TCS Daily

A Diagnosis of Corporate Pathologies

By John Baden - October 22, 2007 12:00 AM

Economists have no monopoly on tools explaining the pathologies that afflict  organizations. However, their approach offers some illuminating insights. Here's one -- within an organization decisions are made on the basis of information and incentives faced by the decision maker.

Consider business practices that alienate customers and clients. Surely no business with a general clientele, such as Amazon, Home Depot, or Kmart, has this as a goal. Yet it occurs. Why?

The offending employee may be evil, bitter, or malicious, but economists have little to say about individual characteristics. Rather, economists examine the incentives and information facing the person who annoyed or harmed the customer. Here are two examples.

The Wall Street Journal recently featured an account by Laura Landro, one of their senior editors. In preparation for her granddaughter Emily's new school term, Landro, who is responsible for all New York reporters covering the media and marketing, took her shopping at Kmart. Her and Emily's mother together spent "more than $800." When they went to pay at the register, their haul included a pair of loose flip-flops that had, in error, been put in the wrong box. Big mistake. Landro was accused of cheating the store out of $8.

She notes, "retailers face a daily battle against scam artists. But let the customer beware: With security on high alert, even law-abiding shoppers can fall under suspicion." Eight dollar error detected, she was taken to a security room, detained for an hour, and accused of deliberately switching a more expensive item into a cheaper box. Her driver's license and credit card were temporarily confiscated. She was told to expect a civil notice of a fine and the security guard "Š told me I couldn't come back to the store; I assured him I had no intention of returning to any Kmart, ever."

The security guard did nothing wrong; he had incentives to follow company policy and he did so. The results, however, were surely perverse. While Kmart's practices no doubt reduce shrinkage generated by price switching, if misapplied, they drive good customers away.

Customers like me... I have spent too many thousands of dollars on and, until recently, never had a problem. They advise me of new books reflecting my interests based on my purchasing history. I have a weakness, perhaps an addiction, for books.

Earlier this year I received notice of an Amazon credit card that offered special privileges and discounts. I signed up, and placed an order.

I always immediately pay credit card bills. A bill with my initial charge of $43.08 never arrived. The first statement received included a late fee of $15.00 and a $1.00 finance charge. I, of course, protested. Alas to no avail.

I first sent a letter protesting. Then called and went through an interminable phone tree. Then wrote again, and called again, and again. And then canceled my card and received another late fee added to the first. It was clear that I would not receive satisfaction.

I often lunch with my primary banker and shared my plight and genuine anger at Amazon with him. Suddenly, with his help, the problem became clear.

My new Amazon card wasn't really with Amazon. Rather it was a Chase Bank "affinity card" sponsored by Amazon. Apparently, Amazon has an arrangement with Chase to offer this card. In return it receives some small percentage of each charge.

The bank has many such affinity cards. The person receiving complaints about charges has incentives to collect all payments, late charges, penalties, etc. He has no interest in customers' feelings toward Amazon or any other company. It is likely his performance is measured by the charges he collects.

In this case, Amazon's CFO no doubt saw an opportunity to add a small percentage to each sale by establishing an affinity card operated by Chase Bank. There is no system to note and correct sorry treatment to customers.

Huge organizations create policies that look good at headquarters. However, they often have negative consequences at the individual level. 


Hence the Niche market
I own a small, very successful, high tech company. 99% of my customers come to me because they have been screwed over by larger contractors who's lack of customer service has driven them to me by word of mouth.

I deliver very specialized products, usually custom, on budget and on time. If a customer complains, I fix it.

The issue here is partially scale. I can take business from giants as they can't compete on small contracts. I cannot on large ones.

Hence the niche market. If you see a company doing something stupid, then start a company and compete. You don't have to take on the entire company, just pick a bone and start chewing.

These types of pathologies are well know amongst all big outfits. That's exactly why you'll never get monopolies in free market places. As big ones screw up certain people in certain ways, they'll just switch to a competitor, or nich player as dbt states in his comment. So it's actually good in this manner, it gives a chance for others to do better, or even put the big guy out of business. This is a case for free markets.

Nice dbt
In the newspaper world they've co-opted the word "innovation" to describe what you're describing.

"You don't have to take on the entire company, just pick a bone and start chewing."

You're not going to start a website and take down YouTube in a direct competition, but you can capitalize on a YouTube weakness, build a business model totally different from YouTube's, put it in the market and it could possibly evolve into a lucrative product.

And success rarely happens on the first go-round, so prepare to fail fast and cheap. Create a company culture prepared for constant change, don't be afraid to fail. In fact, plan for failure, so you don't blow your load on the first try and you're ready to adapt and try again.

There's a lot of discussion and planning around these concepts going on right now, so its on the top of my brain, your comments are so similar... and you're already doing it in the real world. Nice. You hiring?

I am thinking about it.
Yes, I have now decided to hire. The problem is benefits, etc. It is a tough nut in this industry as I am not hiring low wage hourly employees. In my market people want salaries, insurance, 401K. Not a trivial undertaking.

One huge complaint I have with the current education system is the total lack of this type of thinking in schools. We train kids to be minions and employees, not employers and business owners.

Thank God neither K-Mart nor Amazon are run by the government...
The nicest part about free enterprise is that you can take your business elsewhere.

This means that businesses have to learn to compromise and deal with dissatisfied customers, or they will lose them. It costs five to seven times as much to attract a new customer as it does to keep an existing customer. Repeat customers refer other customers to your business twice as often and spend a third more than new customers. Keeping your existing customers happy provides a much better ROI than advertising, and because of the referral factor, actually attracts more customers. Dissatisfied customers lead to bad word of mouth, and articles on TCS Daily.

I've done pretty well for myself advising people not to invest in companies with bad customer service records. They are not going to grow anywhere near as fast as a Southwest Airlines or a Wal-Mart.

Of course, when it comes to the government, there generally is no other option. Government is the only agency that can truly create monopolies, and it has no incentive to respond to "customers" upset by the quality of their goods and services. Anybody who lived through the Bell era remembers how awful phone service was in those days. Now, we're moving to do the same thing to health care... When will people learn? We've all switched suppliers of something at one time or another because of bad service, what idiot actually thinks that not having the option to switch will make things any better?

Upper management disconnect...
One of the underlying problems for an upper management team inside any very large corporation is the career path required for its executive candidates to actually come to power "during this lifetime".

There are too many promotions necessary during the 15 or so years after the MBA for these young people to spend any substantial period immersed in the nuts and bolts of middle management. They simply do not know what goes on inside the operation of their own industries.

But it is worse than this. The personalities who are able to work their way to the top are typically political gamesmen who are fundamentally uninterested in manufacturing, sales and accounting. If they do pass through middle managment, they are not paying attention.

But, five years at McKinsey right out of B School followed by a "grooming position" in Strategic Planning?...Oh yes! They sit in conference rooms immersed in Power Point presentations...and they are very good at this. They manage "by the numbers". However, they do not know what those numbers represent. Such is our "corporate officer corps" here in America.

Very large industrial entities operate businesses that deliver commodities into the global marketplace. Such commodities should enjoy mature, efficient technologies and methodologies so that executive management need not understand (to any depth) exactly how middle management gets things done. Global competition should have already sorted all that out so that the companies remaining are on "automatic pilot". That would include customer service. Such industries fighting for "share points" might not be expected to earn great unit-margins...and this is typical of competition in any commodity market.

However, when an industry dominated by large players (such as banking) does make a lot of money then there should be opportunities for the nimble. This is because healthy margins mask underlying sloppiness. "We might have problems (and we are working on those)...but we are making our numbers!"...and that is the attitude.

If the barriers to entry into such businesses seem too restrictive, here in America, then those competitive opportunities immediately move offshore in search of more suitable venues.

"Better, faster and cheaper" operations residing in foreign markets will ultimately find a way back into our own.

vry good
But there is a difference between the type of company (retail sales) involved in both listed complaints and your Tech business. Few small start-ups can find a niche to compete with the walmarts, targets shopkos and K-marts. They have each other for competition and that is about all in many cases. The reason? P-R-I-C-E!!! Sure, I can make a niche market out of higher-end items; Sachs is still doing fine in a Walmart world.

As for word of mouth as a business building tool, watch out! I hope you have a real advertising strategy and some kind of PR capability. Any person who had been in business more than a few years can tell you that "word of mouth" is usually more damaging that helpful, in the long run.

But the rest of your post is right on, and it is a good general example of how to make a go of it in a "Big Box Store" world. Good luck and I hope you have unlimited growth and profits!

Incentive and structure

A lot of merchants use (for example) Yahoo to handle their credit card billing and payment. If a customer has problem with billing, how much leverage is there?

A different point: as a matter of disclosure, shouldn't the card issuer indicate, when the card is delivered, what the monthly statement date will be so the recipient can react properly when the first bill is missing? With that information denied, the customer has no way to deal with a failed delivery.

Of course, not indicating that date might be security-by-obscurity to make it harder for someone who has intercepted the card to also intercept the statement. But which is more important?

Choice regarding sovereigns...
The business of operating a sovereign government is in decline. Military imperialism as a growth option is off the table. Nations must now compete in terms of GDP growth.

As competing (global) economies approach parity growth will become directly related to population...both in raw numbers and in quality. Here in the US we continue growing because people aggressively immigrate here. Motivated people.

As opportunities improve elsewhere in the world that urgency to come to America must decline. There will be a reverse flow of Americans moving overseas to find better jobs and more robust economies. This is already starting.

We saw the same thing occur here in America. Workers from Southern states moved north in the middle part of the last century...but toward the end of that period the North (New England especially) started losing people as the Southeast opened for business.

It is easy to simply get on a plane and go almost anywhere (with your US Passport) today. It should be a straightforward matter for certain developing nations to attract some of our best young people.

"Few small start-ups can find a niche to compete with the walmarts, Targets, Shopkos, and K-marts."

Then compete somewhere else.

I surely hope that K-mart and Tarjay are not become the measure of quality in our nation.

"Faster and cheaper"
do not necessarily equate with "better".

Public schools in the state Maine now are giving out birth control to middle-school children--and they do not even need to consult parents first, it's all the administrations' call.




"Better" is not BEST. "Faster" is not MOST EXPEDIENT. And we all know what it means to be called "cheap".

Excessive taxation, ****-poor public education, and strong drifts toward Socialism on the part of both major political parties (spearheaded by the Left) comprise the United States' "neat and tidy trinity" of problems.

All three...

Better, faster and need all three to achieve a breakthrough.

There are always better and faster technologies but they cost too much. If you have all the money in the world...then that's the way to go.

There are better and cheaper methods but they take forever. If you have lots of manual labor standing idle then this is one way to turn cheap labor into export dollars.

There are faster and cheaper products and services but they are terrible. When you don't care about quality then why waste your money and why wait?

There is already a market (and a fortune to be made) when you have any two of the "better, faster and cheaper" paradigm.

But if you have all three?...10 fortunes!

Amazon pathology
I have ordered books for two years from Puerto Rico from Amazon. They would not, however, ship videos and CDsto this address. When I sent them an email suggesting that since they would send books maybe they should also send videos and CDs if they came from the Amazon warehouse. The customer service people said that it seemed like a good idea and would bring it up with whatever section within Amazon that dictated policy. The result was that now I can't get books. They lost a good customer (I probably order a couple hundred dollars a year from them). Now I tell everyone not to use them and re-tell my story. Amazon got a double effect for this stupidity - they lost my ordering and I am a poison pill for them that costs them money. They fit your thesis to a T.

God Forbid!
But in the mass sales arena K-Mart, Wal-Mart, etc. are the giants and pretty much own the landscape.

There are small niches for quality items, but in the retail sales arena they seem to be very small and hard to make profitable.

Want to compete? A few places are wide open to the smart go-getter. One is dbt's tech business and the other is construction sub-contracting. Be a specialist in foundation laying, rough work or finishing work and you can make pretty good money, work for yourself, and live in just about any part of the country you want.

"attract some of our best young people."
It would work the same if the USA opened its borders to all immigrants.

Actually, making it somewhat harder to get in for us...
Immigrating to America is difficult. Those who are able to pull it off are among that part of a foreign population that is more motivated. So this works for us. Even the direct labor workers who come here without documents are more industrious than those who stay back home.

However, moving in the other direction is less compelling for Americans. Our best young people can easily find good jobs, here. Nevertheless, even better opportunities might well exist overseas...but we cannot make that risk/reward hill too high for them to climb.

Otherwise, foreign economies will only recruit those American players with less (upside) potential and nothing (much) to lose.

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