Critical Management Thinking 4/2/2014 6:12:00 AM

The Logistics of the Roman Grain Trade

How do complex markets work?
Series of political, economic, & social systems
Financing source, controls, hierarchy/division of labor, & physical
infrastructure

Why do they work?
Theres a need for good that arent produced there (Rome couldnt
produce enough food on its own)
Someone finances them and builds infrastructure (necessary
systems)

How do they evolve?

Rome (capital) was enormous
1MM people by 1
st
century CE
Largest city world had ever seen (and would see until London in
1800s)
One big challenge to sustain a huge population is food! Average
Roman needed 3,000+ calories/day
o Based on 1MM people, Rome needed to provide ~3.0Bn
calories daily
o Because of the lack of modern-day agriculture techniques, the
amount of food is simply amazing!!

Had many broad & well-paved roads (infrastructure)

Cities relied on the surrounding area (catchment area) to provide food for
population
But was very small & had low yields near capital of Rome
Land transport was very expensive so this provided a natural
boundary for many cities
Boats were the only way to transport long-distances (remained true
until modern-day)
o This is why all large pre-modern world cities are port-cities
o Reliability of transport was difficult, even by boat~
All cities until London 19
th
century were capped at
~100k people because of these constraints
Food Choices:
Olive oil has high weight to calorie ratio so became a staple
Wine also has high weight to calorie ratio shipped all over empire
Wheat comprised ~80% of average caloric intake
o Best yields were in Northern Africa (better climate) so ~75%
of all wheat consumed in city of Rome was from here!


Rome succeeded based on political, military, economic, & social conditions
Certain regions developed specialized production
There was trade across the empire
Lots of opportunities with ag. Surplus but also complex challenges

Wheat - not the easiest crop to grow (esp. in Italian climate) or ship
Requires suitable soil & adequate rainfall
o North African yields were much higher than Italian yields!
Requires annual minimum rainfall of 400mm (15.7inches)
Heavy and bulky to move around it easily shifts and is heavy (so
requires special containers) basically only possible by ship except
for very short distances
Molds and rots easily (needs cool and dry conditions)

Key Factors:
Maintaining controls (carefully counting sacks & measuring quality)
Formalized hierarchy of labor (with specialized workers &
supervisors)
Physical infrastructure that was specially devoted to storage and
delivery of grain (established process to move along grain)
o Large quantity of grain was moving
o Transport over large distances
o Changed hands between many middlemen
o Ships designed to transport
o Ports & Roads systems

As the empire expanded, it could draw on resources from territories it
conquered.
Taxes paid in kind (actual goods)
Cash (gold & silver)
o Empire used tax revenue to purchase supplies for the center
o Monetization was key to help goods & cash flow freely
o Helped increase the division of labor and growth of Roman
world
o Helped increase integration of the empire

Land grants were given to Roman citizens in conquered provinces
Generated wealth and income for the elite
They financed trade and brought goods from periphery to center

Overall pattern of trade was weighted in the direction of Rome (despite the
existence of other large cities)
They absorbed surplus of both goods & money at the expense of
other locations

Egypt was a perfect supplier to the Roman empire
Ideal climate with regularly fertilized soil & abundant irrigation
Built-in river highway
Ideally located port

Trade was done through a Network of private merchants

Financing & Organizing the Grain Trade:
Financing largely came from small, powerful elite with disposable
wealth (senators & knights)
Trading/organizing came from merchants (typically came from
descendants of slaves, or slaves themselves)

These operations were like modern corporations
Silent partners provided capital (like shareholders)
Companies signed contracts, maintained accounts, & paid dividends
o They were responsible for the arrangement of delivery of
grain
They owned or subcontracted ships (most important!)
Had huge physical infrastructure
Network of agent (local buyers, logistical staff,
overseers)
Joined together in a trade association
Some companies depended on inter-personal networks, but some
existed beyond the lifetime of the original owner

Informational Uncertainty:
Info was highly constrained to local context
Eventually a courier service was established over much of the
empire but it was expensive, slow (horses), and mostly for govt.
Typically, limited information would create undercapitalization and
systemic inefficiencies but not the case for Roman Empire!!
Firms used hierarchical structure to manage operations between
firm & market
o Principal-agent problem must have been very severe with
limited info and slow info flow
o But Roman system was able to develop ways to use the
market efficiently
Signed binding legal agreements
System of quality control & weights verifications
introduced supervision at critical supply chain points
Grain merchants banned together to get assistance and
support from the state (from elements like weather o/s
their control)
Paper Trail receipts across entire process
Merchants used networks of trust within the organization
o Freed slaves were essentially part of the network of the
wealthy family that freed them
o Responsible people who intervened throughout the process
always acted in the best interest of the organization via a
shared reputation mechanism

Role of the State:
Interested and involved in the grain trade to supply food to the
Roman army and the city of Rome
Invested in considerable infrastructure like large-scale facilitates
Incentivized grain trade
o Promoted construction of larger ships through tax incentives
o Allowed monopoly of grain trade - Merchants had special
advocacy groups to represent their interest with the state
(exclusive right to trade grain)
o Was the largest single purchaser of grain (maybe subsidies
for 30-40% of population)


Class Discussion:
Sheer size of the city was impressive it was the only enormous
city in an un-ideal location (Exceptional Outcome)
o Means market was operating at near-optimal efficiencies
Primary problem: Asymmetric information (one side has no
information- which would typically mean there would be no market)

If theres a market without information, you need to give it information
Market starts at farmer (who has all information at first)
Quality of information between farmer and first buyers transaction
is good first purchaser will make sure the grain is high quality
o guards against adverse selection (choosing poorly)
o no moral hazard (risk your undertaking isnt your own)
o info in goods in cart has complete information with it
Quality of information remains good and complete throughout the
chain when one buyer is purchasing from another person for their
own needs
Transaction costs
o get so huge across the market because people are charging a
premium to purchase each time (since its their own personal
risk)
o complete information is very expensive! (which means market
cant function because its too expensive)

Romes Solution:
Companies / Hirearchy (Vertical Integration)
o This tells us why there are firms efficient response to a
transaction cost problem
o Cheaper to put people on salary than have them negotiate
each individual transaction because risk premium is no
longer theirs!
Companies create another problem: principal-agent problem
o Someone has to capitalize the firm and make it happen
(principals
o Other people have to carry out the activities (agents)
They might not negotiate as well for the company as
they would for themselves
If they have a relationship, then they might do the
transaction even if its not good!
Firms are a principal-agent problem that has more-or-less been
solved
o Managers jobs are to reduce principal-agent problems in
firms
They implement controls / feedback to monitor &
diminish the principal-agent problem
This makes sense because you cant supervise them
directly on a day-to-day basis
o This only works if information can travel well or you trust
them completely
In Roman times, the slavery relationships allowed them
to work
Their Companies were possible because the former
slaves and their descendants
Wealthy Romans didnt want to be part of the
trade business because it was dirty/below
them
the slaves had incentives to serve as agents to
maintain the reputations of their former owners
and themselves (would take the name of their
former owner) - TRUST
Slaves werent the same concept as we use now
(just didnt have citizenship)
Even though there was no information available,
the trust was so huge, that the companies were
still capitalized
It was like a family company

There is no such thing as 100% alignment of interests.
Maybe Roman market wasnt 100% efficient, but it was highly
effective because it worked for so long. So there must have been
strong trust in this market.
Money wouldnt have flown into the market if there wasnt at least
some high level of trust on the level of returns

Wal-Mart versus Costco:
Employees at both do relatively the same types of work
Theres a huge difference on employee retention
o Costco = ~90%
o Wal-Mart = ~10%
The huge divergence is because of:
o Pay & Incentives = very generous at Costco
o Company culture
Why does Costco pay their employees twice as much as Walmarts?
o It was unionized initially and kept that model while
expanding
o Unions are about raising costs and we think this reduces the
ability to maintain competitive advantages but in this case,
its not true!
o Theres a shared reputation at Costco (versus Walmart) which
encourages self-monitoring among employees

Overall Summary:
Companies solve situations with high transaction costs
however, because of the principal-agent problem, you need some
type of monitoring of the employees
Rome solved this by trust/reputation which aligned incentives
enough for capital to be invested

Agency Costs
Up-or-Out Reviews
Meritocracy cant promote a lot of people just because you like
them
Clear rules and steps for employees (transparent evaluation)
Fosters competition among employees / motivation
Constantly rejuvenating companys talent
Sends positive market signals we only have the best with us (to
work for you!)
Productivity of employees is generally higher because you have
high incentives to perform!

On the other hand, sometimes this type of reviews is not beneficial!
o As soon as old CEO left Microsoft, the new management
changed the review system away from this!
o Most peoples objectives in this type of system is to not get
fired. Because theres a lot of reputation risk with being
fired (makes you look bad to be fired there who will hire
you?)
People typically avoid negative consequences
Especially reputational risk
o Results of desire to avoid reputational risk = agency costs
Lowers risk appetite
Reduced collaboration and teamwork
No talent clustering (because you dont want 1 of the
top workers to be let go)
Firms may suffer from ability to mobilize internal
knowledge
Encourages people to actively drag others down
Incentivized to leave early / look for other opportunities
(so dont have reputational signal)

Were looking to reduce agency costs, by having this type of ranking. But
employees primary motivation is to minimize their reputational risk, which
increases agency costs.
If this is the case, why do firms still do the forced ranking? (There
is no study to show statistically that this is a good thing to do.)
o Firms only do things to optimize their output
There are some anecdotal stories about negative impacts of this
system.
If one firm in the industry does it then others try to imitate them
to not lose their competitive advantage.
Based on the Roman Emprires Grain Trade it looks like trust is a
key success factor in maintaining a strong market.

We have to think of management decisions from every point of view
not just top down!!

Something catastrophic happened in Roman Empire that made the entire
market collapse quickly (not gradually). Possible reasons:
Lose source of trust or confidence (its binary its either there or
not there)
o Political crisis
o Loss of confidence in currency
had to constantly expand their territories to bring new
resources to sustain the Capital
This meant there were higher military expenses that
Rome had to control their territories
They had to pay the soldiers, but they couldnt just
print more money (gold/silver standard)
The money started making money with less and less
pure gold/silver in them to keep up with

Roman empire had a constant need for growth which was unsustainable.
In our own society, growth is the key benchmark for managerial
success (there are no other benchmarks for companies to measure
themselves by)
But is it a reasonable, or even good factor, for us to consider? Does
it create optimal management outcomes?
o Sometimes maybe its probably perfectly acceptable to stay
where you are

Since the 1930s, firm longevity has halved.
Could be because of market efficiency the waste or bad firms
are forced out of the market
Could also be because over the past 40 years, weve put in more
policies to engage their demise
o Maybe its okay for us to have firms that dont last that long
o But we dont have that conversation we just think growth is
the best policy
Too many of us think that growth is the best policy at any cost
because thats what we need to happen

You can choose to accept an argument but only after you evaluate
the alternative and outcomes.

Innovation:
Do Reading on the Box
Musical Assignment (just first movement)
Compare it to the first movement to any with Hyden or
Mozart
Go to GoogleBooks and type in Innvoation choose a book
and read a few pages with the preview function to see
what author says is compelling about this book

THE BOX
1. What does innovation mean as a concept and as an experience?

2. How can we recognize it?

3. Does innovation have to be about something different, unknown,
new?

4. Is innovation necessarily a good thing?

Value of the shipping container isnt in the physical object but how its
used
Its at the core of a highly-automated system for moving goods with
minimum costs & complications

Container made shipping cheap, which changed the shape of the global
economy.
Destroyed Old Economy/System:
o No longer required waterfront communities to unload ships
o Waterfront activity declined significantly
o Manufacturers didnt have to spend extra money to be in
urban plants simply to be closer to suppliers & customers
o Old ships faced huge adaptation costs
Built new Economy/System:
o New ports were built in different harbors (Seattle/Malaysia)
o Small towns could entice companies with cheap land and low
wages
o Exporting became plausible: Poor countries could realistically
supply wealthy countries far away

Workers lives changed, too:
Positives
o Lots more choices of goods to purchase
o Increased competition between suppliers quickly generated
new products @ low prices boosted standard of living
around the world!
Negatives
o Global economy meant mobile-companies had higher
bargaining power and workers had far less
o Work policies in China could impact US workers

Amazing things about ships to me:
Only need a crew of 20 for a huge ship of 3,000 40-foot containers
Cranes can unload 30-40 boxes an hour from ship to dock
Extremely efficient know exactly where to put each box and at
what time so that trucks/trains can take them to their next stop!
o Its become so efficient that for many purposes, freight costs
dont really effect economic decisions
o Before shipping containers, costs were higher than tariffs

Terrible for customs inspectors & officials
Since nobody opens the containers, they dont know whats inside
(beyond a manifest listing its contents)
No easy way to check opening just shows a wall of boxes

Containers not only reduced costs, but also saved time!
Combined with computers, they made Just-in-time manufacturing
possible
o HUGE cost savings and reductions in inventories
Despite the lack of economic expansion drivers (that typically
stimulate the economy) in 1966, volume of international trade in
manufactured goods grew twice as fast as global manufacturing
production.
o Can be attributed in a main party to the drop in freight costs

Transportation Revolution:
Lower rail freight rates increased ag. Productivity, knitted North
together before Civil War, and made Chicago an economic hub
o Innovation (refrigerated railcar) made meat affordable for
average households
o Passenger car & trucks shaped urban development
Shipping container had a similarly large effect in stimulating trade &
economic development

How does innovation help employ labor & capital more effectively to produce
more goods & services.
New technology, by itself, has little economic benefit
Innovations in early-stages are ill-adapted to wide range of uses to
which theyre eventually put.
Resistance can impede their adoption
o People may avoid commitment until future is more certain
Benefits are from entrepreneurs who discover ways to put
innovations to practical use especially from organizational
changes through which businesses reshape themselves to take
advantage of the new technology
Once this happens, change occurs very rapidly

Transportation costs were only considered in economics since 1990s
When transportation costs are high, manufacturers main concern is
proximity to customers
As transportation costs decline, they can relocate to reduce other
costs

Prior to Shipping Containers,
Loading and unloading ships was dangerous & hard-labor work!
o Highly labor-intensive
o Lots of injuries/deaths! (3x as many as in construction!)
o Labor was also unpredictable (choosing gangs each day)
Corrupt system requiring kickbacks from workers
Lot of uncertainty around wages & hours worked
Formed waterfront cultures; unwelcoming to outsiders
o Lots of people were related to each other so very protective
o Hard work, but paid better than most other jobs for workers
not finishing high school
o Frequent strikes
Liberty Ships cheap US ships built small so less cargo would be
loss if sunk by German sub
o Biggest cost item for ships was the wages of the longshore
gangs could amount to of ocean voyages expenses!
o Odd-shaped ships required experienced workers to fill them
appropriately so nothing would break or capsize the ship in
bad weather

Antagonistic labor-management relationship caused 2 problems:
Theft
o Especially after trade of higher-value products grew post
WWII
Intense suspicion of employers / resistance to anything that might
eliminate jobs
o This lead to unions insisting on specific contract language
o Made workers much less efficient

Solution: Put things in boxes and move them easily!
Railroads adopted to containers in early 1920s
Transferring containers was much easier than individual goods
o Loose freight cost $0.85/ton
o Containers cost only $0.04/ton
Railways started changing the way they charged for shipping by
weight
o Commission ruled that railroads couldnt charge less to carry
a container than to carry the equivalent weight of the most
expensive commodity inside the container
o This made containers no longer make economic sense on rails

Next generation of containers was terrible
Some didnt have any lids or were not easily loaded
They were often small (inefficient)
American containers were made of steel (good protection/enormous
cost)
Based on ship designs, less items could fit onboard!

Shipping Industry felt little pressure for change - change came from an
outsider Malcom McLean

The Interstate Commerce Commission wanted to keep industry stable
regulating body over roads and railways that controlled almost
every aspect.
Any major change required hearings at which other truck lines &
railroads could object
Inefficient system only authorized cargo could be transported
(meaning trucks sometimes had to return empty)

McLean found ways around obstacles
Purchased carriers with attractive routes (versus trying to go
around obstacles to win a new route)
Leased truck lines versus purchasing them
Found ways to lower costs (truck lines could only underprice
competitors if costs were lower)

Started worrying about increasing highway congestion & that domestic ship
lines could potentially undercut his trucking business
Thought about putting truck trailers on ships and ferry them up and
down the coast
To circumnavigate the ICCs regulations, created a new company
and purchased a shipping company to follow this idea.
Size of the containers was chosen because the ships length was
divisible by 33.
o They were at least 7x larger than existing containers at the
time
Lots of protests by rail and trucking industries said that takeover
of Waterman without ICC was violation of the Interstate Commerce
Act

Malcom understood the core problem that shipping industrys business was
moving cargo (versus sailing ships)
This helped him come up with his idea that was a new way of
handling freight


Innovation on Google Books - Managing Innovation: Integrating
Technological, Market, & Organizational Change by Joe Tidd & John
Bessant

We always eat elephants confidence in taking on challenges normally
seen as impossible for companies our size (grounded in a culture of
innovation)

Innovation is driven by the ability so see connections, to spot opportunities,
& to take advantage of them. Opens up new markets and offers new ways
of serving established & mature ones.

Technology often plays a key role. New technology or old technology in
new ways.

US refused to recognize copyrights from Europe; only after we had enough
technology & innovation ourselves did we start enforcing IP rights.


Origins of Innovation Channels/Processes Outcomes
Imagination Market Profit
Ideas Opportunity Advantage
Accidental New Markets Growth
Technology Dissemination Survival
Knowledge Executable
Connections Need
Contextual Project
Failure Costs
Creativity
Unconventionality
Agility
Values
Disruptive (radical)
Incremental
Risk

Least agreement Some agreement Most agreement

Social acceptability of failure is important
As firms become bigger and bigger, they become more risk adverse (good at
stability & predictability) there are no real obvious structural way out of
this.
This means theyre less good at innovating, in general.
Ability to take risks is diminished because firms are hierarchies
o The willingness to take risks is reduced in this structure

Risk correlates to information
The more you go out, the less information you have, the riskier the
decisions likely are

Theres lots of modeling built in to a lot of the innovation books. Or steps on
how to be innovative.
Firms that arent attempting to grow and take advantage of new
situations have a doubtful future

Theres some disagreement among people for the channels/processes
Some people say you need to focus on your clients
Others say you cant listen to them they dont know what they
want (i-pod)

Theres more disagreement about origins of innovation
People can find any idea and find contradictory arguments around
them
Because of this, its hard to know what innovation actually is

Many firms commit to innovation (even though they dont exactly know what
it is) because otherwise they wont survive.

Beethoven replaced melody with a motif
It shows a sense of urgency or constant flow
Hes writing a symphony without any opening melody
He created something entirely new by re-thinking what hes trying
to achieve.
o It took him 2 years to come up with the 5
th
symphony
o Innovation, therefore, by definition is hard! otherwise we
devalue innovation


Box Class Discussion:
Cost & efficiency
Converted labor-intensive market to automated market
Globalized world increased competition
o Companies have to worry about competition from all over the
world (prior just localized competition)
o Need for global managers (the reason were here is maybe
because of the shipping container)
Consumers have changed as a result
o More options/reduced costs
o Increased standard of living for us (from lower priced goods)

Consumers usually indifferent the location of production
Consumer indifference to origin is relatively new
Companies have a huge amount of pressure to source production
from the lowest cost place possible.

What does consumer choice look like 40-50 years from now?
Do we assume that people will continue to being indifferent to
origin? And only motivated on price?
Sir. Dyson (advocate of British manufacturing and then suddenly
relocated company to Malaysia) s example shows we probably do
just mostly care about price.

Why does the shipping box happen when it does?
Post WWII economic growth (growing consumer markets)
Expanding trade
o Trade as diplomacy after WWII
o US developed close ties with allies through economic
relationships
High cost of using the market
Congestion on in-land transportation routes
Nature of vessels
Labor costs / disruption
Nature of competition was changing
Malcom was in the right place & right time

What makes a good innovator:
1. Relentless focus on cost-cutting
2. Rule-breaker
3. Identified needs
4. New perspective logic of trucker to market of shipping
5. Vision
6. Determined / Single-Focus
7. Capacity for risk

This costs so much money though, that it will usually only happen through
government intervention
Govt. needs to invest in the new ports, new facilities, etc
Govt. has some political risk (issuing bonds, etc) but they still did
it because:
o Something catastrophic was happening in the market
o Main problem = human agency of the people who made the
market move.
Slow, inefficient
Accidents
STRIKES
You cant factor these costs into your pricing
structure because theyre unpredictable
Unpredictability leads to instability
These ideas to go on strike happened locally
(versus globally)
You wouldnt know if people were going to
be at your port would stop or be on strike
Now decisions for doc workers is taken
nationally
Even though the market costs were high, it
tolerable because everyone had high costs
(nobody had competitive advantage)

Beyond the success of the innovation, the doc workers failed
From the point of the union, this situation was the worst possible
outcome.
Their issue was that they failed to adapt to the rapidly changing
environment
o Not only did they not adapt, but also they made the market
less efficient and less optimal and accelerated their demise
o They didnt see that this change was coming

ADAPTATION is critical (innovate is one type of adaptation)
Adapt or Die
Innovation is 1 way to deal with a changing market-place (but not
always the best)
Its innovation

Adaptation in the context of a changing circiumstance
Doesnt prescribe a specific right outcome
You do what you need to do to have an optimal outcome at the
end
This could mean getting smaller, divesting, shutting down
businesses
Even if its the best possible outcome enhances the firms ability
to remain competitive and move forward
Adaptations problem is that its not the buzz-word for
management you dont want to get smaller!

Innovation in the management context is about growing and getting more
profits, etc
This isnt always possible for companies
It costs a lot of money in strategies that might not work (e.g.
Research in Motion)
Growth frequently isnt the answer so if its our only focus, then
well end up with sub-optimal results.

HOUSING MARKET
There was a housing bubble in 1988
Buyers were influenced by an investment motive
They had strong expectations about future price changes in their
housing markets
They perceived little risk

Home purchase decisions driven in large part by emotion & casual word-
of-mouth
Houses are sticky downward
o When excess supply occurs, prices dont immediately fall to
clear the market
o Sellers have reservation prices, below which they tend not to
sell
o This is connected with a belief that prices never decline & with
some underlying parameters of housing bubbles

Homebuyer behavior in 4 Metropolitan Areas, 1988 & 2003
LA, SF, & Boston have experienced 2 boom cycles and a bust over
the past 20 years
o They had run-ups in prices which started off slowly,
accelerated for a period, and then slowed as it approached
the peak
o Home price increases outpaced income growth
Milwaukees price index was very different it had a steady climb of
5.6% annually
o This is the same as the growth in income per capita
o Over the entire cycle, Milwaukee did about as well as LA
(prices tripled), but not as well as Boston (increased 5x) or SF
(prices quadrupled)
The effects of declining mortgage rates on cash costs of buying
homes
o In 1995 (beginning of run-up), the 30-year fixed = 8.8%; by
2003 = 6%
o This kept the monthly payment required to buy the median
home from rising faster than incomes
o The ratio of annual payment to income / capita fell in CA and
WI (stayed flat in MA)

Housing as an Investment
Tendency to view housing as an investment is a defining
characteristic of a housing bubble
o Expectations of future appreciation of the home = motive for
buying
o Deflects consideration from how much one is paying for
housing services
o People buy for future price increases, instead of for the
pleasure of occupying the home
o This idea is further enhanced if buyer perceives that
investment is very low risk
In 3 of the 4 markets (not Milwaukee), there was more
perception of risk in the 2003 survey than in the 1988
one

Exaggerated Expectations, Excitement, & Word of Mouth
People expected average annual growth of ~15%
In 2003, fewer people thought it was a good time to buy a home
because prices may be rising in the future
o But they thought there was a risk that delay may mean not
being able to afford a home later
General indicators of the defining characteristics of bubbles were
strong in 2003, but less strong than in 1988

Simple (or Simplistic) Theories:
Simplistic theories are powerful Most people dont perceive
themselves to be in a bubble, even at the height of the bubble!
o Desirable R/E just naturally appreciates rapidly
o Housing prices have boomed because more people want to
live in that location (people thought in glamor cities; not
Milwaukee)
o When closing prices are above asking prices, people seem to
think its a sign of a crazy boom that suspends the economic
laws of supply & demand

Popular beliefs
Interest Rates = a dominating theme for people at heights of both
booms
o Although this was a big topic, there wasnt any quantitative
evidence that they pointed to
Declines in stock market led to appearance of R/E bubble
o People had a flight to quality and sought safer investments
in R/E
o On the other hand, a falling stock market could have a
negative wealth effect on home buying decisions
o People mostly said that the change in the stock market had
no effect on their decision to buy a home
Perhaps this is because they would have bought some
home in any event
o People thought R/E market doesnt lose value, where stock
market is very volatile

Largest Holder of US Debt:
Largest = Federal Reserve (holds about 24% of the total US debt
since 2008)
Second Largest = US Social Security (~15-20%)
China (~10% of US Debt)

General perception is that China is the largest debt holder. Why is there a
complete & gross misperception?
News & Media Coverage!

Well over 90% of entrepreneurship is covered by small business owners, but
when you ask people what they think of in entrepreneurship, its more
likely Steve Jobs
So when we read that entrepreneurship activity is responsible for
x% of job creation, is that good?
o Probably not because they dont have any incentive to pay
you more than the market minimum wage or give you any
benefits
So why, when we think of entrepreneurship, do we think of Steve
Jobs instead of these small business owners?
Weve distorted the idea of entrepreneurship to the point where
its always something you want to promote & foster
o Its not unambiguously good!
o We dont stop to think of what entrepreneurship really means
we just take one small part of entrepreneurship & make
that normative

Stereotypes and past experiences influence our perceptions
universal narrative when we see some cues, then we can use
that to fill in the gaps of what we dont see.

Why does the bible have 3 different versions of what Jesus last words were
on the cross?
Theyre writing for specific audiences and want to tailor their
messages to the audience! its the stories theyre telling to their
own communities.
Historians can tell a lot about the community where the Gospel was
written because of the way they portrayed Jesus and his last words

Narratives what are the stories were telling ourselves?
Why did we read this specific housing bubble article?
1) Timing it was published in 2003, which means data was
collected in 2002.
o This is important because the bubble they were talking about
in the article didnt collapse until 2007ish
o They were talking about traditional mortgages (not subprime
mortgages)

2) This article is a private conversation that were privy to listening
in on. Case & Shiller (Nobel-Prize Winner) and Greenspan (the Fed)
on the other side.
o Telling him please raise interest rates, people think theyre
getting low risk with higher rate of return this is a very
irrational market and this is dangerous! They need to be
stopped!! You should do something!!
o Greenspan didnt do anything at all-
They were bringing old tools to a new market
This market had a much more effective manner to
disperse risk (derivatives)! So you cant gain insights
from just looking at the past.
Every time the government tried to add more
regulations to protect the market, Greenspan argued
against it because he thought:
This time is different he had told himself a
narrative and it became his truth

When you take the core predictors of housing pricing, it showed that housing
prices were increasing more quickly than they should

90% of the homeowners saw their house as an investment
only 10% were actually using it as an investment (renting out)

Opportunity Cost = costs you incur from forgoing the next best alternative

Why did respondents say they bought houses?

Housing Stocks
Long-term Losses
Low-risk Lack of knowledge
Appreciation (13.8% p.a.) High risk
Low interest rates Intangible
Demand volatility
Tangible
Utility
Capital guarantee (sticky factor
dont want to sell it for less than you
bought it for)


Rational Investor- if offered the housing investment opportunity (as noted
above) would reject it, because they
know the cost of reducing risk is lower returns
also know that the potential for the stock market (as its shown
above) with huge losses is very large!

Paradox
Why were people seeing the market this way if it were defying
rational thinking?
How is it that these investors were perfectly irrational they
thought that its best to sell low and buy high

Youtube channel look to his channel for more resources

Although this is US based information, its not a US-based phenomenon!
Timing matters for house buying
o If you want to buy a house, but know pricing is going to
decline significantly in 12 months, most people will wait

Where is the information for these people coming from? our Information
Sphere
Experience market has been increasing since 1996 (going up for 6
years)
R/E Agents who are trying to sell!!!
o Theyre extremely biased because their livelihood is
dependent on your business
o However, if you want to buy a house & you hear stuff that
hes saying thats in-line with what you want to hear!
You give him more authority!
Media
o Increasingly characterized by news that there are housing
bubble conditions forming
o But people arent accessing this media they use more of
local information
Cultural Discourse Everyone should be buying a house! - Its the
American Dream!
Friends & Family people brag / promote their good news stories
(dont bring up their failures)
BANKER also incentivized to get your business!
o But theyre the most important part of this decision influence
because they have the most money at stake
So they wouldnt lend me the money if it wasnt a good
idea
People place more due diligence / risk assessment to
the banks! it alleviates me from doing real due
diligence

People have confirmation bias when populating their information sphere
They look and value information thats confirming what they want
to hear


In table 9, how often do you talk about your housing purchases?
Honest answer yes (because its a huge purchase, so its a big
deal to you) 80-90% of people said they are frequently talking
about their housing purchase decision
Theres been a good deal of excitement surrounding recent housing
prices have these influenced you? about 40-50% of people said
yes.
So theyre saying theyre creating a lot of hype around housing, but
arent impacted by this hype/excitement.

In table 10, response with agreements with theories on Housing Prices
Reason for people to be lining up to purchase houses
o This is because theres a panic
Why are the home prices increasing?
o Because of demographics, population changes, & interest
rates
These ideas are mutually incompatible Cognitive Dissidence
o This is a characteristic of a market bubble

Participants could sort of tell something was odd/something was happening
with this market.
How are they able to remain committed to their purchasing even
when this is completely irrational behavior?

Responses to what factors drive up housing prices:
Many people in SF said that it was Asian investors/Immigrants
in 1988 the Japanese economy had extremely dangerous bubble
territory
o Capital seeking fair value left Japan and went to US to
purchase assets there
o But this was happening all over the country so why was it
just in the SF responses?
SF had a huge Japanese American population theres
a pre-disposition for Japanese American to be in the city
Something triggered a reaction (maybe media or
something else) and that made this factor become very
important in SF
This is an example of a narrative a story theyre
telling themselves
It no such a powerful narrative to them, that it no
longer was a story it became the truth!

Management can also be faced with this problem impacted by narratives
they tell themselves

AOL & Time Warner = worst merger in history!!
They wanted to achieve synergies bringing together AOLs online
presence with Time Warners content.
o First few years of internet, people would get on, but there
wasnt necessarily content for them to view. Huge idea that
content was the biggest problem so people thought as long
as you get enough good content, then you could win!
When they made the decision to merge, the people who evaluated
it, they used a new tool (google) to help them gather information.
o Google helps you find the information you want
o Google makes the content / internet issue irrelevant -
because if you have a robust search engine, you can find the
information and content you need you dont need it placed
right in front of you!!
o So why did they still do the M&A
CEO said that they didnt anticipate Google
But Google was already a major force when they
started going the M&A
o They told themselves a story of information/internet
convergence it was part of their information sphere and
once they told themselves this story, they didnt have access
to the idea that their story wasnt right anymore.

We live in a world with an enormous amount of information
The way we deal with it, is packaging it up into stories
We need to stop and ask ourselves every once in awhile to make
sure our stories are in fact correct and still valid

Instead of taking things on face-value, you should ask critical questions to
see what the real answer is (without expecting or having a bias of what is
going on)

The wisdom we can have is knowing when we dont know!

THE AGE OF CUSTOMER CAPITALISM

Modern Capitalism had 2 main eras:
1932 firms should have professional management
o management should be divorced from ownership
o instead of owner/CEOs, more firms were run by hired,
professional CEOs
1976 firms should maximize shareholder value
o Thinking was that if firms pursue this goal, both shareholders
& society will benefit
o Argument owners were getting short changed from
professional CEOs who were focused on own futures/well-
beings
Now should be a new era: customer-driven capitalism

But shareholders arent actually better off since they became center of the
business universe
From 1933-1976, S&P earned an average of 7.6% annually
From 1977-2008, it earned 5.9% annually (when they were the
focus)

Best way to improve shareholder value is by focusing on customer
satisfaction
Cant have dual objective because companies cant maximize 2
different things at once

Shareholder value creation & destruction are cyclical and not under
managements control
Management can push shareholder value up in short bursts, but not
in the long-term
Since CEOs cant play this game, they turn it into something they
can win
o To increase shareholder value (stock prices), CEOs have to
continue to push growth and often in non-sustainable places

Focusing on Customers:
Obvious constraint you cant give everything away for free but
you should maximize customer satisfaction while ensuring
shareholders earn an acceptable RA- ROE
o E.g. Johnson & Johnson focus on customers, employees,
communitites, & then shareholders
Why does this work? Because CEOs are free to focus on building
real business value rather than on managing shareholder
expectations

MAXIMIZING SHAREHOLDER VALUE: A NEW IDEOLOGY for
CORPORATE GOVERNANCE

Focus in US/UK on maximizing shareholder value = recent (from 1980s)
Decade long boom in US economy impressed European & Japanese
executives with potential of shareholder value
Prior, companies focused on retain & reinvest both people &
capital
o Began to run into problems in 1960s and 1970s because of:
Growth of corporation sizes through M&As and
internal growth, they grew too big/diverse
Central offices were too far removed to make
informed decisions of retaining & reinvesting
Rise of new competitors
Japan was able to challenge US in mass-
production industries (cars, electronics, etc)
because of development & utilization of integrated
skill bases
New type of investor institutional investor also
supported quest for shareholder value
US Banking Sector experienced significant deregulation
Made it possible to issue junk bonds to help
finance hostile takeovers of even very large
corporations, which left the new companies with
huge debt burdens
Despite a market crash in 1987, the market made a
quick recovery and had been on its longest bull-run in
history which seemed to support this shareholder
value maximization idea
Lots of layoffs continued, even in 1990s (with
considerable business cycle improvement)
Job cutting is much more prevalent among large
employers than smaller ones
Displaced workers suffer real costs (lower wages
once they were reemployed)
There was an increase in corporate pay-out ratios
(dividends)
Companies also sold shares on the market at an
inflated price to pay off debt;

Why and how was there a shift from retain and reinvest to downside &
distribute?
A trend started in 1970s that favored the pay of top managers over
pay of everyone else in the corporation
Pursuit of the retain & reinvest strategies permitted lots of different
stockholders to gain
o Workers could get paid higher wagers & have higher stability
o Consumers could get lower prices on goods they purchased
This lead to conglomerates managers faced a strategic
crossroads:
o They could fine new ways to generate productive gains
through retain & reinvest OR
o They could surrender to the new competitive environment
through corporate downsizing
Further, the increased segmentation within organizations made it
more difficult for managers to understand what type of innovative
strategies they should pursue & the capabilities of their
organizations

Lots of problems:
Significant cost of job loss
Income inequality (much wealth is held in stocks)
o From WWII through 1970s there was stable employment,
and high pay, despite the low training & education standards
(compared to other global locations)
Lack of investment was a huge competitive
disadvantage for US firms.

Class Notes (3/26/14):

What type of capitalism do we want? Whats good for GM is good for
America & vice versa
Hypothesis: In general whats good for a country should be good
for the firms that operate in it.

Focus on maximizing shareholder value
Stems from Milton Freemans 1970s article
o Said under ethical boundaries, companies should do all they
can to maximize value for shareholders/owners
Another article was also written by Jensen & Meckling (1976)
o They said there were lower ROA because of higher agency
costs in these large conglomerates

These articles were paid attention to because they were addressing a
problem that firms of that time were perceived to be facing
Typical firms that these articles were addressing were large
conglomerates creates systematic agency problems @ the level of
senior management
o Monitoring and trust networks can help reduce the agency
costs for the lower people
o But who can monitor the people at the top??
The board of directors!!
But as a structural organization, boards are terrible
because theyre very overlapped so you cant rely on
them (CEOs of 1 company are board members of
others)
As firms are more and more conglomerate then the
agency costs grow larger and larger
o One way they can get external monitoring for these
companies is monitoring share price
This is based on information
Before, Management didnt worry about the stock
price, because their idea was that investors
dont know the real value since theyre not privy
to the information
Idea markets always price an asset efficiently, given
the information available - so the share price should
always be an accurate gage
So emphasis from these articles was that management should be
putting an emphasis on share price

Why was the context ripe in the 1970s for this?
o American Economy faced lots of competition from unexpected
places (especially Japan!!)
o Stagflation partially because of the oil crisis; stock markets
declined (post Vietnam War) & then flat-lined
Many companies P/E ratio was well below book-value
(people were valuing them less than their assets on the
F/S were valued)
o This downturn is described in these articles as more than just
part of the business cycle its because the firms arent doing
what they need to do to unlock the value
Share price (external factor) is the best way to monitor
& help this situation!!

Theory 2:
In the 1950s heyday of the progressive taxes (the high income
earners of the 1950s had to pay extremely high taxes ~95% at
highest bracket)
Even at $100k and $200k they had to pay very high taxes
o Lots of these people were corporate executives
At the same time, the government starts allowing stock options
(taxed as capital gain which are subject to much lower tax rates)
o So this becomes a much more popular way of remunerating
executives (before, wasnt used at all during/after 1970s
it became a huge portion of pay!)
o Went from becoming an obscure instrument to a popular tool
o But share prices collapse and so these stock options are
basically worthless
These were mostly old, white, unhealthy males so
they didnt have a ton of more time to wait for the
stocks to improve once again

Other Factors:
Nature of shareholding underwent a profound transformation
Prior to 1970s the institutional participation on the equity side was
forbidden (had been instituted in Great Depression)
This restriction was eliminated in the 1970s
o So more mutual funds and institutional investors came into
the market
o This changes the way investments were seen

Restriction on pension funds for investing in equities were also lifted so
more capital was coming into the market

US government also lifts the cap on the interest rate that banks can offer
their customers
This produced the Savings & Loan crisis so instead of offering P
+ x%, they were offering extremely aggressive and high interest
rates to attract deposits
o They had to invest in high-risk investments to match these
interest rates (below investment grade assets)
o Junk bonds were an attractive source of high-interest rate
funds.
Junk bond credit started moving into capital markets
Junk bond financing permitted quick & aggressive
corporate take-overs for companies that werent being
run efficiently
Conglomerate firms were threatened because
they were undervalued in the stock market
(because of their embedded agency costs)
What should they seek to do to not be a victim?
increase its share price a high enough P/E could
help protect them from a take-over
Started thinking about best way to increase
share price in the short-term

1990s another article was written (by nerds) that quickly jumped into
modern management practice
Idea of core competence emerged from nowhere to become a
dominant idea in the firms
o You have to focus on their core resource & get rid of the best
(fits into resource-based view of firms)
o Im going to get rid of all these underperforming assets -
this will send information to the market that Im going to be
boosting my Net Enterprise Value which should increase the
share price
Why was diversification so great before and now were more
focused on core competencies?
o In the 1950s & 1960s responsible firms mitigate risks /
diversify because firms are there to maintain employment
(if you have lots of types of industries in your business, you
can smooth out the business cycle)
o Now we argue, that you have sub-optimal returns from
diversification; shareholders should be able to diversify their
own risk
o Theres a preference for moving diversification from company-
level to shareholder level

Management principles in 1950s most critical quality emphasized was
leadership!!
Today, we dont think thats the most important quality now
knowledge applicable to your area is the most important!!

Before, MBA gave you general management skills (which allowed
you to work anywhere because you knew how to lead)

Now, MBA gives your existing experience more value (ability to shift
industries is significantly lower) Prior knowledge = most important
factor

Core Competence Model as a way to unlock value:
Sara Lee in mid 1990s, they went through a lot of de-
virtualization they wanted to return value to the shareholders.
o Decided their core competence was the brand
They dont need to make cakes they could just take
cakes from other companies and put their brand name
on it
o They became a brand manager and got rid of all its stuff,
instead of branding and distributing
o Share price increased a lot!!
It basically disappeared but because it didnt really do anything
anymore, nobody really noticed it
o They stripped themselves down too far and had nothing
left!

Who is the shareholder?:
Top 10% richest people- and actually mostly the top 1% wealthiest
elite!
o ~80% of all investments are held by the richest 10% of the
people
o top 1% control ~46% of the investments
Instrument by which its done investing via mutual funds
(institutions)
o They have more knowledge & economies of scale
o Job of money managers is to generate the best returns
(based on information available) for their clients
o Money managers having a long-term relationship with
companies isnt a good idea because theyd be tied into
staying with these companies, even when these companies
were generating sub-optimal returns for the clients.
Its morally inconsistent with the money managers job
as an investor
On the firms side of the equation, this means that theyre in a
short-term battle fighting for capital (because they have no
expectations that investors will stay in their firm)
o Their goal is to give information out to the market that
supports this goal of having capital!!
o Businesses actively manage their earnings / expectations
(give analysts your forecast and then meet them) on a very
short-term basis
o This leads to a short-term mentality for companies they
cant have a long-term
o CFOs are shockingly willing to forego long-term performance
for higher short-term performance!

Owner of the firm = itself at a most basic legal level (limited liability)
Price of the limited liability shareholder has a proxy ownership of
the company
o You typically get to vote for the board of directors & choose
CEOs but thats a privilege that the company defines &
gives to the investors
o So why should the firm focus on driving value for the
shareholders (who are definitionally short-term institutional
investors and behind this, were looking at the top 1% of
society)
The ecosystem of a firm is made up of a lot of long-term partners
o Customers; governments; employees; communities;
Why do we take all of these long-term stakeholders and make them
secondary (or tertiary) to the short-term investor?

Dangers of this way of thinking:
Average CEO is worth 10-30x more now than in the 1950s.
o The shareholders approve these salaries
o Institutional investors dont vote they just agree with
management
If they make the management another shareholder
this ensures that their goals are aligned with
institutional investors
If something bad happens, the investors dont protest
because the money manager just clears their position
and moves their money somewhere else

Apples stock price had been increasing gradually then suddenly in 2012,
its price became much more volatile
In 2011, Steve Jobs died and stock prices increased
o People started thinking that apple would start distributing its
cash stockpiles because theyd run out of innovative ideas
o Steve Jobs hadnt given out any dividends he had been just
reinvesting the money
A shareholder sued the company because of the huge amount of
cash balances and said they wanted some of this money
o But this lawsuit was thrown out because there is no
precedent for companies having to distribute their cash
o The most that shareholders can do is elect a board of
directors who can choose to have distributions
o In 2012, the stock price was ~$700/share based on 50%
continued margins - Apple had to know that this was
unsustainable but didnt say anything to investors
Their success had been because they were focused just
on their customers and by this the shareholders were
able to benefit from this success as well.
They cant say dont buy our firm at this level but they
should because not doing this is management failure
o Apple decided to give back a lot of money to their
shareholders
This isnt good for the company in the long-term
This also isnt good for shareholders in the long-term
Because this type of decision isnt making the company
better-performing

Companies shouldnt be just vehicles for putting more money into the hands
of the top elite its not an optimal solution / situation for society!
Levels of wealth inequality has spread significantly!!
o Instead of raising wages for employees or doing other things
like that, firms are focusing on efficiently transferring money
from the firms to the shareholders.
Does this create strong societies?

It should be discarded as a vehicle for corporate governance
Firms should find ways to excuse themselves from this logic of this
marketplace
CEOs need to be able to say to shareholders if you only want to
focus on ROI, then maybe this firm isnt the best one for you to
invest in.

THE RISE AND FALL OF NOKIA

Nokias success was based on developing strategic capabilities gained from
competitive advantages in its previous business endeavors & applying them
to new fields adaptability, strategic flexibility, & customer focus

Started as a family-business in the lumber / forestry sector
Turned into a public company after WWI
Allowed Nokia to focus on opening new markets & expanding old
ones especially electrical power generation line
1970s-1980s, Finland was Nordic Japan with rapidly developing
telecommunications industry (including Nokia)
o Nokia decided to reach into international markets more
broadly;
o Its key assets = technologies, customer information, brand,
reputation, & culture
o Through acquisitions and growth, became large enough to get
international recognition; but not strong enough to dominate
competitors
Mid 1980s had 11 different industrial groups, each with own
future vision & lots of debt!!
o Divested all non-strategic businesses
o Nokia suffered from a collapse of the Soviet Union (which had
been an important market)
o New CEO (in 1992) saw that mobile telephony was going to
become a major consumer staple
Refocused company around its mobile handset division
and divested all assets (over several years) not
related
Said product innovation, flexibility, & rapid
responsiveness were KSF

Nokias Restructuring:
Realized as early as 1997 that future of mobiles would be with
internet integration
o Decided to pioneer in internet-enabled telephony while
maintaining current position as global giant of mobile
headsets
Seen as a bold, risky move
But allowed Nokia to be the early dominant smartphone
player
o Had developed success / growth based on establishing a
brand name not technology (which was unsustainable)
Nokia recognized this and centered future strategy
around internet & consumer demand for greater
mobility

A move into the mobile digital economy wasnt easy it required a cash-rich
company willing to increase R&D to service a rapidly-changing market.
Nokia decided for focus on:
o Development of a 3G cellular system
If successful, forecasted to have 2Bn+ users worldwide
by 2010
Nokia wanted to get first-mover advantage by
establishing strategic coalitions & alliances which had
yet to exist
Given extensive delays in rolling out 3G networks, this
wasnt a successful strategy in the long run
o Mainstream implementation of the wireless applications
protocol (WAP)
By 1999, this strategic vision was producing extraordinary results!
o In less than a decade, it had become the global leader in
mobile telephony
o Unlike many tech boom companies, Nokias rapidly rising
share price was supported by a substantial increase in NI
o Were aiming for 40% market share!
However, the rapid growth was causing strain
o Growth had challenged its traditional corporate structure &
made internal decision making more difficult
o Despite strong R&D investments, it was being challenged by
other players (both in MS & Profits) through innovation
o
Got new CEO in 2006 who helped the company reinvigorate itself & get
back on track
Early results were promising but growth was primarily in
emerging markets (not as much $ to be made there); sales were
flat in Western Europe & America
The introduction of the iphone in 2007 rocked their world (in a bad
way)
But Nokia didnt even realize that Apple was a serious rival it
thought they were expensive phones that dont appeal to business
customers (because no keyboard)
Actually, many of the novelties introduced by Apple were already
part of Nokias suite

Challenging times
While the smartphone revolution intensified, the Operating Systems
became more and more critical
o Nokia tried to improve theirs but was unable to launch a top
tier alternative device
o Sales continued to increase but in emerging markets, where
handsets had been commoditized
Microsoft and Nokia started a partnership Nokia licensed
exclusively Microsofts mobile platform
But Nokia had never had much of a presence in the high-end device
market

Class # 9: 4/2/14:
30-40 questions, multiple choice & short answer (80 minutes test time)
broad content of reading & core themes of the classes
no computers, no phones paper & pencil

How did they go from having almost everyone own their phones to having
basically nobody own their phones?
Their options at the end of certain death or near certain death for
150,000 employees shows a certain level of management failure
Its not true that they were knocked-off by Microsoft and apple
maybe these companies contributed to their decline, but it wasnt
all their fault (decline started 3-4 years earlier!)
Many of the themes weve been looking at have been captured in
this case!

Nokias great insight was that cell phones were going to be a mass-
consumer good!
1980s Nokia had become saddled by debt
one of its principle markets, Soviet Union, was disappearing quickly
They did a quick analysis and found that telecommunications
division as doing the best so decided to focus on that
o The initial cell phones were terrible and huge so you have to
have a good sense of the abstraction of technology to see
that itd become an important staple device
o Their strategy:
They went global (text-book way of going global)
from ground up; sensitive to local conditions &
circumstances;

It also pioneered distribution channels they had 3
rd

party agents meant that phones were part of a larger
value-add package (of service & device)

Re-thought what a phone meant in 1980s it was a
piece of hardware; Nokia recognized that they were as
much about the software as they were about the
hardware they plowed lots of cash into their operating
system

Created lots of customer loyalty (you know how to use
it and know what to expect)

Also, they built into an aggressive obsolescence into the
phones trickle innovation there were lots of small,
incremental product innovations to make the customers
want a new phone every year! (while not pissing off
customers)
This model still applies today its a longer cycle
because the devices are more expensive

1990s there were a lot of books saying that Nokia was a huge
success story.
o By 1999, they were the largest cell phone provider world-
wide.
o More market share than next 3 competitors combined
o They were thinking about what they wanted to do next
Wanted to grab 40% of market share they were
already dominant, but wanted to be even more
dominant
It embraces the core-competences of the firm (went
from large conglomerate to a focused company)
But ironically, it initially had a telecommunications
business because of diversification

What went wrong (class brainstorm):
Lack of focus on user experience
Dismissive of new innovation (yeah but they had already done
that)
Poor execution of new technology
Failure to adapt
Loss of product identity (Focused on increasing sales)
Loss of brand mojo (stopped being a cool brand)
Misread market
Corporate structure
Hubris (too much pride)
Excessive focus on features/hardware
Focused on raising sales volume

Nokia lost the market for the top-tier market but they really never had a
foothold in that market to begin with. It has always been one of any
number of players in that top-market.
A lot of its focus is trying to get a foothold in this top-tier market
The source of lots of the features of phones now is Nokia (touch
screen, music device/stores, navigating the internet, first internet
tablet, apps developed by independent developers)

Timing matters maybe people werent ready or the infrastructure wasnt
developed enough to support these features (e.g. internet connectivity)

Declining profit margins!! 24% in 1999 to 16.5% in 2003!! ~33% decrease

Do we read that as a management problem?
o Permitting inefficiencies
o Theyre in a market thats undergoing commoditization, so
management has to:
Differentiate itself
But they dont have a problem with innovation /
R&D
So why cant they innovate?
Improve brand signal
Most of their sales were to non-top-level of phones (not
smart phones) and these were the sales that were
commoditizing.
Apple deals with this by just not entering the
market

We have this idea that if you innovate, youre going to do well
But Nokia was trying to innovate for a part of the market that was
commoditizing and these people werent interested in innovation.
Innovation matters at the top percent of the market which they
werent a big player in! All the profits were concentrated at the top
Nokia wanted to be part of the top market and was innovating for
this segment but their ability to play in this market segment was
very confined!
o They shouldve thought about whether or not innovation
would get them into this new segment.
o Their innovation ate up billions of dollars and go them really
nowhere.

Was their problem internal or external?
Internal Nokia saw it as an internal problem; thought it was a
management issue they restructured, recommitted to innovation
External - But, it was actually an external problem. If youre in a
commodity segment, then thats just the nature of the market it
has nothing to do with Nokia, theres nothing that the company can
do (its not a failure of management) to get back to where they
were
o Improving profit margins to back where they were isnt a
possibility for management
o The market is not a problem its just reality. Youre missing
the point if you call it a problem
o The issue is how you choose to address it
Instead of recognizing this as market evolution, Nokia
said that it was management problems.
They thought they could return to their higher profit
margins
But having a high profit margin with 40% market
share in a rapidly commoditizing industry are 2
objectives that are incompatible.
Maybe if they had chosen to focus on the
top market (high profit margin segment)
and a small market share, they could have
been okay with innovation
Management failure was for them to fail to ask
how their market would look like! they couldve
looked at other technology to see that the market
characterized by rapid consumer uptick & then
commoditizes
Lets look at markets that looked like this
one in the past and see what happened
First mover advantage gains rapid market
share and high profits
As the market expands, your ability to make
profit is constrained as new entrants come
into the industry your market share falls
every single time, without exception!
o The amount of money to be made in their market was simply
shrinking
Its really difficult to differentiate in a commoditizing
market.

There are features of management that impede us from asking the right
questions.
Theyre focused on growth!!! But thats not consistent with what
happens in industries
Shareholders dont want to hear that the company is shrinking or
going to get lower profits
But this is going to happen its the pattern of markets!!
Your best bet is to understand what the market is going to do and
figure out how you want to look in 10 years
o Do you want to be a major commodity player, with small
margins
o Or do you want to have a small, top-share, innovative sector
of the market?

This case illustrates the value of critical management thinking they didnt
think beyond the traditional assumptions that we bring to management
styles (just focusing on growth)
They needed to find a way to challenge their assumptions and to
think through their assumptions (that innovation is the best way to
address all issues)
Encourages us to rethink logics of core competencies (should they
have sold everything off??)
The internal management told themselves a dialogue and they so
completely bought into their story / internal narrative that they had
no access to history and facts about other similar industries prior.

They misread the consumer value of their product so much because of their
internal narratives!

Critical management thinking is about engaging in critical reflections and
understanding what/why true knowledge consists in knowing you do not
know
Over and over the decisions we make that end up terribly is
because we dont actually know the answers and truth and we
derive incomplete pictures of the information!
We dont want to fall victim to our own assumptions!!
Always remember that the true knowledge we have is knowing we
dont know always keep questions at the fore of your mind!
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4/2/2014 6:12:00 AM

4/2/2014 6:12:00 AM