The key challenge that healthcare enterprise leaders face is determining how to drive innovation while addressing problems of affordability, inefficiency and gaps in quality. This task is now complicated by strong economic headwinds that limit the resources available to attack these problems. Industry executives are also dealing with new sets of competitive and regulatory pressures on their efforts to drive business growth.

At Columbia Business School’s 5th Annual Healthcare Conference held in New York City on November 21, over 500 students, alumni and other professionals heard more than 40 speakers and panelists discuss these issues.

The featured healthcare leaders said they are embracing change to develop creative solutions to the industry’s growing problems and to provide attractive investment opportunities on a global basis. A career strategies panel of executive and corporate recruiters also presented their views on the skills and talents necessary for healthcare professionals to succeed in this dynamic environment. This was followed by a concluding career fair and networking reception with the conference’s 17 corporate sponsors.

Ed Ludwig ’75, chairman and CEO of BD (Becton, Dickinson), gave the opening keynote address. Ludwig said that a successful global healthcare company must use technology, scale, global reach and operational excellence to offer value-added products. These products should reduce costs, enhance the quality of patient care and generate sustainable earnings growth.

Following his remarks, four concurrent panels took place in the morning session on the topics of pharma and biotech, medical devices, diagnostics and payor/provider issues.

The pharma and biotech panel discussed the trend among companies to narrow their therapeutic priorities, focus on biologics, pursue licensing and target acquisitions and seek enhanced productivity and cost savings. Numerous early-stage biotechnology companies are turning to larger pharma and biotechnology firms to survive as they are unable to secure capital from the public market. Global medical device companies are seeking to introduce innovative and cost-effective products in a challenging regulatory and pricing/reimbursement environment and pursuing acquisitions and new markets to meet growth objectives. The consensus of the payor/ provider panel was that any healthcare reform in 2009 would likely be incremental due largely to economic and political headwinds, and that a key focus would be on information technology and expanding access to those without insurance coverage.

Robert Essner, former Chairman and CEO of Wyeth Pharmaceuticals and now executive-in-residence at Columbia Business School, provided the lunchtime keynote speech. He suggested that although the pharma industry faces significant challenges, the combination of new drugs, biologics and vaccines in key areas of unmet need (e.g. Alzheimer’s, cancer, congestive heart failure) and the massive influx of informed baby boomers, who are demanding health solutions, provides favorable long-term growth prospects for innovative global pharmaceutical companies.

Three afternoon panels covered M&A, life science investments and emerging markets. It is anticipated that healthcare M&A will remain active across all sectors and that consolidation among Big Pharma companies appears inevitable. Early-stage life science companies and investors face a capital squeeze, which is threatening the viability of existing companies with lower levels of funds available for new investment. Emerging markets are an increasing focus for global pharmaceutical and medical device companies that are seeking new markets for their products.

The final panel of the day focused on the changing talent acquisition and development strategies of major healthcare enterprises. Panelists commented that successful leaders will need to have global and cross-functional experiences; that employees should be open to lateral moves that broaden their skills and experiences; and that healthcare companies considering new hires are seeking a broader “toolkit” of skills that reach beyond the traditional focus on healthcare backgrounds.

For more information about the conference and sponsors visit www.cbshealthcareconference.com.

Between 2:30 and 3 p.m. on May 6, 2010, the Dow dropped 7 percent before partially restoring itself by the closing bell. In the days following that sudden market shock, regulators have investigated possible causes, looking at a single trade in the Standard & Poor’s e-mini futures contract and other causes for the brief panic. The plunge has telescoped focus on the role of “circuit breakers” and the way high-frequency traders function in response to irregular use of those safety mechanisms.

“I think that market-wide coordination of regulatory mechanisms such as circuit breakers is a very positive thing. The lack of such coordination seems to have had a significantly detrimental effect,” says Professor Ciamac Moallemi, who has studied behavior in financial markets. In his recent research, he created a quantitative model to value latency or the delay between decision and trade execution, finding that the higher frequency of trading, the more impact latency has on transaction costs. (Read more about this research in Ideas at Work.)

Moallemi said the events of May 6 raised a number of unanswered questions, including:

1. Did buy-side firms employing algorithmic trading strategies contribute to the crash? Many mutual funds, pension funds, etc., try to efficiently buy or sell large positions via computerized strategies that buy or sell at a predetermined rate over the course of the day despite market conditions. Such strategies often trade at a faster rate in periods of high volume. Did these strategies accelerate selling just as the market was crashing?
2. High-frequency liquidity providers implement computerized market-making strategies based on the statistical analysis of markets. In periods of market anomaly, where historical statistical relationships may not hold, these traders may withdraw from the market and hence remove liquidity at times when it is most needed. To what extent did high-frequency liquidity providers withdraw liquidity from the market immediately prior to the crash?
3. Given that there does not seem to be any trading “error” involved in the crash, is it a wise policy for the exchanges to cancel trades that occurred at anomalously low prices? This would seem to destroy any incentive for investors to provide liquidity by buying during a crash. What incentives can be created for liquidity provision in turbulent times?

“Equity markets have changed dramatically in recent years, with the proliferation of electronic trading and the decentralization of trading across many new venues,” Moallemi adds. “While these changes have offered investors many benefits, there may be unintended consequences such as the momentary breakdown that occurred on May 6. This event highlights exactly how little we know about the complex and highly interdependent systems that constitute the market.”

Image credit: Google Finance

This post contains an update.

Like many great rivers, the Delaware has multiple identities: water supply for New York City, habitat for native fish populations and flooder of riverside hamlets. Historically, four states have vied for specific claims on the river’s water supply. New York City’s summertime dam releases have posed some of the most challenging problems for river management over the past 30 years, and caused political and environmental tension.

That changed in October 2007. The Delaware River Basin Commission (DRBC) implemented a plan called Flexible Flow Management Policy (FFMP) based on research from Peter Kolesar, a professor emeritus in the Decision, Risk and Operations Division. His work, done in collaboration with scientists and fish experts from the Nature Conservancy, Trout Unlimited and Delaware River Foundation, has been nominated for this year’s Franz Edelman Prize. The award ceremony takes place April 18–20, 2010.

The Commission’s FFMP policy is based on Kolesar’s adaptive inventory control research, which expresses the dam releases as a function of the storage in the reservoirs and the season of the year. In the two years since the plan has been in place, estimates place the economic benefit at $163 million annually in fishing and boating income and potential flood mitigation. (Read more about the research in Ideas at Work.)

The plan has potential for other water and river management systems, especially in the Southeast where officials from Georgia and Florida have been fighting for years over water allocation from Lake Lanier and the Tennessee River. The Delaware River case could help solve their conflict and key players from the DRBC have already made visits to Atlanta to share knowledge.

“The benefit of what we did — to bring disputing parties into agreement and our analysis — were breakthroughs,” Kolesar says, whose interest in the river originated with his fly-fishing experience in the Catskills. He says the combination of factors — from the scientific research and involvement of conservationists to local politics — made the success of the FFMP unique. “The whole package is now a possible model for other disputes.”

Photo credit: Flickr/Chris Martino

	Professor Paul Glasserman moderated the panel “Does the Practice of Quantitative Finance Need to Be Changed?” at the research symposium on December 4 .

The research symposium “The Quantitative Revolution and the Crisis: How Have Quantitative Financial Models Been Used and Misused” at Columbia Business School on December 4 explored the causes and effects of the proliferation of quantitative finance. Donald MacKenzie, a professor of sociology at the University of Edinburgh, gave the keynote speech (PDF).

Professor Bruce Kogut, in his opening remarks, acknowledged that financial engineering and innovation have received an onerous rap in the fallout from the financial crisis. However, he suggested that the field was ripe for public debate.

“It might be easy to leap to the conclusion that the subtext of today is that financial models created the crisis and hence innovation is bad. But such a deduction is in fact deeply complex and largely suspect,” he said. “Why is there such debate over financial innovations? After all, innovation is a driver of economic growth and wealth, so why all the fuss?” Kogut suggested three possibilites, including the disparity between private and social value, unanswered questions about systemic risk and the speed at which innovation takes place.

Professor Paul Glasserman pointed to popular media portrayals, like WIRED’s “The Secret Formula That Destroyed Wall Street and Nuked Your 401(k)” (Feb. 2009), which excoriated the financial industry’s use of models, as perpetuating misunderstanding about the uses and capabilities of quantitative finance.

“The article sets the record for the most incorrect statements packed into a title,” Glasserman said. “In a very short time there has been a dramatic shift in perception of quantitative finance.”

Glasserman moderated the panel “Does the Practice of Quantitative Finance Need to Be Changed?”, which comprised Professor Emanuel Derman, Department of Industrial Engineering and Operations Research at Columbia University; Professor Daniel Beunza, London School of Economics; Kent Daniel, Director of Research at Goldman Sachs; and Adam Parker, Director of Reserch and Chief Investment Strategist at Sanford C. Bernstein & Co. LLC.

Much of the panel’s discussion focused on when models are useful — and not useful — in financial markets. Derman, author of My Life as a Quant, led the discussion and offered a discourse on what models are and how they can be applied (download presentation PDF). He cautioned that there is never a “right” model but rather ”somewhere north of common sense and south of hubris lies the appropriate use of models.”

Beunza, formerly a visiting professor at the Business School, cautioned that the use of models is a “doubled-edged sword”; his research shows that they lead both to increased arbritrage and better reflexiveness.

Goldman Sachs’ research director Kent Daniel argued that models benefit many fields, such as airline safety, and not only financial markets. However, he cautioned that exacting data was fundamental to the use of models. “A successful quant model has to be subjected to every kind of scrutiny you have,” he said. “If your organization doesn’t do that, you’ll have a failure.”

The symposium "The Quantitative Revolution and the Crisis: How Have Quantitative Financial Models Been Used and Misused" took place on December 4 and was co-hosted by the Center on Japanese Economy and Business and the Sanford C. Bernstein & Co. Center for Leadership and Ethics.

Photo credit: Leslye Smith

As the vitriolic debate on healthcare reform dominates the news, healthcare industry leaders continue to focus on several issues: innovation to drive growth and promote cost efficiencies; new offerings to generate higher value for each healthcare dollar invested; and the emergence of attractive new global markets and technologies. They recognize that continued economic weakness and new sets of competitive and regulatory pressures create a more challenging environment to drive business growth. At the same time, they see tremendous opportunities to develop cost-effective products and services that can dramatically improve patient care on a global basis.

At Columbia Business School’s 6th Annual Healthcare Conference held on November 6, nearly 500 students, alumni and other professionals heard more than 35 speakers and experts discuss these issues. The attendees benefited from panels on an array of healthcare topics including biopharmaceuticals, medical devices and diagnostics, healthcare services and information technology, venture capital/private equity, mergers and acquisitions and emerging markets. The day concluded with a networking reception and career fair where attendees met with the event’s 20 corporate sponsors.

Fred Hassan, chairman and CEO of Schering-Plough, gave the opening address. Despite economic, competitive and regulatory pressures facing the pharmaceutical industry, he was confident that new therapies and vaccines would be developed to address large areas of unmet needs, most notably Alzheimer’s disease, which represents a devastating social and economic threat to society.

Following his remarks, three concurrent panels took place in the morning. They focused on information technology solutions, growth strategies of Big Pharma and small-cap biotechnology companies, venture capital and private equity investment strategies in healthcare, and the impact of proposed healthcare reform initiatives on payors and providers.

Mike Barber, vice president and head of Healthymagination for GE, reviewed GE’s new $6 billion global commitment to develop new technologies and services to reduce costs, improve quality and expand access for millions of people around the world. Among other objectives, this initiative will accelerate healthcare information technology, support consumer-driven healthcare, create new wellness and healthy worksite programs and facilitate access to cost-effective healthcare in rural and underserved areas.

Three concurrent afternoon panels covered healthcare mergers and aquisitions, medical devices and diagnostics, and challenges and opportunities for healthcare companies in the emerging markets. Alex Gorsky, worldwide chairman for medical devices and diagnostics at Johnson & Johnson, discussed emerging opportunities to develop new therapies to extend and improve a patient’s quality of life, as well as new cost-effective and less invasive medical devices and procedures. He also commented on the changes underway in global healthcare companies and how employees need to expand their skills and experiences, such as seeking new functional roles and positions in new geographic regions to broaden their understanding of different healthcare systems and customers.

Photo courtesy of the Healthcare Conference

Monday, November 9, is the deadline for banks to apply for the Treasury’s Capital Assistance Program. Chances are, none will sign up.

The program — CAP for short — is the other shoe of last spring’s stress test. Announced on February 9 as a “core element of the Administration’s financial stability plan,” the program was designed to backstop banks that are unable to raise sufficient private capital. Secretary Geithner presented the plan to the Senate Banking Committee on February 10 and it was featured in Chairman Bernanke’s Senate testimony two weeks later.

Under the CAP, a bank receives government funds by issuing preferred securities to the Treasury. These CAP securities include complex embedded options for both the bank and the Treasury. In current work with Zhenyu Wang of the New York Fed, we have estimated prices at which these “structured products” would sell in a market transaction between private participants rather than as part of a government program. We have applied our method to the 18 publicly traded bank holding companies that participated in the stress test. (The 19th stress test bank, GMAC, is privately held and received funds through a special program for the auto industry.) Our estimates indicate that the CAP securities represent significant value — one might even say a huge potential subsidy — to eligible banks.

So why no takers? In many respects, the lack of participation is good news: the mere availability of CAP funds may have been enough to boost confidence in the financial system. The nine banks that were required to raise additional capital following the stress test all report being on track to meet their targets through the private sector, though some of the new capital, like the $2.1 billion in deferred tax assets claimed by Bank of America, falls short of a ringing endorsement from investors. But even if all the capital raised is solid, the question remains: Why pass up a good deal?

The circumstances suggest several possible explanations. A bank may avoid taking government funds if the strings attached require it to forgo other profitable opportunities. Citi’s sale of Phibro and troubles with Banamex illustrate this possibility, but such costs are unlikely to offset the value of the subsidy. In an odd twist, weak corporate governance may save taxpayers money. This explanation applies if bank executives pass up CAP funds to protect their own positions rather than the interests of shareholders. Senior management at any of the top banks would be unlikely to survive another injection of government capital.

These considerations apply to all the TARP programs, but one other explanation is specific to the CAP preferred securities. In our analysis, much of the value to a bank of the CAP securities lies in the option a bank gets to convert them to common equity. This feature comes at the cost of higher dividend payments than shares issued through earlier programs, which did not include a conversion option. But Citi negotiated conversion of some of its earlier shares, and remarks from Treasury officials and banks indicate that similar conversions have been discussed at other banks. Banks may be reluctant to pay for an option they think they can get for free.

Complex structured products designed in the private sector have drawn criticism for contributing to financial instability through a lack of transparency. The complexity of the Treasury’s design of the CAP shares — intended, no doubt, to avoid direct government purchase of bank stocks — may well have been a final factor in discouraging participation.

The reasoning went that if you could gain large market share in a growth market, you could capture a major cost advantage. That would give you a competitive advantage over smaller-share rivals.

You remember the matrix, of course: the 2x2 grid in which you plot the growth rate of your market against your position in that market. The high/high box (big shares in growing markets) were “stars”; the high/low box (big shares in slow-growth markets) were “cows”; the low/low box (small share in slow-growth markets) were “dogs” and the remaining quadrant (small share in low-growth markets) were question marks.

The strategy advice was to invest in stars, use the cows for cash, sell off the dogs, and … well, it was never quite clear what to do with the question marks. At one time, an academic study found that 75% of all CEOs of American companies were aware of and had used some aspect of the BCG matrix in making portfolio allocation decisions. It later transformed into the famous GE Matrix and also found its way into other tools offered by consulting firms such as McKinsey.

Well, it was too good to last, I suppose, because as the model gained in popularity, criticism of it grew. Observers argued that it was fundamentally flawed and led to starved cows, mis-fired stars, lost opportunities for profit and worst of all, the wholesale abandonment of markets whose domestic growth might have stalled, but which were growing globally (such as televisions).

The academics weighed in as well, with studies by Columbia’s own Don Hambrick and Ian MacMillan empirically testing the conclusions in the model (see references). But wait — it’s back!

In the May issue of the Harvard Business Review is an article (“Is Your Growth Strategy Flying Blind?”) on growth strategies that advocates a granular approach to analyzing possible markets, based on — you guessed it — market growth rate and market share (among other things). The approach differs from the old BCG approach in that the units of analysis the authors suggest are smaller — right down to individual product lines, customer segments and regions, but the strategic advice remains pretty much the same. Invest in those segments that show high growth rates, in which the position is strong and in which there is momentum. A great idea whose time came … and went … and has come again.

References: Hambrick, D. C., I. C. MacMillan & Day, D. L. 1982. Strategic attributes and performance in the BCG matrix: A PIMS based analysis of industrial product businesses. Academy of Management Journal, 25(3): 510-531.

Hambrick, D. C. 1982. The Product Portfolio and Man's Best Friend. California Management Review (pre-1986), 25(000001): 84.

	From left to right: Prof. Yusheng Zheng, Wharton School and Cheung Kong Graduate School of Business, paper award winner Guoming Lai and Prof. Fangruo Chen.

Channel stuffing can lead to all kinds of distortions and ultimately hurts the long-term value of a company. So what are the incentives for a manager to engage in the practice? That was the winning topic for the Best Paper Award at this year’s Conference of the Overseas Chinese Scholars Association in Management Science and Engineering (OCSAMSE), which took place in Shanghai in July.

The conference was sponsored by Columbia Business School’s China Business Initiative, which is part of the Chazen Institute for International Business. OCSAMSE is the only organization representing overseas Chinese scholars in management science and engineering. The conference series was focused on integrating theory and practice and panelists discussed supplier relationship, supply chain and operations management.

Professor Fangruo Chen awarded the research prize to Guoming Lai and Lin Nan from David A. Tepper School of Business at Carnegie Mellon University and Laurens G. Debo from University of Chicago Booth School of Business for their paper “Manager Incentives for Channel Stuffing with Market-Based Compensation.”

The winning paper authors suggest that managers find real earnings management more attractive in the wake of the Sarbanes-Oxley Act. However, managers also now face more “real” constraints, such as bounds on physical inventory and often their interests are not aligned with long-term stakeholders. The results create three effects that drive the manager’s incentives for channel stuffing.

Other speakers at the conference included Dr. Weihua Ma of China Merchants Bank, Qinghou Zong of the Wahaha Group, Weimin Sun of Suning Appliance Co. Ltd., Steve Graves of M.I.T. and Mike Pinedo of New York University Stern School of Business.

Photo courtesy of Mei Xue

With at least 2,000 car dealerships from Chrysler and GM slated to close this year (and more than 1,000 dealerships overall that closed last year), the existing American dealership model is in crisis. The closings appear to underscore just how over-extended — and over-stocked — the U.S. dealership system has become. One of the fatal flaws for dealerships has been an inefficient distribution network.

My research, conducted with my colleague Gérard Cachon at The Wharton School at the University of Pennsylvania, shows that the current structure of the U.S. brands’ dealership network led to inefficiencies in the distribution system. These inefficiencies add to the total distribution cost, which accounts for 30% of the price of a new car.

A major inefficiency is the pattern of holding inventory — an important part of the distribution cost. Most of the vehicles in the U.S. are purchased directly from dealer stock and holding inventory is expensive, especially when credit is scarce as it is now. The graph below illustrates important differences in the monthly days-of-supply for Chevrolet, Ford and Toyota.

The popular press suggests that 60-day supply is the ideal level of inventory for the auto industry. This is, in fact, the industry average, but the figures show that Toyota is consistently below that benchmark while Chevrolet and Ford are usually above it (other brands of Ford and GM also show a similar pattern). Overall from 2000 to 2004, Chevrolet held about 130,000 more vehicles in inventory relative to Toyota (300,000 compared to 170,000 units), even though the two brands sold about the same number of vehicles in the U.S.

The huge number of GM dealerships explains most of this difference in inventory performance. As of 2007, Chevrolet had around 4,000 dealerships compared to 1,200 Toyota dealerships. That means that an average Toyota dealership sells three times as many vehicles.

Source: Automotive News 2007 Yearbook

Due to economies of scale, managing inventory for a Chevrolet dealership is much more costly than for Toyota. In general, dealerships from domestic manufacturers carry substantially more days of supply. Consequently, they require more cash to operate, their inventory is less fresh and they tend to have more overstock at the end of the model year, which in turn leads to more rebates. All of this translates into higher distribution costs and lower profits for the dealer.

How could U.S. auto dealerships be improved? Reducing the number of dealerships can do several things.

First, it will reduce cannibalization between dealerships, increasing average sales per dealership. Dealers can take advantage of economies of scale in the distribution process and have more frequent deliveries and lower safety stocks, thereby reducing the amount of inventory held without hurting (and possibly improving) customer service. It also helps to keep a fresher stock to better match customer preferences and to lower markdowns at the end of the season.

All of this leads to a more profitable dealership and a more efficient distribution network. Higher dealership earnings can be used to invest in better showrooms and better training of the sales force, which can improve customer service and further boost revenues.

Photo credit: never a safe second

In a recent Forbes.com op-ed, professors Bruce Kogut, Patrick Bolton and Tano Santos argue that in order to be effective, a good regulatory system must distinguish between prevention and resolution. The current system, they say, has failed to do so, instead relying on “stop gap” prevention measures.

Kogut, Bolton and Santos say that the current system failed to follow the principles of crisis prevention by allowing incentives to become misaligned, creating risk-blind structural silos and failing to require the disclosure of risk exposure, particularly in the case of credit default swaps. The solution, they propose, is the creation of a new entity — the Crisis Resolution Board. They write:

A new regulatory system must also be capable of crisis resolution, because the hallmark of modern financial crises is that the limits of institutions and markets quickly bleed into one another, and the problem rapidly takes on a global scale. The data show that as the most recent crisis hit, all the crickets began to sing in harmony — all markets behaved erratically simultaneously. A “regulator of regulators” — which we will call the Crisis Resolution Board — should be charged with monitoring and responding to systemic risks.

The Crisis Resolution Board cannot be merely an honorary posting. Effective intervention by the Crisis Resolution Board will require social capital — crises always rely upon the personal knowledge among the players. Thus, this oversight board should include the chiefs of the Treasury, Fed and an FSA regulatory agency, as well as industry and investor representatives. In addition, the board must have more than global access to data — it must have knowledge of the global exposure and the systemic risk provided by a research staff that continually tests its instruments against the dynamic evolution of markets.

Concretely, what would the Board do? First, it will have power to monitor the exposure of all financial institutions and markets, and to issue early warning signals. This is hardly a radical idea. The IMF plays a similar role at the global level in monitoring national reserves. The role is clearly feasible for a national regulator and will lead to a strengthening of global financial market coordination.

Second, like any good fire brigade, which has a deep respect for plumbing, when things get hot the board will ensure that the financial markets’ plumbing is functioning. Markets depend on brokerage, exchanges and settlement. That’s their plumbing, and it’s also the key to systemic risk. It must be charted and tracked globally if we are to know what to do when the next crisis comes.

Regulatory reform should seek to distinguish between crisis prevention and crisis resolution. Prevention relies upon a tripartite structure and clear rules of accountability. Crisis resolution demands an integrated approach to systemic risk. Both structures are required and yet, no country has yet to design such a system. This is the time to do so.

Photo credit: SKPY/Scott

The Credit Cardholder’s Bill of Rights, which was signed into law on May 22, is the first major overhaul of credit card regulation in 30 years. Is the bill a game-changer for the way consumers use credit or the way lenders dole it out? We spoke with assistant finance professor Enrichetta Ravina, who has done research on the credit card industry and consumer behavior, about the relationship between the lenders and borrowers, how it might change, and whether credit cards make us happier.

Now that credit card holders have a bill of rights, how might that affect consumer behavior?

1. Better debt management More transparency in the credit card terms could mean that consumers are more informed and better understand the terms of their credit card contract. They might avoid paying fees due to their inattention/misinformation and to switch to cheaper forms of credit if they need to borrow. The caveat is that more information doesn’t always lead to restraint. In the same way that knowing that fats are unhealthy doesn’t make everybody restrain from fast food, it is unlikely that being better informed on the terms of the credit card contract will make everybody manage their debt more carefully.

2. Prevent early onset debt New restrictions for issuing cards to people below 21 will make it harder for students and very young consumers to have easy access to credit. The legislation is aimed at protecting a category that might be less financially educated, has fewer incentives to be financially responsible and preventing that they become overwhelmed by debt even before starting their working life.

3. Harder to get easy credit The new legislation requires credit card companies to wait until the account is 60 days late before applying a penalty interest rate and to give 45-day advance notice before changing the interest rates or any other terms. Thus, the credit card companies’ pricing strategy will change. A better ex-ante assessment of the creditworthiness of the consumers will be necessary and credit card contracts will have lower credit limits, higher interest rates for certain categories of consumers and more upfront fees. Lower credit limits and higher interest rates will make it harder for overly optimistic, financially uneducated consumers to get into unmanageably high levels of debt.

What does a consumer’s spending say about his or her behavior?
Most consumers are very predictable in their credit card use. In my research I find that consumers exhibit a high degree of habit in their consumption choice and that they prefer a smooth, increasing consumption path. Demographics like gender, age and income bracket are important, but mostly people’s spending on catalog and online shopping and on other credit cards are the best predictors of their behavior and of whether he or she will carry a balance, pay late or always be on time.

Who are credit card companies making money from?
The most profitable consumers for a credit card company, and therefore the most sought after, are those that spend a lot, pay late and carry a balance (which 45% of Americans do). People’s attitudes to money and their finances tends to be remarkably consistent across financial instruments and therefore people that miss payments on other credit cards and auto loans, stretch themselves with high loan-to-value mortgages are more likely to do the same on this card. Among these very profitable consumers, however, are those that “hide” and who will generate charges only for a short period and will soon default.

Can credit card companies tell who might default from their spending behavior?
It is very difficult to predict this behavior early in advance. These consumers that are very risky are those with limited financial education. Such consumers do not understand the terms of the credit card contracts, are not good at budgeting, saving and spending within their means. At the beginning, they are very profitable for the credit card companies because they generate fees and interest charges. However, once an income shock hits them, or their spending habits get out of control, they rapidly become the worst type of accounts.

What is the upside to easy credit?
Credit cards constitute a tremendous opportunity for some consumers and are very important for economic growth. They allow entrepreneurs to finance the very first stages of their companies when it is hard or impossible to get a loan from a bank. They also allow households to finance durables, consumption goods and other projects. For these reasons, they promote economic activity and a more efficient allocation of economic resources. Compared to other countries where credit cards (and debt) are less diffused, U.S. consumers face more dangers, but also more opportunities and more means to fulfill their projects.

Does this greater opportunity and means to fulfill projects translate into more happiness?
In my research I find that happiness is a relative concept. Above a certain level of consumption that satisfies the necessities of a comfortable life, happiness doesn’t depend on the amount we consume, but rather on the amount we consume compared to the people around us. The reference group we belong to are work colleagues, neighbors, people with a similar socioeconomic status to which we tend to compare ourselves. Credit cards can be used to consume more than the reference group (even though the income is not enough to cover spending), in the hope that income will continue to grow or that no emergency comes to disrupt this fragile equilibrium. Such a use of the credit card is usually associated with short-term happiness and economic problems and anxiety down the road.

Photo credit: Andres Rueda Lopez

The outbreak of swine flu, which is responsible for at least 159 deaths in Mexico, has put the U.S. vaccine industry into overdrive. However, the New York Times reports that federal officials are warning consumers that a swine flu vaccine will not be available until late November at the earliest. What does this long lead time teach us about supply chain risks?

In the case of vaccines, it underscores how dependent the U.S. supply is on a traditional — and slow — manufacturing process that involves growing the vaccine viruses in hen eggs. The process takes approximately six months for a finished product to be ready for market.

Professor Awi Federgruen, who has written in Ideas at Work about his research on supply chain risk in general and the flu vaccine in particular, says that the vaccine industry is lacking adequate incentives for investments in better and faster technology and larger capacities.

“When the need arises for a new type of vaccine — like we have now — and to act on it with traditional technology, it takes an enormous amount of time to produce something that can be used,” says Federgruen. “That’s a real problem because by the time it gets to market the epidemic may have done all the damage. If we had an industry that was more agile, we would be in much better shape. How do you provide an incentive structure to invest in such technologies?”

While faster technology does exist, it has not been implemented on a scale that would be needed to supply an entire domestic market. Part of problem, says Federgruen, lies in the roulette-nature of flu vaccine manufacturing in general, where assessments are made far in advance of flu season or potential pandemics and easily result in mismatches of supply to the demand.

“This is another way in which we collectively pay a big price in that we have suppliers operating with inferior technology,” Federgruen says. “And they are operating with inferior technology and low capacities because to change these amounts to large investments, the long term benefits of which are too risky. The federal government has started to address the problem by providing roughly $1 billion in grants for construction costs and guaranteed vaccine purchases. However, considerably more needs to be done to provide adequate incentives to the industry.”

Photo credit: hmerinomx

This post is part of a special series celebrating the School’s Alumni Forever Week (March 30 through April 3).

Profile
Rob Torti ’07
Turnaround Consultant, AlixPartners LLC

Tell us about your career path.
Like every other former investment banker, I wanted to be in private equity. I pursued that but I learned it was a solitary job and that my real passion was for management, and that was something I was good at. After school, I took the summer off and traveled and then came back and looked for jobs at turnaround firms. I wish I could say that it was the result of having foresight, but realistically I liked the job description. The job entails a lot of finance, business analysis and strategy as well as some law; there is a huge management aspect where you get parachuted into a company and take a senior management role.

Looking back at your Columbia Business School experience, what was your aha! moment?
While I was in school my ideas changed dramatically. I took Turnaround Management with Gregory Rourke during the first semester of second year and that opened that whole world to me that I didn’t know that existed. I also took Professor Ralph Biggadike’s Top Management Process class. I really enjoyed the complexity of management, and I realized I had a passion for working with a lot of different people and solving complex problems.

In your industry, what trends are you watching and where is there opportunity?
I probably have a more doom-and-gloom view of the economy in the next two years than most. Having been an investment banker myself, I know that some of these companies just cannot survive. Given the distresses out there, I am looking at the end of 2010 for the economic recovery — and it won’t be a quick bounce back. If you see your company headed for a bad spell and think that bankruptcy will be a real possibility, rather than put everyone in bind at the eleventh hour, you need to get professional help. The bankruptcy process is not something to be feared; you have to embrace it. Don’t wait for a white dove to save you. There won’t be a huge turnaround.

What advice do you have for current or prospective MBA students?
Think of your career as a tree: move along the trunk and don’t jump to a branch too early. When you work for a distressed company, you are given more work and you learn so much more. If the company has a good management team and you are there to help them through the process and see the nuts and bolts at a unique time in their business, you will be successful. This climate allows you to learn at a magnified rate.

At Friday’s community forum, Professors Paul Glasserman, Trevor Harris and Hitendra Wadhwa (pictured at right) held an open discussion with students about how best to move forward from the financial crisis. The forum covered economic issues ranging from risk management to accounting to the importance of not allowing the near-constant stream of negative news to affect your decision making.

Professor Glasserman began the event by speaking about capital requirements for banks as they relate to the banks’ risk management practices. He offered three main points:

1. Tightly linking capital requirements to risk can lead to dangerous procyclical behavior

   “When a bank’s assets start to look more risky [as a result of a downturn], it must hold more capital. How does it hold more capital? It cuts back on lending. So at the worst possible time, there’s an incentive — in fact, a requirement — for banks to cut back on lending.”

   To help prevent this, Glasserman suggested that banks take countercyclical measures, such as averaging out their risk over the business cycle. He also recommended that banks be required to hold additional capital in good times so that in down times there’s a buffer for them to draw on.

2. Banks should continue to bear the responsibility of regulating their own risk
   

   While it’s understandable that the recent trend of forcing banks to regulate their own risk has received a lot of criticism, Glasserman said, putting the burden back onto regulators might make matters worse.

   “If you go to an environment where the regulators are specifying a very precise set of rules, you’ve created an enormous incentive for banks to manufacture products that look low-risk by regulators’ standards but are in fact high-risk in all the ways the regulators haven’t anticipated. And that’s a large part of what’s led to the current crisis.”

3. Systemic risk must be factored into capital requirements
   

   “A traditional view of risk management says, ‘What harm can the market do to me?’” Glasserman said. “When you ask about systemic risk, you’re asking, ‘What harm can I do to the market?’ It’s a fundamentally different approach, and it’s not been part of the way capital standards have been set to date.”

Professor Harris referred to the situation described by Glasserman as a “classic accounting problem.”

Harris spoke about a critical flaw in the subprime mortgage-backed securities that are a big part of the crisis, is that all parties (originators, intermediaries, investors, rating agencies and auditors) lost sight of the underlying fundamentals of people who had borrowed more than they could afford.

“My whole view is that people have forgotten fundamentals, and they’ve created lots of quant-based analytics that actually have nothing to do with reality,” Harris said. “What that leads to in many cases is the illusion of precision. We have so many techniques, including valuation techniques, to come up with point estimates, and the reality is that there’s huge amounts of uncertainty going forward, and we have to deal with that.”

He concluded, “I view [the crisis] as a great opportunity to fix a lot of systemic problems. My biggest fear is that if we come back too quickly, we won’t actually address a lot of these issues. If we don’t deal with complexity and address these fundamentals, we will actually end up in a much worse situation.”

Professor Wadhwa said that while it’s easy to allow the near-constant stream of negative economic news to affect your mood, doing so can impair your ability to make critical decisions.

“[Maintaining a positive outlook] broadens your mind, making you more aware of the periphery of whatever it is you’re looking at. It makes you more mindful of a whole range of ideas.”

To support his position, Wadhwa cited research that demonstrated a link between the mood of physicians and their ability to properly diagnose patients.

To keep yourself in a positive state of mind, Wadhwa suggested taking the following steps:

1. Break the causal link between external events and your internal mood. Do this by injecting behaviors, such as displaying gratitude.
2. Use humor and body language to project a positive mood not only outward but also inward.
3. Turn adversity into transformational opportunities.

“Even with the constraints many of us face,” Wadhwa said, “there’s a potential for us to ask ourselves, ‘What is there within this that might be redemptive?’ By the fact that certain doors might have closed on us, we are forced out of our comfort zone to think anew about our skill set and interests and who we are.”

Photo courtesy of Columbia Business School

This post contains an update.

Retailers have been stunned by how abrupt the change in the economy has been and that it has happened across all strata of consumers. It is most pronounced in the luxury sector. As recently as seven or eight months ago, luxury thought that it was invulnerable, but that is not true.

Many luxury customers are aspirational and are vulnerable to downturns in the economy. The core customer with essentially unlimited disposable funds may no longer find it fashionable to behave as they had in the past. Irrational exuberance may not return and people may not seek to live beyond their means, choosing a more conservative lifestyle. Now, the customer is saving for the first time in many years, and this recession will leave a lasting mark on consumer behavior.

Jobs, confidence are lacking
Retailers are one of the largest sectors of the economy. They are very large employers. When business declines, retailers stop hiring. Layoffs soon follow. We’re seeing this across the country. Laying off large numbers of people creates a cascade of breakage. This impacts consumer confidence; everyone knows someone who was laid off. Stores begin to close. That is very visible. At the end of the day, if people don’t have jobs, there is no recovery and that’s the end of it. The consumer has to be viable, which means jobs and a rise in confidence. Many people with viable jobs become increasingly fearful of losing their employment. We’ve gone from irrational exuberance to irrational fear.

It’s good to be different
This downturn creates powerful opportunities for organizations to emerge if they can successfully differentiate themselves. Retailers with notable products and services can create enormous energy and value. Two examples are Apple and Amazon. Apple has a highly differentiated product and a selling environment at retail that is incomparable. Their market share will continue to climb as long as they continue to satisfy their customers’ needs and wants. Amazon aggregates assortments of merchandise in an on line setting that is the best in the world and continues to acquire more and more market share. They invested in an esoteric device, the Kindle, and surprise! It looks like a $1.4 billion business next year.

On the other hand, retailers with little or no forward strategy like the department stores, who have been playing out a “Last Man Standing” end game have little likelihood of future success and vitality. Layoffs in this sector are a tragic and ineffective expression of survival. You can’t use reductions in force as a strategic blueprint. It creates enormous disruption and leads to more crises downstream.

Good news for the shopper
Currently there is an enormous excess of inventory in many retailers supply chains because of recent extreme and unanticipated shortfalls in sales. These excesses will have to be liquidated. Retailers are dumping inventory, canceling what they can and avoiding buying forward product. In the next year we’re going to see fewer stores, less inventory overall in stores and less discounting because of less inventory. Prices will come down because consumers will expect more value and will be less willing to play the high-low game as they have in the past.

This economic downturn, recession if you will, is likely to continue for at least 12 to 18 months and maybe longer. I believe that when it is over the retail landscape will be very different than it is today.

UPDATE (2/25/09): Follow up from the Retail & Luxury Goods Conference. Keynote speaker Robert Burke said, “I don't think the department stores are completely dead and I don’t believe luxury is over. … It became overused and ambiguous terminology.” View the complete video (part 1, part 2) of his speech. -CN

Photo credit: Christopher Chan