a product that sold 1,000 units a year was considered a big hit, 3,500 to 4,000 units of Hatsune Miku were sold in the first two weeks following its release.14 Within three weeks, Hatsune Miku held a 30 per cent share of Japan’s music-related software market.15 Selling at 15,750 yen, Hatsune Miku soon became the number 1 selling software on Amazon Japan. In its first year on the market, 40,000 units were sold.16

What was surprising, though, was who was buying the software and how they were using it. Like Meiko and Kaito, Hatsune Miku was aimed at, and initially marketed to, professional music producers. But it seemed that amateurs and “otaku”17 were buying the software too and using it to experiment, create and share. Songs written by amateur users inspired others to produce illustrations, remixes and 2D and 3D animation. Word of Hatsune Miku spread via social media, and video-sharing websites such as Nico Nico Douga and YouTube became places for collaborative creation. Some creators uploaded unfinished work and asked others for ideas.

Crypton marketing director Wataru Sasaki described what came to be known as the Hatsune Miku phenomenon, and Crypton’s response to it:

It’s spreading among peers through these sites — really, word of mouth. It’s become popular in various countries [in such ways that] there really haven’t been any prior examples . . . . In a way, it’s been a struggle to find out how to best work with such phenomena. We believe that it’s best to get feedback from fans about . . . how best to handle things, how to do what’s best for the fan base. We’re not in a hurry to make money on this.18

Crypton supported the growing popularity of Hatsune Miku and her community of fans and amateur creators in various ways. The company published guidebooks and provided magazine support that showed how to use the software and get the most out of Miku’s vocals. A freeware animation software program, MikuMikuDance, was developed and released (independently, but with Crypton’s cooperation) to enable users to animate and create 3D animation movies. In 2011, Crypton launched MIKUBOOK.com, an English social network site for fans of music videos featuring Vocaloids, where fans can watch, share and talk about Vocaloid videos. As a result of this collaborative creativity and Crypton’s efforts to foster it, hundreds of thousands of Hatsune Miku songs, illustrations and animated videos were created and posted on the Internet. Among the 110,000 original songs that had been written for Miku, some were major hits. In May 2010, a Miku compilation album, “Exit Tunes Presents Vocalogenesis feat. Hatsune Miku,” debuted at number 1 on the Japanese Oricon album charts.19 In May 2011, the Miku song “World is Mine,” by Supercell, hit number 7 in the top 10 world singles rankings on iTunes the first week it was released.20 Supercell was an 11- member Japanese band who, as amateurs, used the Hatsune Miku singing software to produce the vocals for songs they uploaded to Nico Nico Douga. The popularity of “World is Mine” and other Supercell songs led to a contract with Sony Music Direct and the professional release of their first album, titled “Supercell,” in 2009.21

Following up on Hatsune Miku, Crypton developed and released additional Vocaloid characters, Kagamine Rin/Len (December 2007) and Megurine Luka (January 2009), as well as Miku Append and

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Page 5 9B14M110 Rin/Len Append add-ons that provided various colour tones to the voices. See Exhibits 1 and 2 for the Crypton Vocaloid software product lineup and Vocaloid character details. Items and Derivative Characters One active area of secondary creation involved illustrators and animators portraying Miku and other Vocaloid characters holding or wearing particular items. For example, one popular amateur Miku video featured a funny-looking Miku, called “Hachune Miku,” waving a leek while singing the Finnish song “levan Polkka.” Other fans and creators were inspired by this, and more and more illustrations and animations showing Miku holding a leek appeared, until the leek became one of her signature items. Miku could be seen holding one in many derivative works, including the SEGA video game “Project Diva.” Popular items were often licensed for production as character goods.

Similarly, many fans created derivative characters based on existing Crypton Vocaloids. The most popular of these, such as Hachune Miku, were “officially recognized” by Crypton and were featured in related products. Hachune Miku made appearances in the manga series “Hatsune Miku: Unofficial Hatsune Mix” and the Project DIVA video game series and had her own officially licensed merchandise, such as plush toys and key chains.22 Tako Luka (“Octopus” Luka) was a Vocaloid derivative based on Megurine Luka. Tako’s creator, “Sangatsu Youka” (“March 8”), was inspired to create Tako Luka when she realized that Megurine’s hair reminded her of an octopus. Tako Luka also appeared in Project DIVA and in the form of licensed character goods.23 Live Concerts Hatsune Miku also performed “live.” Miku performed eleven official live concerts, most of them sold- out, at various venues in Japan as well as in Singapore, Los Angeles, Taiwan and Hong Kong. On stage, Miku appeared as a hologram — a 3D image projected on a clear screen. Programmers choreographed Miku’s movements for each song so that she strutted and moved like a real-life pop star. In concerts, she was often joined by fellow Vocaloids Kagamine Rin and Len, Megurine Luka, Meiko and Kaito.

An American fan described a Miku concert he attended in Tokyo as “. . . extremely energetic. Despite the fact that Miku is not physically on the stage, the crowd treated her as if she were, as if she were part of the band.”24 That sentiment was echoed by keyboard player Jun Abe, one of the live musicians who backed Miku at her gigs: “As you keep playing for Miku, you start to think you are a band member for a human artist . . . the feeling is very unique.”25

A journalist for Anime News Network wrote that the illusion of Miku on stage was “impressive,” and added: “Even more impressive is that every song on the set list was, obviously, fan-made — not a product churned out by songwriters slaving away in Crypton’s basement, but the creations of genuine musicians expressing themselves through the Vocaloid medium.”26 Itoh explained that putting on a Hatsune Miku concert was not as easy, or as cheap, as many people assumed:

Miku doesn’t exist. She doesn’t eat so much and never gets tired. But she’s computer generated, which means there are costs to generate her image. The rental fee for a hologram projector is around $10,000 per day. In some concerts, we use two projectors, so that’s $20,000. In others, we use four. The more projectors you use, the better the image. Concerts are costly.

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Page 6 9B14M110

Also, fans want concerts to have more music, because Miku now has so many songs. But for each new song we do in a concert we have to program her movements so they fit the music. That takes time.

BEHIND THE HATSUNE MIKU PHENOMENON: CREATING AN ENVIRONMENT FOR COLLABORATIVE CREATION Itoh felt that Hatsune Miku’s success owed a great deal to the collaborative possibilities that the Internet age had brought and to the particular environment that Crypton had set up to help overcome copyright barriers to sharing and building on others’ work. Copyright Issues Rights to the Hatsune Miku software and to Miku’s name and image were clear. Under the Character Vocal Series license that came with Hatsune Miku, the software was considered to be a musical instrument — like any music synthesizer — which produces sound: Miku’s voice. The license stated that the software could be used to create vocals for commercial or non-commercial use and that copyrights to vocals created belonged to the software user. Rights to Hatsune Miku’s name and image belonged to Crypton; Miku’s name and image could not be used for commercial purposes, and Miku-sung vocals could not be commercially distributed without Crypton’s permission.

The problem was how to create a flexible environment for amateurs to do secondary creation. Japanese law strongly protected the rights of creators of intellectual property, including music, lyrics, illustrations and animated videos. Secondary creation — the use of others’ music, lyrics, illustrations and animations to create something new — could be viewed as copyright violation. Itoh found an answer in the Creative Commons license.

The Creative Commons (CC) license was a standardized license similar to the General Public License (GPL), a widely-used free software license that allowed a user to use, study, share and modify a piece of software. The difference was that a CC license was for content, such as music, illustrations and movies. Under a CC license, the content creator kept the copyright but allowed others to use and distribute the work as long as they gave the original creator credit and abided by specified conditions. The license that allowed the greatest dissemination and use of a work was the Attribution CC-BY license, which “lets others distribute, remix, tweak and build upon your work, even commercially, as long as they credit you for the original creation.” Other versions with stricter conditions included the Attribution – NonCommercial CC BY-NC (non-commercial use only) and the Attribution – NoDerivs CC BY-ND (the work cannot be changed in any way) licenses. 27 Itoh explained:

We had been very interested in and used open source and GPL long before Hatsune Miku, because these allow our work of making computer software go way more smoothly than it would otherwise. We had also been paying attention to CC for a long time because, as a company that makes music software, how music gets distributed throughout the world is very important to us. We thought Creative Commons was a very unique and useful mechanism.

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Page 7 9B14M110 Piapro In December 2007, Crypton launched Piapro — short for “peer production”— a site for sharing Hatsune Miku-related content. On Piapro, users could upload their music, illustrations, lyrics and 3D models. In doing so, they agreed to abide by the Piapro Character License (PCL), a “character” version of a non- commercial CC license crafted to be compatible with Japanese copyright law. For users outside Japan, the CC BY-NC applied. The latter was described as follows on Piapro’s English-language site:

Subject to the terms and conditions of “Creative Commons – Attribution-NonCommercial, 3.0 Unported” (“CC BY-NC”), Crypton Future Media Inc. (Crypton) grants you a license to copy, adapt, distribute and transmit illustrations of Hatsune Miku, Kagamine Rin, Kagamine Len, Megurine Luka, MEIKO and KAITO (collectively, the “Characters”) for non-commercial use.28

In uploading a work to the Piapro site, a creator agreed to make the work freely available to others for non-commercial use. The website also made it easy for users to communicate with each other about their work and about secondary creation and collaboration.

Itoh explained how Piapro addressed the rights issue that arises with collaborative creation:

Some people are good at drawing, others at music, others at making animation — very few are good at all of these. When someone writes a song and posts it on YouTube or Nico Nico Douga, they need some visuals for it — you can’t just have an empty space. So they do an Internet search, find some illustration they like, “borrow” it, incorporate it into their music video, and post it.

Some people are happy when others use their work. But other people get angry. The person that made the illustration may feel his work was used without permission. But there was no place for creators to communicate about this. So we created the Piapro website. The idea was if there’s a place that creators of music, illustrations and animation can all post work, and freely use what’s there to create new things, then we can avoid disputes over permission to use things.

Itoh believed that the flexible environment for collaborative creation that Crypton had created was what set Hatsune Miku apart from the Vocaloids of other companies:

Anyone can license Yamaha’s Vocaloid technology. Other companies see that Hatsune Miku is selling well, and so they imitate us by marketing their own Vocaloid — a similar-concept product, but with a different character, a different voice. But this is nothing more than copying us superficially. They’re missing the substance. They don’t have the viewpoint of “Let’s create this kind of culture.” People don’t just upload content to Piapro; they communicate with each other about it. One person will say, “Thanks for letting me use your illustration. I used it in this animation that I made.” And the illustrator will say, “Thanks for using my illustration!” There’s no monetary transaction going on, people aren’t doing this for money. The thanks and the communication give motivation to the creator. When someone says, “I used it,” the creator feels happy. It’s not just posting your work publicly. It’s that other people use your work and communicate with you after they use it. That makes people very happy, and they’re motivated — “What shall I make next?” And they come to feel attachment for Hatsune Miku. We were the first to create a place where this kind of culture can develop. And we issued the license.

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Page 8 9B14M110 A Blank Piece of Paper Another key part of the environment that Crytpon built for Hatsune Miku fans was the space to create freely. Itoh explained:

Miku is a symbol. She’s 16, a girl with this long hair — that’s about the only thing that’s decided. Same with our other characters — not much is fixed. This is what makes it easy for people to do so much creating. If too many details are officially decided about the character, that stuff has a lot of power, and when it comes to creating, or stimulating creation, it’s a minus. Therefore, I thought it was best to do nothing, to make her like a blank piece of paper. The most important thing was to create an “I can do anything” situation for creators. On the business side, Hatsune Miku has become quite famous, so there are a lot of Miku works and products out there — music, artwork, video games. But if people feel that we are controlling all that as a business, then they will run away, they’ll stop cooperating with us. So we have to maintain the “blank paper” condition, and not intervene. We have to keep our distance. If we try to control, if we get too close, many people will not like us.

THE HATSUNE MIKU BUSINESS ECOSYSTEM Hatsune Miku was at the center of a business “ecosystem,” depicted in Exhibit 3, through which money, creativity, content, rights and awareness flowed. It began with the original Vocaloid patent holder, (1) Yamaha Corporation. Yamaha licensed the fundamental technology patents to (2) Crypton Future Media in exchange for licensing fees. Next, Crypton Future Media integrated the image and voice of Hatsune Miku into the Vocaloid technology to create their own pre-packaged Vocaloid software, which they sold to (3) professional and amateur music creators. Crypton sold this software from its own proprietary website as well as through online and offline retailers. Music creators, after purchasing the software, then created songs or other Vocaloid-based musical works and typically posted them on (4a) commercial websites, including YouTube, Nico Nico Douga and Crypton’s own website, Piapro. Once these original songs were shared through these websites, (5) secondary creators, that is other fans and amateur creators, enhanced or built on them by adding illustrations, animations and new lyrics and then re-posted these works on one of the commercial websites. At the same time, (6) professional industry players, such as Sega and Kadokawa Publishing, had their own special licensing relationships with Crypton, which allowed them to develop and sell stand-alone (7) marketable products, such as concert events, game software, CDs and DVDs and character goods. These products were developed independently in collaboration with professional creators or based on popular amateur-produced songs, videos or derivative characters discovered through the commercial websites and (4b) fan websites. In the latter case, the songs and characters were licensed from their creators for commercial use. The professional industry players sold these products to (8) fans and consumers, both in Japan and globally. And as the popularity of Hatsune Miku continued to grow both online and offline, (9) prospective new fans and consumers were brought into the ecosystem, becoming paying consumers and even collaborators and co-creators themselves. See Exhibit 4 for a partial list of Hatsune Miku-related business activities.

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Page 9 9B14M110 This was a highly evolved, co-creative ecosystem whose fan base continued to grow and that generated revenues and creative motivation that inspired greater collaboration and investments from all its members. CREATING A NEW CULTURE While business success was important and rewarding to Itoh, the Crypton CEO also felt strongly that his company had a cultural mission. One element of this was Crypton’s efforts to build an environment — and from that environment a “culture” — where creators could easily collaborate and build on each other’s work. Another element had to do with creativity and collaboration at the level of Japanese society. Itoh explained:

We call our company a “meta-creator.” What that means is most of our customers are creators — creators of music, pictures, videos, anime, games, lots of things. And we are creators too. We create and make available products and services for those creators, to make possible and support their creative activities. I believe that is our company’s role.

What can a meta-creator do? It’s not just music or videos or games. Here in Hokkaido, we have strong agriculture and tourism industries and a little IT. “Creating” those industries is also our mission, I believe. In Japan, music, books, games — it all comes from Tokyo. Everything is concentrated in Tokyo. Musicians, manga artists — they can’t do anything unless they go to Tokyo. Creators have to go to Tokyo, otherwise they can’t get their works out in the world. Until 20 years ago.

But now, thanks to the Internet, we can do all that here — make music, create content. Until now, all the creators gathered in Tokyo, there weren’t many in other places. But from now on, there are creators in many places. They make music, illustrations, promote them on Facebook. Those creators — if they have ways to connect and work together — make possible lots of creative activities in places other than Tokyo.

I think we have to do that — help create ways for people to do create activities without going to Tokyo. Not just in Hokkaido but in other local places all over Japan. That’s our mission as a meta-creator: creating ways that make it possible for people to engage in creative activities outside of Tokyo and earn money doing that. If we can do this, there will be more and more creators all around Japan. I think this will continue, and the resulting creativity, if it can be linked up with local industries and local information sources, will contribute to the Japanese economy and lead to development of new and different industries in Japan. That’s what I really want to see happen.

THE ROAD AHEAD For Crypton and CEO Itoh, the success of Hatsune Miku had brought financial rewards and worldwide attention. Crypton had grown from 30 employees in 2008 to 70 in 2014. The Vocaloid business continued to develop. Kaito V3, Crypton’s first singing software based on Yamaha’s next-generation Vocaloid 3 engine, was released in February 2013. This was followed by other Vocaloid 3-based releases: Hatsune Miku V3 in September 2013, Meiko V3 in February 2014 and Hatsune Miku V3 English in August 2013 (see Exhibit 1).

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Page 10 9B14M110 The Vocaloid 3 engine used triphones (combinations of three phonemes) as the basic unit of sound, resulting in more natural-sounding vocals. (Vocaloid 2 had used biphones.) The sound quality of the Vocaloid 3 engine was such that it was beginning to be used in music education. Atsushi Masuda, associate professor of popular music at Shikoku University, was planning to offer a course in 2015 in which students would learn to write music using the Vocaloid singing voice synthesizer. Masuda commented: “Creating [a] singing voice with Vocaloid is profound because you can make adjustments to the vibrato tone or the intake of breath.”29 Hatsune Miku continued to be in high demand. Itoh said: “Many record companies and other companies want to make Miku-based products. They want to make anime, they want to make books, many people say ‘Let us borrow [license] Hatsune Miku!’” But Itoh also had plenty to worry about. One constant challenge was how to manage Miku’s “career.” Though she was virtual, she was still a celebrity, and celebrities in other industries — sports and music, for example — had managers and agents whose job it was to help guide their careers, build their brand and maximize their long-term earning power. That included making decisions about which product endorsements, personal appearances and sponsorship opportunities to accept and which to decline. In Miku’s case, a key decision area was which licensing opportunities to accept. Itoh had made it a rule that Miku would not be connected with anything political. In 2012, Crypton declined an invitation for Miku to perform in Beijing as part of ceremonies to mark the 40th anniversary of the normalization of China– Japan relations. Itoh did not want Miku to be strongly associated with Japan. He said, “Hatsune Miku doesn’t live in Japan. She lives on the Internet.” But with so many people wanting a piece of Miku, deciding what to say yes to and what to say no to was not always easy.

Another question was the potential for international expansion. Itoh himself was international-minded. Musically, he loved British rock bands Led Zeppelin and Deep Purple and the British electro-music of Thomas Dolby and Depeche Mode, 30 and he enjoyed the opportunities for international travel and exchange that had come with Hatsune Miku’s popularity:

Requests for Hatsune Miku concerts come in from all over the world. Most of them are from countries I’ve never been to, so I’d like to visit as many of these places as I can . . . At concerts everywhere around the world, the fans hum the phrases of the songs and sing along in Japanese. Every time I see this happening before my very eyes, I realize that, in a way, we are promoting Japanese culture to people overseas. At performances abroad, we try to incorporate the works of local creators into our concerts, by adding a song to the album, or using a drawing for the poster. For example, when we released a CD in Taiwan, we used an illustration drawn by a Taiwanese high school girl. We try to involve as many local people as possible in order to add to the aspect of international exchange.31

Hatsune Miku Expo, Miku’s first overseas festival, was scheduled to be held in Jakarta, Indonesia, in May 2014. This Miku extravaganza would feature “exhibitor booths with Miku-related items, toys and services, an exhibition about the history and cultural movement that was inspired by Miku, fan gathering activities and as absolute highlight the fabulous live show of Hatsune Miku using cutting-edge projection technology.”32 But were there limits to Hatsune Miku’s marketability outside Japan? How much of her appeal was culture-specific? At a seminar on leadership and innovation held in London, Itoh explained that the Japanese liked the idea of virtual cities, virtual gods and falling in love with virtual people; that the concept of being virtual is linked to technology; and that robots, artificial intelligence and computer

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Page 11 9B14M110 science are popular fields of study at Japanese universities.33 Did that have something to do with Hatsune Miku’s popularity in Japan and would it transfer overseas? Itoh wasn’t sure:

I feel that Hatsune Miku is looked at in a way that is strange, that is uncommon, really strange — not particularly in a nice sense — by the audience outside Japan, especially in America and Great Britain. In Japan, I feel more comfortable that Hatsune Miku is more accepted. But outside of Japan, especially in Western culture, people tend to look at Hatsune Miku as strange.34

A broader question concerned the relationship between the business “ecosystem” that had grown out of Hatsune Miku’s success and Crypton’s core skills and main business area of developing and selling music software: Were they synergistic, or did they conflict? Some scheduled Crypton software releases had been delayed,35 suggesting that the time and attention spent dealing with the Hatsune Miku phenomenon might be taking a toll on Crypton’s other business activities. How could Crypton maintain a healthy balance between its original business and the new direction in which Hatsune Miku was pulling the company?

These were some of the questions that were on Hiroyuki Itoh’s mind as afternoon turned to evening in Sapporo and the city’s neon-lit entertainment district came to life, opening its doors to Japanese “salary men” and “office ladies” ready to kick back after a long day of work.

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Page 12 9B14M110

EXHIBIT 1: CRYPTON VOCALOID SOFTWARE PRODUCTS Vocaloid

Meiko (female, released 2004); Kaito (male, released 2006)

Vocaloid 2

Hatsune Miku (released August 2007)  “Pop music, cute, virtual idol singer”  Price: 15,000 yen + tax36

Hatsune Miku, © Crypton Future Media, Inc., 2007

Hatsune Miku Append (released April 2010)  Additional Miku voice library containing six different vocal expressions/tones: Soft (gentle, delicate

voice), Sweet (young, small voice), Dark (mature, heartbroken-like voice), Vivid (bright, cheerful voice), Solid (loud, clear voice) and Light (innocent, heavenly voice)

 Price: 16,000 yen + tax Kagamine Rin/Len (released December 2007)

 “Powerful and charming twin vocals”  Price: 15,000 yen + tax

Kagamine Rin/Len Append (released December 2010)  Additional voice library containing six different vocal expressions/tones: three for Kagamine Rin and

three for Kagamine Len  Price: 16,000 yen + tax

Megurine Luka (released January 2009)  “Cool and husky! High capacity bi-lingual vocal”  Price: 15,000 yen + tax

Vocaloid 3

Kaito (released February 2013)  “Japanese- and English-singing male vocalist”  “Skilled expressive power, four voices: straight, soft, whisper, English”  Price: 16,000 yen + tax

Hatsune Miku V3 English (released August 2013)  English version, downloadable only  Vocal editor and music production software included  Price: 15,400 yen + tax

Hatsune Miku V3 (released September 2013)  Japanese version, packaged  Five singing voices: “original, sweet, dark, soft, solid”  Price: 16,000 yen + tax

Hatsune Miku V3 Bundle (released September 2013)  Hatsune Miku V3 + English voice library  Price: 21,000 yen + tax

Meiko V3 (released February 2014)  “virtual singer like a professional”  Voices: “power, straight, dark, whisper” + English voice library  Price: 16,000 yen + tax

Sources: Crypton Future Media, Inc. website, Virtual Singer Lineup (www.crypton.co.jp/mp/pages/prod/vocaloid/); Tomoko Otsuka, Crypton Future Media, personal communication.

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Page 13 9B14M110

EXHIBIT 2: CRYPTON VOCALOID CHARACTER DETAILS Meiko

 Character information: female; age unspecified; colour: red  Popular item: One Cup Ozeki (brand of Japanese rice wine)  Official derivative character: Meiko Sakine  Voice provider: Meiko Haigo

Kaito  Character information: male; age unspecified; colour: blue  Popular items: muffler, ice cream  Popular derivative characters: Kaiko (Kaito “gender bend”)  Voice provider: Japanese male singer Naoto Fuga  Voice sample: You can hear Kaito’s singing voice at http://vocaloid.wikia.com/wiki/Kaitovoice

Hatsune Miku  Character information: female; age 16; height: 158 cm; weight: 42 kg; colour: blue-green  Popular item: leek  Popular derivative characters: Hachune Miku (Hachune = childlike mispronunciation of Hatsune);

Yowane Haku (“say negative thoughts”); Akita Neru (translates as “got bored, go to bed”)  Voice provider: Saki Fujita  Illustrator: Kei

Kagamine Rin/Len  Character information: female (Rin) and male (Len); age 14; height: 152 cm (Rin), 156 (Len); weight:

43 kg (Rin), 47 kg (Len); colour: orange (Rin), yellow (Len); their relationship (twins, boyfriend- girlfriend, etc.): unspecified

 Popular items: banana (Len), orange (Rin), road rollers (both)  Popular derivative characters: Rin no Youchuu (Larvae Rin), Magane Rin (heavy metal version;

Magane = “misfortune sound”)  Voice provider: Asami Shimoda  Illustrators: Kei, Osamu (for Append)

Megurine Luka  Character information: female; age 20, height: 162 cm; weight 45 kg; colour: pink  Popular item: tuna fish  Official derivative character: Tako Luka  Voice provider: Yu Asakawa  Illustrator: Kei

Sources: Crypton Future Media, Inc. website, Virtual Singer Lineup, www.crypton.co.jp/mp/pages/prod/vocaloid/; Tomoko Otsuka, Crypton Future Media, personal communication.

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Page 14 9B14M110

EXHIBIT 3: VALUE CO-CREATION MAP

Source: Based on information gathered during interview and general information from case.

EXHIBIT 4: HATSUNE MIKU-RELATED BUSINESS ACTIVITIES (PARTIAL LIST) Licensing of Miku’s Name and Image Apparel: Miku t-shirts and other clothing items have been produced by Putumayo, AmiAmi, earth music & ecology

and COSPA. Figurines: Miku figurines have been produced by Max Factory, Bandai, Tony Taka, Good Smile Company, Polygonia,

Replyfrom and Ambivalent. Video Games: SEGA holds the rights to develop and sell Miku-based video games. As of March 2014 SEGA and

Crypton had produced and released:  The Project Diva rhythm game series (for PlayStation, Nintendo, iOS and Sega platforms): Hatsune Miku

Project DIVA; Hatsune Miku Project DIVA 2nd; Hatsune Miku Project DIVA Arcade; Hatsune Miku Project DIVA Extend; Hatsune Miku and Future Stars Project Mirai; Hatsune Miku Project DIVA-f; Hatsune Miku Project Mirai 2; Hatsune Miku Project DIVA-f 2nd

 Miku Flick: A rhythm game for iPhone, iPad and iPod Touch. Manga: “Hatsune Miku: Unofficial Hatsune Mix,” a Japanese manga featuring Miku and other Crypton Vocaloid

characters, written by Kei, serialized by Comic Rush and licensed for North American distribution by Dark Horse Comics.

Trading Card Game: Hatsune Miku starter and booster pack, by Precious Memories.

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Page 15 9B14M110

EXHIBIT 4 (CONTINUED) Misc. Character Merchandise: Pullip dolls (by Groove Inc.), calendars, manicure kit, key rings, cosplay outfits, cell

phone case, iPad mini cover, seven-inch Android tablet.

Music KARENT, an independent music label established by Crypton, licenses Vocaloid music from creators and distributes it through websites such as iTunes Japan, Amazon mp3 and Hear Japan.

Advertising and Sponsorships Domino’s Pizza: A free iPhone application that allows users to order directly from Miku, check order status, see Miku

uniforms designed by Dominos staff and take photos with Miku. When the user points the app at the box the pizza is delivered in, Miku performs a song.1

Other: Other companies that have used Hatsune Miku in advertising or as a sponsor include Toyota (ad for the

Corolla), Good Smile (Super GT series Good Smile Racing race car painted with Miku image) and Google (Miku song used as BGM for commercial in Japan).

Events Live Concerts and Festivals Snow Miku: A series of Miku-related activities that are part of Sapporo’ annual Snow Festival, including a Snow Miku

outfit design contest, train cars covered inside and out with Miku art and a live Miku concert. Other

 “All you need is LOVE: From Chagall to Kusama and Hatsune Miku”: Miku appeared as an art work in the 10th Anniversary Exhibition of the Mori Art Museum in Tokyo, April to September 2013.

 “The End”: An opera without humans, sung by Hatsune Miku, performed in Yamaguchi (November 2012), Tokyo (May 2013) and Paris (November 2013).

 “Symphony Ihatov,” by Isao Tomita: A symphonic work on the world of Kenji Miyazawa (beloved Japanese poet and writer of children’s books, 1896 to 1933), featuring Hatsune Miku as soloist with an orchestra and chorus (https://www.youtube.com/watch?v=n_3pV8xA08E).

Sources (accessed December 6, 2014 unless otherwise specified): Amazon.com, “Hatsune Miku,” www.amazon.com/s/ref=nb_sb_noss_1?url=search-alias%3Daps&field-keywords=hatsune+miku; Sega Corporation, “Games,” www.sega.com/Search/?q=project+diva; Sega Corporation website, http://miku.sega.jp/flick/en/; Dark Horse Comics, https://www.darkhorse.com/Books/21-734/Unofficial-Hatsune-Mix-TPB; O-Ami, Inc., www.amiami.com/top/detail/detail?gcode=CGM-4267; Mikufan.com, News and Resources About Hatsune Miku, www.mikufan.com/; Karent, http://karent.jp/; (Debut of Dominos Pizza – Hatsune Miku official collaboration application), iab, Global Insights Report, www.iab.net/globalinsightsreport/case-studies/domino’s-app-featuring-hatsune-miku; “Hatsune Miku / Vocaloid,” Know Your Meme, http://knowyourmeme.com/memes/subcultures/hatsune-miku-vocaloid; “Who is Hatsune Miku?” Crypton Future Media, Inc., www.crypton.co.jp/miku_eng, accessed July 1, 2013; Goodsmile Racing, www.goodsmileracing.com/en/; Akky Akimoto, “Google Chrome Promotion with Hatsune Miku,” Asiajin, December 16, 2011, http://asiajin.com/blog/2011/12/16/google-chrome-promotion-with-hatsune-miku/; Piapro, “Snow Miku 2014,” http://piapro.net/snowmiku2014/index_en.html; Mori Art Museum, www.mori.art.museum/english/contents/love/; “Japan’s Keiichiro Shibuya to Stage Futuristic Android Opera,” The National, October 22, 2014, www.thenational.ae/arts- lifestyle/music/japans-keiichiro-shibuya-to-stage-futuristic-android-opera; Patrick St. Michael, “Isao Tomita Shows the World an All-new Hatsune Miku,” MTV 81, December 1, 2014, www.mtv81.com/features/live-reports/isao-tomita-shows-the-world- an-all-new-hatsune-miku/.

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Page 16 9B14M110 ENDNOTES 1 Tomoko Otsuka, Crypton Future Media, personal communication, March 26, 2014; “Who is Hatsune Miku?” Crypton Future

Media, Inc., www.crypton.co.jp/miku_eng, accessed April 9, 2014. 2 Kazuya Sato, “初音ミクの認知度は 95％ –「好きな音楽はボカロ曲」10 代女性で 4 割” (Hatsune Miku Name Recognition:

95 to 40 Per Cent of Teenage Girls Say the Music They Like Is Vocaloid Songs), CNET Japan, February 26, 2013, http://japan.cnet.com/entertainment/35028758, accessed June 15, 2013.

3 Takamasa Sakurai, “Turquoise-haired Idol Rules the World,” The Daily Yomiuri, November 8, 2012. 4 Tomoko Otsuka, Crypton Future Media, personal communication, March 26, 2014. 5 “Music Artists You’d Like to Perform at the 2012 London Olympics Opening Ceremonies,” The Top Tens, www.thetoptens.com/singers-perform-london-olympics-opening-ceremonies, accessed June 25, 2013. 6 Carly Smith, “Digital Pop Star Hatsune Miku Will Open Lady Gaga Concerts,” The Escapist, April 18, 2014, www.escapistmagazine.com/news/view/133817-Digital-Pop-Star-Hatsune-Miku-Will-Open-Lady-Gaga-Concerts, accessed April 23, 2014. 7 Tomoko Otsuka, Crypton Future Media, personal communication, March 26, 2014. 8 Yoshinori Yamasawa, “初音ミク、「リアル」に商機、ライブ・カラオケ・ＣＭ…関連消費１００億円超” (Hatsune Miku,

“Real” Business Opportunity, Over 10 Billion Yen in Related Consumption: Live Events, Karaoke, Advertising…), SankeiBiz, March 27, 2012, www.sankeibiz.jp/business/news/120327/bsg1203270754009-n3.htm, accessed June 26, 2013.

9 “Seminar Series 2012: Leadership and Innovation,” Daiwa Anglo-Japanese Foundation, www.dajf.org.uk/annual- seminar/leadership-and-innovation, accessed July 6, 2013.

10 “BCN Awards 2013, Software Division,” BCN Ranking, http://bcnranking.jp/award/sokuhou/p4.html, accessed June 29, 2013.

11 “Company Information,” Crypton Future Media, www.crypton.co.jp/mp/pages/aboutus/company_info.jsp, accessed June 29, 2013.

12 Hiroyuki Itoh, personal communication, April 8, 2014. 13 Hiroyuki Itoh, “Hatsune Miku, the New Social Phenomenon,” Wochi Kochi Magazine,

www.wochikochi.jp/english/special/2013/02/hatsune-miku.php, accessed June 27, 2013. 14 “「初音ミク」特集雑誌 3 日で完売ヤフオク、アマゾンで 3 倍の価格も” (Hatsune Miku Special Edition Magazine Sells

Out in 3 Days, Goes for Triple the Retail Price on Yahoo Auction and Amazon), J-CAST News, October 10, 2007, http://news.livedoor.com/article/detail/3339276, accessed June 30, 2013.

15 “大ブレイクの「初音ミク」、売り上げもぶっちぎりのトップを爆走中！” (Hatsune Miku’s big breakout, explodes to #1 in sales), BCN Ranking, 27 Sept. 2007, http://bcnranking.jp/news/0709/070927_8497.html (accessed 30 June 2013).

16 Yuka Okada, “「初音ミク」発売からもうすぐ 1 年開発者が語る、これまでとこれから” (One Year after the Launch of Hatsune Miku, Her Developer Looks Back and Ahead), IT Media News, July 23, 2008, www.itmedia.co.jp/news/articles/0807/23/news046.html, accessed May 30, 2013.

17 “Otaku” is a Japanese word for people with an obsessive interest in something, typically manga or anime. 18 Carlos Santos, “The World is Hers: How Hatsune Miku is Changing Everything,” Anime News Network, July 15, 2011,

www.animenewsnetwork.com/feature/2011-07-15, accessed June 5, 2013. 19 “初音ミク”ボーカロイドアルバム”が徳永を押さえ、初首位” (Vocaloid Album Reaches #1 for First Time, Overtaking

Tokunaga), Oricon, May 25, 2010, www.oricon.co.jp/news/rankmusic/76554/full, accessed June 29, 2013. 20 “Supercell/Miku Song in U.S. iTunes’ World Top 10,” Anime News Network, May 16, 2011,

www.animenewsnetwork.co.uk/interest/2011-05-15/supercell/miku-song-in-u.s-itunes-world-top-10, accessed June 20, 2013.

21 “Supercell,” Oricon Style, www.oricon.co.jp/music/release/d/804088/1/, accessed September 29, 2014. 22 “Hachune Miku,” Wikia, http://vocaloid.wikia.com/wiki/Hachune_Miku, accessed June 30, 2013. 23 “Tako Luka,” Wikia, http://vocaloid.wikia.com/wiki/Tako_Luka, accessed June 26, 2013. For other examples of fan-created

derivative characters, see http://fanloid.wikia.com/wiki/List:_Established_derived_characters. 24 Peter Bucani, interview by Tim Craig, June 18, 2013. 25 Wappler., op. cit. 26 Santos, op, cit. 27 “About the Licenses,” Creative Commons, http://creativecommons.org/licenses, accessed July 1, 2013. 28 “For Creators,” Piapro, http://piapro.net/en_for_creators.html, accessed July 2, 2013. 29 “Music Educators Tapping Vocaloid,” The Japan Times, April 1, 2014,

www.japantimes.co.jp/news/2014/04/01/national/music-educators-tapping-vocaloid/#.Uz5mdlyGjwI, accessed April 4, 2014).

30 “Seminar Series 2012: Leadership and Innovation,” op. cit. 31 Itoh, op. cit., “Hatsune Miku, the New Social Phenomenon.” 32 “What’s HATSUNE MIKU EXPO 2014 in Indonesia?” http://mikuexpo.com/inindonesia.html, accessed April 8, 2014. 33 “Seminar Series 2012: Leadership and Innovation,” op. cit. 34 Paul Browne, “An interview with Hiroyuki Itoh,” J-pop Go, October 11, 2012, www.jpopgo.co.uk/jpg/an-interview-with-

hiroyuki-itoh, accessed July 6, 2013. 35 “Hatsune Miku,” Vocaloid Wiki, http://vocaloid.wikia.com/wiki/Hatsune_Miku, accessed July 7, 2013. 36 Sales tax in Japan was 5 per cent until March 31, 2014; on April 1, 2014, it was raised to 8 per cent.

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August 1, 2009

CHAPTER ONE

Living and Working in the Global Village

From Cultural Intelligence: Living and Working Globally,

Second Edition, by David C. Thomas and Kerr Inkson

Published by Berrett-Koehler Publishers, Inc.

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LET’S JUST TALK IT OUT

Bob Weber hangs up the telephone and leaps to his feet. Furious, he bounds out of his office in search of his Korean-born admin- istrative assistant, Joanne Park. He has just been berated by his customer in Pennsylvania for not sending the contract for softwood lumber to him on the date specified. This exchange, plus the current volatility in the Canadian stock market, is really making him edgy. As he walks down the hall toward the employee lunchroom, he begins to calm down. He knows he must handle this situation with an employee carefully.

He arrives at the lunchroom and pokes his head in the door. “Is Joanne here?” He sees her at a table, sharing her lunch with

several other administrative staff. He still feels annoyed, but he keeps his voice in control.

“Oh, I see you are in here. I was looking for that contract to Zott Industries that I asked you to type. Did you forget?”

Everyone stops talking. They look uncomfortable. Joanne gets up from the table.

“Oh, Mr. Weber. I am so sorry! I will do it right this minute!” “No, that’s okay. After lunch is fine. But, we do need to get it out

today.” He goes out.

CHAPTER 1

Living and Working in the Global Village

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Joanne averts her eyes. She looks miserable. The other staff are looking at each other knowingly.

A few minutes later Bob is sitting behind his desk busily talking on the telephone. Joanne comes in briskly and delivers the contract (with two hands, typical of Korean culture) into Bob's in-box.

She then turns and goes out just as briskly and closes the door firmly but quietly behind her.

Bob ends his phone call, gets up from his desk, and follows Joanne into the hall. His anger has gone. After all, Joanne has never made such a mistake before. Now he is concerned for her.

“Joanne, can you come in here for a minute.” Joanne comes in obediently and stands in front of him with her

head down, not making eye contact with Bob. “Is there some sort of a problem here? If so, we need to talk

about it.” There is no response from Joanne. “Does it have something to do with forgetting to type the

contract?” Joanne nods. She still doesn’t look at him. He is conciliatory, friendly. “Oh! That was no big deal! It’s done

now. Just forget about it. But in the future just make sure and tell me if something is wrong so we can talk it out. Okay?”

Joanne nods again. Over the next few weeks Joanne takes several days of sick leave,

and three weeks later she resigns.

The actions and reactions of Bob Weber and Joanne Park reveal quite different outlooks on resolving a problem at the office. Like most Americans, Bob thinks the best way to resolve conflicts is to have a frank and open discussion about them and work through any differences. In contrast, Joanne’s cultural background tells her that she will never be able to recover the status she had formerly enjoyed after being rep- rimanded in front of her peers. And being confronted again with her mistake by Bob in his office just added to her loss of face. Both Bob and Joanne continue to operate as if they were totally immersed among others of their own culture.

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Living and Working in the Global Village 3

As a result, both Bob and Joanne endanger the things they value most: Bob, despite his good intentions, has failed to correct the cause of the administrative error and portray himself as a caring boss. And Joanne has left a job in a good organization that she generally enjoyed. If each had been willing and able to accommodate, at least in part, the other’s customs and had made more effort to help the other to understand his or her own customs, Bob might have been able to create an efficient and friendly working environment, and Joanne might have learned some new ways of dealing with her new culture.

For example, Bob might have had some discussions with the other managers who have Korean staff and adjusted some of his managerial style and communication behavior. For her part, Joanne might have noted her own feelings and com- municated to Bob how his behavior affected her.

The story of Bob Weber and Joanne Park is typical — it is a story that is enacted again and again in many situations around the world as ordinary people, working both within their own countries and overseas, grapple with the problem of relating to others who are from cultures where things are done differently.

Consider the following examples:

■ A British company trying to run a Japanese subsidiary experiences inexplicable problems of morale and conflict with its Japanese workforce. This seems out of character with the usual politeness and teamwork of the Japanese. Later it is found that the British manager of the operation in Japan is not taken seriously because she is a woman.

■ Two American managers meet with executives and engi neers of a large Chinese electronics firm to present their idea for a joint venture. After several meetings, they notice that different engineers seem to be attending the meetings and that their questions are becoming more technical, so much so that the Americans have difficulty

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4 c u l t u r a l i n t e l l i g e n c e4 c u l t u r a l i n t e l l i g e n c e

answering them without giving away trade secrets. The Americans think this attempt to gain technological infor- mation is ridiculous. Don’t the Chinese have any business ethics? How do they sleep at night? Later they learn that this is common practice and considered to be good busi- ness among the Chinese, who often suspect that western- ers are interested only in exploiting a cheap labor market.

■ In Malaysia, an old woman is struggling to unload some furniture from a cart and carry it into her house. The fur- niture is heavy, and she stumbles under the weight. Many people crowd the street, but no one makes an effort to offer help. A couple of young American tourists who are passing by see the problem, rush up, and start helping the old lady. The locals on the street seem bemused and per- plexed by these Americans helping someone they don’t even know.

■ A Canadian manager faces difficulties because his five key subordinates are, respectively, French-Canadian, Indian, Italian-American, Chinese, and Iraqi. How can he treat them equitably? How can he find a managerial style that works with all of them? How should he chair meetings?

■ A Dutch couple, an engineer and a teacher who have vol- unteered for two-year assignments in Sri Lanka to assist local economic development, spend an evening visiting a Sri Lankan couple to whom they have been introduced by a friend. They want to “get a feel for” the Sri Lankan people. Their hosts are gracious and hospitable but much more reserved than the Dutch couple are used to. The guests feel awkward and find it hard to make conversa- tion. Later, they panic because of the ineptitude they felt in dealing with the Sri Lankans.1

These stories provide real-life examples of people from different parts of the world struggling with problems caused by intercultural differences. Do you identify with any of these

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Living and Working in the Global Village 5 Living and Working in the Global Village 5

situations? Do you wonder how to deal with people from other countries, cultures, or ethnic groups? Have you been in situations, like the ones above, that have left you puzzled and frustrated because you simply haven’t felt tuned in to the people you have been dealing with? If so, you are not alone; you are attempting to operate in a multicultural world.

The Global Village There are seven billion people in the world from myriad differ- ent cultures, but we live in a village where events taking place ten thousand miles away seem as close as events happening in the next street. We find ourselves in this global village whenever we read a newspaper or watch television or buy a product from the grocery store shelf. We can watch a Middle East firefight as if we were there, eat tropical fruit with snow on the ground outside, and meet people from far-off exotic places at the local mall. The following dramatic examples of globalization are familiar to almost everyone.

THE GLOBAL WORLD COMES TO THE UNITED STATES

Americans’ consciousness of the increasingly global society that they live in has been powerfully raised by what may turn out to be the two major crises of the first decade of the new millennium.

On September 11, 2001, the world came to America in a new and horrifying way. The young men who flew their hijacked air- liners into the great U.S. citadels of the World Trade Center and the Pentagon were citizens of the global village. They were operating in a world with a profoundly increased consciousness of differ- ence — haves versus have-nots, Christians versus Muslims — as well as far fewer boundaries. To the terrorists, America was not a dis- tant vision but an outrage beamed nightly into their homes through their televisions, a place they could visit personally for the price of a plane ticket. They slipped easily into the world’s most powerful nation, acquired its language, were accepted by their neighbors, and took flying lessons from friendly, helpful locals. Most likely they

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tuned in to U.S. television at night and paid special attention to the regular bulletins on conflict in the Middle East.

The news of the attacks traveled, virtually instantaneously, to all corners of the world. Californians stared aghast at the strange horrors of the day’s breakfast show. Europeans interrupted their shopping to crowd around television screens in appliance store windows. Australians phoned each other in the night and said, “Switch your telly on.” A billion viewers around the globe watched as the Twin Towers collapsed in front of their eyes.

After September 11, people struggled to understand. Who were these people who had plunged the world into crisis? Where were they from? What did they believe? What was it in the ever more complicated cause-and-effect kaleidoscope of global economics and politics that America had done to cause such bitter enmity among these terrorists and their supporters?

In October 2008 people around the world again watched in horror as the financial morass labeled by the term subprime mort- gages quickly spread into their lives. Some of the biggest and apparently most impregnable financial institutions suddenly went out of business, crippled by multibillion-dollar debts. Flows of credit — the lifeblood of business — froze, stock markets plunged, and memories of the horrors of the Great Depression of the 1930s were revived. The president of the United States quickly called his top advis- ers together to put together a rescue package, and within a few days a $700 billion government “bailout” of stricken banks was announced — a de facto reversal of the country’s most cherished principles of free-market capitalism.

Despite this intervention, however, the share markets continued to fall. And they fell not just in the United States but all around the world. Banks in many countries had to be bailed out by their governments. It seemed that the “toxic mortgages” that had started the problem had ended up being processed into various forms of “derivative” debt and exported all around the world. In addition, it turned out that the culture of lax bank regulation and incentivization of massive, unsustainable credit was not a particularly American problem but one shared and developed in concert with many other industrialized countries. So it was only when the world’s leaders all

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Living and Working in the Global Village 7

came together, in meetings of the G7 and G20 countries (meetings of the leading industrialized counties), and developed integrated global solutions to a global problem, that the bleeding stopped and markets around the world begun to stabilize. At the end of 2008, it was not just America but all countries that faced bleak economic times ahead.

After both of these events, people said, “The world will never be the same again.” What they might rather have said: “The world has been changing rapidly for some time. These events have caused us to notice it.”

These events can be understood only if one takes a global perspective. These matters are not just about New York or about America or about the Middle East and its relationship with America or about finance in the developed world. The forces involved are economic, political, legal, and cultural forces that cross international boundaries, create interna- tional problems, and require international solutions. We all see these things, and whether we like it or not, we are all involved. We are all citizens in a global world. And none of us can escape the fact.

Forces of Globalization

We are all living increasingly global lives. And we are begin- ning to see and understand the importance of the process known as globalization, particularly the way it affects the lives of people. Globalization means an increase in the perme- ability of traditional boundaries, not just those around busi- ness organizations but those around countries, economies, industries, and people.2

Globalization has accelerated by a host of factors in the international business environment, including the following:

■ Increased international interconnectedness, as repre- sented by trade agreements, the growth of international trade, the growth of multinational corporations, and the

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8 c u l t u r a l i n t e l l i g e n c e

ability to locate business, particularly manufacturing, wherever cost is lowest.

■ The increased volume and importance of human migra- tion, particularly from less-developed to more-developed countries. In many nations now a large percentage of inhabitants were born and brought up in other countries or are culturally influenced by their parents who were themselves immigrants.

■ The ability of information and communication technol- ogy to transcend time and distance so that at the touch of a computer keyboard or a cell phone, we can be some- where else, thousands of kilometers away, and participate in events and change outcomes there.

Until recently only a few very large multinational compa- nies were concerned with foreign operations. Now, business extends across all manner of porous boundaries — some of which have become so porous they have almost ceased to exist — across the entire globe. Even very small firms now have the capability to be global: indeed, small and medium- sized organizations account for an ever-increasing share of global business.

Because of globalization, the environment of business is now more complex, more dynamic, more uncertain, and more competitive than ever before. And there is no evidence that these trends will reverse or decrease. Tomorrow’s managers, even more than today’s, will have to learn to compete, and to work, in a global world.

Globalization of People

However, globalization affects not only businesses and their managers but employees at all levels, as well as customers and indeed everyone in the general population. Inevitably, global- ization brings about interactions and relationships between people who are culturally different. In business today, and

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Living and Working in the Global Village 9

as tourists and members of families, networks, and com- munities that have “gone international,” we travel overseas among people from other cultures, we speak with them on international telephone calls, and we correspond with them by e-mail. Even in our home cities, we notice that more and more of our colleagues, our clients, and even the people we pass in the street are observably from cultures different from our own. The trend is inexorable. This globalization of people creates a new and major challenge for everyone, especially those who work in business. Although we increasingly cross boundaries and surmount barriers to trade, migration, travel, and the exchange of information, cultural boundaries are not so easily bridged. Unlike legal, political, or economic aspects of the global environment, which are observable, culture is largely invisible. Therefore, culture is the aspect of the global context that is most often overlooked.

The potential problems are enormous. Even when people come from the same culture, interpersonal skills are often poor, and this weakness is costly to business. Where interper- sonal interaction is taking place across cultural boundaries, the potential for misunderstanding and failure is compounded.

The conclusion is clear. Whether you are conscious of it or not, you are a member of the global community. This is true, even if you have never done business abroad or even traveled abroad. You may never have gone around the globe, but the globe has come to you. Any organization you work for will most likely buy or sell in another country, or will at least be influenced by global events. And you will increasingly have to interact with people from all parts of the globe right in your own home town.

Here is a story about two global people. One is an inter- national migrant who is trying to create a new environment for himself in a very different place. The other is a manager who has never left her own country but now is confronted by an immigrant from a part of the globe she has never been to, coming into her office and sitting down in front of her.

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10 c u l t u r a l i n t e l l i g e n c e

THE JOB APPL ICANT

In California, the human resource manager of a manufacturing company sits in her office. She is interviewing candidates for fac- tory work, and the next candidate is due. Suddenly the door opens, and a dark-skinned young man walks in without knocking. He does not look at the manager but walks to the nearest chair and, without waiting to be invited, sits down. He makes no eye contact with the manager but instead stares at the floor. The manager is appalled at such graceless behavior. Can’t the man even say “Good morning”? The interview has not even started, and even though the jobs being filled do not require strong social skills, it is already unlikely that the young man will be appointed.

Observing this scene, most Americans and Western Europeans might think that the human resource manager has come too quickly to a conclusion about a candidate who may have the potential to be a good worker, but they would fully under- stand why she felt as she did. The man’s behavior certainly seems odd and disrespectful.

But suppose we give the manager some new knowledge about the young man and his perspective on the interaction.

The young man is Samoan. He was born and brought up in Samoa and only recently immigrated to the United States. Samoans have great respect for authority, and the young man sees the manager as an important authority figure, deserv- ing of considerable respect. In Samoa you do not speak to, or even make eye contact with, authority figures until they invite you to do so. You do not stand while they are sitting, because to do so would put you on a physically higher level than they are, implying serious disrespect. In other words, in terms of his own cultural background and training, the young man has behaved exactly as he should. The human resource manager in this case, if she herself were a job candidate, would greet her interviewer politely, make eye contact, offer a handshake, and wait to be invited to sit down. Therefore, she

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Living and Working in the Global Village 11

tends to expect similar behavior of everyone she interviews. In doing so, she is not only being unfair to candidates who for various reasons operate differently, she is also reducing her (and her company’s) opportunity to benefit and learn from people from different cultural backgrounds.

We are all different, yet all too often we expect everyone else to be like us. If they don’t do things the way we would do them, we assume something is wrong with them. Why can’t we think outside our little cultural rule books, accept and enjoy the wonderful diversity of humankind, and learn to work in harmony with others’ ways?

In the cases we have provided so far, Bob Weber and Joanne Park and the human resource manager and the young Samoan man are playing a game that we all play. The game is called Be Like Me. Do it my way. Follow my rules. And, when the other party can’t, or doesn’t want to, the characters in our stories withdraw into baffled incomprehension.

We all tend to be like Bob and Joanne and the human resource manager and the young Samoan man. We all find cultural differences hard to deal with. We all tend to play Be Like Me with the people we live and work with.

Intercultural Failures

Many of us fail in intercultural situations is in all sorts of ways, such as the following:

■ Being unaware of the key features and biases of our own culture. Remember that just as other cultures may seem odd to us, ours is odd to people from other cultures. For example, few Americans realize how noisy their natural extroversion and manner of conversation seem to those from most other cultures, many of which value reticence and modesty. By the same token, people from Asian so- cieties, where long silences in conversations are consid-

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12 c u l t u r a l i n t e l l i g e n c e

ered normal and acceptable as participants reflect on the topic, do not realize how odd and intimidating silence in this situation seems to many Westerners.

■ Feeling threatened or uneasy when interacting with peo- ple who are culturally different. We may work not to be prejudiced against people from other cultures, but we no- tice, usually with tiny internal feelings of apprehension, the physical characteristics of others that make them different from us. All of us find difference threatening to some extent.

■ Being unable to understand or explain the behavior of others who are culturally different. When we use a Be Like Me approach to explaining the behavior of others, we are often wrong, because their behavior may not be based on the same goals or motives as ours.

■ Being unable to transfer knowledge about one culture to another culture. Even people who have lots of travel experience in many different countries are often unable to use this experience to be more effective in each subse- quent intercultural encounter.

■ Not recognizing when our own cultural orientation is influencing our behavior. Much of our behavior is pro- grammed by culture at a very deep level of consciousness, and we are often unaware of this influence. Behavior that is normal to us may seem abnormal or even bizarre to culturally different others.

■ Being unable to adjust to living and working in another culture. Anyone who has lived in a foreign culture for six months or more can attest to the difficulty in adjustment. The severity of culture shock may vary, but it affects us all.

■ Being unable to develop long-term interpersonal relation- ships with people from other cultures, because even if we learn how to understand them and communicate with them a little better, the effort of doing so puts us off try- ing to develop the relationships any further.

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Living and Working in the Global Village 13

In all of these examples, stress and anxiety for all parties is increased, and the end result is often impaired performance, loss of potential satisfaction and personal growth, and, in organizations, lost business opportunities.

Ways of Overcoming Cultural Difference

If the above are the symptoms, what is the cure? How can we ordinary people acquire the ability to feel at home when dealing with those from other cultures, to know what to say and do, and to pursue business and other relationships with the same degree of relaxation and the same expectation of synergy and success that we experience in relationships with people from our own culture?

E x p e c t i n g O t h e r s t o A da p t

One way of trying to deal with the problem is to stick to the Be Like Me policy and try to brazen it out. We can reason, particularly if we come from a dominating economy or cul- ture such as the United States, that it is for us to set norms for behavior and for others to learn how to imitate us.

You may think there is something in this. First, a dominant culture may win in the end anyway.3 For example, the English language is becoming the lingua franca of business and educa- tion, and is increasingly spoken in business and professional interactions all over Europe and large parts of Asia. Second, many people believe that different cultures are converging to a common norm, assisted by phenomena such as mass com- munication and the “McDonaldization” of consumption.4 Eventually, they argue, the whole world will become like the United States anyway, and its citizens will think, talk, and act like people from the United States. Many cities around the world already mimic New York, with the same organiza- tions, brands, and architectural and dress styles; why resist the process?

In fact, the evidence in favor of cultural convergence is

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14 c u l t u r a l i n t e l l i g e n c e

not compelling. Convergence is probably taking place only in superficial matters such as business procedures and consumer preferences.5 Also, insisting that other people behave as we do robs us of the great gift of diversity and the novelty it brings in the form of new ways of thinking and working. Finally, anyone who plays Be Like Me overtly or excessively is behaving insensitively and will be perceived as insensitive by others. Under these circumstances, many opportunities will soon disappear.

U n d e r s t a n d i n g C u lt u r a l D i f f e r e n c e s

Can we solve the problem of cultural differences and seize the opportunity they create simply by learning what other cultures are like? Do we even know, in any organized way, what they are like?

Plenty of easily accessible information about other cultures is available. Cultural anthropologists have researched many of the cultures of the world, and cultural differences affect- ing specific fields such as education, health, and business have also been explored.6 This information has been useful in establishing the behavior or cultural stereotypes of many national cultures, and it provides a starting point for antici- pating culturally based behavior.

Understanding some of the key cultural differences between countries and how those differences affect behavior is an im- portant first step on the way to gaining cultural intelligence. This book provides some basic information on these matters.

However, this basic knowledge is only the beginning of the process of changing cultural differences from a handicap to an asset. Even at their best, research on cultural difference and the sort of account that says, “Japanese behave in this way and Americans in that” can provide only a broad state- ment about cultural identity. Generalizations about a country are likely to conceal huge variances within that country and considerable subtlety in the way cultural differences are made apparent. A country may have, for example, religious or tribal

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Living and Working in the Global Village 15

or ethnic differences, forms of special protocol, or regional variations.

The “laundry-list” approach to cross-cultural understand- ing attempts to provide each individual who is to have inter- cultural interactions with a list — “everything you need to know” — about the particular country. Such lists often attempt to detail not just what the key cultural characteristics of the country are but the regional or organizational variations, the expected behavior in that country, the detailed customs to be followed, the type of speech inflections to use, and expres- sions and actions that might be considered offensive, as well as functional information on matters such as living costs, health services, and education. Tourists and travelers can buy books of this type about most countries, and some companies preparing executives for an assignment to a foreign country take this approach to preparing prospective assignees and their families for the transition.

Laundry lists have their place, but they are cumbersome. They have to document every trait of every conceivable cul- tural variant, along with drills and routines to cater for each. For an expatriate, this kind of intensive preparation for a single destination may be highly appropriate, but for most of us our engagement with other cultures is a less intensive interaction with a variety of cultures. If we are traveling in, or entertaining visitors or interacting with immigrants from half a dozen countries, do we have to learn an elaborate laundry list for each one? If we are suddenly introduced to culturally different people without warning and have no laundry list readily available, how can we cope with the situation?

Furthermore, laundry lists tend to be rather dry and for- mal. The essence of culture is subtler, it is expressed in com- bination with the unique personality of each individual, and it is hard to express in print. Formal and abstract knowledge needs to be supplemented by and integrated with experience of the culture and interactions with its people. Learning facts about other cultures is not enough.

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16 c u l t u r a l i n t e l l i g e n c e

B e c o m i n g C u lt u r a l ly I n t e l l ig e n t

A third approach to the problem is to become culturally intelligent.7

Cultural intelligence means being skilled and flexible about understanding a culture, learning more about it from your ongoing interactions with it, and gradually reshaping your thinking to be more sympathetic to the culture and develop- ing your behavior to be more skilled and appropriate when interacting with others from the culture. We must learn to be flexible enough to adapt to each new cultural situation that we face with knowledge and sensitivity.

Cultural intelligence consists of three parts.

■ First, the culturally intelligent person requires knowledge of culture and of the fundamental principles of cross- cultural interactions. This means knowing what culture is, how cultures vary, and how culture affects behavior.

■ Second, the culturally intelligent person needs to practice mindfulness, the ability to pay attention in a reflective and creative way to cues in the cross-cultural situations encountered and to one’s own knowledge and feelings.

■ Third, based on knowledge and mindfulness, the cultur- ally intelligent person develops cross-cultural skills and becomes competent across a wide range of situations. These skills involve choosing the appropriate behavior from a well-developed repertoire of behaviors that are correct for different intercultural situations.

The model in figure 1.1 is a graphic representation of cultural intelligence.

Each element in figure 1.1 is interrelated with the others. As we describe in chapter 8, the process of becoming culturally intelligent involves a cycle or repetition in which each new challenge builds upon previous ones until cultural intelligence is ultimately achieved. A major advantage of this approach

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Living and Working in the Global Village 17

over the laundry-list approach is that as well as acquiring growing competence in a specific culture you simultaneously acquire general cultural intelligence, making each new cul- tural challenge easier to face because of what has been learned from the previous ones.

You have probably heard of the psychologists’ concept of intelligence, the ability to reason, and its measure, the intel- ligence quotient (IQ). More recently has come recognition of emotional intelligence, the concept that it is important how we handle our emotions. A measure of emotional intelligence is the emotional intelligence quotient (EQ). Cultural intelligence (or CQ as its measure might be called) is a relatively new idea that builds on these earlier concepts but that incorporates the capability to interact effectively across cultures.8

In the three chapters that follow, we present a road map for improving your cultural intelligence by addressing the three elements of cultural intelligence one by one.

In chapter 2 we examine the information base that provides the necessary background understanding of cultural phenom- ena. A secure knowledge of what culture is and what it is not;

MindfulnessKnowledge

Skills

FIGURE 1.1. Components of cultural intelligence (CQ)

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18 c u l t u r a l i n t e l l i g e n c e

of the depth, strength, and shared and systematic nature of culture; and of some of the main types of cultural difference provides a good basic set of tools to give one confidence in any cross-cultural situation.

In chapter 3 we consider how observation of the everyday behavior of people from different backgrounds — including our own behavior — can be useful in interpreting the frameworks of knowledge introduced in chapter 2. Most people operate interpersonally in a condition of “cruise control,” in which their experiences are interpreted from the standpoint of their own culture. We develop the idea of mindfulness — a process of observing and reflecting that incorporates cross-cultural knowledge. Developing the habit and the techniques of mind- fulness is a key means to improving cultural intelligence. We then outline the process through which knowledge and mindfulness lead to new skilled behavior. The cross-cultural skills associated with cultural intelligence are general skills that are derived from specific knowledge. By developing this repertoire of behavior, you can translate the understanding of culture into effective cross-cultural interactions. Finally in chapter 4 we show how you can develop a functioning cultural intelligence.

The concept of cultural intelligence as outlined in this book is not difficult to understand, but is hard to put into practice on an ongoing basis. It takes time and effort to develop a high CQ and the accompanying skills. Years of studying, observ- ing, reflecting, and experimenting likely lie ahead before the learner develops truly skilled performance. Becoming cultur- ally intelligent is substantially learning by doing, so it has useful outcomes beyond the development of skilled intercul- tural performance. In addition, new cultures are intriguing: learning how to live in them or work in them or interact with people who are from them can be fun and can open up wonderful possibilities of new insights, new relationships, and a new richness in your life. This book is the place to start on this journey.

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Living and Working in the Global Village 19

Summary This chapter describes the forces of globalization that are dramatically changing the environment for people around the globe. Those confronted by the phenomenon of cultural difference and diversity include not just global managers but all of us. In a sense we are all becoming global managers, for even those who stay in their own countries have to think in global terms. The essence of being global is interacting with people who are culturally different from ourselves. Culture is more difficult to deal with than other aspects of the environ- ment, partly because much of culture operates invisibly. We know a great deal about how cultures around the world dif- fer. However, this knowledge is only the beginning of the pro- cess of becoming culturally intelligent. Cultural intelligence involves understanding the fundamentals of intercultural interaction, developing a mindful approach to intercultural interactions, and finally building cross-cultural skills and a repertoire of behaviors so that one can be effective in any intercultural situation. Interacting effectively across cultures is now a fundamental requirement for all of us in today’s global environment.

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Note on Behavioral Pricing.pdf

Harvard Business School 9-599-114 May 25, 1999

Assistant Professor John T. Gourville prepared this note as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.

Copyright © 1999 by the President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.

Note on Behavioral Pricing

It is important for a firm to get its pricing “right.” Consider the impact of product pricing on a firm’s net income. If Coca-Cola could increase its prices by an average of 1%, without affecting consumer demand for its products, it would increase its net income by 6.4%. A price increase of less than 1¢ on a can of cola would translate to an increase in net income of about $300 million.

Similar 1% price increases, if they did not negatively impact demand, would lead to increases in net income of 16.7% for Fuji Photo, 17.5% for Nestle, and 26% for the Ford Motor Company. In fact, an average price increase of 1% would boost the net income of the typical large U. S. corporation by about 12%.1

These examples highlight the potential impact on a firm’s net income of optimally setting product prices — small changes in price can have an enormous impact on income. Before raising (or lowering) prices in an attempt to improve the bottom line, however, a firm must understand and anticipate a consumer’s response to a product price change.

Unfortunately, it appears that many firms lack the necessary understanding of a consumer’s “willingness to pay” to optimally set product prices. When asked whether they were “well- informed” on six of the potential inputs to the product pricing decision, managers at one well- respected U.S.-based multinational responded as follows:2

• 84% were well-informed on the variable cost of providing their product. • 81% were well-informed on the fixed cost of providing their product. • 75% were well-informed on the price of competitors’ products. • 61% were well-informed on the value of their product to the customer. • 34% were well-informed on how consumers would respond to price changes. • 21% were well-informed on consumers’ willingness to pay at various price levels.

These managers were well-informed on the costs of providing its products and on the price of competitor’s products. They were also well-informed on the value its products delivered to consumers. However, when it came to a consumer’s willingness to pay or to a consumer’s response

1 From Robert J. Dolan and Hermann Simon’s, Power Pricing, The Free Press, New York, NY (1995) 2 Ibid.

For the exclusive use of M. Dagstanyan, 2016.

This document is authorized for use only by Marie Dagstanyan in Marketing Concepts & Strategies - SPRING '17 taught by Tony Stovall, Woodbury University from December 2016 to June 2017.

599-114 Note on Behavioral Pricing

to potential price changes, these managers were lacking the insight needed to optimally set prices. Experience suggests that this company is not unique in this regard.

Purpose of this Note

Any firm’s ability to optimally set product prices is governed by many factors. Some of these factors are well understood and are routinely incorporated into a firm’s pricing decisions. These factors tend to be heavily weighted toward those economic factors that are easily obtained by a firm, including their own variable and fixed costs of production, the market price of competitors’ products and the firm’s internal assessment of the value that their product delivers to the intended consumer. Not surprisingly, these are the four factors on which the surveyed managers claimed that they were well-informed. We will briefly review these factors in a moment. 3

However, optimal product pricing also hinges on a consumer’s willingness to pay and on a consumer’s response to price changes, factors on which the surveyed managers claimed they were poorly informed. In addition, research has shown that a consumer’s willingness to pay is often influenced by “psychological” or “behavioral” variables that typically are not considered when setting price. Specifically, consumers often are as concerned with the behavioral question of “how fair a deal am I getting” as they are with the economic question of “how good a deal am I getting.”

This note is an attempt to highlight the potential impact of some of these behavioral variables on a consumer’s willingness to pay. In the process, it provides a more complete picture of consumer response to pricing and provides some insight for optimal product pricing.

Value Pricing and the Economic Perspective

The traditional economic approach to product pricing is driven by a small handful of factors, as shown in Figure A. One of these factors is the “objective value” the product delivers to the consumer. 4 This is a measure of the benefits that the product delivers to the consumer, regardless of whether the consumer recognizes those benefits. When 61% of managers claim they are well- informed on the value of their product to the consumer, they are most likely referring to this “objective value.”

A second factor in the economic approach to pricing is the “perceived value” of the product to a consumer. Perceived value is the value the consumer understands the product to deliver. Sometimes, a product’s benefits are readily apparent to the consumer and “perceived value” approaches “objective value” with little effort by the firm. Other times, a product’s benefits are less obvious and need to be communicated by the firm to the consumer (e.g., via advertising, personnel selling). In such cases, the “perceived value” of a product typically falls below its “objective value.”

The perceived value of a product also can be influenced by the price of competing products or “substitutes.” Company A may develop a product that creates great objective value for consumers. Consumers may recognize this value and be willing to pay a high price to obtain the product.

3 For a more complete discussion of these economic factors, you should refer to Professor Corey’s “Note on Pricing” [HBS Note #580-091] or Professor Dolan’s “Pricing Policy” note [HBS Note #585-044].

4 Given consumer heterogeneity, “objective value” and “perceived value” will tend to vary across consumers. For some consumers, these values will be high, for others, they will be low or zero. For simplicity, we will ignore consumer heterogeneity in this note and only consider the “typical” consumer. Nevertheless, the behavioral perspective offered in this note apply equally well to a heterogeneous consumer population.

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However, if Company B introduces an identical product at a much lower price, the perceived value of Company A’s product would be reduced to the price of Company B’s product.

It is important to note that the “perceived value” of a product to a consumer should equal the maximum price that consumer is willing to pay for the product. Imagine a consumer who perceives the value of a modem to be $100. If priced above $100, the consumer has no incentive to buy the modem. If priced at $100 or less, however, the consumer always stands to gain from purchasing.

Figure A Value Pricing and the Economic Perspective

The last major component to the economic approach to pricing involves the firm’s cost of goods sold (i.e., COGS). Just as the consumer requires an incentive to purchase a product, the firm requires an incentive to sell the product. In order to stay in business and make a positive return, a firm must charge a price that covers both its cost of production. 5

All of these economic factors come together to form the “value pricing” approach to pricing. In optimally pricing a product, a firm is bound at the upper end by the consumers’ “perceived value” for the product. This “perceived value” is influenced by the “objective value” of the product to the consumer, by the firm’s marketing effort to communicate that objective value, and by the price of substitute products. At the same time, the firm is bound on the lower end by its COGS.

By pricing above COGS and below perceived value, the firm has an incentive to sell the product, measured as [price – COGS], and the consumer has an incentive to purchase the product, measured as [perceived value – price]. In value pricing terminology, the firm has “created” value by offering a product that the consumer values at a price greater than the firm’s COGS. In turn, by pricing between perceived value and COGS, the firm has “captured” some of that value for itself and has allowed consumers to capture the remainder.

5 For simplicity, we will ignore strategic reasons for pricing below cost such as to build share or volume or to temporarily respond to a competitor’s pricing efforts.

Objective Value

Perceived Value

Cost of Goods Sold

Product Price

Consumer’s Incentive to Purchase = [Perceived Value - Price]

Firm’s Incentive to Sell = [Price- COGS]

Price of Substitutes

Marketing Efforts

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599-114 Note on Behavioral Pricing

Adding a Behavioral Component to the Economic Perspective

This “value pricing” framework provides a basic model of how an economically rational consumer should respond to a firm’s pricing of a product. A rational consumer should purchase a product as long as the “perceived value” of that product is greater than the actual price being charged. In addition, the more one’s perceived value exceeds actual price, the greater should be a consumer’s incentive to buy. This leads to the fairly straight forward claim that:

The Economic Perspective: Consumers Buy When Perceived Value Exceeds Price

Consumers should purchase an item whenever the perceived value of that item exceeds its actual price [i.e., whenever (Perceived Value – Actual Price) > 0].

Adding a Behavioral Component

To complement this economic perspective, we now add a “behavioral” or “psychological” perspective to product pricing. This perspective captures “how fair a deal” one is getting. To make this point clear, consider the following scenarios first proposed by Professor Richard Thaler. 6

Scenario #1:

You are lying on the beach on a hot day. All you have to drink is ice water. For the past hour, you have been thinking about how much you would enjoy a nice cold bottle of your favorite beer. A friend gets up to make a phone call and offers to bring back a bottle of your favorite beer from the only nearby place where beer is sold — a small, run down-grocery store. He says that the beer might be expensive and asks how much you are willing to spend. He says he will not buy the beer if it costs more than the price you state. What price do you tell your friend?

What is your “perceived value” for a nice cold bottle of your favorite beer brought to you on a hot beach? Once you have decided upon the price you would tell your friend, consider a second scenario, identical to the first, except for the source of the beer, which is underlined.

Scenario #2:

You are lying on the beach on a hot day. All you have to drink is ice water. For the past hour, you have been thinking about how much you would enjoy a nice cold bottle of your favorite beer. A friend gets up to make a phone call and offers to bring back a bottle of your favorite beer from the only nearby place where beer is sold — a fancy resort hotel. He says that the beer might be expensive and asks how much you are willing to spend. He says he will not buy the beer if it costs more than the price you state. What price do you tell your friend?

If you are like most people, your responses to these two scenarios differ. When Thaler presented these scenarios to a group of executives in the early 1980s, the median response in the grocery store scenario was $1.50 and the median response in the fancy resort hotel scenario was $2.65. Similar results repeatedly have been obtained using Harvard MBAs — albeit, with somewhat higher average prices.

6 Scenarios 1 and 2 have been adapted from Richard H. Thaler’s paper, “Mental Accounting and Consumer Choice,” Marketing Science, 4, 3 (Summer 1985): p. 199-214.

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The interesting question is why? As pointed out by Thaler, for the person consuming the beer on the beach, nothing of importance has changed between the two scenarios. Specifically,

• in both scenarios, the ultimate consumption is identical — the same beer is consumed on the same beach.

• no atmosphere from the fancy resort hotel or the run-down grocery store is being consumed by the beer drinker to justify different prices.

• there is no strategic reason to report a price below one’s “perceived value” for the beer [e.g., you cannot haggle over price with hotel or store owner].

As a result, a person’s “perceived value” for the beer should be identical across the two scenarios. To report otherwise would suggest that a bottle of beer consumed on a beach somehow tastes better or quenches thirst more effectively when purchased from one location than another. In turn, if the “perceived value” of the beer should be identical across the two scenarios, a person’s “willingness to pay” also should be identical across the two scenarios.

Yet people’s prices do differ and it appears that this difference is due to expectations consumers have regarding the price of a bottle of beer at a fancy hotel versus a run-down grocery store. As noted by Thaler, “While paying $2.50 for a beer is an expected annoyance at the resort hotel, it would be considered an outrageous ‘rip-off’ in a grocery store.”

In the end, it appears that one’s “willingness to pay” in these two scenarios is driven not only by the “economic utility” of the transaction [i.e., perceived value – price], but also by the “psychological utility” of the transaction, driven largely by a consumer’s perception of “fairness.” Over the next several pages, we will look at scenarios that highlight specific drivers of transaction “fairness” and of the “psychological utility” of a transaction.

Some Behavioral Updates to the Economic Perspective

1. The Relative versus Absolute Value of Money

In the economic approach to pricing, all money is equal – e.g., $10 in one transaction is worth the same as $10 in another transaction. Research suggests that this may not be the case when it comes to one’s willingness to pay, however. Consider the following scenario and think about how you would respond. 7 There are no right or wrong answers. There is only your intuition as to how you would behave if you found yourself in such a scenario.

Scenario #3:

You set off to buy a Sony Walkman at what you believe to be the cheapest store in the area. Upon arriving, you find that the Walkman you want costs $29, a price consistent with your prior expectations. As you are about to make the purchase, a reliable friend tells you that the very same Walkman is selling for $10 less at a store approximately 10 minutes away. Do you go to the other store to buy the Walkman?

7 Scenarios 3 and 4 have been adapted from Richard H. Thaler’s paper, “Toward a Positive Theory of Consumer Choice,” Journal of Economic Behavior and Organization, 1 (1980), p. 39-60.

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What would you do? Do you go to the other store and save $10 or do you simply go ahead and purchase the Walkman in the first store and pay $29?

A purely economic approach to this question would be to ask yourself whether 10 minutes of your time is worth $10. If you decide that 10 minutes of your time is more valuable than $10, you should forget about the potential savings and purchase the Walkman at the first store for $29. If, however, you decide that 10 minutes of your time is less valuable than $10, you should travel to the second store and purchase the desired Walkman there for $19.

Now consider a second scenario, identical to the first, except for the nature and the price of the product being purchased.

Scenario #4:

You set off to buy a Sony Camcorder at what you believe to be the cheapest store in the area. Upon arriving, you find that the Camcorder you want costs $495, a price consistent with your prior expectations. As you are about to make the purchase, a reliable friend tells you that the very same Walkman is selling for $10 less at a store approximately 10 minutes away. Do you go to the other store to buy the Camcorder?

From the economic perspective, if you decided to travel to the second store to save $10 in the first scenario, you also should have decided to travel to the second store to save $10 in this second scenario. In both scenarios, the tradeoff is $10 for 10 minutes of your time.

If you are like most people, however, your natural inclination will be to answer “yes” in Scenario #3 and “no” in Scenario #4. After all, $10 on a $29 Walkman represents a savings of over 33%, but $10 on a $495 Camcorder represents a savings of a measly 2%. While the dollar savings are the same, the psychological value of the savings is far greater in the first scenario than the second. Whereas a $10 savings on a $29 Walkman is perceived as a “fair” (and even generous) incentive to travel to the second store, a $10 savings on a $495 camcorder is perceived as a rather inadequate incentive to travel to the second store.

These two scenarios raise a curious and important fact about money. Namely, the “psychological utility” of a fixed amount of money (e.g., $10) is relative. Saving $10 on a $29 item will have much greater impact on a consumer’s behavior than saving $10 on a $495 item.

This directly carries over to a consumer’s willingness to pay. Imagine two consumers, one of whom is debating whether to pay $19 for a Walkman that he values at $29, the other of whom is debating whether to pay $485 for a camcorder that he values at $495. While both consumers have the same “economic utility” to enter their respective transactions [i.e., perceived value – price = $10 in both cases], the first consumer will be more likely to make a purchase than the second due to the higher relative incentive to enter his transaction.

This leads to our first update to the economic perspective:

Behavioral Update #1: Willingness to Pay is Impacted by Relative Incentives

In determining his willingness to pay, a consumer will consider both his absolute “economic utility” from the transaction [i.e., perceived value – actual price] and his relative incentive to enter the transaction [i.e., (perceived value – actual price)/(actual price)].

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2. The Impact of a Salient Reference Price

Expectations about “what a product will cost” also seem to impact a consumer’s “willingness to pay.” 8 Read the following scenario and think about how you would respond. Again, there are no right or wrong answers. Only your intuition matters.

Scenario #5

Your favorite sports team has made the playoffs. Its first-round playoff series is a best-of- seven series9 with Games 1, 2, 5, and 7 played on your team’s home field. General admission tickets had been priced at $20 during the regular season. The team decided to raise general admission prices to $40 for these four playoff games. Is this price increase fair or unfair?

Is it fair for a sports team to raise prices by $20 between the regular season and the playoffs? Most people who encounter this scenario say “yes.” About two-thirds of Harvard MBAs not only believe it to be “fair,” but would expect such an increase. Arguments in support of this stance include:

• The nature of the product has changed – playoff games are more exciting than regular season games.

• Demand almost certainly will be higher for the playoff games and the team is merely responding to this increase in demand.

• It is common for ticket prices to increase for playoff games.

Now consider a second scenario, similar to the first scenario except for the timing of the $20 price increase.

Scenario #6

Your favorite sports team has made the playoffs. Its first-round playoff series is a best-of- seven series with Games 1, 2, 5, and 7 played on your team’s home field. General admission tickets had been priced at $20 during the regular season. General admission tickets were also priced at $20 for Games 1 and 2 of the playoffs. After Game 2, the team decided to raise prices to $40 for Games 5 and 7. Is this price increase fair or unfair?

In considering this second scenario, note that from a purely economic perspective, if Games 5 and 7 are worth $40 in Scenario #5, they should also be worth $40 in Scenario #6. Therefore, any difference in “fairness” between the two scenarios is not being driven by a change in the “economic utility” of the transaction, as measured by [perceived value – price], but by the “psychological utility” of the transaction.

8 In these and subsequent scenarios, individuals are being asked to assess the “fairness” of a firm’s pricing decision. Perceptions of fairness should impact “willingness to pay” in a straightforward fashion. In particular, in the short-term, consumers will be less willing to pay a price they feel is “unfair.” In the long-term, consumers will be less likely to purchase from a firm that makes an unfair pricing decision.

9 In a best-of-seven series, the teams play games until one team wins four. This guarantees a minimum of four games and a maximum of seven. Often, Games 1, 2, 5, and 7 are played at one teams location, Games 3, 4 and 6 are played at the other teams location. Also, for each of Games 5, 6 and 7, tickets often are not sold until it is apparent that each game will be required.

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599-114 Note on Behavioral Pricing

If you are like most individuals, however, you find the price increase in Scenario #6 to be “unfair.” What seems to drive this sense of unfairness is the fact that ticket prices were raised mid- playoffs. Once ticket prices were set for Games 1 and 2, those prices created an expectation for prices for the remainder of the playoffs. By raising prices for Games 5 and 7, this expectation was violated.

These two scenarios highlight the power of a salient “reference price,” a price against which consumers compare other prices to assess both the “goodness” and “fairness” of a given transaction. In Scenario #5, regular season ticket prices were not a salient (nor appropriate) reference price due to the fundamental difference between regular season games and playoff games. In contrast, in Scenario #6, ticket prices for playoff Games 1 and 2 did establish a salient (and seemingly appropriate) reference price for Games 5 and 7. As a result, price changes in Scenario #5 are deemed “fair” while price changes in Scenario #6 are deemed “unfair.”

Interestingly, Scenario #6 was actually played out in the spring of 1997. In a best-of-seven playoff series between basketball’s Miami Heat and New York Knicks, Miami raised ticket prices in the middle of the playoff series. For Games 1 and 2, Miami Heat management had set the prices for various seats at $20, $30 and $40. After Game 2, the Heat raised ticket prices to $50, $80 and $90 for Game 5. Public outrage resulted and Game 5 was one of the very few basketball playoff games that year not to sell out. The extent of the outrage forced Miami Heat management to return prices to $20, $30 and $40 for the final and deciding Game 7.

In more mainstream consumer transactions, how are reference prices formed? The most common basis for a reference price is the previous price paid for a product. If a consumer has been paying $9.99 for bottle of wine that they have come to enjoy, this $9.99 price becomes this person’s reference price for the wine. If the consumer subsequently encounters the same bottle of wine at the same store for $14.99, the price difference will likely be questioned — not because the wine isn’t worth $14.99 to the consumer, but because the consumer has grown to view $9.99 as the “fair price.” This concept is captured in our second update to the economic perspective:

Behavioral Update #2: Willingness to Pay is Impacted by Salient Reference Prices

In determining her willingness to pay, a consumer will consider her “economic utility” from the transaction [i.e., perceived value – actual price] and the consistency between the actual price and a salient reference price [i.e., actual price – reference price].

3. The Impact of a Firm’s Cost of Goods Sold

Scenarios #5 and #6 show that a salient reference price can impact a consumer’s perception of fairness (and, by extension, her willingness to pay). Another factor that impacts a consumer’s perception of “fairness” is a firm’s cost of goods sold, as indicated by the following two scenarios.10

Scenario #7:

A grocery store has no peanut butter in stock, but is about to receive a new shipment. Prior to delivery, the owner finds out that the wholesale price of peanut butter has increased 20% and will affect this new shipment. The owner decides to increase the price of the new peanut butter by 20%. Is this retailer’s actions fair or unfair?

10 These two scenarios are adapted from Kahneman, Knetsch and Thaler, “Fairness as a Constraint on Profit Seeking: Entitlements in the Market,” American Economic Review 76, 4 (1986): p. 728-741.

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With little argument, most consumers find this retailer’s actions to be entirely “fair.” After all, the retailer is only passing along a wholesale price increase to the consumer. The retailer has not caused the price increase and is not benefiting from it. Contrast that with the following scenario:

Scenario #8:

A grocery store has a one week supply of peanut butter in stock and is due to receive a new shipment in the near future. Prior to delivery, the owner finds out that the wholesale price of peanut butter has increased 20% and will affect the new shipment. The owner decides to immediately increase the shelf price on his current stock of peanut butter by 20%. Is this retailer’s actions fair or unfair?

In thinking about these two scenarios, let us again consider the purely economic perspective. In particular, one’s “perceived value” for peanut butter should not differ between the two scenarios – the peanut butter is the same in both scenarios. In addition, the price being charged for the peanut butter has increased 20% in both cases. Therefore, any sense of “fairness” is not being driven by the “economic utility” of the transaction [i.e., perceived value – actual price], but by the “psychological utility” of the transaction.

Nonetheless, most consumers find the retailer’s actions “unfair” in Scenario #8. Why? The typical argument is that this retailer is only entitled to pass on a cost increase on a product that has been subject to that increase. In Scenario #8, by raising the price of the in-stock peanut butter that has not been subject to the wholesale price increase, the retailer is “taking advantage of the consumer.”

In addition to the magnitude of their own incentive to purchase, these two scenarios suggest that consumers are concerned with the magnitude of the firm’s incentive to sell [i.e., actual price – cost of goods sold]. In particular, consumers do not want to be taken advantage of and desire a fair division of value between themselves and the firm that makes a product. As a result, they are willing to label a price increase “unfair” when that price increase is coupled with little or no change in the cost of goods sold. This concept is captured in our third update to the economic perspective.

Behavioral Update #3: Willingness to Pay is Impacted by Cost of Goods Sold

In determining his willingness to pay, a consumer will consider his own “economic utility” from the transaction [i.e., perceived value – actual price] and that of the firm [i.e., actual price – cost of goods sold].

4. The Nature of the Product Being Sold

To this point, it has been shown that factors such as a salient reference price or a known cost of goods sold can impact perceptions of transaction fairness. How do these perceptions of fairness vary by the type of product being sold? Consider the following scenario:

Scenario #9

In 1996, baseball’s Seattle Mariners made it to the American League playoffs. During the season, general admission to a Mariners game cost $15. For the playoffs, the Mariners raised the price of general admission tickets to $20. Is this fair or unfair?

Most individuals who encounter this scenario feel that this price increase is fair and justified, for many of the same reasons that a ticket price increase in Scenario #5 was fair and justified. In particular, the underlying conditions have changed (playoffs vs. regular season) and consumer

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599-114 Note on Behavioral Pricing

demand almost certainly will increase. Under those conditions, a price increase is reasonable and should be expected. Now contrast this first scenario with the following:

Scenario #10

A hardware store had been selling snow shovels for $15. The morning after a large snowstorm, the store raises the price of its snow shovels to $20. Is this fair or unfair? 11

From an economic perspective, the arguments that support a price increase in Scenario #9 also seem to apply in Scenario #10. In this second scenario, the underlying conditions have changed (snow vs. no snow) and demand almost certainly will increase.

Nonetheless, while the price increase in the first scenario generally is viewed as “fair,” the price increase in the second scenario is almost universally viewed as “unfair.” Why the difference? One possible explanation lies in the nature of the product being promoted. Whereas the purchase of tickets to a Seattle Mariners playoff game is viewed as a discretionary expense, a purchase of a snow shovel after a large snowstorm is viewed as a necessary expense. As a result, to raise the price of tickets when your team makes it to the playoffs is viewed as legitimate, but to raise the price of snow shovels after a snowstorm is viewed as exploitation.

These final two scenarios provide our last update to the economic model.

Behavioral Update #4: Perceptions of Fairness Vary Across Product Categories

In determining her willingness to pay, the degree to which a consumer will rely upon her “economic utility” from the transaction [i.e., perceived value – actual price] will vary across product categories (e.g., discretionary vs. necessity, luxury vs. utilitarian).

Managing Perceptions of Transaction Fairness

This note was designed to highlight some of the psychological drivers of consumer price response. As captured in Figure B, it adds a behavioral component to the more familiar economic approach to product pricing.

Figure B Combining the Economic and Behavioral Drivers of Willingness to Pay

11 Scenario #10 is adapted from Kahneman, Knetsch and Thaler, “Fairness as a Constraint on Profit Seeking: Entitlements in the Market,” American Economic Review 76, 4 (1986): p. 728-741.

[Perceived Value – Actual Price] [(Perceived Value – Actual Price)/(Actual Price)]

[Actual Price – Expected or Reference Price]

[Actual Price – Cost of Goods Sold]

Consumer Willingness to Pay = +Economic Utility

of the Transaction Fairness of the

Transaction

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This framework suggests that an economically rational consumer should decide whether to buy a product solely on the economic utility of the transaction — i.e., by comparing perceived value to product price. In reality, consumers incorporate a host of psychological or behavioral factors into their decision making. These factors include the relative size of the incentive to purchase, the consistency between actual price and expected price, and the difference between product price and the firm’s cost of goods sold. These behavioral factors influence perceptions of transaction “fairness” and tend to reduce a consumer’s willingness to pay relative to a purely economic perspective.

Armed with these insights, however, how can a firm more effectively manage perceptions of transaction fairness and anticipate a consumer’s willingness to pay for its products. Two strategies are recommended.

Strategy #1: Actively Manage Price Expectations

A consumer usually enters a transaction with some expectation about the price of a product. As evidenced by the scenarios presented in this note, these expectations can have systematic and significant effects on that consumer’s willingness to pay for the product. Unfortunately, firms often do very little to understand and/or manage these expectations.

Instead, firms should actively manage the reference prices and comparisons that consumers employ when assessing product prices. In particular, a firm should look to:

• Establish credible reference prices. A firm should look to establish a benchmark price for its products whenever possible. Common tools for doing this include the use of a credible “suggested retail price” or “list price.” Through the clear posting and reliance upon list prices, the automobile industry has done a good job of managing the benchmark price against which consumers evaluate the fairness of the final price paid.

• Manage product price trends. The single most influential reference price that consumers employ when assessing the fairness of a product price it the previous price paid for that product. As a result, it is far easier to lower prices that are too high than to raise prices that are too low.

• Encourage favorable comparisons. Consumers naturally compare the prices of products within and across product categories. In anticipation of this reliance upon comparisons, a firm could suggest comparisons for consumers to consider. For instance, to combat the perception of excessively high prices for its cereals, Kellogg might be well- advised to compare the daily cost of its cereals (about 30¢) to the cost of other breakfast alternatives, such as the cost of a donut or bagel (50¢ or more).

• Avoid unfavorable comparison through product differentiation. When compact discs first appeared in the music market, they suffered from price comparisons to vinyl records. At $15, CDs were about twice the price of the alternative they were replacing. It was only after convincing consumers that such comparisons were inappropriate, due to vast improvements in sound quality and scratch resistance, that consumers accepted the higher CD prices as fair and reasonable.

Strategy #2: Actively Manage Perceptions of Cost of Goods Sold

As Scenarios #7 and #8 suggest, consumers are sensitive to a firm’s cost of goods sold. As a general rule, consumers are reluctant to pay for products they perceive to be overpriced relative to cost.

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599-114 Note on Behavioral Pricing

This consideration of COGS is especially problematic for firms that operate under high fixed and low variable costs. For example, Microsoft charges hundreds of dollars for its software, yet can churn out incremental copies of that software at the cost of a floppy disk. Many consumers view this as “unfair” and, as a result, have few qualms about using pirated software. In a similar vein, some consumer label drug companies as “greedy” when those companies charge $40 or $50 for a single dose of a branded drug when comparable generics cost a fraction of the price.

Such thinking on the part of the consumer fails to appreciate the fully-loaded cost of product delivery. In the case of Microsoft, the incremental cost of producing another copy of Windows pales in comparison to the cost of developing and supporting that application. And in the case of the drug company, many years and many millions of dollars may have gone into the research and development needed to bring that drug to market. These examples highlight the need for firms to manage the consumers’ perceptions of cost of goods sold. This can be accomplished in several ways.

• Focus attention of fully-loaded cost of goods sold. For firms in high fixed cost/low variable cost industries, it is difficult to justify high product prices based on the incremental cost of production. Rather, the firm can focus consumer attention on the fully-loaded cost of production. For instance, if drug companies and software developers effectively communicated the high cost of product development and product support to consumers, they may successfully combat impressions of pricing “unfairly.”

• Bundle products to obscure cost of goods sold. Some firms sell products where costs are readily apparent to the consumer (e.g., personal computer retailers). Other firms choose to bundle those very same products with additional goods or services so as to obscure the true cost of goods sold. For example, rather than sell computer components, value-added resellers sell turn-key systems. And rather than sell tickets to sporting events, travel agents sell vacation packages that include airfare, hotel and game tickets. By bundling products, a firm can make its costs less transparent to consumers.

• Focus attention of consumer value. A final means by which firms can look to minimize the impact of cost of goods sold is by focusing attention on the consumer’s incentive to purchase. In the end, a consumer benefits whenever perceived value is greater than product price, regardless of the firm’s cost of goods sold. As such, through effective product positioning and communication of value, a firm can minimize the impact of COGS by maximizing attention to the net benefit of purchase to the consumer.

Summary

This note began with the statement, “It is important for a firm to get its pricing ‘right.’” Yet, “getting prices right” is a complex process that few firms seem well-equipped to manage. While firms have a relatively good grasp of the readily available economic inputs to the pricing decision (e.g., cost of goods sold, price of substitutes), most lack the behavioral inputs needed to fully understand and anticipate a consumers response to a pricing change. In particular, few firms anticipate the behavioral implications of transaction “fairness,” as perceived by the consumer. This note does not attempt to offer a comprehensive behavioral perspective to pricing. Rather, it is meant to raise awareness that behavioral factors exist and that these factors are important if a firm expects to “get its pricing right.”

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9-512-077

R E V : J A N U A R Y 3 1 , 2 0 1 3

________________________________________________________________________________________________________________

Professors Vineet Kumar, Bharat Anand, Sunil Gupta and Felix Oberholzer-Gee prepared this case with the help of Research Associate Dharmishta Rood. This case was developed from published sources, and the presentation of some data have been simplified to aid in classroom discussion. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2012, 2013 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545- 7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/educators. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

V I N E E T K U M A R

B H A R A T A N A N D

S U N I L G U P T A

F E L I X O B E R H O L Z E R - G E E

The New York Times Paywall

Every newspaper in the country is paying close, close attention [to the Times paywall], wondering if they can get readers of online news to pay. Is that the future, or a desperate attempt to recreate the past?. . . Will paywalls work for newspapers?

— Tom Ashbrook, host of On Point, National Public Radio1

On March 28, 2011, The New York Times (The Times) website became a restricted site. The home page and section front pages were unrestricted, but users who exceeded the allotted “free quota” of 20 articles for a month were directed to a web page where they could purchase a digital subscription.

The paywall was launched earlier on March 17, 2011, in Canada, which served as the testing ground to detect and resolve possible problems before the global launch. The Times website had been mostly free for its entire existence, except for a few months in 2006–2007 when TimesSelect was launched. Traditional newspapers had been struggling to maintain profitability in the online medium, and they were eager to see how the public would react to the creation of a paywall at the most popular news website in the U.S.

Martin Nisenholtz, the senior vice president of Digital Operations at The Times, was optimistic about the willingness of users to pay:

I think the majority of people are honest and care about great journalism and The New York Times. When you look at the research that we’ve done, tons of people actually say, “Jeez, we’ve felt sort of guilty getting this for free all these years. We actually want to step up and pay, because we know we’re supporting a valuable institution.2

However, many commentators, both in the blogosphere and in the traditional media, were openly critical of this approach. Michael DeGusta, a blogger, represented the critics’ view: “It’s sad that instead of competing for the future by pricing for the digital age, The Times has opted to fight an inevitably doomed battle to hold on to the past.”3

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512-077 The New York Times Paywall

Mathew Ingram of GigaOm considered The Times paywall as a stopgap arrangement and went on to say, “If paywall is your only strategy, then you are doomed.”4 Katharine Weymouth, publisher of The Washington Post, another major newspaper, strongly resisted a paywall:

For us, we believe at the moment it doesn’t make sense. We are making a bet for the long term. We want to be around as The Washington Post for a long time and many generations to come, and at the moment, we think that the best way to do that is to have a free website that is open to everybody and attract as many people as we can to spend as much time as they can with our journalism, and assume that that will bring them back for more.5

By December 2011, digital subscribers for The Times grew to 390,000, and Arthur Sulzberger, Jr., the company’s chairman, described the paywall as a success that represented “a robust new revenue stream.”6

However the long-term prospects of paywalls remained uncertain. The subscriber growth was slowing down, and many of the paid subscribers of The Times were enticed by the introductory offer of 99 cents for a 4-week subscription. A previous experiment with a paywall, TimesSelect, was abandoned in 2007 after The Times secured 227,000 paying customers.

Was the paywall a good idea for the long-term? Would it provide a foundation for a sustainable business model as The Times approached an ever-evolving technology and media landscape?

Company Background

The New York Times Company was a leading global multimedia news and information company with 2011 revenues of $2.3 billion and an operating profit of $57 million, and operated The New York Times, the International Herald Tribune, The Boston Globe, and About.com. (See Exhibit 1 for company structure, Exhibit 2 for business units and their revenues, and Exhibit 3 for company financials.) The company defined its core purpose as “enhance[ing] society by creating, collecting and distributing high quality news, information and entertainment.”7

The New York Times, the flagship daily newspaper of the company, was founded on September 18, 1851, by journalist and politician Henry Jarvis Raymond, and former banker George Jones. By 2011, the newspaper had won 106 Pulitzer Prizes, the most of any news organization. Reflecting on The Times’s importance, Michael Hirschorn, the contributing editor of the Atlantic, remarked:

The Times still, I think to a remarkable degree, does set the agenda. You really can trace almost any major story these days to something that originally appeared in The Times. The problem is that once it reaches the public, they may not even know it came from The Times.8

In spite of its prize-winning journalism, The Times was facing significant pressures. Its subscription and revenues had steadily declined over the years (see Exhibits 3 and 4). Its advertising revenues in 2011 were down by over 6% compared with 2010 ad revenues, and in spite of cost cutting, the operating profit in 2011 was 76% less than the previous year. In January 2012, the company sold its Regional Media Group consisting of 16 regional newspapers for $143 million in cash.9

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The New York Times Paywall 512-077

The Newspaper Industry

The New York Times was not alone in feeling this pressure—the entire newspaper industry was facing significant challenges. Overall circulation in the industry for both weekday and weekend newspapers was declining (Exhibit 5). Traditional sources of newspaper revenues—subscription, retail, and classified advertising—were also declining (Exhibit 6). In contrast, most of the costs for editorial staff, production, and distribution were fixed and had very little room for reduction. Table

A shows the revenue and cost structure of a typical U.S. newspaper.

Table A Revenue and Cost Breakdown of a Typical U.S. Newspaper, circa 2010

Revenue (%) Cost (%)

Advertising 75% Core 37%

Retail 42% Promotion 13% Classified 25% Editorial 15% National 8% Administrative 9% Subscription and Newsstand 25% Production & Distribution 52% Production 20% Distribution 14% Raw materials 18%

Source: Harold L. Vogel, Entertainment Industry Economics, 8th edition (Cambridge University Press, 2010), p. 371.

The U.S. newspaper industry, with 2009 annual revenues of around $35 billion, was highly fragmented with over 5,000 players.10 However, the top 50 firms accounted for over three-quarters of the industry’s revenue. The top 25 newspapers ranged from national newspapers like USA Today and The Wall Street Journal to more regionally focused dailies like The Boston Globe (Exhibit 7).

Digital Disruption

The rise of the Internet brought new opportunities and challenges for the newspaper industry. Nicholas Carr, a technology writer at The Times, described the digital disruption for this industry:

The nature of a newspaper, both as a medium for information and as a business, changes when it loses its physical form and shifts to the Internet. It gets read in a different way, and it makes money in a different way. A print newspaper provides an array of content—local stories, national and international reports, news analyses, editorials and opinion columns, photographs, sports scores, stock tables, TV listings, cartoons, and a variety of classified and display advertising—all bundled together into a single product . . . . When a newspaper moves online, the bundle falls apart.11

The industry had clearly struggled with the advent of digital media. James McQuivey of Forrester Research summed up the dire situation: “The newspaper industry didn’t see monster.com taking the jobs portion away. They didn’t see Craigslist taking the classified portions away. They didn’t see Ford or GM making their own websites to take automotive advertising basically away forever.”12

Clay Shirky, a writer and media commentator, provided a grim perspective of newspapers:

Society doesn’t need newspapers. What we need is journalism. For a century, the imperatives to strengthen journalism and to strengthen newspapers have been so tightly wound as to be

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512-077 The New York Times Paywall

indistinguishable. That’s been a fine accident to have, but when that accident stops, as it is stopping before our eyes, we’re going to need lots of other ways to strengthen journalism instead.13

Newspapers’ Response

While the Internet posed some threats to newspapers, it also offered them new ways to reach their audience. Almost all of the major newspapers rushed to put their content online for free, and the industry witnessed a tremendous growth in online traffic of readers (Exhibit 8). According to comScore, a market research company, over 123 million people in the U.S. visited newspaper websites in May 2010, making the transition to online news highly important for the entire industry. The Pew Research Center reported that the Internet was the number-two source for news after television, but was ahead of newspapers and radio.14

For newspapers, the new source of revenue through online advertising, however, did not compensate for the revenue decline from print. Online advertising rates for newspaper websites were significantly lower than the print advertising rates, and by 2009, online advertising revenue was only 8.2% of total newspaper revenue.15

Some local newspapers, like the Detroit Free Press, responded to falling circulation by limiting home deliveries to certain days of the week (e.g., Sundays) when advertising was high.16 Others, like the Ann Arbor News, chose to shut down print operations and move all of its content online.17

A few newspapers had implemented paywalls, most notably The Wall Street Journal (WSJ), which received over 15 million unique visitors to its website every month, in addition to remaining the largest newspaper by weekday circulation. However, this experience was not representative for most newspapers, since WSJ dealt with more specialized content. In fact, when The Times of London had introduced a paywall in May 2010, its traffic dropped from 2.79 million unique visitors before the paywall to 1.61 million a few months after the paywall was introduced.18

Other media sectors, including music, books, and movies, had struggled through their own transitions to digital media. Reflecting on the challenges of transition accompanied by these new channels, Jeff Zucker, the CEO of NBC Universal, said in 2008:

What we know historically is every time there’s a new avenue of distribution, that’s good for the consumer . . . What we have to do is make sure we’re playing in both worlds, the digital world, and the analog world. The economics around these digital properties are not yet fully formed—they will be, but that’s five years at least. We can’t trade analog dollars for digital pennies.19

The iPad Arrives: Spring 2010

In the midst of the online trends buffeting the industry, the introduction of the iPad provided a revolutionary new platform for consuming news. On January 27, 2010, Martin Nisenholtz joined Steve Jobs on stage to present a slick Times iPad app during launch, saying: “We’re incredibly psyched to pioneer the next generation of digital journalism. We want to create the best of print and

best of digital, all rolled up into one.”a

a In pricing the digital subscription, The Times had to account for a 30% revenue share with Apple if a new subscriber was

acquired through the app store, but consumers who had subscribed directly with The Times were not subject to the 30% fee.

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The New York Times Paywall 512-077

There was huge speculation in the media about the effects of the iPad, with diverging opinions on whether it was the last best hope for an old media industry, or whether it would merely hasten its decline. Mercedes Bunz of The Guardian, a UK-based newspaper, had commented: “If Steve Jobs would save journalism, it might be possible that publishers would get him the Holy Grail.”20 Rupert Murdoch, the chairman of News Corporation, which owned The Wall Street Journal and Fox News in the U.S., remarked: “The iPad may well be the saving of the newspaper industry [ . . . ] it’s better than them getting out of business altogether.”21

The iPad was considered a significant new way to consume digital media, since the “lean back” experience it enabled was more immersive and considerably different from the “lean forward” experience that users typically had with a computer. A survey by the Reynolds Journalism Institute in Fall 2010 revealed that 99% of iPad users consumed news on the device, and user experience on the iPad was closest to a print newspaper. Those who owned iPads were also found to be less likely to have and retain subscriptions to newspapers.22

Earlier Paywalls at The Times

The First Experiment

In 1996, The Times launched its website and started charging overseas users $35 per month for access to the site. This experiment was abandoned about two years later; the company cited an interest in increased advertising revenue as the cause for the shift.23 Nisenholtz explained: “Internet usage overseas is growing at a faster pace than domestic usage and we are intent on building our franchise worldwide. We are convinced that our advertiser-supported, no-fee registration model, which has worked so well for us here, is the best path to accomplish this.”

TimesSelect—The Second Experiment

TimesSelect was the second attempt by The Times to charge its readers. The program was introduced in September 2005, and was priced at $49.95 per year for access to noted columnists like Thomas Friedman, Nicholas Kristof, and Paul Krugman. Access to news and other content on The Times website remained free. The paywall offered discounts to college students and other select readers, and remained free to all of its print subscribers.

Within two years of its introduction, TimesSelect grew to 227,000 paid subscribers (Exhibit 9). However, the rise of social media and high-quality blogs led many users to question the value of the content on TimesSelect. In addition, the columnists featured in TimesSelect were said to be unhappy with the system. Tom Friedman had remarked at the time, ”It pains me enormously, because it’s cut me off from a lot of people, especially because I have a lot of people who read me overseas . . . .”24

Faced with widespread criticism of the paywall approach, the program ended on September 19, 2007. In a letter to readers explaining the decision, Vivian Schiller, senior vice president and general manager of The Times, wrote:

Since we launched TimesSelect in 2005, the online landscape has altered significantly. Readers increasingly find news through search, as well as through social networks, blogs and other online sources. In light of this shift, we believe offering unfettered access to The New York Times reporting and analysis best serves the interest of our readers, our brand and the long-term vitality of our journalism. We encourage everyone to read our news and opinion—as well as share it, link to it and comment on it.25

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512-077 The New York Times Paywall

Designing the New Paywall

The Times management designed the new paywall after considerable research and its own reflections on lessons learned from the nearly two years of operating TimesSelect. The success and failure of other newspapers were also helpful in management’s deliberations.

Metered System

There were four broad options for designing the new paywall, based on the degree of access provided to users, the type of content, and the type of medium that was included.

 All or nothing: In this option users would not get access to any content unless they subscribed to the newspaper. The Economist and The Times of London were examples of publications that chose a version of this option.

 Exclusive content: Another option was to make the news content available for free to everyone, since many consumers viewed news as a commodity, but restrict access to exclusive content, such as op-ed articles and analysis, to paid subscribers. TimesSelect was based on this option.

 Metered system: The third option was to use a metered system where users would be able to get free access to all content up to a pre-specified number of articles or pages, but would need to subscribe for access beyond this threshold.

 Device-specific offer: The Times could also charge consumers based on the medium (e.g., print newspaper, website, iPad) by which they consumed news. Given the recent evolution of these technologies, few publications had chosen this option.

After much debate, the management chose a device-specific and metered system that allowed users to read 20 articles a month without paying. The limit of 20 articles was chosen to draw in subscription revenue from the most loyal readers who saw value in The Times content, while not driving away casual visitors who made up the vast majority of the site’s traffic. The home page at nytimes.com and all section front pages were free to all users at all times, whereas for the iPhone and iPad apps, the “Top News” was free and all other content was placed behind the paywall.

Since the cost of serving more content to an additional user was minimal, not everyone in the industry agreed with the idea of charging based on the amount of content consumed. Raju Narisetti, managing editor at The Washington Post, disagreed with this approach, tweeting: “Don’t penalize engaged readers of websites with a paywall: reward your active users.”26 Jeff Jarvis, a journalism professor and media expert, went even further by suggesting a “reverse paywall” where the more active users would see their charges reduced as a reward for their loyalty.27

Leaky Wall

The new paywall accommodated users who came in from traffic generators like social networks and search engines. Readers who came in through Google were restricted to a five-article-per-day limit over and above the 20 monthly allotted articles, whereas those who visited from social media sites like Facebook and Twitter as well as other search engines faced no limits, as long as articles were linked directly from those sources.

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The New York Times Paywall 512-077

Thus, the company created a “leaky paywall” design rather than the “bulletproof paywall” approach adopted by other publishers like the Financial Times or The Wall Street Journal, which did not permit any user who had not registered to have access to any article.

Although this system had the potential to cause user confusion about what was freely available, The Times was trying to generate additional revenue while promoting the social buzz generated by its articles. (Exhibit 10 shows the top five sources of incoming traffic to The Times website.)

Pricing

The pricing for digital access was put into three tiers depending on the device used to access content (see Table B for the pricing of digital and print editions). After accounting for introductory offers and special deals, the average price paid by the digital subscribers of The Times by the end of 2011 was estimated to be a little over $4.00 per week.28 All print subscribers were granted full access to all content across all media without any additional charge.

Table B Pricing of Digital and Print Editions of The New York Times, 2011 (per week)

Digital Print Home Delivery

Subscription Price Subscription Price

NYTimes.com + Smartphone $3.75 Seven Days $15.40

NYTimes.com + Tablet $5.00 Friday–Sunday $10.80

All Digital Access $8.75 Sunday $7.80

(NYTimes.com + Smartphone + Tablet) Monday–Friday $7.70

Note: Print home delivery prices are approximate and depend on location.

Source: Company website.

Bloggers and media pundits were highly skeptical about this pricing. One blogger, Michael DeGusta, compared the annual cost of digital access to The Times with the cost of other digital content (Exhibit 11), and commented: “Does The Times really think the mass audience is going to decide their $455/year is better spent on The Times rather than getting 20+ free articles/month from The Times plus The Wall Street Journal ($207/year) plus The Economist ($110/year) plus say The Daily ($39/year) for good measure, and still having ~$100 left over each year?”

Promotions

In addition to marketing the new digital program to its current print subscribers (who got the digital access for free) and lapsed subscribers, The Times also partnered with the auto manufacturer Lincoln to provide free subscriptions to heavy users of the website until the end of 2011. Lincoln aimed to reach an audience that would help the company build its brand, and it expected to execute this strategy with an e-mail campaign and through interstitial ads on The Times website.

Connie Fontaine, manager of U.S. Lincoln marketing communications, said, “Our brand is one that has a lot of great news and a lot to say but isn’t always heard. The Times did bring us this idea and we thought it was really relevant to the brand for a lot of reasons. The type of reader we’ll be able to engage through this program is a thought leader.”29

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512-077 The New York Times Paywall

Although Lincoln would not pay the actual subscription costs for participating readers, valued at $150 per reader, the company was expected to increase its online ad spending with The Times.30 Details of the agreement were kept private.

Early Results

In a press release in February 2012, the company reported 390,000 paid subscribers for its new digital initiative, including The Times and the International Herald Tribune (Exhibit 12).31 In addition, almost 70% of the print subscribers registered for digital access, which was free with their print subscription. Commenting on the 2011 results, chairman Sulzberger, Jr. said:

In 2011 we made significant strides in our strategy to transform and rebalance our Company. Our fourth-quarter results demonstrate the continued focus on building The Times’s digital subscription base and developing a new robust consumer revenue stream, while maintaining its significant digital advertising business.32

A key concern was the potential drop in website traffic and online advertising revenue. The Times of London had started a paywall in July 2010, and within 17 days its web traffic dropped by 66%.33 (Exhibit 13 shows unique visitors and page views of The New York Times before and after the paywall.)

In Q4 2011, the digital advertising revenue for the News Media Group—that included The New York Times Media Group, The New England Media Group, and The Regional Media Group— increased by 5.3% but print advertising revenue declined by 7.8%. For 2011, digital advertising revenue for the company was about 28% of total ad revenue. Table C shows the revenues of The New York Times Media Group (which included The Times and International Herald Tribune).

Table C Revenues of The New York Times Media Group (in millions of dollars)

Revenues 2011 2010 2009 2008

Advertising 756 780 797 1,068

Circulation 705 684 683 668

Other 93 93 101 181

Total 1,555 1,557 1,582 1,917

Source: Compiled from company annual reports and press releases.

Note: Circulation in 2011 includes revenues from both print and digital subscribers.

The Future of Newspapers

Some experts in the industry considered The Times paywall a success. Encouraged by the results of The Times paywall, in September 2011 the company introduced a paywall for The Boston Globe, another newspaper in its News Media Group which covered the New England region. By the end of December 2011, The Globe had attracted 16,000 paid subscribers.34

At the same time, others viewed this as only a stopgap arrangement for the eventual decline of newspapers. John Paton, CEO of the Journal Register Company that oversaw several local newspapers, was a particularly outspoken critic of the paywall strategy:35

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The New York Times Paywall 512-077

Newspapers have less than 10 years in America to change their business models profoundly or they’re going to go out of business. And this doesn’t do it, focusing on paywalls, marrying a new idea to an old model. Focusing on paywalls is an idea that’s never going to fail to fail [sic].

The industry was buzzing with a series of questions and speculation. Was the paywall working? Would the paid subscriber growth continue? Would subscribers enticed by the introductory offer pay full price? Would churn among digital subscriber be higher or lower than for print subscribers? Would digital subscription cannibalize print subscription? Would the digital strategy change the content and editorial process of the print edition? Most important, would the strategy provide a sustainable business model for The Times to create a multimedia multi-platform news presence in the future?

Newspapers across the world were carefully watching The Times experiment with the paywall in the hope that this might provide a solution to their declining fortunes. Frédéric Filloux, a blogger who covered technology and media, had remarked on the blog Monday Note: “Every newspaper, magazine or website is working on a paywall of sorts and closely monitoring what everyone else is doing…The strongest players don’t just bow to the inevitable, they accelerate their transition to digital.”36

But as Tom Ashbrook had wondered, could the paywall be a strategy of the past with no relevance to the future, which would instead bring new and ever-evolving technologies for consumers to receive news? Or could the strategy be a savior for the declining newspaper industry?

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512-077 The New York Times Paywall

Exhibit 1 The New York Times Business Units

Source: Casewriters, from company website.

Exhibit 2 The New York Times Company Revenue by Business Unit

Source: Compiled from company annual reports and press release.

The New York Times Company

New York Times

Media Group

New England

Media Group

Regional

Media Group

About

Group Joint

Ventures

• The New York Times

• International Herald

Tribune

Fifteen newspapers in the

Southeast and California

(sold in 2012)

• About.com

• caloriecount.com,

a diet and nutrition

Community

• consumersearch.com,

a product review

aggregator

• The Boston Globe

• Worcester Telegram &

Gazette

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The New York Times Paywall 512-077

Exhibit 3 Selected Financials of The New York Times Company ($ millions)

2011 2010 2009 2008

Revenues

Advertising 1221 1300 1336 1771

Circulation 941 931 936 910

Other 160 162 167 258

Total Revenues 2323 2393 2440 2940

Operating Costs

Production Costs 957 962 1021 1310

SG&A 1020 1054 1153 1328

Depreciation and amortization 116 121 134 144

Total Operating Costs 2094 2137 2308 2783

Operating Profit/Loss 57 234 74 (41)

Net Income/Loss (40) 108 20 (58)

Source: Compiled from company annual reports and press release.

Note: In 2011, the company took a non-cash charge of $161 million for the write-down of goodwill at the Regional Media Group.

Exhibit 4 Print Subscriptions to The New York Times

Source: Casewriter, based on data from Audit Bureau of Circulation and publisher’s statements.

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

2007

2008

2009

2010

2011

S u

b sc

ri p

ti o

n s

Date

New York Times Print Subscriptions

Sunday Print Weekday Average Print Saturday Print

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512-077 The New York Times Paywall

Exhibit 5 Number of Newspapers and Total Circulation (000s)

Source: Casewriter, based on data from Newspaper Association of America.

Exhibit 6 Newspaper Advertising and Classified Revenues ($ millions)

Source: Casewriter, based on data from Newspaper Association of America.

200

400

600

800

1,000

1,200

1,400

1,600

10,000

20,000

30,000

40,000

50,000

60,000

70,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Weekday Cirulation Sunday Circulation

Weekday Newspapers Sunday Newspapers

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

$40,000

$45,000

$50,000

2003 2004 2005 2006 2007 2008 2009 2010

National Retail Classified Total Print Online

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The New York Times Paywall 512-077

Exhibit 7 Top 25 Daily Newspapers in the U.S. by Circulation in 2011

Rank State Newspaper Name Average Daily

Circulation

1 NY Wall Street Journal 2,096,169

2 DC USA Today 1,784,242

3 NY New York Times 1,150,589

4 NY New York Daily News 605,677

5 CA Los Angeles Times 572,998

6 CA San Jose Mercury News 527,568

7 NY New York Post 512,067

8 DC Washington Post 507,465

9 IL Chicago Tribune 425,370

10 TX Dallas Morning News 409,642

11 NY Newsday 404,542

12 IL Chicago Sun-Times 389,353

13 TX Houston Chronicle 369,710

14 CO Denver Post 353,115

15 PA Philadelphia Inquirer 331,134

16 MN Star-Tribune 298,147

17 AZ Arizona Republic 292,838

18 CA Orange County Register 270,809

19 OH Cleveland Plain Dealer 243,299

20 WA Seattle Times 242,814

21 OR Oregonian 242,784

22 FL St. Petersburg Times 240,024

23 MI Detroit Free Press (e) 234,579

24 CA San Francisco Chronicle 220,515

25 CA San Diego Union-Tribune 219,347

Source: Audit Bureau of Circulation, compiled by Poynter Institute; http://www.poynter.org/latestnews/mediawire/ 151696/wall-street-journal-usa-today-new-york-times-top-latest-circulation-report/, accessed February 2012.

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512-077 The New York Times Paywall

Exhibit 8 Online Newspaper Web Traffic in the U.S. (unique monthly visitors)

Source: Nielsen Online, MegaPanel data.

Exhibit 9 TimesSelect Subscriptions over Time

Source: Company public communications.

10,000,000

20,000,000

30,000,000

40,000,000

50,000,000

60,000,000

70,000,000

80,000,000

Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09

135,000

156,000

183,000

198,690

220,090 224,580 227,000

50,000

100,000

150,000

200,000

250,000

Sep 2005 Nov 2005 Jan 2006 Jun 2006 Sep 2006 Apr 2006 Jun 2007 Sep 2007

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The New York Times Paywall 512-077

Exhibit 10 Source of Traffic to The Times Website

Source: comScore Media Metrix, http://www.comscoredatamine.com/2011/03/google-most-popular-incoming-traffic-

source-worldwide-for-the-new-york-times/, accessed February 2012.

Exhibit 11 Comparison of Annual Subscription Rates for Online Content

Source: Adapted from chart by Michael DeGusta, theunderstatement, http://theunderstatement.com/post/4019228737/ digital-subscription-prices-visualized-aka-the-new, accessed February 2012.

100

150

200

250

300

350

400

450

500

Hulu Plus Netflix USA Today The Economist

The Wall Street

Journal

The New York Times

Annual Subscription Rates in US Dollars

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512-077 The New York Times Paywall

Exhibit 12 Paid Digital Subscribers to The Times

Source: Company, from public announcements.

100,000

224,000

324,000

390,000

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

Mar 2011 Apr 2011 Jul 2011 Oct 2011 Dec 2011

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The New York Times Paywall 512-077

Exhibit 13 Online Newspaper Web Traffic (a) Number of unique visitors (millions)

(b) Page Views (millions)

Source: comScore.

May-2010 Aug-2010 Nov-2010 Feb-2011 May-2011 Aug-2011 Nov-2011 Jan-2012

NYTIMES.COM USATODAY.COM WASHINGTONPOST.COM

LATIMES.COM WSJ.COM CHICAGOTRIBUNE.COM

100

200

300

400

500

600

700

800

May-2010 Aug-2010 Nov-2010 Feb-2011 May-2011 Aug-2011 Nov-2011 Jan-2012

NYTIMES.COM USATODAY.COM WASHINGTONPOST.COM

LATIMES.COM WSJ.COM CHICAGOTRIBUNE.COM

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512-077 The New York Times Paywall

Endnotes

1 “Fees And Free-Riders: The News Content Paywall Debate,” On Point with Tom Ashbrook, March 28, 2011, http://onpoint.wbur.org/2011/03/28/behind-the-paywall, accessed February 2012.

2 Peter Kafka, “Q&A: New York Times Digital Czar Martin Nisenholtz on the Paywall, Pricing, Google and Apple,” AllThingsD, March 18, 2011, http://allthingsd.com/20110318/qa-new-york-times-digital-czar-martin- nisenholtz-on-the-paywall-pricing-google-and-apple/, accessed February 2012.

3 Michael DeGusta, “Digital Subscription Prices Visualized (aka The New York Times Is Delusional),” theunderstatement, March 21, 2011, http://theunderstatement.com/post/4019228737/digital-subscription-prices- visualized-aka-the-new, accessed February 2012.

4 Mathew Ingram, “If a paywall is your only strategy, then you are doomed,” GigaOm, October 31, 2011, http://gigaom.com/2011/10/31/if-a-paywall-is-your-only-strategy-then-you-are-doomed/, accessed February 2012.

5 Keach Hagey, “A Washington Post paywall? No time soon,” Politico, October 20, 2011, http://www. politico.com/news/stories/1011/66429.html, accessed February 2012.

6 Amy Chozick, “Fourth-Quarter Profit and Revenue Declined at the New York Times Company,” The New York Times, February 2, 2012.

7 The New York Times Company, “Our Core Purpose,” http://www.nytco.com/careers/mission.html, accessed February 2012.

8 Page One: Inside the New York Times, Magnolia Entertainment (DVD, 2011).

9 The Associated Press, “New York Times selling regional papers for $143M,” December 27, 2011. http://www.businessweek.com/ap/financialnews/D9RT7E3G1.htm, accessed February 2012.

10 U.S. Census Bureau, Service Annual Survey, 2009, http://www2.census.gov/services/sas/data/ Historical/sas-09.pdf, accessed February 2012.

11 Nicholas Carr, “The Great Unbundling: Newspapers & the Net,” Encyclopedia Britannica Blog, April 7, 2008, http://www.britannica.com/blogs/2008/04/the-great-unbundling-newspapers-the-net/, accessed February 2012.

12 Page One: Inside the New York Times, Magnolia Entertainment (DVD, 2011).

13 Clay Shirky (blog), “Newspapers and Thinking the Unthinkable,” March 13, 2009, http://www.shirky. com/weblog/2009/03/newspapers-and-thinking-the-unthinkable/, accessed February 2012.

14 Pew Research Center, “Understanding the participatory news consumer,” March 1, 2010, http://www. pewinternet.org/~/media/Files/Reports/2010/PIP_Understanding_the_Participatory_News_Consumer.pdf, accessed February 2012.

15 Hal Varian, “Newspaper economics: offline and online,” Google Public Policy Blog, March 9, 2010, http:// googlepublicpolicy.blogspot.com/2010/03/newspaper-economics-online-and-offline.html, accessed February 2012.

16 Richard Perez-Pena and Mary Chapman, “Detroit’s Daily Papers Are Now Not So Daily,” The New York Times, March 30, 2009, http://www.nytimes.com/2009/03/31/business/media/31paper.html, accessed February 2012.

17 Jaclyn Trop, “Ann Arbor to stop the presses,” The Detroit News, March 24, 2009. http://www.detroitnews. com/article/20090324/BIZ/903240382, accessed February 2012.

18 Sarah Shearman, “Times loses 1.2 million readers,” August 16, 2010, Media Week (UK), http://www. mediaweek.co.uk/news/1022312/Times-loses-12m-readers/ , accessed February 2012.

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The New York Times Paywall 512-077

19 Liz Gannes, “NBC Jeff Zucker Dishes on Strike, Hulu, iTunes, Kitchen Sink,” GigaOm, February 27, 2008, http://gigaom.com/video/nbc-jeff-zucker-dishes-on-strike-hulu-itunes-kitchen-sink/, accessed February 2012.

20 Mercedes Bunz, “Can the Apple iPad save newspapers?” January 28, 2010, PDA The Digital Content Blog, The Guardian (UK), http://www.guardian.co.uk/media/pda/2010/jan/28/can-apple-ipad-save-newspapers, accessed February 2012.

21 Judith Burns, “Apple’s iPad may save the newspaper industry, says Rupert Murdoch,” Dow Jones Newswires, April 7, 2010, The Australian, http://www.theaustralian.com.au/media/rupert-murdoch-to-stop- google-from-taking-free-content/story-e6frg996-1225850986707, accessed February 2012.

22 Reynolds Journalism Institute, 2012 Mobile Media News Consumption Survey, May 2012, http://www.rjionline.org/news/2012-rji-mobile-media-news-consumption-survey-description, accessed October 2012.

23 Beth Lipton Krigel, “N.Y. Times lifts overseas fee,” July 14, 1998, c/net (CBS Interactive), http://news.cnet.com/N.Y.-Times-lifts-overseas-fee/2100-1023_3-213316.html, accessed February 2012.

24 Dylan, “Why NYT‘s Thomas Friedman Hates TimesSelect,” June 13, 2006, FishbowlNY (blog), Mediabistro, http://www.mediabistro.com/fishbowlny/why-nyts-thomas-friedman-hates-timesselect_b2384, accessed February 2012.

25 Vivian Schiller, “A Letter to Readers About TimesSelect,“ Member Center, The New York Times, 2007, http://www.nytimes.com/ref/membercenter/lettertoreaders.html, accessed February 2012.

26 Mathew Ingram, “Don’t penalize loyal users with paywalls, reward them,” GigaOm, December 20, 2011, http://gigaom.com/2011/12/20/dont-penalize-loyal-users-with-paywalls-reward-them, accessed February 2012.

27 Jeff Jarvis, “Why not a reverse meter?” Buzzmachine, December 19, 2011, http://www.buzzmachine. com/2011/12/19/why-not-a-reverse-meter/, accessed February 2012.

28 Ken Doctor, “At Almost 400,000 Digital Subscribers, Inside the New York Times Pay Strategy, Year 2,” Newsonomics, February 2, 2012, http://newsonomics.com/at-almost-400000-digital-subscribers-inside-the-new- york-times-pay-strategy-year-2/, accessed February 2012.

29 PSFK, “Lincoln Offers Frequent NY Times Readers a Way around the Paywall,” 2011, http://www.psfk.com/2011/03/lincoln-offers-frequent-ny-times-readers-a-way-around-the-paywall.html, accessed February 2012.

30 “Lincoln to Sponsor New York Times Readers,” The Wall Street Journal, March 22, 2011, http:// online.wsj.com/article/SB10001424052748704461304576216770555617038.html, accessed February 2012.

31 The New York Times, 2011 Earnings Report.

32 The New York Times Company, “The New York Times Company Reports 2011 Fourth-Quarter and Full- Year Results,” press release, February 2, 2012, http://www.nytco.com/pdf/FYRE20LEA11E.pdf, accessed February 2012.

33 Doug Mataconis, “London Times Web Traffic Falls 66% After Paywall Goes Up,” Outside the Beltway, July 19, 2010, http://www.outsidethebeltway.com/london-times-web-traffic-falls-66-after-paywall-goes-up/, accessed February 2012.

34 The New York Times Company, “The New York Times Company Reports 2011 Fourth-Quarter and Full- Year Results,” press release, February 2, 2012.

35 “Fees And Free-Riders: The News Content Paywall Debate,” On Point with Tom Ashbrook, March 28, 2011, http://onpoint.wbur.org/2011/03/28/behind-the-paywall, accessed February 12, 2012.

36 Frédéric Filloux, “Cracking the Paywall,” Monday Note, January 8, 2012, http://www.mondaynote.com/ 2012/01/08/cracking-the-paywall/, dated January 8, 2012.

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Thinking Strategically .pdf

Thinking Strategically

Harvard Business Press Boston, Massachusetts

ISBN-13: 978-1-4221-5559-2

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Thinking Strategically

Blind Folio i

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Becoming a New Manager

Coaching People

Creating a Business Plan

Delegating Work

Developing Employees

Dismissing an Employee

Executing Innovation

Executing Strategy

Fostering Creativity

Giving Feedback

Giving Presentations

Hiring an Employee

Laying Off Employees

Leading People

Leading Teams

Making Decisions

Managing Change

Managing Crises

Managing Difficult

Interactions

Managing Diversity

Managing Projects

Managing Stress

Managing Time

Pocket Mentor Series

The Pocket Mentor Series offers immediate solutions to

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Each book in the series is packed with handy tools, self-tests,

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and weaknesses and hone critical skills. Whether you’re at

your desk, in a meeting, or on the road, these portable

guides enable you to tackle the daily demands of your work

with greater speed, savvy, and effectiveness.

Books in the series:

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Managing Up

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Negotiating Outcomes

Performance Appraisal

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Preparing a Budget

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Running Meetings

Setting Goals

Shaping Your Career

Understanding Finance

Understanding Marketing

Writing for Business

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Thinking Strategically

Expert Solutions to Everyday Challenges

Harvard Business Press

Boston, Massachusetts

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vi Blind Folio

No part of this publication may be reproduced, stored in or introduced into a

retrieval system, or transmitted, in any form, or by any means (electronic,

mechanical, photocopying, recording, or otherwise), without the prior permission

of the publisher. Requests for permission should be directed to permissions@hbsp.

harvard.edu, or mailed to Permissions, Harvard Business School Publishing,

60 Harvard Way, Boston, Massachusetts 02163.

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mailto:[email protected]

Contents

Mentor’s Message: Why Learn to Think Strategically? xi

Thinking Strategically: The Basics

An Overview of Thinking Strategically 3

A look at key elements of strategic thinking.

What is strategic thinking? 4

Why is strategic thinking important? 5

Who needs to think strategically? 6

What are the distinguishing characteristics of

strategic thinkers? 7

What are the steps in strategic thinking? 9

Step 1: See the Big Picture 11

How to begin setting the stage for thinking strategically.

Understanding company and unit strategies 12

Analyzing customers, competitors, and your industry 16

Considering internal stakeholders’ priorities 18

vii

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viii Contents

Step 2: Articulate Strategic Objectives 23

Suggestions for focusing on important goals.

Understanding your boss’s objectives 24

Defining your own objectives 26

Identifying project-related objectives 27

Making your objectives “SMART” 28

Step 3: Identify Relationships, Patterns, and Trends 31

Ideas for seeing connections and paring down the number of issues

to grapple with.

Understanding how it works 32

Devising solutions 33

Categorizing information 34

Step 4: Get Creative 37

Tips for generating alternative courses of action.

Challenging your assumptions 38

Inviting provocation 39

Envisioning an ideal world 40

Gathering others’ perspectives 41

Fostering an environment for creativity 42

Step 5: Analyze Information 45

Ideas for sorting through and prioritizing information.

Identifying critical information you need 46

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Contents ix

Steering clear of irrelevant information 49

Crafting an information-gathering plan 50

Building on existing knowledge 52

Step 6: Prioritize Your Actions 55

Recommendations for staying focused on your objectives.

Establishing time lines 56

Keeping the big picture in sight 57

Step 7: Make Trade-Offs 59

Tactics for striking the right balance in the course of action

you’ve chosen.

Assessing the pros and cons of a proposed course of action 60

Comparing short- and long-term outcomes 61

Balancing unit and company needs 63

Learning to say no 64

Tips and Tools

Tools for Thinking Strategically 69

Worksheets to help you assess your strategic thinking skills.

Test Yourself 89

A helpful review of concepts presented in this guide. Take it before

and after you’ve read the guide, to see how much you’ve learned.

Answers to test questions 93

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x Contents

To Learn More 97

Further titles of articles and books if you want to go more deeply

into the topic.

Sources for Thinking Strategically 105

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Mentor’s Message: Why Learn to

Think Strategically?

As a manager, you work in one part of an organization that has

many parts. And every day, you make decisions—choices that can

help or hurt your organization, depending on how strategic they

are. To make decisions that generate the best possible results overall

for your organization, you need to consider the wider implications

of each course of action you’re considering. And you have to work

around the fact that you’ll always have limited (and often confus-

ing) information with which to approach complex decisions.

To make the wisest possible choices, you need to think strategi-

cally. But thinking strategically is a process consisting of a set of skills

that you must practice, learn, and apply in a particular sequence.

This book helps you master the skills essential to the process. You’ll

start by discovering how to understand the business environment

you’re operating in and how to clarify objectives you want to

achieve—to set the stage for making a strategic decision. Next, you’ll

learn how to apply five crucial strategic thinking skills: identifying re-

lationships, patterns, and trends in your business environment;

thinking creatively; analyzing information; prioritizing your actions;

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xii Mentor’s Message

and making the trade-offs that inevitably come with choosing one

course of action.

Master the strategic thinking process and its specific skills, and

you become a true strategic partner in your organization.

David J. Collis, Mentor

David J. Collis is a professor in the strategy unit at the Harvard Busi-

ness School, where he teaches in the MBA and Executive Education

programs. He is an expert on corporate strategy and global competi-

tion, and is the author of the recent books Corporate Strategy (with

Cynthia Montgomery) and Corporate Headquarters (with Michael

Goold and David Young). His work has been frequently published in

Harvard Business Review, Academy of Management Journal, Strategic Management Journal, European Management Journal, and in many

books, including Managing the Multibusiness Company, International Competitiveness, and Beyond Free Trade. In 2008, Professor Collis won

the 50th Anniversary McKinsey award for the best article published

in Harvard Business Review in that year.

In addition to teaching, Professor Collis consults to several major

U.S. corporations, and serves on the board of trustees of the Hult

International Business School, and the advisory boards of Vivaldi

Partners and Folderwave. He is also the cofounder of the eLearning

company E-Edge, and of the advisory firm Ludlow Partners.

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Blind Folio 1

Thinking Strategically:

The Basics

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An Overview of Thinking

Strategically

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4 Thinking Strategically

Your boss just told you to “think strategically”—but what

does that mean? In the pages that follow, we’ll take a closer

look at several key aspects of thinking strategically—what it is,

why it’s important, who needs to think strategically, what distin-

guishes strategic thinkers, and what are the steps in the strategic

thinking process.

What is strategic thinking?

In its most basic sense, strategic thinking is about analyzing oppor-

tunities and problems from a broad perspective and understanding

the potential impact your actions might have on others. Strategic

thinkers visualize what might or could be, and take a holistic ap-

proach to day-to-day issues and challenges. And they make this an

ongoing process rather than a onetime event.

Like other managers, you routinely encounter complex situa-

tions, difficult problems, and challenging decisions. Your job is to

deal with these situations as best you can by using the information

you have. In an ideal world, you would have access to all the infor-

mation you need to navigate through these challenges. Unavoid-

ably, however, you have only a limited amount of information to

work with. And because you sit in a particular part of your organ-

ization, you have a limited view of the forces that lie outside your

sphere of influence.

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An Overview of Thinking Strategically 5

Strategic thinking helps you overcome these limitations. When

you think strategically, you lift your head above your day-to-day

work and consider the larger environment in which you’re operat-

ing. You ask questions and challenge assumptions about how things

work in your company and industry.You gather complex, sometimes

ambiguous data and interpret it. And you use the insights gained to

make smart choices and select appropriate courses of action.

Moreover, you do all these things with an eye toward generat-

ing the best possible business results tomorrow, using the oppor-

tunities presented to you today.

Why is strategic thinking important?

When you and others in your organization think strategically, you

generate important benefits for your organization:

• You chart a course for your group that aligns with the

overall corporate strategy.

• You make smart long-term decisions that complement and

align with decisions that others in your organization are

making.

• You gain your employees’ commitment to supporting your

decisions.

• You boost your group’s performance and maximize business

results.

• You foster a culture that supports fresh thinking and

embraces strategic initiative.

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6 Thinking Strategically

Strategic thinking also nets you valuable professional and per-

sonal benefits—including the respect and appreciation of your su-

pervisor, peers, and direct reports.

The real voyage of discovery consists not in seeking new lands but in

seeing with new eyes.

—Marcel Proust

Who needs to think strategically?

In today’s highly competitive and fast-changing business world,

everyone in an organization must know how to think strategically.

Only then can an organization leverage the full range of creativity

and knowledge embodied throughout its workforce.

Strategic thinking can be especially effective when it’s done col-

laboratively as well as individually. By thinking strategically in

groups, you gain other people’s perspectives on critical and com-

plex issues—an important benefit in today’s challenging business

landscape.

Every manager in your organization has a unique view of how

the company operates. By asking peer managers questions about

how they interact with people from various parts of the enterprise,

you strengthen your understanding of how your actions might

affect them and their work.

For instance, suppose you work in accounts receivable and want

to overhaul your billing system. You know that the IT group, as well

as all managers who generate bills, will be affected. However, you de-

cide to ask others in the organization about how changing the billing

system might have an impact on them. Through conversations with

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An Overview of Thinking Strategically 7

people in the marketing department, you learn that your proposed

changes will have significant consequences for the package design

group. Why? All designs will now need to incorporate a larger bar

code to accommodate changes in the billing-system technology.

By collaborating with others, you gain greater insight into the

complex ramifications of even seemingly minor decisions. This

insight, in turn, helps you make more strategic choices.

What are the distinguishing characteristics of strategic thinkers?

Managers who think strategically demonstrate specific personal

traits, behaviors, attitudes, and thinking skills. For example, you’re

on your way to becoming a strategic thinker if you exhibit the fol-

lowing personal traits:

• Curiosity. You’re genuinely interested in what’s going on

in your unit, company, industry, and wider business

environment.

• Flexibility. You’re able to adapt approaches and shift ideas

when new information suggests the need to do so.

• Future focus. You constantly consider how the conditions in

which your group and company operate may change in the

coming months and years. And you keep an eye out for op-

portunities that may prove valuable in the future—as well as

threats that may be looming.

• Positive outlook. You view challenges as opportunities, and

you believe that success is possible.

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8 Thinking Strategically

• Openness. You welcome new ideas from supervisors, peers,

employees, and outside stakeholders such as customers, sup-

pliers, and business partners. You also take criticism well by

not reacting in a defensive manner.

• Breadth. You continually work to broaden your knowledge

and experience, so you can see connections and patterns

across seemingly unrelated fields of knowledge.

You have the makings of a strategic thinker if you continually

anticipate your actions’ impact on a wide range of individuals—

including, but not limited to, your boss, direct reports, peers, and cus-

tomers. To do this, you need to demonstrate the following behaviors:

• Seek other people’s opinions.

• Ask questions and challenge assumptions about how the

world works.

• Focus on the future.

• Identify the forces driving your unit’s and company’s per-

formance and think about how to improve that performance.

• Watch the competition.

• Reassess who your customers are and what they value.

• Stay up to date on developments occurring in your unit, in

other groups in the company, and in your industry overall.

• Open yourself to ongoing learning by reading books, maga-

zines, and industry reports; attending seminars; and talking

with experts.

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An Overview of Thinking Strategically 9

By practicing these behaviors, you more readily spot valuable

new opportunities to capitalize on. And you identify and repel po-

tential threats before they can do any real damage.

Finally, strategic thinkers demonstrate characteristic thinking

skills. They:

• Objectively analyze a situation and evaluate the pros, cons,

and implications of any course of action.

• Grasp abstract ideas and put the “pieces” together to form a

coherent picture.

• Generate a wide range of options, visualize new possibilities,

and formulate fresh approaches to their work.

• Factor hunches into their decision making without allowing

their hunches to dominate the final outcome.

• Understand the cause-and-effect linkages among the many

elements that make up a system—whether the system is

their team, unit, or organization, or a project or process.

In strategy it is important to see distant things as if they were close

and to take a distanced view of close things.

—Miyamoto Musashi

What are the steps in strategic thinking?

Strategic thinking can be broken down into two phases, each of

which consists of specific steps.

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10 Thinking Strategically

Phase 1—setting the stage—consists of two steps:

1. Seeing the big picture—understanding the broader business

environment in which you operate.

2. Articulating strategic objectives—determining what you

hope to achieve by thinking strategically.

Phase 2—applying your skills—consists of five additional steps:

3. Identifying relationships, patterns, and trends—spotting

patterns across seemingly unrelated events, and categorizing

related information to reduce the number of issues you must

grapple with at one time.

4. Getting creative—generating alternatives, visualizing new

possibilities, challenging your assumptions, and opening

yourself to new information.

5. Analyzing information—sorting out and prioritizing the

most important information while making a decision, man-

aging a project, handling a conflict, and so forth.

6. Prioritizing your actions—staying focused on your objectives

while handling multiple demands and competing priorities.

7. Making trade-offs—recognizing the potential advantages

and disadvantages of an idea or course of action, making

choices regarding what you will and won’t do, and balancing

short- and long-term concerns

In the remaining sections of this book, we’ll take a closer look

at each of these steps.

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Step 1: See the Big Picture

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12 Thinking Strategically

S trategic thinkers continually improve their view of the larger

“business ecosystem” in which they operate. They under-

stand their company’s and unit’s strategies. They stay up to date on

the issues and concerns of their customers, competitors, and indus-

try as they relate to their job function. And they consider the poten-

tial impact of their decisions and actions on the company overall and

on their boss, managers of other units and teams, and employees.

They do all this with a long-term perspective rather than focusing

only on the short-term implications of their actions. They then use

their awareness of the big picture to inform their on-the-job choices.

Understanding company and unit strategies

Awareness of your company’s and unit’s strategies is vital to your

ability to think strategically. Do whatever it takes to understand

the corporate strategy and how it affects your unit’s strategy. Talk

with your boss and peer managers, examine annual reports and

other company publications, and listen to your CEO’s speeches.

Sometimes the way in which executives allocate resources in

your company can suggest something about the high-level strat-

egy. If you observe the company is investing in acquisitions of

competing firms, you might deduce that its strategy involves erad-

icating rivals and growing its market share.

Then use your understanding of this strategy to ensure that your

group supports it. For example, suppose your company has a clearly

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Step 1: See the Big Picture 13

?What Would YOU Do?

Toying with New Ideas

SHANE IS A PRODUCT MANAGER at Bailey Toys and

Games. Top management has recently challenged all

units to increase revenues by 5 percent in the coming year.

Shane’s boss has asked him to think strategically about ways to

fulfill this mandate.

Shane has some ideas about how to update some of the games

in his product line with new packaging and new features that

would really appeal to customers. He’d like to explore the implica-

tions and feasibility of his ideas, but he’s not sure how to proceed.

What would YOU do? The mentor will suggest a solution in

What You COULD Do.

stated strategy of expanding into new markets overseas. You can use

awareness of this high-level strategy to define your group’s direction.

• If you lead a product development group, you might evalu-

ate the appeal that your existing products have in the tar-

geted overseas market.

• If you lead a market research group, you may want to design

surveys and other tools for testing potential interest in your

company’s offerings in the intended new market.

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14 Thinking Strategically

• If you lead a customer service group, perhaps you’ll explore

how your group’s services can be scaled to meet the demand

of the overseas customer segment you’ll be serving.

With every important decision that you weigh, ask, “Will what

I’m considering doing help my unit and company carry out its

strategy? Or will my proposed course of action make it more diffi-

cult for us to achieve our strategic goals?” “Steps for understand-

ing your company’s and unit’s strategies” provides additional

guidance for this aspect of seeing the big picture.

Steps for understanding your company’s and unit’s strategies

1. Determine whether your company and unit have strategic

plans. Ask your boss whether strategic plans exist at the

corporate and unit levels. If so, see if you can obtain copies.

The information contained within these documents will help

you gain a better understanding of your company’s and unit’s

strategic missions, visions, and goals.

2. Talk with your boss about your corporate and unit strategies.

After you have reviewed all the strategy documents that are

available to you, talk with your boss about the company’s

and unit’s future direction. Ask your boss to tell you about

corporate or unit planning sessions that he or she has

attended.

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Step 1: See the Big Picture 15

3. Ask for your peers’ perspectives on company and unit

strategies. Talk with other managers in your organization to

understand how the company and units approach strategy

formulation, planning, and execution.

4. Observe the decisions and messages that executives and

managers in your organization are communicating. Read or

listen to presentations that the CEO has made to the board,

investors, and others. CEO presentations typically communicate

direction and progress toward both short-term business goals

and long-term strategic initiatives. Also:

• If your company is public, read its annual report.

• Review your organization’s Web site.

• Review your company’s advertisements and press releases.

• Look at marketing and product information.

• Examine newsletters and other communication channels

for information about your organization’s strategy.

• Attend all company meetings in which strategies and re-

sults are discussed. Doing so will keep you on top of

changes taking place in the organization.

5. Be able to discuss your company’s and unit’s strategies with

others. By talking about your corporate and unit strategies and

answering questions that others may have, you will deepen your

understanding of the strategies at play within your organiza-

tion. Questions you should be able to answer include:

• What are your company’s and unit’s strategies?

• Why were they chosen?

• What is needed for the strategies to succeed?

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16 Thinking Strategically

Analyzing customers, competitors, and your industry

When thinking strategically, you need to consider what’s going on

outside your company as well as what’s going on inside. That

means staying current with external customers’ needs, competi-

tors’ moves, and industry trends. Your job function will determine

how much you’ll need to make this a priority.

For example, if you work in sales, you’ll need to know your cus-

tomers, competition, and industry intimately. If you work in man-

ufacturing, however, you may not need to study your company’s

competition quite as closely.

The future influences the present just as much as the past.

—Friedrich Nietzsche

To assess developments outside your company, ask these

questions:

• Customers. “Who are our customers, and what do they

value? How might their needs evolve in the future?” Cus-

tomer surveys, focus groups, and other methods can help

you gain answers to these questions. For example, after

surveying customers about their latest challenges, one

manager at an industrial-gas supplier proposed that the

company start providing environmental consulting services

to customers. He won approval for his idea, and the new

service proved a hit—enabling the gas supplier to capture

more of its customers’ spending.

• Competitors. “Who are our current competitors, and what

tactics are they using? How are we different from them?

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Step 1: See the Big Picture 17

What strengths do they have that might prove a threat to us?

What weaknesses might they have that we could exploit?”

You can gain information about competing companies by

becoming their customer yourself, reading analysts’ reports

(of publicly traded companies), and networking with other

professionals who are familiar with these firms.

For instance, one manager at a local retail store

visited a major rival discount store in town and listened

in on shoppers’ conversations. He concluded that shoppers

cared far more about the discounter’s low prices than

brand-name styles. The manager suggested to his store’s

executives that, to compete against the big discounter, they

could strive to attract style-conscious customers. By going

after a different customer segment than that sought by their

rival, the store maintained a solid position in the business.

• Industry. “What trends—in technology, governmental

policy, natural resources, and other key forces shaping our

industry—might have important implications for our busi-

ness?”You can stay on top of this information through read-

ing a wide range of business publications, talking with other

informed professionals, and participating in trade and pro-

fessional associations.

For example, while reading a food-industry trade

journal, one manager learned that the government was

considering requiring food companies to list additional

ingredients in their product labeling. The manager knew if

this legislation passed, the label size would increase and

could potentially overlap with some of the marketing copy

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18 Thinking Strategically

on the products. Thus, the manager met with people in the

marketing department and together developed a solution

that met everyone’s needs. By having ideas ready, he was able

to prepare his company for immediate compliance with the

new legislation—should it pass—with minimal delay and

disruption to the business.

Tip: Look at your group through your customers’ and

competitors’ eyes. Ask, “What would I think of my group if

I were a customer? A competitor? What would I see as

my group’s strengths and weaknesses?”

Considering internal stakeholders’ priorities

Also take into account how your choices and ideas will affect the peo-

ple around you in your organization—your supervisor, managers of

other units and teams, and your direct reports. All these people are

internal stakeholders in any important decision you make. Some

may have an interest in the decision’s outcome. Others will be pro-

foundly affected by that outcome. Still others may want to block your

plans or even oppose your course of action outright. Whatever the

case, you’ll need their support to implement your decisions.

The following approaches can help you systematically consider

your internal stakeholders’ needs and concerns:

• Identify potential stakeholders and their interests. When

you’re considering a course of action or a decision,

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Step 1: See the Big Picture 19

brainstorm all the individuals who may be affected by

or have an interest in your choice. Consider the business

process that your decision will affect. Ask: “Who’s involved

in this business process? What are their roles and responsi-

bilities? What’s the nature of the relationships among them?

What are their goals?”

• Gather information from stakeholders. Present your ideas

to the stakeholders you’ve identified, and invite these indi-

viduals to share any concerns and ideas they might have.

Ask open-ended questions about your idea, such as “What

problems do you foresee? What ideas do you have for im-

proving the plan? What’s needed for this idea to work for

you? What do you see as the pitfalls?”

• Listen carefully to underlying issues. Define problems from

the perspective of each stakeholder, listening carefully to his

or her concerns. Look for ways to address concerns that

overlap multiple stakeholder groups.

For example, suppose you advocate adopting a new cus-

tomer database to better manage customer relationships. This

idea may raise concerns for several stakeholders: The IT group

will need to spend extra time researching and installing the

database. Your employees will have to learn how to use the

new system. The finance group may be concerned about its

cost. Managers in other units may not want to take the time to

input customer data from their records. As time seems to be

a common concern, you might propose a short pilot project

that enables everyone to test the new database quickly before

deciding whether to commit resources to a larger initiative.

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20 Thinking Strategically

Tip: Think “What if?” With every idea or course of

action under consideration, ask yourself and others,

“If we implement this idea, how will other units and

stakeholders be affected? What might be the long-term

ramifications of this decision?”

If you neglect to understand your internal stakeholders’ concerns,

you can inadvertently create widespread problems. For instance,

suppose you run a manufacturing group at your organization. You

decide to buy a piece of equipment that lets you produce five thou-

sand units of a particular product part that your group manufac-

tures, at a dramatically lower cost per unit. That’s good news for

your group’s performance—but you discover that the decision has

created problems for the key accounts group. Why? They’ve prom-

ised small, cost-effective, quick-delivery customized products for

major customers. The set-up cost associated with switching the

equipment for small runs is high in relation to the number of units

being produced. Furthermore, to fulfill those orders, you have to

wait until your new machine has finished a five thousand-unit run

before you can use it to produce the smaller, customized orders. The

expensive set-up fees and the delays in switching the equipment

make it difficult for the key accounts group to promote customized

orders and promptly fulfill those orders.

Use the “Worksheet for Seeing the Big Picture,” located in the

Tips and Tools section, to document your thoughts about each as-

pect of this step in thinking strategically.

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Step 1: See the Big Picture 21

?What You COULD Do.

Remember Shane’s question about

how to explore ideas for enhancing

his products to meet company goals?

Here’s what the mentor suggests:

Shane realizes that many of the games in his product line re-

quire strategic thinking. He could use the same strategic thinking

process to assess his ideas’ potential and select an appropriate

course of action. To do that, Shane would need to gain a solid un-

derstanding of the broader business environment in which he is

operating and consider how his ideas would affect other parts of

his organization. Then Shane could apply some strategic thinking

skills, such as weighing the possible trade-offs of spending re-

sources on repackaging existing products instead of developing

new games. He could also engage his team in creative thinking

sessions to generate other alternatives for increasing revenues

and meeting the company’s strategic goals.

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Step 2: Articulate Strategic Objectives

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24 Thinking Strategically

Once you’ve gained a sense of the big picture, it’s time to

clarify your strategic objectives. That is, you need to deter-

mine what you hope to achieve through strategic thinking. Your

boss, you, and the projects you think could generate strategic

value can be important sources of information on objectives.

Once you have some ideas for objectives, it’s important to articu-

late them effectively—through a set of criteria called “SMART.”

Understanding your boss’s objectives

Often, your boss may define strategic objectives for you—for ex-

ample, “We need to cut costs to improve company profitability.”

But if such objectives are presented in vague or overly general

language, confusion may result. For instance, you might think

you’re satisfying the cost-cutting mandate by reducing expenses in

your immediate group—only to discover that your boss wanted to

implement broader-scale programs to cut costs across the entire

division.

What do you want to achieve or avoid? The answers to this question

are objectives. How will you go about achieving your desired results?

The answer to this you can call strategy.

—William E. Rothschild

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Step 2: Articulate Strategic Objectives 25

To avoid such misunderstandings, ask your boss questions about

the objectives he or she defines for you. Examples might include:

• Where in our organization do we need to focus our cost-

cutting efforts?

• What degree of cost cutting are we aiming for?

• Which processes am I free to change in order to cut costs,

and which processes must remain untouched?

Also offer additional ideas about objectives your boss has de-

fined. For instance, “Are there different objectives that can help us

further enhance the company’s profitability—such as boosting

sales in addition to cutting costs? If we cut costs in this particular

area, would these changes affect other areas of the company in

ways that could ultimately raise costs and defeat our purpose?”

Taking a broader perspective and asking questions about how

your potential actions will affect others are hallmarks of strategic

thinking.

Tip: Don’t assume you understand objectives mandated

by your boss. Ask questions to gain the most specific

possible understanding of what your boss wants you to

achieve. Then augment your boss’s ideas. Offer ideas for

additional objectives that might generate valuable

strategic results for your group and company.

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26 Thinking Strategically

Defining your own objectives

In addition to handling immediate objectives presented by your

boss, you also need to define your own long-term objectives for

your group. To do that, make time to regularly ask yourself ques-

tions such as the following:

• What should my group be doing in five years to make the

best possible contribution to the company?

• What business will our organization be in five or ten

years from now, and how can my group support that

business?

• What changes might be looming on the business horizon,

and how can my group best plan for and benefit from those

changes?

By regularly asking such questions and gaining agreement from

your boss on the strategic objectives for your group, you help

ensure that your group stays on track and remains aligned with

corporate strategy.

Tip: Envision future challenges for your group. Decide

what your group needs to accomplish now in order to

address challenges or take advantage of opportunities that

may present themselves in the future.

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Step 2: Articulate Strategic Objectives 27

Identifying project-related objectives

Frequently, you may come up with ideas for projects that you

believe will generate important strategic value for your organiza-

tion. For example, suppose you’re a manager in the IT department

and you propose developing a new database that will enable the

company to acquire and analyze more comprehensive and accu-

rate information about customers’ preferences and purchasing ac-

tivities. In your mind, the project’s objective is clear: to improve

knowledge of customer preferences so as to serve them more prof-

itably. But other managers may have additional objectives in mind

for the project—such as extracting customer information more

quickly than before, obtaining customer reports in new formats,

and so forth. If you try to satisfy all these objectives, the project

scope may soon balloon to impossible proportions. Result? Re-

sources end up getting spread too thin, and the project fails.

To think strategically in such situations, you need to clarify the

strategic priority that the project is intended to serve. Here are

some questions that can help you ensure that your project sup-

ports strategic objectives and balances the needs of various stake-

holders with higher-level strategy:

• What is the perceived strategic need that this project is in-

tended to satisfy?

• Who has a stake in the solution or outcome?

• How do the various stakeholders’ goals for the project differ?

Do their goals align with the higher-level strategic goals

we’re trying to achieve through this project?

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28 Thinking Strategically

• Are there other projects that would help us better satisfy the

strategic need we’ve identified? If so, what are they? And

how do they compare with the current proposed project—

in terms of cost, feasibility, and so forth?

Tip: Define the project’s purpose. Be able to articulate

exactly how it will benefit your company. Avoid “scope

creep,” whereby you agree to expand the purpose of the

project to accommodate a wide variety of demands from

numerous stakeholders.

Making your objectives “SMART”

Whether your objectives have been given to you by your boss or

you’re creating your own objectives, make sure they are SMART—

specific, measurable, achievable, realistic, and time bound. For

example, one human resource task force charged with developing

a new health care benefits plan defined the following SMART

objective: “To recommend at the June board of directors’ meeting

the three providers that offer the best and broadest coverage at

a cost that is at least 10 percent less than the company’s current

per-employee contribution.” The table, “SMART objective and

criteria,” shows how this objective meets all five SMART criteria.

Use the “Worksheet for Clarifying Strategic Objectives,” located

in the Tips and Tools section, to document your thoughts about

this step in the strategic thinking process.

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Step 2: Articulate Strategic Objectives 29

SMART objectives and criteria

Example of SMART objective SMART criterion

“To recommend . . . Achievable

. . . at the June . . . Time bound

. . . board of directors’ meeting, the three . . . Specific

. . . providers that offer the best and broadest coverage at a cost that is at least 10% less than the company’s current per-employee contribution.”

Realistic and measurable

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Step 3: Identify Relationships, Patterns, and

Trends

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32 Thinking Strategically

The capacity to understand relationships across different parts

of your organization, and to spot patterns and trends in

seemingly unrelated events and information, constitutes a hallmark

of strategic thinking. By seeing relationships, patterns, and trends,

you can generate valuable solutions to problems and reduce the

amount of detail you must grapple with in order to make decisions.

Understanding how it works

Consider these examples of seeing relationships, patterns, and trends:

• A new IT system. By serving on a cross-functional team

comprising managers from several other parts of your or-

ganization, you learn that the IT group is proposing that the

company install an enterprise resource planning (ERP) sys-

tem that links customer databases and other software appli-

cations throughout your company. But your group has just

decided to adopt a stand-alone customer database. You realize

that your group and IT will be working at cross-purposes if

both plans move forward. You conclude that it would be bet-

ter to hold off installing your stand-alone database until you

know more about whether the ERP project will be approved.

• Automobile manufacturing processes. You’re reading an

article about a method for improving shop-floor processes

in auto manufacturing. You find yourself thinking about

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Step 3: Identify Relationships, Patterns, and Trends 33

ways to apply some of the method’s principles to your own

unit’s operations—even though you lead a customer call

center, not a manufacturing unit.

• Defecting employees. You work in human resources, and

you notice that the employees who leave your company

for jobs with other organizations increasingly tend to be

those individuals who possess unique technical skills and

knowledge—such as expertise with leading-edge software

applications and familiarity with the latest code-writing

practices. This trend prompts you to examine how your

organization uses recognition and rewards to retain

employees who possess unique and rare skills.

• Customer complaints. As you’re reviewing customers’ an-

ecdotal comments on complaint forms compiled from the

past year, it strikes you that many of the different comments

seem related. For example, you see explicit remarks such as

“Your reps don’t know anything about the product you’re

selling.” But you also see more ambiguous comments, in-

cluding “Fed up with lousy treatment” and “Don’t have time

to keep calling.”You begin to see an underlying theme re-

lated to sales representatives’ competency—and devise ways

to define and strengthen required competencies.

Devising solutions

Seeing patterns and trends can help you generate creative, valuable

solutions to problems. For example, suppose you learned that an au-

tomaker had found a way to improve its operations—in real time, as

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34 Thinking Strategically

people carried out their work. Perhaps the company stopped work

processes each time a problem arose, identified the cause of the prob-

lem, and devised a trial solution that it then tested immediately on

the job. In this case, you might decide to use a similar real-time ex-

perimental method to address process problems in your own unit.

For instance, perhaps your customer call center has a goal of

answering calls within three rings. Yet representatives often have

difficulty meeting this goal. With the auto manufacturer’s method

in mind, you decide to conduct a simulation: one of your employ-

ees poses as a customer and makes several phone calls to a service

representative within an hour. Every time the representative can’t

answer the “call” within three rings, you stop the simulation and

ask, “What kept you from answering on time?”You hear responses

such as “I couldn’t resolve the current call in time to pick up the

next one” and “I didn’t hear the first few rings because of a distrac-

tion in the next office.”

You and your team design potential solutions to these prob-

lems, then restart the simulation to test your ideas. One thing you

do is to reconfigure office space to reduce distraction. You discover

that the change enables the representative to meet the goal more

often. Thanks to your ability to see that a process-improvement

strategy could work in two organizations as different as an auto

manufacturing floor and a customer call center, you enable your

group to provide better customer service.

Categorizing information

When you see patterns across supposedly unrelated informa-

tion, you can more easily organize detailed information into

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Step 3: Identify Relationships, Patterns, and Trends 35

categories—thereby reducing the number of details you need to

pay attention to.

Consider a scenario about customers’ comments on complaint

forms. If you were unable to see patterns in the information on the

forms, you might conclude that each comment represented a

unique type of problem that customers were experiencing. And

you’d probably feel overwhelmed by the degree of detail. Equally

important, you’d find it difficult to design a solution that ad-

dresses each problem.

But what if you were able to recognize that many of the com-

ments reflected a shared, underlying theme? You decide to contact

the customers who wrote the ambiguous comments and ask for

more detail. By doing this, you discover that many of these cus-

tomers have experienced frustrations during their interactions

with sales representatives.

You conclude that there are inadequacies in your representatives’

competencies. By grouping the data into one category—employee

competency—you create a more manageable degree of detail. And

you focus your efforts on dealing with that one problem area.

Because the ability to see relationships, patterns, and trends

helps you categorize detailed information, it enables you to

process information more quickly—and therefore boosts your

chances of arriving at effective solutions more speedily.

See “Tips for strengthening your ability to identify relation-

ships, patterns, and trends” for ideas on how to enhance this im-

portant strategic thinking competency.

Use the “Worksheet for Identifying Relationships, Patterns, and

Trends,” located in the Tips and Tools section, to document your

thoughts about this step in the process of thinking strategically.

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36 Thinking Strategically

Tips for strengthening your ability to identify relationships, patterns, and trends

• Get to know people in other functional groups by volunteering

to serve on cross-functional teams or committees. Find out

these groups’ strategies and goals, and compare them to your

group’s objectives to assess whether they fit—or whether

you’re working at cross-purposes.

• Obtain a copy of your company’s organization chart. Find out

what major functions other groups in your company are respon-

sible for and how these groups affect your group’s work—and

vice versa. Ask your manager or an experienced peer to help

explain these connections.

• When examining large quantities of seemingly unrelated data or

looking at apparently unconnected events, ask, “What seems to

be the common theme underlying the different pieces of infor-

mation or events? What does the data seem to be telling me?”

• Whenever you hear about or read about a good idea or practice,

ask, “How might I apply this approach to my own situation? What

common challenges does my group share with this seemingly dif-

ferent group that might mean this good idea could work for us?”

• Track changes over time for performance metrics that are im-

portant to your group. For instance, if customer loyalty, as

measured by repeat purchases from key accounts, is vital to

your group’s performance, monitor customers’ repeat purchases

and watch for any signs of trouble—such as flattening or declin-

ing loyalty, or defection of key customers to a competitor.

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Step 4: Get Creative

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38 Thinking Strategically

C reative thinking is the ability to generate fresh alternatives,

visualize new possibilities, formulate new approaches to

getting things done, and open yourself to new information that

doesn’t support your existing assumptions about the way people

should do things at your company. When you think creatively, you

create new value for your unit and company—in the form of more

efficient processes, more innovative product ideas, and better ways

to serve customers. In the pages that follow, you’ll find ideas for

getting your creative juices flowing.

Challenging your assumptions

Challenging your beliefs about how things should be done in your

organization can generate valuable new ideas. To challenge assump-

tions, ask questions such as “Why do we believe this process should

be handled only in this way? What if we did it this other way instead?”

For instance, suppose your unit has always shipped products to

customers on Tuesday mornings, but this approach has led to bot-

tlenecks in the shipping department. You ask, “Why do we ship

products on Tuesday mornings only? How might customers re-

spond if we shipped later in the day, or shipped on Wednesday?”

With a little market research, you discover that customers would be

equally satisfied with shipments on Tuesday evenings or Wednesday

mornings. You change the shipping schedule—removing a major

bottleneck in the delivery department.

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Step 4: Get Creative 39

Tip: Challenge current approaches to work. Consider

whether you and your direct reports might work together

in new, previously unimaginable ways.

Inviting provocation

Be willing to entertain ideas that strike you as provocative and

even downright preposterous at first. Some of these ideas may

ultimately lead to new ideas that can be turned into practical

value.

For example, suppose you work for a consumer electronics com-

pany. It’s Monday morning, and you’re chatting with a colleague

about the weekend. Your colleague happens to mention that he in-

stalled new windows in his home on Saturday. Suddenly, an image

forms in your mind: a television screen with small “windows” that

show what’s on other channels. Though at first this idea seems

strange, your company eventually develops it into an innovative fea-

ture that scores a major hit with consumers.

Tip: Model provocation. By offering playful and

seemingly preposterous ideas to others, you model creative

thinking. Others may emulate you—further stimulating the

creative energy in your group.

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40 Thinking Strategically

Envisioning an ideal world

Sometimes imagining what might be possible in an ideal world

can help you generate useful new ideas or solve a nagging prob-

lem. For instance, suppose you run a manufacturing unit, and em-

ployees are increasingly uninterested in working the weekend

shifts. You conduct a brainstorming session with fellow managers

to come up with solutions to the problem. Someone mentions,

“We need to use better incentives with our employees. Let’s pay

people more to handle the weekend shifts, or withhold promo-

tions from those who refuse to take those shifts.”

While this may seem like a possible solution, you don’t stop

there. You ask, “In an ideal world, what would we see happen?”

Someone else answers, “Well, in my ideal world, people would love

working weekends.” This comment leads you to envision a perma-

nent Saturday/Sunday workforce that is separate from the Monday-

through-Friday workforce. The idea initially seems unworkable—

after all, the company has never tried this before. However, the

organization agrees to test it in a pilot program—and it proves

successful.

Tip: Use mind maps. On blank sheets of paper, draw

pictures representing your thoughts and the ways in which

they can be connected. You may generate more

connections than if you merely listed ideas on a

lined sheet of paper.

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Step 4: Get Creative 41

Gathering others’ perspectives

Deliberately inviting people who work in other parts of the or-

ganization to share their views of a problem or challenge can help

you see that there is more than one way to perceive a situation.

For instance, imagine that you’re an account manager for a prod-

uct line that has experienced flat sales. You believe that the prod-

uct’s price may be causing the problem. You call together a group

of peer managers to discuss pricing strategy. At the meeting, you

present your thoughts: “As I see it, we’ve got three alternatives:

leaving the price as is, lowering it, or raising it. Is that how you all

see the situation?”

A manager from marketing responds, “You know, these aren’t

the only options. Have you thought about changing your promo-

tion of the product to give it a more sophisticated image, and then

using that image to justify a higher price? What about leaving the

price as is and giving special discounts?” A key account manager

chimes in, “You could also try lowering the price on some of the

product line, or reducing it for a specific amount of time and then

raising it again.”

These ideas generate additional ideas from other participants

in the meeting. By the end of the meeting, you’ve generated many

more alternatives than you would have if you had stuck with your

original perspective. And whenever you generate more alterna-

tives, you stand a better chance of selecting a more effective solu-

tion to a problem than if you had considered only one or two

options. Indeed, your meeting ultimately leads you to create a low-

price commodity version of the product and a high-price pre-

mium line—both of which sell briskly.

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42 Thinking Strategically

Tip: Call on creative types. Identify the creative people

in your company. Ask them to get involved in

brainstorming sessions and other such activities if you

need help stimulating participants’ creative juices.

Fostering an environment for creativity

By far the most important ingredients for creative thinking are

having an open mind and not being defensive or territorial about

your ideas. Create a supportive environment where people feel

they can generate ideas freely, without being judged or criticized.

For example, during brainstorming sessions, allow people to

blurt out as many ideas as they can generate. List all ideas without

commenting on them or permitting anyone else to comment on

them. Express appreciation for seemingly “wacky” ideas—the more

playful and imaginative, the better. Don’t worry about narrowing

wide-ranging ideas down to the most practical ones until everyone

has finished brainstorming.

Use toys and humor to “loosen” people up and put them in a

playful mood. The more relaxed people are, the easier it is for them

to envision fresh possibilities and open themselves to new ideas.

Use the “Worksheet for Thinking Creatively,” located in the Tips

and Tools section, to document your thoughts about this aspect of

thinking strategically.

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Step 4: Get Creative 43

Tip: Encourage your employees to reserve time to be

creative. They can block out time in their daily or weekly

schedule that will not be booked with a meeting, task, or

other work-related activity. Invite them to use that time to

let their thoughts wander: they may well find themselves

thinking of new ideas for solving old problems.

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Step 5: Analyze Information

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46 Thinking Strategically

Whenever you’re confronted with a complex situation

on the job—whether it’s making a crucial decision,

managing a complex initiative, solving a problem, or improving a

process—you often must wrestle with large volumes of informa-

tion. How do you ensure that you’ve got all the right information

at hand? And how do you weed out irrelevant information so you

can address the situation most effectively? The following guide-

lines can help.

Identifying critical information you need

Before you gather information, begin by listing the critical infor-

mation you need to know in order to resolve the issue facing you.

One way to do this is to step away from the details of the situation

and view the issue from a fresh perspective by asking questions as

if you were an outsider.

For instance, suppose you run an order-fulfillment group. Re-

cent survey results indicate that customers are not satisfied with

the timeliness of their order deliveries. You believe there might be

a demand for an expedited delivery service at a premium price. To

explore this option, you might ask those in your unit the following

questions:

• How is increasing the level of customer service a strategic

goal for our unit?

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Step 5: Analyze Information 47

• How might the overall level of customer satisfaction be

improved?

• Have customers voiced a need to have products shipped

faster?

• Do other companies who compete with us offer expedited

delivery options?

• If we did offer an expedited delivery service, how might

that have an impact on other groups in the company? For

example, how quickly could the IT group add this informa-

tion to the order-entry screen?

• How might faster order-fulfillment times affect inventory

management?

• Has anyone in the organization rolled out a similar type of

service in the last year or two? If so, what lessons can we

learn from that experience?

• Does the order-fulfillment group have the capability to

provide this type of service?

As you sort through the information you receive, consider the

80-20 principle, which offers helpful lessons for prioritizing infor-

mation. This rule (often referred to as the Pareto principle, or the

“law of the vital few”) states that the relationship between input

and output is rarely, if ever, balanced.

When applied to work, it means that approximately 20 percent

of your activities produce 80 percent of your results. The 80-20

rule reminds you to focus on the 20 percent that really matters.

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48 Thinking Strategically

?What Would YOU Do?

Dispensing Efficiency at ExcelCare?

ANDREA IS A PURCHASING MANAGER at ExcelCare,

a major medical center. Top management has chal-

lenged all departments to find ways to improve efficiencies in

processes, among other strategic goals. Andrea talks with peer

managers in other departments to see what they’re doing to meet

the organization’s goals. She also calls a friend, Kevin, who works

in purchasing for another hospital, and asks what they’re doing to

achieve similar goals.

Kevin tells Andrea about a new electronic system his group has

implemented to keep track of supplies inventory. Nurses and doc-

tors needing supplies go to a vending device, punch in a few codes,

and the items are dispensed. The device updates—in real time—

how many of each item have been used and when. This information

is synchronized with inventory records to ensure that supplies

don’t run low. When inventory reaches a certain level, the system

sends an electronic purchase requisition to the vendor. This new

system, Kevin tells Andrea, has vastly improved efficiency of the

purchasing process.

Andrea calls Marcus, a colleague in IT, and asks if such a system

could be implemented at ExcelCare. Marcus thinks it’s conceivable.

But, he warns, it would require a substantial capital investment.

Andrea wonders how she should proceed from here. Should she get

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Step 5: Analyze Information 49

Identify and focus on those things that contribute to that 20 per-

cent and you will be well on your way to analyzing information

more productively and effectively.

Steering clear of irrelevant information

Don’t bother considering information that’s unnecessary, margin-

ally useful, or overly time consuming to collect—even if it strikes

you as interesting. Focus your information-gathering efforts on

data that will help you move forward to a resolution.

For example, with the question of expedited delivery service,

you might find yourself wondering how late deliveries are affect-

ing your customers. But having this information won’t help you

determine whether to introduce a new service. You already know

that late deliveries are bad for business. To address the issue, you

need to analyze the issue from a broad perspective and understand

the impact that your proposed actions might have on others.

In addition, when your information yields marginal results, try

not to overanalyze small discrepancies. For example, suppose you’re

exploring product defects created by a piece of manufacturing

more information on these systems and craft a proposal advocating

adoption of the system at ExcelCare? Talk with nurses and physi-

cians at ExcelCare about how they’re currently accessing supplies

and whether they’re experiencing any problems?

What would YOU do? The mentor will suggest a solution in

What You COULD Do.

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50 Thinking Strategically

equipment. In one week, the machine might generate 150 defective

products. In another week, the machine might generate 160 flawed

products. In all likelihood, it’s not worth your time to investigate

why one week’s defective products are slightly higher than the previ-

ous week’s. If, however, the discrepancy is greater—say 150 defective

products in one week versus 450 in another—then you probably

should explore the matter further.

The question to continually ask is: “Would gathering more in-

formation fundamentally change the answer that you already

have?” If the answer is no, then you need to move on. If it’s yes,

then you need to collect more information.

Tip: Get critical. With every problem or decision you’re

considering, identify the most important information you

have on hand and the vital data you’re missing.

Crafting an information-gathering plan

Determine how, where, when, and from whom you will gather the

information you need to address your issue. Conversations with

people inside and outside your organization, written materials,

group discussions, surveys, Internet searches, and direct observa-

tion can all be sources of information.

For instance, to determine whether to introduce an expedited

delivery service, you might gather information by talking with your

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Step 5: Analyze Information 51

boss about the need to improve order-delivery times. You might

also visit the various sites (warehouses, customer service centers,

distribution centers) that make up your order-fulfillment system

and interview personnel to find out ways to improve the process.

During these visits, you could:

• Inquire about problems workers are encountering in carrying

out their jobs.

• Ask about changes in their unit (such as new hires or new

technologies) that may be creating difficulties.

• Ask about possible negative outcomes they might encounter

if an expedited delivery service were adopted.

• Listen for possible root causes of the late-delivery problem—

such as lack of awareness of expectations or inefficiencies in

certain processes.

While visiting these sites, you might also take time to observe

how people are carrying out their work and resolving difficulties

as they arise. Again, look for possible root causes of your problem,

and use your conclusions to begin thinking about solutions.

Tip: Ask the five whys. When you identify a problem,

ask, “Why is this happening?” When you hear the answer,

ask why again. Ask why at least five times to ensure

sufficient depth of analysis.

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52 Thinking Strategically

Building on existing knowledge

Avoid reinventing the wheel. Instead, ask: “Have I or someone else

in the organization faced a similar situation in the past? If so, how

was it handled? What were the results? How might we fine-tune

the solution to accommodate conditions that have changed since

that earlier time?”

For example, ask other managers how they’ve handled delays in

their groups’ key processes. They may have developed solutions or

strategies that you can adapt or apply directly to your own situa-

tion. They may also know something about certain steps in your

process that can shed light on possible solutions.

Tip: Leverage insights and wisdom that others have

gained by addressing issues and situations similar to the

one you’re currently handling.

Use the “Worksheet for Analyzing Information,” located in the

Tips and Tools section, to record your thoughts about this step in

the strategic thinking process.

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Step 5: Analyze Information 53

?What You COULD Do.

Remember Andrea’s question about

what to do next regarding the electronic

inventory system idea for ExcelCare?

Here’s what the mentor suggests:

Andrea should talk informally with doctors and nurses (her in-

ternal customers) to learn about their needs and concerns regard-

ing supplies. As she conducts these conversations, she may gain

insights into how best to set up an electronic purchasing system.

She may also think of additional ideas worthy of consideration—a

range of alternatives that may boost her chances of selecting the

best possible solutions to problems with managing purchasing and

inventory control problems.

While an electronic inventory system sounds promising, mak-

ing a proposal at this stage is premature. Andrea should first talk

with all the potential stakeholders of this idea—everyone who

would be affected by adoption of the new system or who would

have an interest in its outcome. Only then can she learn about

their needs and concerns and eventually propose a plan that best

serves the entire organization.

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Step 6: Prioritize Your Actions

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56 Thinking Strategically

Knowing how to prioritize your actions constitutes another

aspect of applying your strategic thinking skills. In any busi-

ness situation—whether it’s managing a project, planning your day,

making a decision, or solving a problem—you can spend your time

and energy in an almost infinite number of ways. Two powerful

ways to prioritize your actions are by establishing time lines and al-

ways keeping the big picture in sight.

Establishing time lines

Think about the goals you want to accomplish and the strategic

initiatives you’re managing. Create clear, realistic time lines for

achieving these objectives. The more realistic your time line, the

better your chance of avoiding the chaos and inefficient use of re-

sources that occur when people set impossible schedules.

To establish a realistic time line for a strategic initiative:

1. Estimate the length of time each phase will take. Create

a chart or diagram depicting the time needed for each

phase. Calculate the time required to carry out the entire

effort.

2. Compare your individual and total time estimates to the

time required on similar efforts that have been completed.

Do your estimates seem realistic? Do you need to add contin-

gency time in the schedule to accommodate potential delays?

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Step 6: Prioritize Your Actions 57

Where might it be possible to tighten up the schedule to liber-

ate time for another phase of the initiative?

3. Identify phases that can’t be completed until other phases are

complete. These represent potential bottlenecks in the process.

4. After making any necessary revisions to your time line,

ask several colleagues or members of your team to examine

the schedule and identify potential problems with it. Also

consult people who will be implementing various aspects

of the initiative, as well as customers, suppliers, and other

external stakeholders. They can offer additional valuable

insight into potential problems with your time line.

5. After gathering a wide range of input, develop solutions to

identified problems and create a final version of your time

line.

Keeping the big picture in sight

As you consider the many different tasks you want to complete

today, tomorrow, or later this week, you may well find yourself

compiling a dauntingly long “to do” list. Rather than tackling the

various tasks at random, picking off the easiest or quickest tasks

first, or plowing through them in the order in which you’ve listed

them, take a moment to prioritize your list items based on how

well they support the big picture—your company’s and unit’s

high-level goals.

Ask yourself, “Which of these are the most critical—that is,

which will generate the most important results for my group and

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58 Thinking Strategically

company? Which are more peripheral—in other words, they don’t

have as much bearing on my group’s or company’s high-priority

goals? If I ran this company, which of these tasks would I pay

someone to work on?”

Tip: Schedule high-priority work. Block out time in your

calendar for strategically important activities, so your

schedule doesn’t fill up with peripheral tasks and meetings.

Remember that some tasks may be urgent but not important in

the big scheme of things. For instance, a report may be due by the

end of the day (urgent), but completing it on time may contribute

little or nothing to your group’s high-level goals (not important).

If you give in to completing urgent but not important tasks, you

risk neglecting more strategically valuable actions.

By identifying high-priority actions, you can more easily figure

out how to use your time and which tasks to focus on in what se-

quence. You can divide your workload into parts and determine

which parts should be done today, tomorrow, next week, and next

month. You can also more readily identify which less strategically

important actions can be delegated to members of your team—or

even be left undone.

Use the “Worksheet for Prioritizing Your Actions,” located in

the Tips and Tools section, to generate some thoughts about this

step in thinking strategically.

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Step 7: Make Trade-Offs

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60 Thinking Strategically

S trategic thinking also includes assessing the trade-offs

involved in selecting a particular course of action—and

selecting the most appropriate trade-off. Most decisions involve a

trade-off. For example, suppose you oversee a product development

group and your team is charged with creating a new product. The di-

rector of sales asks if you can release the product four weeks ahead

of schedule to satisfy a major customer. You know this decision will

require people in other groups—marketing, manufacturing, cus-

tomer service, fulfillment, and so forth—to expedite their work for

an earlier delivery date.You also know that the quality of the product

could be jeopardized. You decide to risk losing the sale to the major

customer and release the product on schedule as originally planned.

As this example suggests, making trade-offs involves setting

priorities, identifying alternatives, understanding the impact of

your actions, and clarifying what you will strive to accomplish

through a particular course of action—as well as what you won’t

seek to attain. The following practices can you help you navigate

through this difficult terrain.

Assessing the pros and cons of a proposed course of action

Whenever you consider a potential course of action—a new strat-

egy for your group, a new product feature, an initiative to improve a

business process—ask yourself what advantages and disadvantages

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Step 7: Make Trade-Offs 61

might be associated with that course of action. The table, “Pros and

cons of new product feature,” gives an example of how one manager

conducted this assessment.

You are unlikely to be able to do it all—develop a new product

feature that avoids expensive redesign, that doesn’t threaten sales

of earlier product versions, that can be sold at a sufficiently high

price, and so forth. Thus, you need to make trade-offs.

How to do so? Consider your company’s and unit’s strategic

goals. Do these goals emphasize reducing costs? Improving brand

awareness? Simplifying product-development processes? Your an-

swers can help guide your decisions about what’s okay to trade

off—and what isn’t.

Comparing short- and long-term outcomes

In considering a course of action, think through the potential

short- and long-term impacts of your choice. For example, sup-

pose you’re wondering whether to cut prices on a product line that

has experienced declining sales. You realize that cutting prices may

Pros and cons of new product feature

Advantages Disadvantages

Lets us charge a higher price Might cannibalize sales of previous product version

Might attract new customer segments

Could be perceived as unnecessary or annoying by consumers

Could improve brand awareness: our company is on the leading edge of technology

Would require expensive redesign of base product

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62 Thinking Strategically

boost sales this month or this year. But in the long run, this move

could hurt sales. How? Perhaps consumers would come to expect

deep discounts on your company’s offerings. Thus, they would

hold off purchasing your products until you provide another dis-

count. These delays could reduce sales over the long term. How-

ever, if boosting sales immediately is a high priority in your

company, you may decide to trade off future sales increases for

current sales increases.

By sharpening your awareness of the possible short- and long-

term consequences of your choices, you can make smarter trade-

offs. “Steps for balancing short-term requirements with long-term

goals” provides additional guidance for this aspect of making

trade-offs.

Steps for balancing short-term requirements with long-term goals

1. Meet with your boss to determine how much time you and

your team should be allocating toward short-term issues ver-

sus long-term goals.

2. Review the work that you and your team have done in the

past month to determine what has been accomplished on

both short- and long-term issues. If the balance is not right

according to your group’s priorities, set new guidelines for how

you and your team spend your time.

3. Keep an ongoing log to determine how you and your team are

spending your time.

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Step 7: Make Trade-Offs 63

Balancing unit and company needs

Some decisions involve trade-offs between your department or

group and the company overall. To illustrate, suppose you lead a

sales group whose representatives have won numerous new ac-

counts by promising customers early delivery dates on a new

product. That’s great for your group. However, it puts a burden

on the product development, manufacturing, order processing,

and customer service departments—all of which must accelerate

their processes in order to meet the promises the sales reps have

made.

4. Every two weeks, evaluate whether you and your team are

giving the proper time and attention to short-term require-

ments and long-term goals. Again, if the balance is not

right according to your group’s priorities, readjust your focus

appropriately.

5. When you face competing priorities, determine which are

the most important and make those your first priority. When

an urgent matter arises, determine how it fits into your daily

plan (is it urgent and important, or simply urgent?) and act

accordingly.

6. Ask your team how it can make progress on long-term issues

while addressing short-term needs. For example, a goal may

be to develop a line of products for a new market. Ask the

team to figure out how to make progress on that goal while

also developing products for existing markets.

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64 Thinking Strategically

This situation may lead to several possible outcomes:

• Your group’s actions may have a negative impact on other

groups. For example, forcing product development to release

a product early may jeopardize the quality of the product.

This in turn, might affect the product development unit’s

strategy of trying to raise the quality standard of all products.

• In the end, your group’s actions could thus eventually hurt

relationships with other groups and with long-standing,

existing customers.

In this case, you might need to consider whether to trade off

some new sales in return for smoother operation of the rest of your

company’s functions, so your organization can serve all its cus-

tomers, not just the newest ones.

Tip: Ask whether a decision that could help your group

vastly improve its performance might pose such serious

problems for other parts of your organization that the

gains for your group might not be worth the price other

groups will pay.

Learning to say no

At times, making a trade-off requires nothing more than specify-

ing what you won’t do—and not bothering with articulating what

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Step 7: Make Trade-Offs 65

you will do. Setting boundaries like this is tremendously valuable

because it helps you avoid wasting time on projects or initiatives

that you don’t support or that will be shut down later.

For example, suppose your group is evaluating the possibility of

creating tiered versions of a product—high-end, mid-market, low-

end. You’ve made a strong argument against introducing a low-end

product: “It’ll hurt our brand image, and it will generate lower

profits for us.” In this case, you might indicate your trade-off deci-

sion by saying something like, “I don’t know what a high-end ver-

sion of the product would look like. But I do know that we won’t do

a low-end version.”

By defining the trade-off in this way, you help your group to

focus on the acceptable courses of action—and to develop or

maintain strategies for ensuring success.

Tip: Think will and won’t. In making a complex decision

or considering an important course of action, identify what

you will and won’t do.

Use the “Worksheet for Making Trade-Offs,” located in the Tips

and Tools section, to document your thoughts about this step in

the strategic thinking process.

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Blind Folio 67

Tips and Tools

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Tools for Thinking Strategically

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THINKING STRATEGICALLY

Worksheet for Seeing the Big Picture

Use this tool to gain a sense of the “business ecosystem” in which you operate. Seeing the big picture can help you set the stage for thinking strategically about your work.

Part I: Your company and unit

1. What is your company’s competitive strategy? If you don’t know, what steps might you take to find out? Consider asking your boss and peer managers, as well as examining company documents and executive communications.

2. What are your unit’s strategic objectives? How do those objectives relate to the corporate strategy? For example, if you work in a product development unit, has your unit defined a strategy stipulating development of new product lines to support a high-level strategy focused on innovation?

3. What actions, plans, and decisions might enable your group to help support your unit’s and company’s strategies? Consider potential process improvements, better management of costs, new revenue opportunities, and other potentially valuable courses of action.

Part II: Your customers, competitors, and industry

4. Who are your company’s customers? Consider various customer segments as well as any internal customers your group may serve if you work in a support function.

70 Tools for Thinking Strategically

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Tools for Thinking Strategically 71

5. What needs and preferences does your organization currently fulfill for its customers? What unique forms of value does your company offer its customers?

6. How might your customers’ needs and preferences evolve in the future? Do you anticipate demand for faster service, higher-quality products, more affordable offerings?

7. What could your group do to help your company fulfill customers’ changing requirements? Consider process improvements, product ideas, and other means of enhancing the value your organization provides customers.

8. With what organizations does your company compete? Ask your boss, peer managers, and business acquaintances for input.

9. What industry trends might have important implications for your company’s business? Consult business publications and talk with other informed professionals to assess these trends.

10. How might your group take advantage of opportunities offered by emerging industry trends or stave off threats posed by such trends? Cite as many examples as you can.

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Part III: Your boss, peers, and employees

11. Think of a decision you’re weighing or a course of action you’re considering. Write it below.

12. Who are all the stakeholders in this decision? List everyone who would be affected by or have an interest in the outcome of the decision. Be sure to consider your boss, any peer managers, and employees.

13. How will you learn about the potential impact of your decision on your various stakeholders in different parts of your organization? List the questions you will want to ask your stakeholders.

14. If you’ve consulted stakeholders about their concerns regarding your decision or proposed course of action, have you identified any underlying issues that cross multiple groups of stakeholders? If so, what are they? Common shared concerns may include cost, time, workload, and so forth.

15. How might you shape your decision or proposed course of action so as to address stakeholder concerns you’ve identified? For example, would a pilot project help ease worries about the expense of a new initiative?

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Tools for Thinking Strategically 73

THINKING STRATEGICALLY

Worksheet for Clarifying Strategic Objectives

Use this tool to articulate your group’s strategic goals and aims, and to clarify what you hope to achieve through strategic thinking. Clarifying objectives enables you to set the stage for

thinking strategically about your work.

1. What strategic objectives has your boss defined for you and your group? List them below.

2. If some or all of the objectives your boss has defined are vague or general, how might you gain further clarity and specificity? For example, if your boss has told you “We need to be more innovative,” you might ask, “Where should we focus our innovation efforts— on products? Processes? Services?”

3. What ideas for strategic objectives might you add to those mandated by your boss? Consider goals your group could aim for in order to make the best possible contribution to your company in the coming years.

4. What strategic initiatives have you recently been charged with leading? Strategic initiatives are projects—such as installing a customer relationship management (CRM) system, or enhancing quality-control processes—designed specifically to help carry out a company’s or unit’s strategy.

5. What is the strategic priority that each of the initiatives you’re leading is intended to serve? For instance, is the new CRM system you’re helping to research designed to enable your company to identify new customer segments?

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74 Tools for Thinking Strategically

6. How might you ensure that your strategic initiatives’ objectives remain clearly focused on the company or unit priorities they are intended to serve? Often, initiative stake- holders have different goals in mind for a particular project—which can lead to chaos and allocation of resources away from strategic priorities.

7. Are there alternative projects that merit consideration in addition to the strategic initia- tives currently on your plate? How do the various alternatives compare in terms of cost, feasibility, and other criteria?

8. For each strategic initiative you’re working on, write the project’s objective below. Ensure that each objective is SMART: specific, measurable, achievable, realistic, and time bound.

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THINKING STRATEGICALLY

Worksheet for Identifying Relationships, Patterns, and Trends

Use this tool to understand relationships, patterns, and trends in seemingly unrelated events and information. This strategic thinking ability can help you generate valuable solutions to problems

and organize details into manageable levels.

1. Think of a problem you’re experiencing in your group or a difficult decision you’re facing. Examples might include increased defection of talented employees, inefficiencies in a particular process, and so forth.

2. What ideas have you read or heard about that you might borrow from to address your own situation? Consider practices applied in other companies or industries—even if those settings differ markedly from your own.

3. What changes over time seem to be occurring regarding the issue you’re dealing with? For example, is turnover in your group increasing at a steady pace? Rising and then falling? Increasing and then flattening out?

4. What changes in other parts of your organization might be related to your issue? For instance, has the company invested less in professional development programs recently? Might that change correspond with increased turnover rates in your group?

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76 Tools for Thinking Strategically

5. What might you do to gain a broader perspective on your issue? Could you participate in more cross-functional task forces to learn more about how changes in different parts of the company affect various units and groups?

6. If you’re evaluating a large amount of data while addressing your issue, how might you organize the data into a more manageable form? Look for common themes underlying different pieces of information or events.

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Tools for Thinking Strategically 77

THINKING STRATEGICALLY

Worksheet for Thinking Creatively

Use this tool to strengthen your creative thinking ability—an important component of strategic thinking.

1. Think of a problem you’re trying to solve or a course of action you’re considering. Write it below. For example, perhaps you want to find ways to generate ideas for improving faulty customer service.

2. What assumptions do you and your group hold regarding the issue at hand? Do you assume, for instance, that customers must receive their orders within two days or they’ll defect to a competitor?

3. What questions might you ask to challenge these assumptions? Could you ask, “Why do we believe this about our customers? What if we delivered orders in three or four days?”

4. How might you stimulate creative brainstorming of ideas within your group? Consider challenging yourself and your employees to dream up the most preposterous ideas possible—without judging one another’s ideas.

5. In your view and in the opinion of your direct reports, what would resolution of your issue look like in an ideal world? For instance, perhaps in your vision of a perfect world, customers would care only about how easy it is to open your product’s packaging and use the contents—not about when they take delivery of the order.

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78 Tools for Thinking Strategically

6. How might you gather the broadest possible perspective on your issue? Could you assemble a one-time cross-functional team comprising managers from other units who can offer ideas for addressing your issue? Are there individuals outside your organization— customers or suppliers—who could provide additional valuable ideas?

7. What steps could you take to create a playful mood in which you and your group can stimulate your creative thinking? Would toys, food, or improvisational exercises help loosen everyone up?

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Tools for Thinking Strategically 79

THINKING STRATEGICALLY

Worksheet for Analyzing Information

Use this tool to strengthen your ability to analyze information—another important strategic thinking skill.

1. Consider a difficult situation, an important decision, or a pressing problem you’re facing in your group. Write it below. Examples might include recurring customer complaints, declining employee performance, flattening sales, and so forth.

2. What critical information do you need to know in order to resolve your issue? List as many questions as you can think of that may generate the information you need—and think of the issue from a broad organizational perspective. For example, if your issue involves improving customer call center service, you might ask questions such as, “How would im- proving this service support our unit’s strategic goals? Do other companies provide better service? If so, in what respects? How might improving our service affect other parts of our organization, as well as processes related to our call center’s work? Do we have the ability to make the desired improvements?”

3. What information do you already have regarding your issue? By listing this information here, you can more easily focus on gathering the needed data you’ve listed in step 2.

4. Whom might you contact to gather the needed information you listed in step 2? Will you talk with your boss? Call center employees? Customers? Competitors? Suppliers?

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80 Tools for Thinking Strategically

5. How will you gather the information you need? Will you visit call center sites to observe workers in action? Act as a “mystery customer” and phone a center yourself to assess the quality of the service? Phone contacts and ask for their ideas about what may be causing the problem?

6. How might you build on existing knowledge to address your issue? Consider whether you or someone else in your organization has dealt successfully with a similar situation before. If so, how might you adapt proven solutions to your current problem?

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THINKING STRATEGICALLY

Worksheet for Prioritizing Your Actions

Use this tool to prioritize your actions while planning management of a strategic initiative and organizing a typical work day.

Part I: Planning a strategic initiative

1. Consider a strategic initiative you’ve been charged with leading. Write it below. Examples might include setting up a new order-fulfillment system, installing a new employee database, and so forth.

2. What phases will your initiative consist of? For example, installing a new database might involve researching off-the-shelf applications, defining the structure of the database contents, testing early versions, and so forth.

3. How much time do you anticipate needing to complete each phase of the initiative? The total initiative? Compare your estimates to times required on similar projects that have been completed.

4. Where in your schedule are delays most likely, and how will you handle them? Consider building more time into these phases of the initiative.

5. Which initiative tasks depend on completion of other tasks? These represent potential bottlenecks, and merit extra attention during execution of the initiative.

Tools for Thinking Strategically 81

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6. How will you gather feedback on your proposed timeline so as to create a final, realistic version? Consider asking colleagues, employees, people who will be implementing parts of the initiative, and any other stakeholders to identify potential problems with your working time line.

Part II: Organizing a work day

7. The next time you come to work on a Monday morning, list all the things you want to accomplish that day. List tasks as they come to mind, without trying to organize them just yet.

8. Review your list. Which items are the most critical? Critical items are those that generate the most valuable results for your group and company when completed.

9. Which items on your list are peripheral? Peripheral items have little or no bearing on your group’s or company’s high-priority objectives.

10. Which items are urgent but not important? Some tasks are time sensitive but have little strategic value.

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Tools for Thinking Strategically 83

11. How will you schedule the critical tasks on your list to ensure that they’re completed effectively and on time? Divide work into parts, if necessary, to help you determine which tasks to focus on in which sequence. Consider what parts of the work must be done today, tomorrow, next week, next month, and so forth.

12. Which items on your list can be delegated to members of your team? Which can be left undone with no harmful impact on your group or company? Knowing when to delegate and when to ignore strategically irrelevant tasks can help you focus further on critical items on your list.

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THINKING STRATEGICALLY

Worksheet for Making Trade-Offs

Use this tool to make smart trade-offs while grappling with a difficult decision or problem.

1. Identify an important decision or problem you’re facing. For example, a key design expert on a new product has fallen behind schedule in handling his part of the project, and you must decide whether to delay launch of the product so as to incorporate his expertise or go ahead without it.

2. What are your choices regarding the issue you’re facing? For instance, you could delay the product launch, borrow an existing design and launch the product on time, find another skilled designer who can step in immediately and take over that part of the project, and so forth.

3. What are the pros and cons of each of the choices you listed in step 2? For example, delaying the product launch would ensure that the product embodied cutting-edge design, but it would risk losing sales to eager customers who expect to purchase the new offering by the original promised date.

4. How might knowledge of your company’s or unit’s strategic goals inform your decision? If your company’s strategy emphasizes increasing sales revenues, you might decide to keep the product on schedule—and trade off design innovation for sales.

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Tools for Thinking Strategically 85

5. What are the potential short- and long-term ramifications of your choices? Launching the product on schedule but with a less-than-stellar design might generate needed sales in the short run but reduce sales in the long run if customers decide that the product is mediocre.

6. What cross-functional considerations should you take into account while making your decision? For instance, delaying launch of the product—even if it’s the right thing to do overall—could overburden the sales group if they have already committed their energy to introducing other products during the time when you now want to launch your new product.

7. Taking all of your above responses into account—pros and cons of alternatives, your company’s and unit’s strategic goals, short- and long-term consequences of your choices, and cross-functional considerations—what trade-off seems most appropriate to make in this situation? Write your decision, and explain your rationale.

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THINKING STRATEGICALLY

Strategic Thinking Self-Assessment

Part I: Assessment

Use this tool to assess your strategic thinking abilities. For each statement below, indicate how accurately the statement describes you. “1” indicates “Rarely,” “5” indicates “Usually.” Be sure to answer based on your actual behavior in real workplace situations. That way, you’ll have the most accurate assessment of your skills.

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Statement

Rating

Rarely Usually

1 2 3 4 5

1. I ask questions about what’s going on in my unit, company, industry, and wider business environment.

2. I am able to adapt approaches and shift ideas when new information suggests the need to do so.

3. I look for opportunities today that might generate valuable results tomorrow.

4. I view challenges as opportunities.

5. I welcome new ideas and opinions—even if they seem strange at first.

6. I take criticism well by not reacting in a defensive manner.

7. I work to broaden my knowledge, experience, and skill set.

8. I seek other people’s opinions.

9. I anticipate how my actions will affect others around me.

10. I question my own long-standing assumptions and encourage others to question theirs.

11. I understand the forces influencing my group’s performance.

12. I know who my company’s customers are and what they value.

13. I know who my company’s competitors are and what makes us different from them.

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Tools for Thinking Strategically 87

14. I stay up to date on important trends affecting my company’s industry and my group’s operations.

15. I objectively analyze situations.

16. I evaluate the pros, cons, and implications of different courses of action.

17. I grasp abstract ideas and put the “pieces” together to form a coherent picture.

18. I generate a wide variety of options, visualize new possibilities, and formulate fresh approaches.

19. I see patterns across unrelated events and information.

20. I can sift out irrelevant from relevant information while deciding how to solve a problem or handle a challenge.

21. I can often visualize new possibilities that others have trouble seeing.

22. I try to generate multiple alternative courses of action while making important decisions.

23. I compare the potential short- and long-term consequences of actions I’m considering.

24. I consider whether improvements I’m making to my own group’s operations may create problems for people in other parts of my organization.

25. I stay focused on my objectives while handling multiple demands and competing priorities.

Total score (Calculate your score by adding up the numbers for each of your

responses.)

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Part II: Scoring

Use the following table to interpret your score.

88 Tools for Thinking Strategically

104–125 Exceptional: You’re a talented strategic thinker who possesses many of the traits, behaviors, attitudes, and cognitive capacities that are necessary for thinking strategically.

78–103 Superior: You’re a highly effective strategic thinker in many areas but would benefit from refining some of your skills.

51–77 Adequate: You know and practice many of the basics of strategic thinking. However, you can increase your success by further extending your skills.

25–50 Deficient: You’ll need to work broadly on your strategic thinking skills so that you can learn how to analyze opportunities and problems from a broad perspective and understand an action’s potential impact on others.

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Test Yourself

This section offers ten multiple-choice questions to help you identify

your baseline knowledge of the essentials of thinking strategically.

Answers to the questions are given at the end of the test.

1. What is strategic thinking?

a. Analyzing opportunities and problems from a broad

perspective and understanding your actions’ potential

impacts on others.

b. Developing plans for persuading your supervisor, peer

managers, employees, or customers to adopt your proposed

course of action.

c. Identifying the root causes of problems without allowing

emotions to dominate or confuse your thinking process.

2. Which of the following is a personal trait that is characteristic

of strategic thinkers?

a. Keeping an eye on competitors’ actions and plans.

b. Viewing challenges as opportunities.

c. Evaluating the pros and cons of alternative courses of

action.

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90 Test Yourself

3. What are the two phases of the strategic thinking process?

a. Seeing the big picture and thinking creatively.

b. Prioritizing your actions and analyzing information.

c. Setting the stage and applying your skills.

4. How do strategic thinkers continually improve their view of

the larger “business ecosystem” in which they operate?

a. They analyze the impact of their company’s products and

services on high-level, emerging developments such as the

accelerating globalization of business and organizations’

increasing emphasis on improving customer service.

b. They understand their company’s and unit’s strategies;

consider what’s going on with customers, competitors, and

their industry; and take into account how their actions

might affect others in their organization.

c. They stay on top of important trends in the industry in

which their company competes—such as changes in govern-

mental policy, technological advances, availability and qual-

ity of natural resources, and demographic shifts.

5. Your boss has just defined an urgent strategic objective for you:

“Enhance quality to improve company performance.” As a strate-

gic thinker, how might you best respond to your boss’s mandate

initially?

a. Gain insights from managers who are working in other

functions about how the company has been performing and

what may be contributing to performance problems.

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Test Yourself 91

b. Move immediately to reduce errors, improve accuracy, and

incorporate cutting-edge innovation into every process for

which your group is responsible.

c. Ask your boss clarifying questions, such as “What do you

mean by ‘enhance quality’?” and “Where should we focus

our quality-enhancement efforts?”

6. Identifying relationships, patterns, and trends is an important

strategic thinking skill. Which of the following is an example of

this skill in action?

a. At a conference, you hear a presenter describe a new

process-improvement approach being used in a different

industry. You consider adapting that process in your own

company.

b. While attempting to solve a recurring problem in your

group, you invite your direct reports to challenge their

assumptions about how work should be done in your

organization.

c. To carry out a strategic mandate to improve order fulfill-

ment for customers, you list all the critical data you need to

know in order to achieve this important objective.

7. Creative thinking constitutes an important strategic thinking

skill. Which of the following is a valuable outcome of creative

thinking?

a. An effective plan for gathering information you need to

solve a pressing business problem.

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92 Test Yourself

b. Awareness of underlying common themes in a wide range of

data you’re evaluating.

c. An open attitude toward seemingly bizarre ideas that your

company hasn’t considered before.

8. Analyzing information is another key strategic thinking skill.

Which of the following is an example of how you might apply

this skill?

a. Borrow from previously developed solutions that proved

useful for addressing problems such as one you’re currently

dealing with.

b. Gather all information directly and indirectly related to a

current challenge, so you can compile the most comprehen-

sive data possible.

c. Concentrate your information analysis on what’s going on

in your immediate group, since you’re most familiar with

that source of data.

9. How might a strategic thinker best approach accomplishing a

long list of “to do’s” facing him or her at the start of a workday?

a. Tackle the easiest items first so as to get rid of distractions

and then focus more sharply on the most important activi-

ties and tasks.

b. Identify and schedule the most critical items on the list first,

while delegating or leaving undone any peripheral items.

c. Address all urgent responsibilities immediately, since these

constitute the most important items on the list.

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Test Yourself 93

10. Knowing how to make smart trade-offs is a vital strategic

thinking skill. Which of the following approaches can help you

apply this skill?

a. Weighing the short- and long-term consequences of a pro-

posed course of action.

b. Identifying the full range of possible advantages offered by a

decision you advocate.

c. Optimizing your group’s performance to improve company

performance overall.

Answers to test questions

1, a. Because you work in a particular part of your organization,

you have only so much information at hand to address difficult

problems and make important decisions. Strategic thinking helps

you overcome these limitations. How? It enables you to view

workplace challenges from a broad perspective and anticipate

your decisions’ possible impact on other individuals and parts of

your organization. As a result, you make smarter choices and se-

lect the most appropriate courses of action to generate valuable

results for your organization.

2, b. In addition to a positive outlook that enables them to view

challenges as opportunities, strategic thinkers demonstrate

other characteristic personal traits—such as curiosity about

their company and industry, flexibility in the face of new

information, a focus on the future, and a breadth of knowledge

and experience.

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94 Test Yourself

3, c. In phase 1 of the strategic thinking process, setting the stage,

you seek to understand the broader business environment in

which you operate and to clarify your strategic objectives. In

phase 2, you apply your strategic thinking skills—which include

identifying relationships, patterns, and trends; thinking cre-

atively; analyzing information; prioritizing your actions; and

making trade-offs.

4, b. Improving your view of the larger “business ecosystem”

means constantly monitoring what’s going on both inside and

outside your organization—and using your awareness to make

smart on-the-job choices that ensure your company’s best possi-

ble future. Familiarizing yourself with company- and unit-level

strategy; understanding changes in customers, competitors, and

your industry; and anticipating how your choices may have an

impact on people and processes in other parts of your organiza-

tion all help you gain the broad perspective you need to make

savvy business decisions.

5, c. When your boss defines strategic objectives for you, it’s

important to ensure that you understand those objectives in the

most specific terms possible. Asking clarifying questions can help

you avoid misunderstandings about goals, specify areas where

you should invest your effort and time, and anticipate possible

impacts of any changes on other parts of the organization. In

addition to asking their boss clarifying questions, strategic

thinkers also offer ideas for additional objectives that may help

their group support company-level strategies.

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Test Yourself 95

6, a. Spotting opportunities to leverage best practices from in-

dustries very different from yours is an example of the ability to

identify relationships, patterns, and trends—particularly in seem-

ingly unrelated arenas. Application of this strategic thinking skill

also enables you to understand relationships across different parts

of your organization, interpret changes across time in important

performance metrics (such as employee turnover or revenues),

and organize seemingly disparate information into more man-

ageable categories.

7, c. Generating fresh alternatives (even if they seem initially

preposterous), visualizing new possibilities, formulating new

approaches to getting things done, and opening yourself to new

information that doesn’t support your existing assumptions are

all hallmarks of creative thinking. By enabling you to generate

more alternatives rather than limiting your choices to just the

first one or two that come to mind, creative thinking boosts your

chances of ultimately selecting the best possible course of action.

8, a. Building on existing knowledge is one valuable way to apply

your skill at analyzing information. By adapting proved solutions,

you save time and help spread wisdom gained in other parts of

your organization. Other ways to apply this skill include deter-

mining the critical information you need to address the issue at

hand, as well as developing and implementing an effective infor-

mation-gathering plan.

9, b. By prioritizing your actions in this way, you keep your

eye on the big picture—a key element of strategic thinking.

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96 Test Yourself

All managers are busy and have many responsibilities. Part of

being a strategic thinker is knowing how to identify and prioritize

the critical tasks on your long list of “to do’s”—those activities

that will generate the most valuable results for your group and

company. More peripheral items can be postponed, delegated, or

even left undone if necessary, so you can focus your time and

energy on strategically relevant activities.

10, a. Some trade-offs involve sacrificing short-term gains in

order to achieve important long-term gains, or vice versa. Thus,

weighing the possible short- and long-term consequences of a

proposed course of action, and considering how each of those

consequences relates to your company’s strategic goals, can help

you make smart trade-offs. Other approaches to making wise

trade-offs include assessing the pros and cons of alternative

courses of action, considering whether actions that benefit your

group will also benefit the rest of your organization, and specify-

ing what you won’t do to resolve a problem or achieve a goal.

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To Learn More

Articles

Christensen, Clayton M. “Making Strategy: Learning by Doing.”

Harvard Business Review, November 1997.

Companies find it difficult to change strategy for many

reasons, but one stands out: strategic thinking is not a core

managerial competence at most companies. Managers are

unable to develop competence in strategic thinking because

they do it so rarely. Harvard Business School Professor Clayton

Christensen helps managers develop a creative strategy and

a proficiency in strategic decision making. This article presents

a three-stage method executives can use to conceive and

implement a creative and coherent strategy themselves. The

three-step process forces managers to dig deep in order to

understand the forces affecting their business. This method

is a useful tool for managers because it helps them link

strategic thinking with operational planning: two processes

that are often separate but are more effective when

connected.

Collis, David J., and Michael G. Rukstad, “Can You Say What Your

Strategy Is?” Harvard Business Review, April 2008.

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98 To Learn More

Can you summarize your company’s strategy in 35 words or

less? Would your colleagues express it the same way? Very few

executives can honestly say yes to those simple questions. The

thing is, companies with a clear, concise strategy statement—

one that employees can easily internalize and use as a guiding

light—often turn out to be industry stars. In this article,

Harvard Business School’s Collis and Rukstad provide a

practical guide for crafting an effective strategy statement

and include an in-depth example of how the St. Louis–based

brokerage firm Edward Jones developed one that has gener-

ated success.

Harvard Business School Publishing. “Essentials: The Building

Blocks of Strategy.” Harvard Management Update, January 2006.

If you haven’t had a great deal of experience with formulating

a strategy for your business or unit, you’re in good company.

It’s not an everyday activity. This article walks you through

the steps you need to take: (1) scan the outer environment for

threats and opportunities; (2) look inside at resources, capabil-

ities, and practices; (3) consider how you will address threats

and opportunities you’ve identified; (4) build a good “fit”

among strategy-supporting activities; and (5) create alignment

between the people and the activities of the organization and

its strategy. And remember—no strategy lasts forever, so learn

to use these steps again and again to keep your strategy re-

sponsive to the ever-changing business environment. (Note:

This article is adapted from Manager’s Toolkit, published by

Harvard Business School Press in 2004.)

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To Learn More 99

Slywotzky, Adrian J., and John Drzik.“Countering the Biggest Risk of

All.”Harvard Business Review OnPoint Enhanced Edition,April 2005.

Slywotzky and Drzik provide examples of how managers work-

ing in a wide variety of organizations apply the strategic think-

ing skill of seeing the big picture. In particular, the authors show

how to assess the implications of important “business ecosys-

tem” developments—such as technology shifts, the emergence

of new competitors, industrywide commoditization of products

and erosion of profit margins, changes in customer priorities,

and maturation of markets. Slywotzky and Drzik then offer

strategies for countering such developments, showing how

particular organizations have used these strategies successfully.

Spear, Steven J.“Fixing Health Care from the Inside, Today.” Harvard

Business Review OnPoint Enhanced Edition, September 2005.

Spear provides a case study of strategic thinking in action—

particularly the ability to identify relationships, patterns, and

trends. The author describes how health care professionals at

several hospitals applied a strategy used by a major automobile

manufacturer to identify and correct process problems.

Though the two industries are very different, health care prac-

titioners realized that the automobile manufacturer’s process-

improvement approach could help them reduce errors in

patient care, save lives, and cut costs.

Stalk Jr., George. “Curveball: Strategies to Fool the Competition.”

Harvard Business Review OnPoint Enhanced Edition, September

2006.

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100 To Learn More

In this follow-up piece to his article “Hardball: Five Killer

Strategies for Trouncing the Competition” (HBR, April 2004),

George Stalk Jr. of the Boston Consulting Group offers

another approach for prevailing over rivals. Strategic hardball

is about playing rough and tough with competitors; strategic

curveball is about outfoxing them. It involves getting rivals to

do something dumb that they otherwise wouldn’t (that is,

swing at a pitch that appears to be in the strike zone but isn’t)

or not do something smart that they otherwise would (that is,

fail to swing at a pitch that’s in the strike zone but appears not

to be). Stalk describes four types of curveball and provides ex-

tended examples of curveball strategies in action at companies

such as the industrial-cleaning chemical supplier Ecolab and

the Australian airline Jetstar.

Books

Langdon, Bruce, Andy Langdon, and Ken Langdon. Strategic

Thinking. The DK Essential Managers Series. New York: Dorling

Kindersley, 2000.

This concise volume provides tips for applying your strategic

thinking skills—including understanding your customers and

competitors, making trade-offs between the short and long

term, clarifying your strategic objectives, assessing the pros

and cons of alternative courses of action, and much more. Ta-

bles, graphics, and case studies all serve to illustrate key points

and summarize important information.

De Bono, Edward. Six Thinking Hats. Boston: Little, Brown, 1985.

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To Learn More 101

De Bono, a leading international authority in the teaching of

thinking as a skill, provides easy-to-follow guidelines for ap-

plying the many skills that constitute strategic thinking. Any

manager, he maintains, can shift from skill to skill by “putting

on” the appropriate “thinking hat.” For example, donning the

“white hat” enables you to evaluate facts, figures, and objective

information, while shifting to the “green hat” helps you spark

your creative thinking. A wealth of examples from a broad

range of organizations helps to illustrate the six thinking skills

De Bono presents.

Kim, W. Chan, and Renée Mauborgne. Blue Ocean Strategy: How

to Create Uncontested Market Space and Make the Competition

Irrelevant. Boston: Harvard Business School Press, 2004.

Since the dawn of the industrial age, companies have engaged

in head-to-head competition in search of sustained, profitable

growth. They have fought for competitive advantage, battled

over market share, and struggled for differentiation. Yet, these

hallmarks of competitive strategy are not the way to create

profitable growth in the future. In a book that challenges

everything you thought you knew about the requirements for

strategic success, W. Chan Kim and Renée Mauborgne argue

that cutthroat competition results in nothing but a bloody red

ocean of rivals fighting over a shrinking profit pool. Based on a

study of a hundred fifty strategic moves spanning more than a

hundred years and thirty industries, the authors argue that

lasting success comes not from battling competitors, but from

creating “blue oceans”—untapped new market spaces ripe for

growth. Such strategic moves—which the authors call “value

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102 To Learn More

innovation”—create powerful leaps in value that often render

rivals obsolete for more than a decade. Blue Ocean Strategy

presents a systematic approach to making the competition ir-

relevant and outlines principles and tools any company can

use to create and capture blue oceans. A landmark work that

upends traditional thinking about strategy, this book charts a

bold new path to winning the future.

Strategy: Create and Implement the Best Strategy for Your Business.

Harvard Business Essentials Series. Boston: Harvard Business

School Press, 2005.

This book helps you focus on the strategic thinking skill of see-

ing the big picture—in particular, understanding your com-

pany’s and unit’s strategies and knowing how to help execute

them. The author explains how to assess your company’s and

unit’s strengths, weaknesses, opportunities, and threats

(a SWOT analysis); describes common competitive strategies

and strategic moves used in the business world; and explains

how to develop action plans for implementing strategy.

Additional chapters provide guidelines for keeping your

implementation plan on course, motivating your people to

execute strategy, and continually testing and revising your

strategy as needed.

eLearning

Harvard Business School Publishing. Case in Point. Boston:

Harvard Business School Publishing, 2004.

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To Learn More 103

Case in Point is a flexible set of online cases, designed to help

prepare middle- and senior-level managers for a variety of

leadership challenges. These short, reality-based scenarios pro-

vide sophisticated content to create a focused view into the re-

alities of the life of a leader. Your managers will experience:

Aligning Strategy, Removing Implementation Barriers, Over-

seeing Change, Anticipating Risk, Ethical Decisions, Building a

Business Case, Cultivating Customer Loyalty, Emotional Intel-

ligence, Developing a Global Perspective, Fostering Innova-

tion, Defining Problems, Selecting Solutions, Managing

Difficult Interactions, The Coach’s Role, Delegating for

Growth, Managing Creativity, Influencing Others, Managing

Performance, Providing Feedback, and Retaining Talent.

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Sources for Thinking Strategically

The following sources aided in development of this book:

De Bono, Edward. Six Thinking Hats. Boston: Little, Brown

and Company, 1985.

Gavetti, Giovanni, and Jan W. Rivkin. “How Strategists Really

Think: Tapping the Power of Analogy.” Harvard Business

Review OnPoint Enhanced Edition. April 2005.

Johnson, Lauren Keller. “Debriefing Paul Nutt: Increase the

Odds of Being Right.” Harvard Management Update, June

2005.

Slywotzky, Adrian J., and John Drzik. “Countering the Biggest

Risk of All.” Harvard Business Review OnPoint Enhanced

Edition. April 2005.

Spear, Steven J. “Fixing Health Care from the Inside, Today.”

Harvard Business Review OnPoint Enhanced Edition. April

2006.

“Strategic Thinking,” white paper, Interaction Associates, April

2005.

105

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106 Sources for Thinking Strategically

28S

29N

Successful Manager’s Handbook: Development Suggestions for

Today’s Managers. 2nd ed. Minneapolis: Personnel Deci-

sions International, 1992.

Successful Manager’s Handbook: Develop Yourself, Coach

Others. 7th ed. Minneapolis: Personnel Decisions Interna-

tional, 2004.

28S

29N

106 Sources for Thinking Strategically

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NOT ALL BUSINESS CHALLENGES ARE CREATED EQUAL. Some require detailed analysis and others

demand a thoughtful solution—but in a quick

and easily accessible format.

Now you can get instant access to the answers

you need by downloading individual chapters

from our most popular books, including:

 Blue Ocean Strategy by

W. Chan Kim and Renée Mauborgne

 Leading Change by John P. Kotter

 Groundswell by Charlene Li and Josh Bernoff

 And many others

The solutions to your toughest challenges are just a click away.

DOWNLOAD BOOK

CHAPTERS NOW

LEARN MORE ABOUT HARVARD BUSINESS PRESS CHAPTERS: www.harvardbusiness.org/press

THE ANSWERS YOU NEED,

WHEN YOU NEED THEM

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Uber Pricing Strategies and Marketing Communications.pdf

UV6878 Rev. May 2, 2016

This case was prepared by Virginia Weiler, Marketing Instructor, University of Southern Indiana; Paul Farris, Landmark Communications Professor of Business Administration, Darden School of Business; Gerry Yemen, Senior Researcher, Darden School of Business; and Kusum Ailawadi, Professor of Marketing, Tuck School of Business, Dartmouth College. Copyright  2014 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to [email protected]. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation.

Uber Pricing Strategies and Marketing Communications

By late March 2016, Uber Technologies, Inc., an e-hail ride-sharing company, was on a roll, rapidly expanding service to untapped markets worldwide and gaining new, enthusiastic customers, as well as a few vocal and visible detractors. Some of its critics were focused on Uber’s practice of “surge pricing,” a tactic that increased rates sharply in times of higher demand for car service. Other groups that disliked the company included competing taxi and limo services, which argued that inadequate driver screening and training endangered consumers and made for unfair competition in the highly regulated industry. In addition, some city governments enacted regulations to limit the number of cars on the road that ride-sharing companies could offer, and others completely banned the service.

Aside from monetizing private cars into ride-sharing services offered around the globe, Uber slowly added a delivery service (UberRUSH) and eventually created an application program interface (API) enabling an Uber button to be added to other organizations’ apps (e.g., Facebook, retailers, florists) for delivery options through UberRUSH and UberEATS for food products.

While Uber explored growth in new markets, competitors in its core space were working hard to take market share. Lyft, Uber’s major U.S. ride-share rival, had raised $1 billion in capital and was investing some of it toward discounts and increased marketing efforts while expanding in major cities across the country.

As Uber’s dominance grew, would striking a balance between becoming ever more present internationally, positioning itself in new service markets, and turning a profit in its home market and competency be the firm’s next major business challenge?

Taxi and Limousine Industry

In 2014, the American taxicab and limousine market was enormous, employing close to 233,700 drivers nationally who earned an average annual salary of $23,210.1 The Bureau of Labor Statistics estimated that there would be a 13% increase in the number of drivers between 2014 and 2024 (more than twice the average total of all occupations). Major cities such as Chicago, Illinois, and New York City, New York, controlled the industry through the use of medallions. New York City alone had 13,437 yellow cabs licensed through the medallion system, as well as 32,000 limousine and livery (call-ahead) vehicles. The number of taxi medallions was fixed, and those sold on the open market could fetch more than $1 million. The New York City Taxi & Limousine

1 United States Department of Labor, Bureau of Labor Statistics, ‘Taxi Drivers and Chauffeurs,” http://www.bls.gov/ooh/transportation-and-

material-moving/taxi-drivers-and-chauffeurs.htm (accessed Mar. 31, 2016).

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This document is authorized for use only by Marie Dagstanyan in Marketing Concepts & Strategies - SPRING '17 taught by Tony Stovall, Woodbury University from December 2016 to June 2017.

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Commission calculated a medallion’s annual return on investment as close to 20%. Many cities used the medallion system as a way to ensure income for the medallion owner.2

Taxis were either hailed on the street or sent out after a passenger called a central dispatcher. Livery car service was prearranged; the cars generally could not be hailed on the street, protecting taxis from competition. There was usually a waiting period between the call for a car and passenger pickup, in some cases up to an hour.3

By and large, taxis were regulated at the municipal level and livery services were regulated by state agencies. One method employed by regulatory agencies to ensure that vehicles hailed on the street were licensed was to standardize their appearance. Taxis had a distinctive look (e.g., mustard yellow in New York City) and were required to indicate clearly whether or not they were in service. Other taxi and livery regulations included a set number of vehicle inspections per year, requirements for the location of a taxi service’s dispatch station/business operations, and whether or not customers could be solicited and cars assigned to customers for pickup.4

Taxicabs charged passengers based on time and distance, which were calculated by a taximeter prominently displayed inside the vehicle. Taximeters calculated fares based on a highly regulated and standardized fare schedule (e.g., $3.50 per mile for the first five miles and $5.00 per mile thereafter). Livery vehicles had no taximeters, and fares were usually based on time, or rough distance with a predetermined minimum price that was agreed on in advance. In general, livery vehicles were not allowed to charge based on time plus distance.

When an alternative ride-share option started to develop in the mid-2000s, the International Association of Transportation Regulators, a trade group representing taxicab and livery drivers, took notice. In July 2013, they called for the prohibition of what it called “bogus” and “rogue” ride-sharing services in the name of public safety. In a press release, the association claimed it was protecting the public from unlicensed drivers who could be drug users or criminals. In effect, the trade group called for a ban on mobile applications (apps) that would allow people to make ride arrangements via smartphone.

Taxi and rental-car usage started to dip—but it was unclear whether ride sharing was responsible (see Exhibit 1 for business traveler data). And unrestricted New York City taxi medallions dropped in price from $1 million in 2014 to as low as $400,000 in 20165— only 19 independent unrestricted medallions had been sold in New York City during 2015.6 Yet it seemed that when regulatory agencies failed to protect the industry in New York City, the response was “if you can’t beat ’em…join ’em.” In the fall of 2015, the New York City Taxi and Limousine Commission (TLC) launched a pilot called Alternative Technology, which was a partnership between the organization and tech companies to test products in New York City cabs. One system was GPS-based taximeters and the other an alternative technology system (ATS) that provided driver payments through credit-, debit-, and prepaid-card payment systems (through an e-hail app); driver authentication and text messaging; trip data collection; passenger notifications that included visual accessibility features; automatic vehicle location systems; and driver, medallion owner, and agent reporting.7

2 Steve Chapman, “Ride-Sharing vs. the Taxi Industry,” Chicago Tribune, February 20, 2014. 3 David Hoyt and Steven Callander, “Uber: 21st Century Technology Confronts 20th Century Regulation,” Stanford Graduate School of Business

case study no. P81 (Stanford, CA: Stanford Graduate School of Business, 2012): 2. 4 Hoyt and Callander, 2–3, 5. 5 NYCITYCAB.com, http://nycitycab.com/business/taximedallionlist.aspx (accessed Apr. 27, 2016). 6 Author calculations based on data from the New York City Taxi & Limousine Commission,

http://www.nyc.gov/html/tlc/html/archive/archive_med_transfer_2015.shtml (accessed Apr. 27, 2016). 7 New York City Taxi and Limousine Commission, “Memorandum of Understanding: Terms and Conditions for Taxi and Limousine Commission

Authorization,” http://www.nyc.gov/html/tlc/downloads/pdf/mou_tech_project.pdf (accessed Mar. 22, 2016).

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This document is authorized for use only by Marie Dagstanyan in Marketing Concepts & Strategies - SPRING '17 taught by Tony Stovall, Woodbury University from December 2016 to June 2017.

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Uber Background

Uber Technologies, Inc., originally called UberCabs, was founded in 2009 by tech start-up veterans Garrett Camp and Travis Kalanick and headquartered in San Francisco. Uber began as a private luxury car service catering to Silicon Valley’s top executives. In those days, someone in need of a ride had to e-mail Kalanick for a code that would give them access to the app. Kalanick had recognized the potential profit in empty limousine seats and idling taxis. In 2010, watching cars traverse San Francisco, Kalanick was convinced that the concept of technology bringing drivers and passengers together efficiently could scale globally. By 2010, Kalanick had executed an aggressive growth strategy.

Uber’s cofounders had very different roles within the company. Camp, a serial entrepreneur who cofounded StumbleUpon in 2002, acted mostly as a silent partner. From Uber, he went on to another start-up, Expa, which developed new consumer products, systems, and services. The public face and voice of Uber clearly belonged to its other cofounder. Kalanick grew up in Northridge, California. He attended UCLA, but dropped out to develop his first start-up, Scour, a file-sharing program. In 2000, Scour was sued for a quarter of a trillion dollars by the Motion Picture Association of America, for copyright infringement.8 Subsequently, Scour filed for Chapter 11 bankruptcy protection. Kalanick’s next venture, Red Swoosh, a peer-to-peer networking site, was bought by Akamai Technologies in 2007 for $15 million.9

Kalanick was personally involved in efforts to overcome regulatory agencies’ resistance to Uber’s expansion in a number of cities. Indeed, he was described as a “brawler” who relished a good fight, whether it be on Twitter with a competitor’s CEO or with the entrenched taxi and limousine governmental bodies he viewed as a threat to Uber’s growth.10 Uber had encountered significant political headwinds in a number of markets; fierce resistance came from Portland, Oregon; Paris, France; Miami, Florida; Denver, Colorado; and Washington, DC. Some states such as California fined the company for regulatory violations. Uber has had legal clashes in Germany (where it was banned), and in Spain, Colombia, France, Australia, Italy, Denmark, China, and England.11

The company expanded rapidly, and by March 2016, it was operating in 400 cities12 in 65 countries, with more than 162,000 active driver partners.13 Examples of cities served were Abu Dhabi, the United Arab Emirates; Amsterdam, the Netherlands; Bangalore, India; Bogotá, Columbia; Doha, Qatar; London, England; Moscow, Russia; New York City; Rome, Italy; Shanghai, China; Tokyo, Japan; and Zürich, Switzerland (see Exhibit 2 for locations). Kalanick was able to attract influential and high-profile investors whose funding helped fuel Uber’s rapid expansion. Among those financiers were Ashton Kutcher, Jeff Bezos, and Google’s investment division, which in August 2013 gave Uber $258 million in capital.14 The company was valued at $62.5 billion just shy of three years later.15

8 John Borland, “Movie Studios Target Scour with Copyright Lawsuit,” CNET, July 20, 2000, http://news.cnet.com/2100-1023-243432.html

(accessed Apr. 1, 2016). 9 “Akamai Acquires Red Swoosh,” Akamai Technologies, Inc., press release, April 12, 2007,

https://www.akamai.com/us/en/about/news/press/2007-press/akamai-acquires-red-swoosh.jsp (accessed Apr. 1, 2016). 10 Marcus Wohlsen, “What Uber Will Do with All That Money from Google,” Wired, January 3, 2014. 11 B. R., “Taxi Services: Unsafe in The Knowledge,” Economist, July 16, 2015, http://www.economist.com/blogs/gulliver/2015/07/taxi-services

(accessed Apr. 1, 2016). 12 “Uber Now Available in Abuja, Nigeria,” Premium Herald, March 24, 2016, (accessed Mar. 31, 2016). 13 Emily Badger, “Now We Know How Many Drivers Uber Has—and Have a Better Idea of What They Are Making,” Washington Post, January 22,

2015. 14 Wohlsen. 15 Matt Levine, “Uber is Raising More Money from Rich People,” BloombergView, January 15, 2016, http://www.bloombergview.com/articles/2016-

01-15/uber-is-raising-more-money-from-rich-people (accessed Mar. 31, 2016).

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This document is authorized for use only by Marie Dagstanyan in Marketing Concepts & Strategies - SPRING '17 taught by Tony Stovall, Woodbury University from December 2016 to June 2017.

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The Uber Product

Uber’s product was a smartphone app that allowed urban dwellers to hail vehicles virtually (see Figure 1). Fares fluctuated, and the company employed no drivers itself. Instead, Uber served as an electronic dispatcher as passengers and drivers connected digitally through its proprietary software. The app matched “willing” drivers and “needy” consumers thusly: a potential passenger, who had downloaded the Uber app onto his or her smartphone, put in a request for a car to take him or her to a specified location. When the passenger requested a ride, he or she got access to a driver’s name, car model, and rating. Based on that information, the passenger could accept or decline the ride.

If accepted, the driver usually arrived within a few minutes. Uber’s short wait times, facilitated by proprietary algorithms that directed drivers to locations where customers were most likely to call, were seen as one of its significant operational advantages. As one customer stated, “I found Uber remarkably convenient, considering chasing down a cab on a New York City weekend evening can be quite the task.”16

Uber’s fares were calculated according to its algorithms—developed by a data-science team of nuclear physics, computational biology, and astrophysics PhDs—which helped match supply with demand. The price for a ride was higher during times of peak usage. Some customers were critical of Uber’s policy of dramatically increasing fares during periods of peak demand (e.g., rush hour, New Year’s Eve, Halloween, and inclement weather), a practice Uber referred to as surge pricing (see Figure 2). Fares were continually adjusted according to a mathematical formula and could be as much as

16 Author interview with Uber user A, January 12, 2014.

Figure 1. Uber app showing Black Car option and UberX option.

Source: Author screenshot from Uber mobile app.

Figure 2. Uber surge pricing notice.

Source: Author screenshot from Uber mobile app.

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This document is authorized for use only by Marie Dagstanyan in Marketing Concepts & Strategies - SPRING '17 taught by Tony Stovall, Woodbury University from December 2016 to June 2017.

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seven or eight times the normal Uber rate.17 Kalanick defended the surge pricing policy as one that benefited passengers, since it incentivized drivers to make more pickups. Indeed, scholars had looked at cab driver behavior and found that many (particularly new drivers) did not finish their entire 12-hour shift if they had hit their target income before the shift ended.18

One group of passengers, however, launched a class-action lawsuit against Kalanick and was successful in being granted standing in April 2016. A federal judge agreed with the plaintiffs that Kalanick may have violated antitrust laws against price fixing by organizing “independent contract” drivers to charge higher prices through surges—a claim Kalanick said was “unwarranted” and against which he planned to defend himself and win.

Despite Kalanick’s aggressive defense of surge pricing, Uber lowered some of its rates in January 2014, although no plans were made to eliminate surge pricing. While dynamic pricing had been around for some time in other industries, by 2016, even the storied, service- oriented Disney Company announced that it would implement demand pricing during peak hours at its theme parks.19

Uber charged the customer’s credit card (which was kept in his or her Uber profile) after a trip was completed and e-mailed a receipt to the passenger (see Figure 3). Uber kept 20% of the fare and paid the driver the remaining 80% via direct deposit; the passenger and driver never exchanged money directly. In the first half of 2015, Uber’s gross revenue was estimated to be $3.63 billion ($2.93 billion the previous year).20 Uber’s share of that revenue would be approximately $726 million annually. In a single month during March 2016, Uber made 169 million trips worldwide and 50 million trips in the United States, earning on average $0.19 per ride.21

Uber Business Model

The ride-sharing platform Uber established meant keeping consumers and drivers connected and satisfied. In an article on the costs and benefits of the sharing economy, one author said that the sharing economy “matches people who want to share assets online,” and that “such efficiency gains may come at cost for

17 David Goldstein, “Uber ‘Surge Pricing’ Controversy Is a Cautionary Tale Against Taxi Deregulation,” Stranger, December 20, 2013,

http://slog.thestranger.com/slog/archives/2013/12/20/uber-surge-pricing-controversy-is-a-cautionary-tale-against-taxi- deregulation?oid=18528505&show=comments&sort=desc&display= (accessed Mar. 18, 2014).

18 Colin F. Camerer, “Taxi Drivers and Beauty Contests,” Engineering and Science no. 1 (1997): 11. 19 S. K., “Disney Discovers Peak Pricing,” Economist, February 29, 2016, http://www.economist.com/blogs/freeexchange/2016/02/price-

discrimination-land (accessed Apr. 1, 2016). 20 Amir Efrati, “Uber’s Losses Grow, But So Do Its Profit Projections,” The Information, January 11, 2016, https://www.theinformation.com/ubers-

losses-grow-but-so-do-its-profit-projections?unlock=aabcb5&token=4c278112edde93bcecd8d27043114b45bb862981 (accessed April 1, 2016). 21 Eric Newcomer, “Lyft is Gaining on Uber as It Spends Big for Growth,” Bloomberg Technology, April 14, 2016,

http://www.bloomberg.com/news/articles/2016-04-14/lyft-is-gaining-on-uber-as-it-spends-big-for-growth?cmpid= BBD041416_BIZ&utm_medium=email&utm_source=newsletter&utm_campaign (accessed Apr. 1, 2016).

Figure 3. Uber receipt.

Source: Author screenshot from Uber mobile app.

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This document is authorized for use only by Marie Dagstanyan in Marketing Concepts & Strategies - SPRING '17 taught by Tony Stovall, Woodbury University from December 2016 to June 2017.

Page 6 UV6878

traditional economy.”22 Uber did not directly employ drivers; rather, it claimed that it simply facilitated the connection between passengers and drivers, similar to how a website such as Expedia connected passengers and airlines. Uber did not own a fleet of vehicles, although it had guidelines as to what vehicle types its drivers could use for each service. For example, UberX vehicles had to be 2000 models or newer (and 2005 models or newer in some cities), have four doors, seat four passengers with seat belts, and have no cosmetic damage.

Services Uber offered varied worldwide. In most of the markets Uber served, customers could select from one of five services: UberX, UberXL, UberBlack, UberSUV, and UberTaxi. UberX was the least expensive option and dispatched drivers in smaller vehicles than those used for the other services. On its website, Uber claimed that its UberX service (which seated four) was “18% lower than taxi prices.”23 UberXL, the larger cousin to UberX, was for bigger groups: the vehicles seated six passengers and could be a van. And unlike the other services, UberX and UberXL utilized both professional and nonprofessional drivers. UberBlack, the original Uber service, used black town cars; fares for these vehicles were roughly 35% more than for UberX. Still, it was described as the “poor man’s town car”—it targeted those customers who could not afford a full- time driver but who wanted more luxurious transportation than a yellow cab or public transit. UberSUV worked well for large parties and was priced higher than the UberBlack service (see Table 1). UberTaxi allowed passengers to use the Uber app to hail a regular taxi. Unlike users of the other Uber services, customers using UberTaxi paid standard taxi rates, plus a booking fee of a dollar or two, and a 29% tip in some cities.24 (See Exhibit 3 for more Uber services offered in certain geographic areas.)

Table 1. Sample Uber rates in Denver, Colorado, April 2016.

UberX UberXL UberSUV UberBlack Base fare (start with this fare) $0.75 $3.00 $14.00 $ 7.00 Per mile (under 11 miles) $1.00 $1.85 $ 3.75 $ 3.00 Per minutes (under 11 miles) $0.13 $0.00 $ 0.00 $ 0.35 Minimum fare $4.95 $7.95 $25.00 $15.00 Cancelation fee $5.00 $5.00 $10.00 $10.00 Service fee $1.95 $1.95 $ 0.00 $ 0.00 Data source: “Denver Uber Prices,” Uberestimate.com, http://uberestimate.com/prices/Denver/ (accessed Apr. 25, 2016).

After a ride was completed, the passenger and driver could rate each other on a scale of one to five stars. Uber drivers had the right to refuse to pick up a passenger whose rating was three stars or lower. One Uber driver defended this practice by stating that low-rated passengers were “not worth the headache and hassel [sic].”25 In some cases, passengers whose drivers reported them as particularly poorly behaved had their accounts suspended.

There were other advantages for Uber drivers—for example, they did not have to provide kickbacks to human dispatchers to increase the likelihood that the dispatcher would steer fares their way. Drivers were guaranteed to be paid, because Uber had passengers’ credit card information on file. One Uber driver in San Francisco noted that when he drove a taxi, he would make about $300 for a 10-hour shift, whereas with Uber, on a good day, he could make $700. “I hope the new idea will work,” Mohamed Mandour said. “Because then we will be taking over the whole Bay Area.”26 (See Table 2 for wage comparison.)

22 Georgious Petropoulos, “Uber and the Economic Impact of the Sharing Economy Platform,” Bruegel, February 22, 2016. 23 “Getting More for Less on UberX: UberX—Better, Faster, and Cheaper than a Taxi,” Uber Newsroom, November 20, 2013,

https://newsroom.uber.com/us-dc/getting-more-for-less-on-uberx/ (accessed Apr. 1, 2016). 24 “UberX vs. UberSelect vs. UberTaxi vs. UberBlack,” Techboomers, https://techboomers.com/t/uberx-uberselect-ubertaxi-uberblack (accessed Apr.

1, 2016). 25 “While You’re Rating Uber, Uber Is Rating You (and It Could Cost You a Ride),” June 10, 2013, http://sarahsfav.es/2013/06/10/while-youre-

rating-uber-uber-is-rating-you-and-it-could-cost-you-a-ride (accessed Mar. 18, 2014). 26 Brian X. Chen, “Uber, an App That Summons a Car, Plans a Cheaper Service Using Hybrids,” New York Times, July 1, 2012.

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Table 2. Earnings per hour, Uber and taxi/limo drivers, 2014.

Cities Uber Taxi/Limo Boston $20.29 $12.92 Chicago $16.20 $11.87 Washington $17.79 $13.10 Los Angeles $17.11 $13.12 New York City $30.35 $15.17 San Francisco $25.77 $13.72 Average for all Uber markets $19.19 $12.90

Data source: Jonathan Hall and Alan Krueger, “An Analysis of the Labor Market for Uber’s Driver- Partners in the United States,” Princeton University working paper, January 22, 2015, https://timedotcom.files.wordpress.com/2015/01/uber_driver-partners_hall_kreuger_2015.pdf (accessed Apr. 25, 2016).

Uber had market-specific criteria for its drivers. On its website, an individual interested in driving for Uber would select the appropriate city, and the requirements for drivers in that market would appear. For example, in March 2014, if someone interested in driving for Uber in New York City went to the company’s website, he or she would be presented with two sets of criteria: one for UberBlack (town car) and one for UberTaxi (yellow cab).27 For UberBlack, the prospective driver had to have “commercial car insurance, a [Transportation Charter Permit], and an airport permit.” His or her vehicle had to be a black “sedan, crossover SUV, or full-size SUV” that “comfortably seats 4+ passengers.”28 If an individual was interested in becoming an UberX driver, he or she had to be “21 years of age or older,” with “an in-state Drivers License (depending on your state),” and “in- state car insurance” who drove a four-door sedan.29 By the end of 2015, Uber had 162,037 driver partners who had made more than three passenger trips.30

Conflict and Regulators

Generally, Uber conflicts centered on the municipal taxi and/or state limousine regulatory agency insisting that Uber was subject to agency authority since Uber was, in effect, operating as a transportation service. These agencies had strict guidelines about how passengers should contact the service provider, the fare structure, and the labeling and appearance of vehicles.31 The use of nonlicensed drivers and contentions that Uber’s fare platform was a high-tech metered service were the basis of many challenges.

Uber countered these regulatory efforts, insisting that it was merely a service that connected drivers and passengers and was not operating as a transportation company. Therefore, it should not be subject to the rules and regulations governing taxis and livery cars. Uber’s entry into the San Francisco market represented one of its earliest victories against regulatory agencies.32

Meanwhile, it was well known that taxi service in Washington, DC, was replete with problems, including not enough cabs in circulation, unreliable call-ahead service, and a reputation for taking advantage of passengers unfamiliar with the city.33 Passengers also complained that taxis would refuse to take them to certain parts of

27 For updated requirements, check Uber’s New York City website at http://driveubernyc.com/tlc/ (accessed Apr. 29, 2016). 28 “Uber Car Requirements,” I Drive With Uber (blog), http://www.idrivewithuber.com/uber-car-requirements/ (accessed Apr. 28, 2016). 29 http://www.idrivewithuber.com/uber-car-requirements/ (accessed Apr. 28, 2016). 30 Badger. 31 Hoyt and Callander, 2. 32 Hoyt and Callander, 5. 33 Author interview with Uber user B, February 3, 2014.

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the city.34 DC taxicabs, unlike those in New York City, did not accept credit cards. “This is my biggest qualm with them,” one passenger said. “It is 2014. I do not have cash.”35 Another practice passengers disliked was when dispatchers managing the taxi line at major destinations (e.g., Union Station) forced them to share cabs with other passengers they did not know. In this instance, both riders paid the full fare, despite the forced sharing arrangement.36 As one disgruntled passenger said, “In New York City, you would never be forced to share a cab but still pay the full fare.”37

These shortcomings made Washington, DC, an attractive location to Uber, and it attempted to enter the market during the summer of 2012. Uber’s relationship with DC regulators was immediately contentious and resulted in Uber drivers being targeted in stings by city officials and having their cars impounded.38 Uber reached out to its users on Twitter, Facebook, YouTube, and its website and asked for support. The result was 50,000 personal e-mails and 37,000 tweets with the hashtag #UberDCLove being sent to City Council member Mary Cheh, who had initially opposed Uber’s entry into the DC market.39 Cheh subsequently dropped her opposition.

Miami proved to be another market where Uber encountered strong political headwinds. In mid-2013, Uber ran afoul of Miami-Dade County commissioners, who refused to approve legislation that would allow Uber to operate in their jurisdiction. Uber continued to operate without adhering to warnings and was then faced with legislation in some areas that required fingerprinting driver-partners. By 2016, Uber had won its battle over fingerprinting in several jurisdictions—especially in those markets where Uber threatened to pull out and citizen backlash was intense.40

The U.S. market wasn’t the only place Uber ran afoul of regulators and legislators. Uber’s unlicensed drivers in Amsterdam resulted in Dutch court battles, and in 2015, the company decided to pull its service called UberPOP (similar to UberX in the United States), but continued to offer its licensed-driver services such as UberBlack and UberLUX in that country.41 In France and Spain, cabbies strongly resisted Uber’s efforts, staging demonstrations and street closures regularly. Taxi driver trade and union groups successfully stopped Uber’s unlicensed-driver services from operating in Germany with a court decision. Only UberTaxi and licensed services continued in certain areas of that county in 2016.

In addition to court battles and political wrangling, Uber was scrutinized on safety issues—often quite publically. Most of the problems involved drivers arrested for assaults (physical and sexual), drivers making lewd or racial comments, drunk drivers, or customer complaints about drivers taking longer routes—although Uber would quickly refund passengers who reported inefficient routes. There were also high-profile news stories about passengers attacking or harassing Uber drivers. While it was difficult to monitor and compare the troubles between Uber and regular taxi rides, the United States Taxicab, Limousine & Paratransit Association started a campaign to track and make public ride-sharing risks and incidents.42

34 Jackie Bensen, “DC Taxicab Passenger Complaints,” August 28, 2013, http://www.nbcwashington.com/news/local/DC-Taxicab-Passenger-

Complaints_Washington-DC-221583171.html (accessed Mar. 18, 2014). 35 Author interview with Uber user C, February 4, 2014. 36 Uber user C. 37 Uber user B. 38 Hoyt and Callander, 7. 39 Christine Lagorio-Chafkin, “Resistance Is Futile,” Inc., July/August 2013. 40 Douglas Hanks, “Uber Faces Fingerprinting Fight in Miami-Dade,” Miami Herald, February 25, 2016,

http://www.miamiherald.com/news/local/community/miami-dade/article62532202.html (accessed Apr. 1, 2016). 41 “UberPOP Stopt in Nederland,” Uber Newsroom, November 18, 2015, https://newsroom.uber.com/netherlands/uberpop-stopt-in-nederland/

(accessed Apr. 1, 2016). 42 “Who’s Driving You?” http://www.whosdrivingyou.org/rideshare-incidents (accessed Apr. 12, 2016).

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Uber had claimed that safety was “built into” all things Uber (i.e., driver background checks, extensive driver screening, and commercial $1 million insurance policies). In April 2016, Uber settled a California lawsuit around misrepresentation of its driver background checks, agreeing to pay $10 million and cease using the terms “safest ride on the road” or “the gold standard” in its marketing.43 Uber also had to refund passengers the $1 “safe ride fee” it had been charging.44

Market Entry/Employee Recruitment

When it was time to launch service in a new city, Uber executed a consistent strategy.45 Approximately six weeks before its targeted start date, Uber would send an advance team to the location to recruit already-licensed drivers. Another team was tasked with community management, which included creating a local social media groundswell about Uber’s impending entrance into the market and hosting private parties for local influencers to help create buzz. Local managers oversaw, in effect, two very different businesses—drivers/logistics and social media/public relations—and Kalanick hired people who could successfully handle both.46

In cities where it was well established, Uber would attempt to hire drivers away from competitors to further increase its share of the market. In some instances, these recruitment efforts were quite direct. A San Francisco Lyft driver recounted how, in November 2013, he picked up two attractive women. Something about them struck him as odd; they were evasive about where they were headed. In short order, they dropped their ruse and tried to recruit him to drive for UberX. They offered him a $50 gas card for checking out Uber’s headquarters, a free lunch, and a $500 bonus for picking up 20 passengers and promised that, if he accepted, Uber would waive its commission for the remainder of the year. As the driver saw it, “How smart is that— recruiting drivers in their very own car?”47 Another driver-recruitment tool Uber utilized in San Francisco in 2013 was a mobile billboard featuring a pink mustache (Lyft cars’ branding feature) and a razor, urging Lyft drivers to “Shave the stache.”48

Ride-Sharing Competition

In addition to traditional competitors, another set of Uber challengers was entering the rapidly developing technology-based personal urban transportation arena. This group—which included the companies Lyft, Hailo, and Sidecar in the United States—employed a business model that closely resembled Uber’s, with passengers and drivers connecting via technology rather than a human dispatcher (see Figure 4).

43 “Settlement with District Attorneys of San Francisco and Los Angeles,” Uber Newsroom, April 7, 2016, https://newsroom.uber.com/da-

settlement/ (accessed Apr. 12, 2016). 44 Caitlin McGarry, “Uber Has to Refund Those So-Called Safe Ride Fees,” Macworld, February 12, 2016,

http://www.macworld.com/article/3033033/software/uber-has-to-refund-those-so-called-safe-ride-fees.html (accessed Apr. 15, 2016). 45 Lagorio-Chafkin. 46 Hoyt and Callander, 2. 47 Ellen Huet, “Uber, Lyft, Sidecar Put Driver Recruiting in High Gear,” SFGate, January 31, 2014, http://www.sfgate.com/bayarea/article/Uber-

Lyft-Sidecar-put-driver-recruiting-in-high-5190676.php (accessed Mar. 17, 2014). 48 Henry Grabar, “Taxi Battle of the Day: Uber vs. Lyft,” Atlantic Cities, May 7, 2013, http://www.theatlanticcities.com/jobs-and-

economy/2013/05/taxi-ad-battle-day-uber-vs-lyft/5519 (accessed Mar. 17, 2014).

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Lyft represented the largest of these competitors. It pursued a differential positioning strategy as the “anti-Uber”49 and offered a peer-to-peer ride-share service. Lyft did not provide a black-car service, and as of December 2013, it was estimated to be doing one- third of Uber’s weekly ride load, although Lyft’s growth rate was more than double Uber’s at that same time. Estimated net revenues in 2014 reached $130 million, and by 2015, reached $1 billion in gross annual revenue.50 Lyft offered a low-tier shared-ride options called Lyft Line and Plain Lyft, similar to UberX, which seated four, and Lyft Plus for larger groups that included SUVs.

Lyft’s passengers and its 315,000 drivers connected through a smartphone app. Passengers were allowed to ride in the front seat of private vehicles when there were too many passengers for the backseat, and drivers (who did not hold livery or taxi licenses) greeted passengers with a fist bump. A distinctive mustache on the front of a vehicle identified it as part of the Lyft fleet (see Figure 5).

In some markets, Lyft published a structured fare schedule. In others, it asked passengers to give drivers a donation. And passengers could tip drivers. Unlike Uber, the company did not practice surge pricing in the beginning, but eventually added “prime time” charges that the company said occurred when demand for drivers exceeded the number of drivers available. One former Washington, DC, Lyft driver, James Montana, described his experience:51

49 Carmel Deamicis, “Lyft Introduces Uber-Style Surge Pricing, Urges Us Not to Call It That,” PandoDaily, November 22, 2013,

http://pando.com/2013/11/22/lyft-introduces-uber-style-surge-pricing-urges-us-not-to-call-it-that (accessed Mar. 18, 2014). 50 Heather Somerville, “Lyft Executive Says on Track to Hit $1 Billion in Gross Revenue,” Reuters, November 17, 2015,

http://www.reuters.com/article/us-lyft-runrate-exclusive-idUSKCN0T621K20151117#7j71Oao6sDUYoY7r.99; and Tracey Lien, “Lyft Defies Predictions by Continuing to Grow as a Rival to Uber,” Los Angeles Times, January 5, 2016, http://www.latimes.com/business/technology/la-fi-0105- lyft-growth-20160105-story.html (accessed Apr.15, 2016).

51 Author e-mail correspondence with James Montana, April 9, 2014.

Figure 4. Lyft app.

Source: “Lyft screenshot,” posted to public domain under Creative Commons (CC BY-SA 4.0) by “Cstockwe,” November 1, 2014, https://commons.wikimedia.org/wiki/Catego ry:Lyft#/media/File:Lyft_screenshot.PNG (accessed Apr. 25, 2016).

Figure 5. Lyft vehicle.

Source: “A Lyft vehicle in Santa Monica, CA,” posted to public domain under Creative Commons (CC BY-SA 4.0) by “Praiselightmedia,” May 13, 2014, https://commons.wikimedia.org/w/index.php?curid=38084668 (accessed Apr. 26, 2016).

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From my point of view, here’s how it went. A Lyft startup team parachuted into DC with orders to get Lyft up and running in the city, and build market share as quickly as possible. To accomplish that, the startup team (1) hired lots of drivers, like me, (2) paid an hourly floor to drivers, either at $15 per hour or $25 per hour depending on day and time, and (3) kept the price of fares very low.

This price and wage regime lasted for about six months. It was clear even to the most distant and careless observer (e.g., me) that this regime was a major money loser for Lyft. Lyft sent me weekly pay statements which listed the amount of money that Lyft took in fees from passengers, and the amount of money that Lyft was paying me in hourly. Lyft never made money on me, because [it] always paid out more in hourly than it earned in rider fees. I drove until midnight on New Year’s Eve, and Lyft lost money on me on that night, too.

From that, I inferred that Lyft was burning lots of venture capital in order to get established in DC. It couldn’t go on forever, though, so, after six months, Lyft eliminated both elements of the old regime: Lyft dropped the hourly pay for drivers and, a few months later, Lyft raised prices for riders. By that time, I had become a Lyft “mentor,” which is Lyft’s way of outsourcing hiring to its own drivers. I noticed that Lyft was hiring lots of new drivers, presumably to replace those who had dropped out due to decreases in pay.

I don’t know how this has changed the experience for riders. Anecdotally, I think there are fewer drivers out there because the passengers report longer wait times. I drive rarely now, because the leisure is worth more to me than the money.

In January 2014, Uber responded to its Lyft competition by placing social media advertisements depicting a man and a woman fist-bumping with the headline “Don’t Pay a Premium to Fist Bump.” The caption read, “Uber costs less than Lyft, guaranteed.”52

Within a year, Lyft had seemingly responded through a brand redesign, shedding the moustache and replacing it with a Lyft window sticker, redesigning the app, and investing heavily in marketing throughout major U.S. cities. There were Lyft ads on billboards, at bus stops, and salespeople handing out $50 coupons in major cities. Lyft was offering new customers discounts of up to half off during the week across the country. During the month of March 2016, Lyft claimed it made 11 million trips.53 (See Table 3.) By 2016, Lyft had raised $1 billion in private equity, including $500 million from General Motors. The firm was valued at $5.5 billion and operated in 190 cities across the United States.54

Table 3. Market share numbers from Lyft and Uber.

Lyft Uber Austin 45% 55% Los Angeles 45% 75% San Francisco 43% 66%

Data source: http://www.bloomberg.com/news/articles/2016-04-14/lyft-is-gaining-on-uber-as-it-spends-big-for-growth.

52 Cotton Delo, “In Quest for Ride-Sharing Supremacy, Uber Takes on Lyft with Facebook Ads,” January 17, 2014,

http://adage.com/article/digital/uber-takes-lyft-facebook-attack-ads/291158 (accessed Mar. 18, 2014). 53 http://www.bloomberg.com/news/articles/2016-04-14/lyft-is-gaining-on-uber-as-it-spends-big-for-growth?cmpid=BBD041416_BIZ&

utm_medium=email&utm_source=newsletter&utm_campaign. 54 Eric Newcomer, “GM Invests $500 Million in Lyft,” Bloomberg, January 4, 2016, http://www.bloomberg.com/news/articles/2016-01-04/gm-

invests-500-million-in-lyft-to-bolster-alliance-against-uber?cmpid=BBD041416 (accessed Apr. 15, 2016).

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Internationally, Uber’s largest competitor was Didi Kuaidi, a ride-sharing company in China. With more than 1.4 billion rides provided annually and a partnership with Lyft, Didi Kuaidi offered serious competition.55 Throughout Southeast Asia, Grab offered a twist to the usual ride-sharing apps—its technology connected dispatch companies to passengers. It too had a strategic partnership with Lyft by 2016.

Promotion and Branding

Uber relied on social media for much of its promotional activity. Platforms included Twitter, Facebook, YouTube, and its own website. The company used campaigns to connect with customers and promote its brand. Uber’s motto, “Everyone’s Private Driver,” was displayed prominently on its Facebook page and incorporated into its YouTube promotional videos in the early years.56 The logo was a black “U” that reflected the motto, according to the company.57 By 2016, Uber had adopted a new motto, “Evolving the Way the World Moves,” and it changed its logo to a teal-colored square with a circle the middle of the bit-like shape for riders and a hexagon in the middle for drivers. The colored square on the outside, meant to symbolize a bit (think bits and atoms), changed to red in China, green in Ireland, and turquoise in India.58 Instead of hiring an agency to redesign the logo, Kalanick worked on it himself with a team of 12. “I didn’t know any of this stuff,” he said. “I just knew it was important, and so I wanted it to be good.”59

In addition, Uber utilized creative one-day promotional events. On Valentine’s Day 2013, Uber launched its “Romance on Demand” service, whereby a customer could order flowers through the Uber app. Uber also held a one-day ice-cream delivery promotion in cities, including Boston, New York, and Munich,60 and a one- day Christmas-tree delivery service in December 2014.61 Uber’s promotional activities were not exclusively social-media based; it also used more established methods to grow its business. For example, new customers could receive a certain dollar amount off their first Uber ride.

Kalanick used his personal Facebook and Twitter accounts, which had more than 63,000 and 115,000 followers, respectively, as of March 2016, to promote Uber. On Facebook, he had posted about Uber’s launches in the new countries, as well as delivery services such as puppies on demand (UberPUPPIES). He used Twitter to publicize Uber’s regulatory difficulties in various markets and an account of his stint as an UberX driver.

Uber also used TV and radio spots in select cities across the United States to recruit drivers and defend its business model and practices. During one campaign in 2015, Uber ran ads on “three radio stations, five broadcast, and 17 cable systems.”62

55 http://www.zacks.com/stock/news/207881/who-are-ubers-biggest-competitors (accessed Apr. 1, 2016). 56 “Uber: Everyone’s Private Driver,” YouTube video, posted by “Uber,” February 5, 2013, http://www.youtube.com/watch?v=P2M0RD7bhYY

(accessed Mar. 18, 2014). 57 Kia Kolkalitcheva, “Uber Explains Its Bizarre New Logo,” Fortune, February 2, 2016, http://fortune.com/2016/02/02/new-uber-logo/ (accessed

Apr. 29, 2016). 58 For more information, see Uber, “The Idea at the Core of Who We Are,” February 2, 2016, https://brand.uber.com/#bits-atoms; and Uber, “A

Local Feel for a Global Brand,” February 2, 2016, https://brand.uber.com/#our-new-look (both accessed Apr. 29, 2016). 59 Jessi Hempel, “The Inside Story of Uber’s Radical Rebranding,” Wired, February 2, 2016, http://www.wired.com/2016/02/the-inside-story-behind-

ubers-colorful-redesign/ (accessed Apr. 1, 2016). 60 Alex Baldinger, “Uber Promises Ice Cream Delivery on Friday, but Will Cones Runneth Empty?” Washington Post, July 18, 2013. 61 “O #Ubertree, O #Ubertree,” Uber Newsroom, December 4, 2013, http://blog.uber.com/UberTREE (accessed Mar. 1, 2014). 62 Ken Kurson, “Revealed: Uber’s TV Buy Is Gigantic,” Observer News & Politics, July 22, 2015, http://observer.com/2015/07/revealed-ubers-tv-

buy-is-gigantic/ (accessed April 19, 2016).

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The Last Mile: UberEATS and UberRUSH

Although Uber had been running promotional delivery partnerships—from delivering ice cream, Christmas trees, and puppies to cuddle—since its early days, there seemed to be a shift from marketing to a new market entry. It started out as a small concept in two single-city markets in Los Angeles, California, and another one in Barcelona, Spain, wherein Uber facilitated foodies with on-demand food deliveries from their favorite restaurants. At first, customers would use their Uber ride-sharing app to make arrangements, but a standalone app, UberEATS, was not far behind. The restaurant delivery quickly expanded to Chicago; New York City; Houston, Texas; Los Angeles; San Francisco; and Toronto, Canada, by March 2016. “UberEATS is like a game- changer for us,” one restaurateur wrote. “People can get our food within ten minutes.”63

Whether prompted by its success moving items in the food-service industry or not, in 2015, UberRUSH was launched in New Jersey, and allowed business owners to deliver items to customers, associates, or friends. UberRUSH started with a $2.25 base fare, plus $1.65 per mile, and had a $5 minimum.64 UberRUSH expanded to include New York City, Chicago, and San Francisco. That service also started with a tab choice on the Uber ride-share app and then partnered with Shopify, Delivery.com, Nordstrom, and several other businesses by adding an UberRUSH API to their websites and apps. For example, a United Airlines passenger could check in for a flight on the United app and then find the closest Uber driver for his or her ride to the airport. Or he or she could set up a dinner reservation on the OpenTable app and summon Uber without having to leave the OpenTable app.

As Uber continued its growth with new product offerings in the delivery space, another tech company, Amazon, would have it on the radar. With its Prime membership offering free two-day delivery service and its Prime Now Flex app on-demand delivery option, Amazon seemed to have a network similar to Uber’s new offering. Flex was created in 2015 and offered one-hour delivery within certain geographic areas (14 U.S. cities). The company had explored the use of drones and even buying its own fleet of jets to get items to customers faster. The Flex app worked the same way as UberRUSH—drivers picked up parcels at Amazon warehouses closest to them. Driver requirements included only the use of a midsize or larger sedan. Hourly rates ran between $18 and $25 dollars and drivers paid for their own gas and insurance.

With both data-driven tech companies moving into the last mile delivery space, had Uber positioned itself to compete with the likes of Amazon in what was a noncore market for both of them? And what effect, if any, would sending customers outside of Uber through its integrated apps have on Uber’s core business? In addition, would Uber’s platform continue to enable it to scale?

63 “UberEATS Now Serving Chicago, NYC,” Uber Newsroom, April 28, 2015, https://newsroom.uber.com/ubereats-now-serving-chicago-nyc/

(accessed Apr. 25, 2016). 64 “Introducing UberRUSH,” Uber Newsroom, February 2, 2015, https://newsroom.uber.com/us-new-jersey/introducing-uberrusha-reliable-ride-

for-your-deliveries/ (accessed Apr. 25, 2016).

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Exhibit 1

Uber Pricing Strategies and Marketing Communications

Business Travelers and Percentage of Uber, Taxis, and Rental Cars as Overall Ground Transportation

Q1 2014 Q2 2015 Uber 9% 29% Taxis 52% 35% Rental Cars 39% 36% Data source: “Infographic: Sharing the Road,” Certify, 2015, https://www.certify.com/infograph-sharing-the-road.aspx (accessed Apr. 25, 2016).

Exhibit 2

Uber Pricing Strategies and Marketing Communications

Uber Geographic Markets

North America 195 Central and South America 27 Europe 71 Middle East 11 Africa 11 East Asia 30 South Asia 29 Southeast Asia 14 Australia and New Zealand 13 Data source: “Uber Cities Across the Globe,” Uber website, https://www.uber.com/cities/ (accessed Mar. 31, 2016).

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Exhibit 3

Uber Pricing Strategies and Marketing Communications

Description of Uber Offerings and Promotions as of April 2016

UBER OFFERINGS* UBER

(NOT OFFERED IN ALL LOCATIONS)

DESCRIPTION

UberTaxi Hail a taxi using Uber app for $2 fee/must pay driver directly UberPOOL Join other riders to share UberPEDAL On-demand bike rack option for cyclists in a jam or that last mile UberMOTO Ride share motorcycles UberMILITARY Drivers are military servicemembers, servicemember spouses, or veterans UberFAMILY Vehicles have car seats UberRUSH On-demand delivery network UberEATS Have meals or snacks from local restaurants delivered UberSELECT Drivers pick up riders in BMW 3-Series, Audi A4, or Mercedes UberDLUX Drivers pick up riders in Rolls-Royce, Bentley, or Maserati UberCHOPPER Drivers provide rides in helicopters

UBER PROMOTIONS UberPUPPIES During select times and in select cities, riders can request and have 15

minutes with puppies brought to their location (most puppies were up for adoption)

UberKITTENS Shelter kittens brought to rider’s location (most kittens were up for adoption)

Zuber Partnership with Disney to turn Uber app into Zootopia Business Profiles Riders have the option to label a ride a business trip, use a business credit

card, add an expense memo or code, receive a work receipt sent to a work e- mail address, and get a weekly or monthly travel report

UberICECREAM Drivers deliver ice cream on demand on select days UberTREE Riders use app to have Christmas tree delivered UberSANTA Drivers deliver a goodie bag from select café/bakery partners UberHEALTH Drivers deliver wellness packets** for $10 and administer a free flu shot UberGIVING Riders can be a secret Santa and pay for gifts delivered to underprivileged

children UberMAYO Drivers deliver Mariachi bands, margarita mix, and piñatas UberCADE Riders can order a black town car with three Uber Secret Service agents and

two Suburbans that flank the town car on President’s Day UberHELMET Riders can use app to order a bike helmet for a $10 donation to charity UberRECYCLE Riders can use app to recycle waste on demand via Uber for free UberCYCLE Riders can request a 20-minute bike ride with pro cyclists UberASSIST Drivers are trained to help disabled or elderly passengers and load

wheelchairs *Excludes car services, such as UberX, mentioned previously in this case.

**Included in packets: water bottle, tissue, hand sanitizer, lollipop, and recyclable tote bag.

Data source: Created by author from Uber websites.

For the exclusive use of M. Dagstanyan, 2016.

This document is authorized for use only by Marie Dagstanyan in Marketing Concepts & Strategies - SPRING '17 taught by Tony Stovall, Woodbury University from December 2016 to June 2017.