Behavioral Economics for Firms

On Friday I read this piece by Karl Smith on Apple and this piece by Matt Yglesias on Barnes and Noble.  I was struck by how both of these examples showed firms actually in the best interest of the executive (who get perks from working at the firm) and not the shareholders (who want to maximize return on investment).

I wonder if there is a limit to how well firms adhere to economic models>  We already have decent evidence that people don't necessarily respond rationally (or else why would they buy Apple shares?).  But the executives in the company create a principal agent problem, which may also cause issues at the level of the company itself.

This is not to knock economic models.  Epidemiology has many of the same limitations and we have to rely on some pretty challenging assumptions.  Rather it is to be careful, with any model, to recall the limitations and exceptions inherent in modeling a complex process.

Tyler Cowen hacks Robert Reich's site

How else to explain this passage?

Apple’s supposed sin was to tell software developers that if they want to make apps for iPhones and iPads they have to use Apple programming tools. No more outside tools (like Adobe’s Flash format) that can run on rival devices like Google’s Android phones and RIM’s BlackBerrys.

What’s wrong with that? Apple says it’s necessary to maintain quality. If consumers disagree they can buy platforms elsewhere. Apple was the world’s #3 smartphone supplier in 2009, with 16.2 percent of worldwide market share. RIM was #2, with 18.8 percent. Google isn’t exactly a wallflower. These and other firms are innovating like mad, as are tens of thousands of independent developers. If Apple’s decision reduces the number of future apps that can run on its products, Apple will suffer and presumably change its mind.

There are, of course, economists who believe that the market will find a way to punish anti-competitve practices but Reich certainly isn't one of them. And Apple, though unquestionably innovative, has always aggressively tried to suppress competition dating back to their we-stole-it-first suit against Windows.

Apple's goal isn't to limit the number of apps they can run; it's to limit the number of programmers supplying apps to other platforms. Admittedly, Google and Microsoft are big boys that can take care of themselves, but with the iPad, Apple has one hell of a first mover advantge. When someone manages to come up with a competitive product, they will have to launch it under the most adverse conditions possible.

I agree with Prof. Reich that regulation of big banks is more important, but that doesn't mean that Apple isn't breaking anti-trust laws.

Comparing Apples and Really Bad Toupees

DISCLAIMER: Though I have worked in some related areas like product launches, I have never done an analysis of brand value. What follows are a few thoughts about branding without any claim of special expertise or insight. If I've gotten something wrong here I would appreciate any notes or corrections.

Joseph's post reminded me of this article in the Wall Street Journal about the dispute between Donald Trump and Carl Icahn over the value of the Trump brand. Trump, not surprisingly, favors the high end:

In court Thursday, Mr. Trump boasted that his brand was recently valued by an outside appraiser at $3 billion.

In an interview Wednesday, Mr. Trump dismissed the idea that financial troubles had tarnished his casino brand. He also dismissed Mr. Icahn's claims that the Trump gaming brand was damaged, pointing to a recent filing in which Mr. Icahn made clear that he wants to assume the license to the brand. "Every building in Atlantic City is in trouble. OK? This isn't unique to Trump," he said. "Everybody wants the brand, including Carl. It's the hottest brand in the country."

While Icahn's estimate is a bit lower:

Mr. Icahn, however, believes his group also would have the right to use the Trump name under an existing licensing deal, but says the success of the casinos don't hinge on that. The main disadvantage to losing the name, he says, would be the $15 million to $20 million cost of changing the casinos' signs.

So we can probably put the value of the Trump brand somewhere in the following range:

-15,000,000 < TRUMP < 3,000,000,000

(the second inequality should be less than or equal to -- not sure how to do it on this text editor)

Neither party here is what you'd call trustworthy and both are clearly pulling the numbers they want out of appropriate places but they are able to make these claims with straight faces partly because of the nature of the problem.

Assigning a value to a brand can be a tricky thing. Let's reduce this to pretty much the simplest possible case and talk about the price differential between your product and a similar house brand. If you make Clorox, we're in pretty good shape. There may be some subtle difference in the quality between your product and, say, the Target store brand but it's probably safe to ignore it and ascribe the extra dollar consumers pay for your product to the effect.

But what about a product like Apple Computers? There's clearly a brand effect at work but in order to measure the price differential we have to decide what products to compare them to. If we simply look at specs the brand effect is huge but Apple users would be quick to argue that they were also paying for high quality, stylish design and friendly interfaces. People certainly pay more for Macs, Ipods, Iphones, and the rest, but how much of that extra money is for features and how much is for brand?

(full disclosure: I use a PC with a dual Vista/Ubuntu operating system. I do my programming [Python, Octave] and analysis [R] in Ubuntu and keep Vista for compatibility issues. I'm very happy with my system. If an Apple user would like equal time we'd be glad to oblige)

I suspect that more products are closer to the Apple end of this spectrum than the Clorox end but even with things like bleach, all we have is a snapshot of a single product. To useful we need to estimate the long term value of the brand. Is it a Zima (assuming Zima was briefly a valuable brand) or is it a Kellogg's Corn Flakes? And we would generally want a brand that could include multiple brands. How do we measure the impact of a brand on products we haven't launched yet? (This last point is particularly relevant for Apple.)

The short answer is you take smart people, give them some precedents and some guidelines then let them make lots of educated guesses and hope they aren't gaming the system to tell you what you want to hear.

It is an extraordinarily easy system to game even with guidelines. In the case of Trump's casinos we have three resorts, each with its own brand that interacts in an unknown and unknowable way with the Trump brand. If you removed Trump's name from these buildings, how would it affect the number of people who visit or the amount they spend?

If we were talking about Holiday Inn or even Harrah's, we could do a pretty good job estimating the effect of changing the name over the door. We would still have to make some assumptions but we would have data to back them up. With Trump, all we would have is assumption-based assumptions. If you take these assumptions about the economy, trends in gambling and luxury spending, the role of Trump's brand and where it's headed, and you give each one of them a small, reasonable, completely defensible nudge in the right direction, it is easy to change your estimates by one or two orders of magnitude.

We also have an unusual, possibly even unique, range of data problem. Many companies have tried to build a brand on a public persona, sometimes quite successfully. Normally a sharp business analyst would be in a good position to estimate the value of one of these brands and answer questions like "if Wayne Gretsky were to remove his name from this winter resort, what impact would it have?"

The trouble with Trump is that almost no one likes him, at least according to his Q score. Most persona-based brands are built upon people who were at some point well-liked and Q score is one of the standard metrics analysts use when looking at those brands. Until we get some start-ups involving John Edwards and Tiger Woods, Mr. Trump may well be outside of the range of our data.