STERNbusinessB R A N D N E W S

F A L L / W I N T E R 2 0 0 4

Global Brand Managers Speak: Visa, MTV, J&JStigmatized CEOs Martha’s Woes Rolex Rolls On Toyota Motors Ahead Paul Newman’s Salad Days Are Fannie andFreddie Too Big? Investors to CEOs: Ditch the G-IV! May I Help You? Customer Assistance Strategies That Work

a l e t t e r f r o m t h e deanIt’s rare to discuss

branding in the context of

a university, or of a busi-

ness school. After all, we

don’t have customers or

products. We don’t try to

gain market share by

rolling out periodic mar-

keting campaigns. And

yet, in one important way

our efforts are inextricably linked to the process that

companies go through when trying to build a brand.

We have a strategy in place to ensure that NYU

Stern signifies and embodies certain values and

attributes in the minds of all our stakeholders –

students, faculty, staff, colleagues, and our counter-

parts in the private sector. Beyond that, we strive to

communicate our values consistently and frequently

to our different constituencies.

What are the components of the NYU Stern

brand? A spirit of rigorous interdisciplinary inquiry;

an openness to the city that is our home, and to the

global context in which we live and work; a commit-

ment to excellence in teaching; and the ambition to

grow, expand, and deepen our knowledge base

through research.

The Stern brand has been built over a century of

sustained effort. We have deep roots in finance and

accounting. But over the decades, as we have grown,

and as our human and financial resources have

grown, we have expanded our horizons. Today, we

are proud to offer strong programs in a range of

disciplines: from economics to marketing, from

management to information systems.

We strive constantly to invigorate Stern by

recruiting new faculty, by bringing a broad range of

guest scholars and executives to share their experi-

ences with us, and by finding new ways to connect

and re-connect with members of our far-flung com-

munity. This September, we are welcoming 11 new

junior faculty to campus. We are also delighted that

Steve Florio, the former president and chief execu-

tive officer of Condé Nast Publications, is coming to

teach at NYU Stern this fall. Our long-running CEO

Series and the popular Author Lecture Series both

continue, with the appearance of business leaders

such as Larry Bossidy and Robert Rubin, respective-

ly. And in October, our Global Alumni Conference in

Paris will feature presentations on topics ranging

from the future of the European Union to the global

luxury market.

SternBusiness is an integral part of these efforts

to explore, raise questions, and establish connections

in New York – and beyond. And this issue proves

that members of our community have significant

intellectual contributions to make on the important

subject of branding. I hope you enjoy it.

Thomas F. CooleyDean

SternChiefExecutiveSeries

Interviews withTom Freston, Viacom, Page 2Carl Pascarella, Visa USA, Page 4William Weldon, Johnson & Johnson, Page 6

12 Brand Equityby Daniel Gross

14 A Very Bad ThingMartha Stewart’s Meltdownby Peter N. Golder

STERNbusinessA publication of the Stern School of Business, New York University

President, New York University � John E. SextonDean, Stern School of Business � Thomas F. CooleyChairman, Board of Overseers � William R. BerkleyChairman Emeritus, Board of Overseers � Henry KaufmanAssociate Dean, Marketing

and External Relations � Joanne HvalaEditor, STERNbusiness � Daniel GrossProject Manager � Lisette ZarnowskiDesign � Esposite Graphics

Letters to the Editor may be sent to:NYU Stern School of BusinessOffice of Public Affairs44 West Fourth Street, Suite 10-160New York, NY 10012www.stern.nyu.edu

contents F A L L / W I N T E R 2 0 0 4

42Helping HandsStrategies for Assisting Shoppers in Malls and Onlineby Eric A. Greenleaf, Vicki G. Morwitzand Russell S. Winer

48 Endpaper by Daniel Gross

Illustrations by: Bryan Leister, Juliette Borda,Jud Guitteau, Ken Orvidas, Steven Salerno,Michael Caswell, Robert O’Hair

B r a n d N e w s

18The Scarlet FWhen Good Executives Go Badby Batia M. Wiesenfeld, Kurt Wurthmann and Donald C. Hambrick

24 What Makes Rolex TickThe Watch Maker’s Success Secretsby David Liebeskind

28 Car TalkNYU Stern Alumnus Tatsuro Toyoda of Toyota Motor Corporation Returns to Campus

30 Flights of FancyDo Stocks Suffer When CEOs Use Private Jets?by David Yermack

36The Trouble with Fannie andFreddieThe Hazardous Growth of Two Mortgage Giants by Lawrence J. White

Tom Freston, co-president and co-chief operating officer ofViacom, received his MBA from NYU Stern in 1969. He hasbeen with the pioneering music channel MTV since its found-ing in 1981 and served as CEO of MTV from 1987 until lastspring. MTV Networks, a division of Viacom, operates cablenetworks MTV, VH1, Nickelodeon, Country Music Television,Spike TV, Comedy Central and TV Land. The company alsocontrols MTV films in association with Paramount Pictures andlicenses consumer products. MTV currently broadcasts to 314million of the world’s households in 136 countries and territo-ries. MTV has branched out from its original fare of music

videos to offer original programming, such as Real World and Newlyweds, and has engaged youngaudiences with its “Rock the Vote” and “Choose or Lose” campaigns. In June 2004, Freston waspromoted to co-president and co-chief operating officer of Viacom, and is now responsible for thecompany’s cable, publishing and theme park units.

sternChiefExecutiveseries

Tom Freston co-president and co-chief operating officer of

Viacom

RR: What television momentsinfluenced you growing up inConnecticut?TF: I grew up in the '50s and'60s, which must seem likeancient history now, and I sawthose iconic moments: Elvis'sfirst time on TV and theBeatles and the Kennedyassassination. But I spentmore time listening to theradio, and I was really touchedby the Beat movement of thelate '50s, early '60s, and therise of the counterculture. Iwasn't a hippie, but I was righthere in Washington SquarePark. And the late '60s was areal interesting time to begoing to business school inNew York City. There are cer-tain themes from those move-ments that resonated with me.

One was the notion that youshould experience as manydifferent things as you can,that travel would be a veryimportant journey to take inyour life.

RR: So what motivated you togo to business school in thefirst place?TF: I couldn't really seemyself being a doctor or alawyer or a dentist. If I went tobusiness school I thought Icould find something that Iliked, although it was reallyhard for me to figure out whatthat would be. It was alsohelpful at the time to get adeferment and stay out of thewar in Vietnam. But I was verypleased to get into NYU. Iwas lucky enough to have

Peter Drucker as one of myprofessors.

RR: Do you remember anything that he specificallytaught you?TF: I always remember himtalking about innovation.Invention is creating somethingtotally new. But the real thingin life is innovation, which istaking two things that alreadyexist and putting them togetherin a new way. That's wheremost businesses come from.

RR: What did you do whenyou left here?TF: I took off a year and a halfand sort of bummed around. Iwas a bartender in Aspen.Then I went to Mexico andworked around the Caribbean.

Then I decided I better get ajob. I wanted to do somethingreally creative. So I got a job atan ad agency, Benton &Bowles. They put me on aProctor & Gamble business. Iwas assigned to the Charmintoilet paper account. But I wasvery alienated at the time. Soafter a year and a half I quit,and I spent a year travelingaround the world. I ended upin Asia, and I was just soenthralled with everything Isaw there. So I made up mymind that I would like to livethere and work, and figuredout a way to support myself.

I came back to the Statesand found a friend who hadsome money. And in 1973,with the advent of air freight, itwas possible to make some-

2 Sternbusiness

thing in a country like India orAfghanistan, and sell it 24hours later in New York City.We set up factories to designand make clothes in India andAfghanistan. I had a house ineach place. We sold ourclothes through a network ofshowrooms here and inEurope and Australia. We didthat for seven or eight years.It was an excuse for me to livean adventurous life in Asia.

RR: Why didn't you staythere?TF: Well, the U.S. put in placea system of quotas on textilesand garments. Then theRussians invaded Afghanistan.And I had this epiphany oneday. I was on a motorcycle inNew Delhi. It was 110degrees, and some gas from adiesel bus was blowing in myface, and I said, “I'm out ofhere.” We had made and thenlost a lot of money, so I cameback to New York with my tailbetween my legs.

RR: So you get to WarnerAmex Satellite Entertainmentin 1980. That’s a pivotal yearfor cable. USA Networks start-ed, CNN debuts, Showtimeand The Movie Channelmerge. What did you think thisindustry was going to be?TF: I was really lucky to get inwhen I did. There was a visionof an alternative television uni-verse other than the threebroadcasters – based on cablerolling out across the countryand the idea of narrowcasting.Almost all the incumbents saidit would not work – the adagencies, the broadcastingcompanies, producers. Youhad this melting pot of people,none of whom had any experi-ence doing it. I was on thedevelopment team of MTV andwe all had a passion for musicand the belief that a networklike this would work. Weemerged at what became MTV

Networks as a real brand-ori-ented powerhouse.

RR: You went from newrecruit, to a company that didn't exist, to CEO in aboutseven years. What were thetouchstones along the waythat led you to the point ofleading this company?TF: One of the good thingsabout being in a new companyin an industry that didn't existis that no one knew what theywere doing. The people aheadof you often got fired becausethey usually did a few thingswrong. So it was easy to rise,if you had your head up, if youwere able to learn. In thosedays, you'd go from a secre-tary to vice president in sixmonths. I was the marketingguy at MTV. Every time some-one would get fired, they'd giveme his job too. So then theyput me in charge of affiliatesales, and I had never had asales job in my life. But we didwell, and then they moved meafter a year of that to generalmanager of MTV. Then VH1came along. And at this point,I’m only at the company fouryears. Then we were sold toViacom and a lot of people left.They made me co-president,for no good reason. Then theguys who bought us got blownout in a takeover battle withSumner Redstone, and hecame in and they made me theCEO. That was in 1987 andI've just been there since. Ihave a distinct lack of ambi-tion. When you have a goodjob, just keep it.

RR: Reflecting back on thealmost 17 years now of beingin charge of MTV, is there adifference between running acompany and leading acompany?TF: If you were in a maturebusiness, like you make thereflectors that go on stopsigns, you could run the com-

pany, make it work more effi-ciently, and get everyone to doa slightly better job. If you're ina world that changes a lot likethe media, the organizationreally has to mutate and movequickly, and it requires strongleadership. That doesn't justmean leadership from me, buta model where there is goodleadership coming from awhole bunch of places.

RR: How do you do that?TF: There are five people whoreport to me, and there aremaybe 15 people or so thatreport to them. And we talk alot. I really believe we're abottom-up company. You periodically will do a strategicplan that looks at how thisworld has changed, and tofocus on, say, the Internet oron international or on digitalservices.

RR: Can you give an exampleof an idea that bubbled upfrom below? Is Spike TV anexample of that?TF: When Viacom mergedwith CBS, they had two chan-nels: TNN and CMT. TNN wasthe Nashville Network and theaverage age of those viewerswas 66. They wanted to makeit a general entertainment net-work like USA Network. That'snot what we do. So we decid-ed, look, there’s Lifetime andOxygen for women. It's under-standable to advertisers andcable operators. And there isno channel for men. Wethought maybe we could makethis a channel for men thatwould include everything frommen's health and finance to

documentaries on sports fig-ures. It's off to a good start.

RR: Would you call that pri-marily a research-basedprocess?TF: It was based on researchand then looking at productavailability. But at the end ofthe day it's about gut. Therewere one or two people stand-ing up, pounding the table,saying this is a fabulous idea.

You need people working foryou who are passionate aboutthe audience and have greatinstincts.

RR: Where do you find thosekinds of people and how doyou nurture them so they stayaround and don't move off andstart their own companies?TF: There is a sort of self-selecting process. You eitherfind someone who is very obvi-ous, who is banging down yourdoor. Or sometimes you justfind somebody you take achance on and you nurturethem; you allow them a certainamount of freedom. We have94 channels we run around theworld, so it's very decentral-ized. Each is run by somebodywho has a team under them,and they make most of theirdecisions.

RR: I think a lot of peoplehere are interested in how youmanage a global company.What's the trick of globaliza-tion in a cultural industry?TF: Coca-Cola can basicallymake the same bottle of sodaand sell it everywhere. But in

“And I had this epiphany one day. I was on a motorcycle in New Delhi. It was 110 degrees, and some gas

from a diesel bus was blowing in myface, and I said, ‘I’m out of here’.”

Sternbusiness 3

continued page 8

Mr. Freston was interviewed by Randall Rothenberg,editor-in-chief of the quarterly business magazineStrategy+Business and editor-at-large at Advertising Age.

We’re 14 percent of the$12 trillion that American con-sumers use to pay in cash andchecks every year. And that’sthe real market. We want todisplace cash and checks.Seven or eight years ago, thedebit check card arena – debitcards that access your check-ing account – was about 6percent of our volume. Todaythey’re over 41 percent of ourtotal volume. So we’ve madesignificant inroads to makepeople aware that you canaccess your checking accountor your savings accountthrough a Visa card, and getthat same level of service with-out having to write checks.

MCC: How do you teach aconsumer to want somethingthat didn’t exist before?CP: The first thing we did wasuse the power of the Visabrand. There are two thingsthat are sacrosanct at Visa –our systems and our brand.We had the capability toexpand our systems, to beable to offer a debit or a checkcard product. Then the ques-tion was: How to get folks tochange behavior? We startedwith educational advertising,and it was two old men up ona porch in 1993, or ’94. Onesays, “You know, I use thiscard to access my checkingaccount.” And we walkedthrough it. We wanted to makesure that everybody under-stood that this was going to bea universal product, that it wassafe and secure. Then therewas a lot of collateral materialthat went out to the branchesof the banks, and they did a lotof training at the branch level.

And then it got to be allabout the facility of the prod-uct, and that’s when westarted doing the ads withYao-Ming, Derek Jeter, andSenator Bob Dole, who say,“Hey, you know, they maynot know who I am, but I can

use this card because theydon’t take checks.” So itmigrated from the education-al side to a message of:“Look how easy this is.”

MCC: I want to take a stepforward. When you talk aboutthe revolution in the electronicpayments that you initiatedand created, 10 years downthe road what does the land-scape look like? CP: If you go back 30 or 40years ago, credit cards werenon-existent. Today you can’trent a car, go into a hotel, orbuy an airline ticket withoutone. So it really is importantfor us to look at this $12 tril-lion and how it’s spent today,and how we can change thebehavior to help the con-sumers and the merchantsaddress this. We look atthings today like automatedpayments and recurring pay-ments, we look at quick-serv-ice restaurants. Those are themarkets that we’re reallygoing after very strongly rightnow. And in 2003, the growthrates were 100 percent plusin terms of entry into thatmarket.

MCC: You’re talking aboutquick-service restaurantsbeing willing to take the debitcards?CP: Yes, that’s right. And cred-it cards, for that matter. Andpeople being able to pay theirutility bills, their mortgages,their health club and cablebills. It’s a great benefit for theconsumer, because they don’thave to sit and write checks allthe time. But the importantthing from the standpoint of themerchant and the bank is thatit makes it a stickier relation-ship. And today in the financialservices industry, the cost ofacquisition is so high, thatyou’ve got to do everything toretain every customer that youhave. We introduced a product

in 2003 that allows companies– instead of issuing paychecks– to issue Visa cards to theiremployees and then just auto-matically update them whenev-er they’re paid. So many of thepeople in the United Statesthat work don’t have a bankingrelationship. These peoplehave to stand in line, payuser’s fees to get their checkscashed, and then have thelack of security of walkingaround with cash. Now theyget a card, the money is putonto their card, it’s safe,

secure, and they can use iteverywhere Visa is accepted,or they can go to an ATM andget cash, so they’ve got totalflexibility.

MCC: How about the tech-nology?CP: About two years ago weemployed Oracle and SunMicrosystems to put in an IPfront end into our legacy sys-tems. And so today, whetherit’s a PDA or a cellphone, orwhatever the latest technologythat Michael Dell wants to putout, you can use that deviceand access your Visa accountand exchange value. But weare totally device-independent,and we are able to route mes-sages and information any-where the parties want it to go.And that’s a significant break-through, because now we’reonly limited by our creativity.We keep looking at this tagline all the time, “It’s every-where you want to be.” We’reabout ubiquity. People aremore demanding today, they’resmarter, they know much moreabout technology.

MCC: You have a lot of expe-rience in Asia. What are theparticular issues that you facein Asia in terms of Visa? CP: The first time I went toChina in 1983, the Bank ofChina picked me up in whatthey called the red flag car – ablack car with a red flag on it.And there was one Chinesehotel where I could stay. Noneof the Chinese could socializewith you individually. Youalways had to be in a group.And from the airport to down-town Beijing, we never passed

a car. Now today, it’s gridlock.Then, everything was done atthe provincial level. We signedan agreement with the Bank ofChina. Then we found out,well, that’s good for Beijing,but if you want to do any busi-ness in Guangzhou, you’d bet-ter sign the provincial leader,because he runs the province.There were no telephonesfrom province to province, sowe had to put up a satellite todo authorizations. The way webroke into China was to say“We can bring you a lot of for-eign income in terms ofaccepting Visa.” And they gotthat right off the bat. TheChinese are the most entre-preneurial people in the world,and I think we’re going to seethat as soon as the infrastruc-ture is built. But you have to becareful not to get too far aheadof the curve.

MCC: How does it feel as acompany to have essentiallychanged the way monetarypolicy works around theworld? I mean, have youthought about that?

Sternbusiness 5

“But since about 1994 or 1995, we’ve really transcended being

a credit card company. We’re goingafter cash and checks.”

continued page 9

Mr. Pascarella was interviewed by Michelle Caruso-Cabrera,co-anchor of CNBC’s Morning Call.

William Weldon is chairman and CEO of Johnson & Johnson.

Johnson & Johnson, founded in 1886 and based in New

Brunswick, N.J., manufactures health care products, pharma-

ceuticals, and medical devices. J&J, which has annual rev-

enues of $42 billion, comprises more than 200 operating

companies that employ more than 100,000 people and sell

products in more than 175 countries. Born in Brooklyn, Bill

Weldon graduated from Quinnipiac University, where he

serves as a member of the Board of Trustees. He joined J&J

as a sales representative in 1972 and, after a 30-year career at the company in the U.S., Asia, and

Europe, rose to become the sixth chairman in the company’s history in 2002.

sternChiefExecutiveseries

William Weldon chairman and ceo of Johnson & Johnson

MCC: This is a wonderfullytimed opportunity. Johnson &Johnson was the lead story allday on CNBC, because itsigned a big deal with Guidant.Tell us about the stent warsand about your deal withGuidant today.WW: A stent is a small devicethat is inserted into the aorta tokeep it open. It was a hugemedical breakthrough about sixor seven years ago, and J&Jactually developed the technol-ogy. It’s a huge and growingmarket, because stents reallyhelp eliminate a lot of heartattacks. Recently drugs havebeen put on the stents, whichkeep the aorta open longer.For about the last nine or 10months, J&J had the first drug-alluding stent, with a drugnamed Sirolimus on it. Boston

and we lost a lot of the mar-ket. Then we came out withthe drug-alluding stent, whichhas really taken the world bystorm. And it’s continuing withthis acquisition.

MCC: Your entire industry hasreally been under siege.People ask why we can’t getcheaper drugs from Canada.Do you feel drug companiesare being treated fairly? WW: I don’t think there is areally good understanding ofthe drug industry. At J&J, about50 percent of our volume is indrugs, about 35 percent is indevices, and the rest is in con-sumer products and diagnos-tics. I don’t think people appre-ciate the amount of time andenergy and cost that goes intobringing a drug to market.

There are literally thousands ofproducts you have to synthe-size in the lab to do so, andonly one out of every threeproducts that comes to marketpays for the investment madein it. You could argue it costs$800 million to a billion dollarsto bring a drug to market in 10years. And the actual time inwhich you can recoup yourinvestment is shortening everyyear. I think the investment isreally to help patients and tobring these significant break-throughs into the marketplace.

You have to put it into per-spective – namely that thesedrugs are having hugeimpacts. If you take choles-terol-lowering drugs, and youlook forward, you’re going toeliminate a lot of open heartsurgery. With stents, you’re

Scientific has another drug-alluding stent, which may getapproved shortly. Today thedeal we signed was withanother maker of stents,Guidant, which has excellentdelivery systems. Puttingthese two top companiestogether will be an advance forpatients.

MCC: All day long we’vetalked about how Johnson &Johnson was moving higher.What’s it like to be at work ona day like that?WW: It’s fun. Innovation iswhat it’s all about. Whetherit’s in devices, or drugs, orconsumer products. We werethe first company that cameout with stents, but veryquickly other companiescame out with better stents,

6 Sternbusiness

going to eliminate open heartsurgery, which is tens of thou-sands of dollars of cost that willbe taken out of the system.

MCC: What do you do as aCEO to try to deal with that?WW: We try to talk to peopleand try to explain the invest-ments that are necessary. Wework with the government andwe work with payers to helpthem understand. And ofcourse we work with patientgroups. If someone is a dia-betic, she doesn’t want us tostop spending in researchand development on newmedicines.

MCC: You started as a salesrep at McNeil Pharmaceuticalsmore than 30 years ago, andnow you’re the CEO ofJohnson & Johnson.Essentially, you’ve been at thesame company for 30 years.Why do you think you got towhere you are now?WW: In every opportunityyou’re given, you do the bestjob you possibly can. I think toomany people have their sightsfocused on what’s the next job,and they forget to do the bestjob where they are. It’s doing alittle bit extra, it’s trying to lookat new programs, new opportu-nities and capitalize on them,and to take advantage ofeverything that’s put beforeyou.

MCC: Do you think being atthe same company for threedecades is a good idea forStern students? WW: I think it’s a great idea,and obviously I’m biased. To beable to go into a company andbuild your career within a com-pany is really extraordinary.You build a network, youunderstand the workings of theorganization. At J&J, there arelots of opportunities to movefrom company to company.Few companies have such a

we just didn’t feel the cultureswere compatible. You neverget all 12 of them, but we gothrough them and then assessthe returns we expect to seeover time on a financial basis.

We don’t go in with the atti-tude that we’ll buy a companyand throw everybody out onthe street. We bought a com-pany called DePuy in 1998 thatwas a leading orthopedic com-pany. We took our orthopediccompany and merged it withDePuy. The reason you want

to acquire companies isbecause they’re great compa-nies. So why would you wantto gut them and get rid ofthem, other than to get costsynergies?

MCC: About half your profitscome from pharmaceuticals,compared with consumerproducts and devices. Is themix going to stay this way?WW: Ten years ago, consumerwas the biggest piece andpharmaceuticals were thesmallest. Because of the tech-nological advances and thegrowth of the market, pharma-ceuticals have grown tobecome the biggest part. Thepharmaceutical industry isgrowing at 15 percent and theconsumer industry is growingat 3 percent. Right now I thinkdevices are the fastest growingsegment of the health careindustry, not just at J&J. I thinkwe will probably have a mixthat will be somewhat similar to

what we have today, as far intothe future as you can see.

MCC: A lot of companies gotrid of their consumer productsdivisions because they wantedto be pure-play pharmaceuti-cals or device companies.Johnson & Johnson didn’t.Why not?WW: We see real value inbeing broadly based. If youlook back, there have beenperiods of time where con-sumer products are more high-ly valued and pharmaceuticalsare down, and then devicescome up. So having a mix ofbusinesses provides some sta-bility. And if you fast forwardand look into the future, you’llsee a convergence of skillsand technologies. We’ve got astent called Cypher that reallycame as a result of an engi-neer working in our devicebusiness and a scientist work-ing in our pharmaceutical busi-ness. Even our consumer busi-ness is becoming so muchmore dependent upon scienceand technology. We’ve movedscientists from our pharmaceu-tical business into our con-sumer businesses. We have acompany called Aveeno, whichis based upon natural ingredi-ents. The scientific work onnatural ingredients has beenable to expand that business.

MCC: There are three CEOson trial this week in NewYork City: Martha Stewart,John Rigas and DennisKozlowski. Any thoughts onthat?WW: It’s unfortunate that a fewpeople try to take advantage ofsituations and then it getsextrapolated out into thebroader industry. I think it’s ourresponsibility to build the repu-tation of business executivesup again. People who tried toabuse the system should bepunished, and I really feel for

broad breadth of businessesand such global opportunities.I started as a sales rep, thenworked in New York City, thenwent into the home office andworked through various jobs. Ithen went overseas, and Ispent time in Asia for aboutfour years working for groupsof companies. I went toEurope, then came back to theU.S., worked in a device busi-ness and ended up back inpharmaceuticals. Then Imoved into the office of the

chairman. I think I’ve moved13 times, and I’ve had I don’tknow how many jobs. You cando everything within a compa-ny like J&J, or a company likeGeneral Electric.

MCC: In the last 10 years J&Jhas bought 52 businesses.How do you determinewhether or not you’re going tobuy a company?WW: We have about 12 crite-ria. We’re in health care, andwe’re going to be in healthcare. We look at the productsthe company has; are theycompatible with our products?And is it going to take us intoareas of new technology, newproduct opportunities? We askif it will accelerate our growth,both short and long term. Welook at the management andask if it is compatible with thevalues embodied in the J&JCredo. We’ve walked awayfrom very good companies,with very good people, where

“I don’t think people appreciate the amount of time and energy andcost that goes into bringing a drug

to market. There are literally thousands of products you have tosynthesize in the lab to do so, and

only one out of every three productsthat comes to market pays for the

investment made in it.”

Sternbusiness 7

continued page 10

Mr. Weldon was interviewed by Michelle Caruso-Cabrera,co-anchor of CNBC’s Morning Call.

the entertainment world youreally can't do that becausemost culture is local. When wewent into Europe in 1987 wehad a pan-regional signal. Wedidn't have the amount ofhomes to develop the scale tohave specialized services ineach country. The VJs werepeople who spoke English as asecond language. That workedpretty well for a while becauseit was a novelty. But the localcompetitors really said we hadto change our model. So wedecided to regionalize and nowwe have 45 different feeds ofMTV around the world.

RR: Do you have programmingand leadership flowingbetween or among theseunits? Do you find great execu-tives in France? TF: Every general managercan pick and choose for MTVor Nickelodeon or VH1 whatev-er they want on the worldwide

feed. In doing so, they get toknow each other. On the man-agement side, outside theUnited States, there is a greatinterchange of people movingfrom region to region. I've beendisappointed continually in theStates by the number of peoplewho are here who don't haveany interest to leave. I alwaysthink, God, I'd be banging onthe door. Send me toSingapore or somewhere. WhatI do find is you're probably bet-ter off having locals run your

niche, there are a lot of greatonline applications where youhave more control over yourdestiny and you can get start-ed with a lower base of capital.

Q: I am employed at MTVNetworks and have been therefor five years now and am apart-time student. I’m curiousto hear your thoughts on someof the threats that we currentlyface with the emergence ofdigital cable?TF: On digital cable, we're try-ing to be at the forefront. I lookto the U.K., which is the testingground. There are 28 musicchannels in the U.K., if you canimagine that, and we haveabout 11 of them. What we'vedone is basically do brandextensions or bring in newbrands. And they captureabout 65 percent of the viewer-ship and the lion's share of themoney. Despite all this compe-tition, we’ve been able toincrease our market share,increase our overall ratings,and increase our business.That's a strategy we're set to

put in place in a bunch of othercountries. Having a strongbrand in a world of endlesschoices becomes even morevaluable.

Q: How about another technol-ogy trend: music downloadingand Napster?TF: We believe that that busi-ness is about to rationalize andbecome a viable pay business.The turning point was withiPod. We didn't want to be thefirst one in there because forthe last several years therehave been so many failedtechnologies. I didn't want toattach our brands to one ofthem early. In the next fewmonths, we are probably goingto announce a music subscrip-tion/downloading service.

Q: It seems the record indus-try is not really signing andwilling to promote new artists.Where do you see the musicindustry and MTV headed inbreaking in and promoting newartists?TF: There is all this talk that

business than bringing insome expatriates, except inthe early days when you wantto do what I call the DNAtransfer.

Audience Questions Q: I’m a part-time MBA stu-dent and a full-time employee

of your sister network,Showtime Networks. When welook at the consolidation inboth programming and distri-bution, what advice would yougive to your 26-or 30-year-oldMBA student who would like tostart their own MTV one day?TF: Most of the good ideasare taken for television net-works where the economicsare such that you could actual-ly make money from advertis-ers and distribution. If youhave great ideas for a real

continued from page 3

8 Sternbusiness

“We have 94 channels we run aroundthe world, so it’s very decentralized.Each is run by somebody who has a

team under them and they make most of their decisions.”

the music industry is downbecause of downloading andfile sharing. I think it's fair tosay one of the reasons themusic industry is down isbecause the willingness oflabels to take chances andnurture artists isn't what itshould be. Bob Dylan had sixalbums out before he had a hitsingle. That wouldn't happentoday. You'd be dropped aftertwo albums if you don't have ahit single, and that's unfortu-nate. I see the record industryas mutating, surviving, andactually I see good daysahead for it. It’s going to beeasier in many ways for inde-pendent labels to get startedonline and to market and mer-chandise and promote theirartists to consumers.

Q: You went from exploring theworld to 17 years in the sameposition at the same company.What makes you want to stay

at the same place for solong?TF: I guess I traveled aroundfor a long time because Inever really – and thissounds like a real cliché –found myself. I came into thiscompany and all the things Ilove are here. Just when it'sgetting boring, there is a newthing that keeps your interest– new services or going inter-national or starting a hugeonline operation. I just thinkI'm still in the middle of thethings I love. I work with agreat team of people. And Iget all these free CDs all thetime. �

CP: I have. And you know, Ijoined Visa for all the wrongreasons. I had been withbanks, and I wanted to get acouple of chevrons on my

sleeve in the overseas environ-ment, and come back and runa bank. I went over there forVisa, and it was in disarray.We had markets where DinersCard had more market sharethan we did. When I look back,I have got to be one of themost fortunate individuals inthe world, because you areable to change the way peoplelive. With that comes such a

huge responsibility, not justpersonal, but also corporate aswell. Because if you misstep,and if you just try to get num-bers, and if you get egotisticalabout this thing, it can blow upin your face at any time.

MCC: How about one piece ofadvice for these folks to close?CP: I think the most importantthing is to be passionate, andto really and truly love whatyou do. And if you don't reallywant to get up every day and

win in the market, or win atwhat you're doing, or enjoy thepeople that you're workingwith, I think you're missing theboat, because life isn't a dressrehearsal. That's very, veryimportant.

When I was at Stanford aprofessor of organizationalbehavior told a bunch of us,“You folks kill me. You've spentall your time on economics, on

statistics, on policy, onaccounting. Those of you thatare going to end up runningbusinesses, you're going tohire economists and CFOs andIT people and statisticians. Butwhat it's all about is motivatingpeople; it's getting to knowpeople.” That was one of thebest pieces of advice that Iever got. Don't lose the humanside of business, don't lose theorganizational side. Because ifyou do, you're only going to getso far.

Sternbusiness 9

“Today in the financial services industry the cost of acquisition is so high, that you’ve got to do

everything to retain every customer that you have.”

“In those days you’d go from a secre-tary to vice president in six months.

I was the marketing guy at MTV.Every time someone would get fired,

they’d give me his job too.”

continued from page 5

Audience QuestionsQ: I would assume that creditcards are a terrific target forcounterfeiters and criminals,given the high value associatedwith them. What's Visa doing tostay ahead of the curve in secu-rity?CP: We've spent hundreds ofmillions of dollars in terms ofwhat we call “neural network-ing.” Today, we can recognizeaberrant behavior at the pointof transaction. So if you havenever come to New York oryou've never gone to a jewelrystore, we'll at least stop thattransaction and ask the mer-chant to do a little bit morechecking. And the consumerresponse to that is very, verypositive. We're launching, aswe speak, the advancedauthorization system, which isgoing to let banks put furtherinformation into the authoriza-tion. In terms of hacking, we'vegot very, very strict rules interms of who has our data andwhether or not it's encrypted.And we always make sure,above anything else, that thefire walls are up and that we’realways ahead of the curve interms of fraud risk and creditrisk.

Q: What kind of threat do yousee from companies like Pay-Pal, which are doing electron-ic payments?CP: Pay-Pal and other aggre-gators are certainly interestingto us. In a lot of cases, the

people that load their Pay-Palaccount load it with a Visacard, and so that's volumethat we get on the front end.With our relationship withYahoo! and Amazon and all ofthe leaders in the Net, wecertainly are aware of what'sgoing on. Is it essential thatwe look at the $2 or the 20cent transaction? It isn't. Butwhat is essential is that theconsumer is protected, andthat we work with theseaggregators to make sure thatthey are protecting the con-sumers.

Q: You talked a lot about business, but you didn't mentionwhat kind of person you are.What were the personalitytraits that made you what youare now?CP: You know, you look backon your childhood and earlyjobs, but I think the mostimportant thing is to haveconfidence. To be sure youknow who you are and whatyou want. You've got to beable to make that tough call.You know, it was a tough callgoing to Asia in 1983. I hadbeen to Asia three times inmy life. And I had enoughconfidence at that point intime to say “That’s an oppor-tunity, I want to do that, and Iwill succeed.”

Q: Can you talk about howsecuritization has affected thecredit card industry? And how

does Visa assist its memberbanks with securitizationefforts?CP: With securitization, you’reselling the risk. And it's done agreat deal in order to grow thebusiness. But there are a lot ofcontingencies that go alongwith this. The quality of theportfolio has got to be main-tained at a certain level. If youhave a downturn in your creditquality in your portfolio, you'vegot to replace those accounts,or you're going to have a capi-tal call. So we help in terms ofmaking sure that a portfolio isup to speed.

Q: In terms of emerging markets, how do you balancethe decision to go into thesemarkets when you know thatrisk exists?CP: You make sure that thesystems infrastructure is therebefore you do anything.Because if you can't handlean authorization, and youcan't clear and settle theaccount to get the payment,it's not going to work. Andthen you've got to work withthe regulatory agencies thatare there. You might go inwith a debit card, or a securedcard first. You don't go in andgive lines of credit to peoplethat don't understand how touse them. �

the people who were secre-taries and janitors – peoplewhose whole lives weredependent upon these organi-zations. I think that we have amoral and ethical responsibilityto try to do what's right. I'm notsaying J&J's perfect, becauseas our general counsel says to

me all the time: “We've got112,000 people. It's the size ofa city, and there's crime in thecity.” At J&J it really does tieback to our Credo and the val-ues embodied in that. MCC: One of the results ofthe scandals has been theSarbanes-Oxley law, whichcreates more regulations andmandates that CEOs sign offon corporate earnings reports.Does it make you nervous? WW: No. We go through halfa day with internal auditorsand our legal people to makesure that what we're signingis as accurate as it can be.You have to have confidencein the people that work foryou. I keep going back to theCredo. It's been around for 60years. It's an extraordinarydocument. And we do prac-tice it. J&J holds that the anteto play in the game is thevalue system that we have.We have to deliver results,but never at the cost of thevalues.

Audience QuestionsQ: I have a small Internetcompany called E-Health-Care Solutions. How do youthink the Internet is going toimpact marketing and adver-tising going forward? And howmany hours a week do youpersonally spend on theInternet?WW: Consumers are usingthe Internet to learn thingsabout our products, and Ithink they need to beinformed. We don’t want tousurp the professional'sresponsibilities but we wantconsumers to be able to havean intelligent dialogue. Myown personal use is very min-imal. I have a 26-year-oldson, who spends an extraordi-

“And if you don’t really want to get up every day and win in the

market or win at what you’re doing, or enjoy the people that

you’re working with, I think you’re missing the boat, because

life isn’t a dress rehearsal.”

continued from page 7

10 Sternbusiness

nary amount of time on theInternet. When I want to findsomething, I just either askhim or my secretary. But I haveto admit, I'm Internet illiterateby and large.

Q: I'm a first-year student atStern, and I'm going to beinterning in your personalproducts company. What aresome of the main challengesyou see in the consumerproducts business?

WW: There's a lot of consolida-tion. Companies like Wal-Martare pushing, looking to get the

best deals. As every companydoes, we've got a whole organ-ization down in Bentonville,Arkansas working with Wal-Mart. In 2003, our consumerbusiness had its best year inthe past decade. And I think alot of it has been this move-ment away from consumer ori-ented products that don’t differ-entiate themselves in the mar-ketplace. Neutrogena, one ofour companies, is making hugeadvances in the area ofhealthy skin and healthy hair. Ithink Neutrogena is the mosthighly recommended productby dermatologists, and that'sbecause we have a profession-al group going to dermatolo-gists who are recommendingthese products and are creat-ing value in the market place.

Q: How do you motivate allof your employees acrossthe different divisions andcompanies?

WW: Motivation is personal. Ithink it comes down to treatingpeople fairly. And you need tohave a sense of urgency. It's

not the old management styleof beating people over thehead. You have to supportthem. You've got to give themthe tools to be able to do theirjob. You've got to make surethat there is fair recognition. Ithink the other thing that is crit-ical, and it is embodied in ourCredo, is treating people withrespect and dignity. I recentlyasked our public relations peo-ple to get together peopleunder the age of 30 who havebeen with the company for lessthan five years. I wasimpressed at their commitmentto the Credo and how many

people came to J&J because ofthe values. Our reputation isthe most important thing thatwe have.

Q: I’m an employee of J&J anda first-year student. In our firstclass on ethics, I find that a lotof what I add to the discussionis the Credo-based decision-making. I wonder if you canarticulate or discuss someexamples where you resolvedthat conflict between fiduciaryresponsibility to the sharehold-ers and making Credo-baseddecisions.WW: I think the best exampleis Tylenol. The Credo of J&Jsays first and foremost,patients, people use yourproducts. That's who you takecare of. Second are theemployees and making surethat employees are treatedwith dignity and respect. Thirdis the environment we work in.The fourth thing is, if you dothose three things, then

there's a fair payback to theshareholder. When we had theTylenol poisonings, we pulledall the Tylenol off the market.We'd never even discussedthe financial implications. TheCredo actually allowed us tomake that decision very clear-ly, to see that this was in thebest interests of the peoplethat consumed our products.Obviously, Tylenol has comeback, and it's a huge brand,probably one of the biggestbrands out there today. �

“I keep going back to the Credo. It’s been around for 60 years.

It’s an extraordinary document. And we do practice it.”

“I think I’ve moved 13 times,

and I’ve had Idon’t know how many jobs. You

can do everythingwithin a company

like J&J.”

Sternbusiness 11

here are comparatively few global brands,words that in a syllable or two can evoke asymbol, a product, or a feeling for billions ofconsumers. One of those is Visa. Plastic mayhave symbolized something artificial and

even boring to a prior generation. (Remember the scenefrom The Graduate in which Mr. Robinson advises theyoung Benjamin to go into plastics? He recoiled in horror.)But today, when money is as likely to change hands in theform of bits and bytes as it is in bills and coins, plasticmeans real business, and growth. And Visa, whose logo isrecognizable the world over (it helps that it’s seen on stick-ers on pretty much every retail outlet from Bangkok toBangor, Maine) has played a significant role in this evolu-tion. “We want to displace cash and checks,” declared VisaUSA CEO Carl Pascarella (p. 4). “There are two sacrosanctthings at Visa – our systems and our brand.”

MTV is another one of those brands that functions as asort of global shorthand. And even in a universe of hun-dreds of channels, Tom Freston, co-president and co-chiefoperating officer of Viacom (p. 2), sees opportunities.“There are 28 music channels in the U.K., if you can imag-ine that, and we have about 11 of them,” said the Sternalumnus, who had been with MTV since its inception.“What we’ve done is basically do brand extensions or bringin new brands.”

Brands can get hurt by a range of external factors – vig-orous competitors and technological breakthroughs,malevolent vandals or unfortunate accidents. But no blowis so damaging as a self-inflicted one. Exhibit A: MarthaStewart. The domestic doyenne hurt her reputation – andthat of her eponymous company – by getting caught up inan insider-trading investigation. Convicted in March oflying to investigators, both Stewart and her company facean uncertain future. But it didn’t have to be that way, saysPeter N. Golder, in “A Very Bad Thing” (p. 14). By seek-ing to become more than the sum of Martha’s many parts,the company could have “developed an impersonal brandthat was synonymous with a certain lifestyle – stylish, aspi-rational, and up-scale.” Instead, the name is synonymouswith an altogether different lifestyle: prison inmate. And,no, there’s no truth to the matter that her next magazinewill be entitled, This Old Big House.

A felony conviction stands as a black mark on any exec-

utive’s resume. But youdon’t have to be a crimi-nal to get branded nega-tively. Serving as anexecutive or a directorat a failed public com-pany can stigmatize amature professional forlife. But not all arebranded equally, sayBatia M. Wiesenfeld,Kurt Wurthmann, andDonald C. Hambrick in“The Scarlet F” (p. 18).The comeuppance boss-es suffer after beinginvolved in businessdebacles is a function ofmany factors – rangingfrom the severity of themishap to the number offriends and connectionsan executive possesses.“The greater the social capital of an elite associatedwith a failed firm, the less the stigmatization he or shewill experience,” they conclude.

or investors, it would be great to knowwhich executives are going to fail and bestigmatized in advance. It would have beengreat to know that Enron’s top brass would

be indicted. But how are shareholders to know?Analysts haven’t yet developed stock-picking toolsthat screen for possible fiascos. However, DavidYermack has identified one aspect of CEO behaviorthat points to potential underperformance of theirstocks. In his article, “Flights of Fancy” (p. 30),Yermack examined the frequent flying habits of CEOsover a 10-year period. He found that “shareholdersreact negatively to the news that CEOs are using cor-porate jets.” And with good reason, it turns out. “Theshares of companies whose CEOs use private aircraftunderperform the market by more than 400 basispoints a year.”

One of the sectors where brands matter most –

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where people pay the highestpremium for goods that havea positive image in the con-sumers’ mind – is in luxurygoods. What makes one pairof shoes worth $500 whileanother, with many of thesame components, costs$39.99? Brands help explaina lot of the difference. In“What Makes Rolex Tick?”(p. 24), David Liebeskindtells the story of how oneSwiss watchmaker managesto hold onto its position withthe regularity of, well, a fine-ly made timepiece. The“largest single luxury watchbrand” has pursued a strate-gy of continuity, limitingproduction, and zealouslykeeping watch not just onhow the watches are made,

but on how they are sold. “The crystal prism that indi-cates a store is an ’Official Rolex Dealer’ is highlyprized,” Liebeskind notes.

olex has been careful not to dilute its brandby branching out into unrelated areas. (Youwon’t find Rolex shoes and socks inBloomingdale’s.) And for many brands, asingular focus on a single product or groupof products is the key to success. But

Johnson & Johnson – which houses as many great brandsas the Yankees’ dugout houses all-stars – has followed adifferent tack. Over the years, J&J has built up threebroad lines of business: consumer products, pharmaceu-ticals, and medical devices. William Weldon, the CEO ofJohnson & Johnson, argues that the diversification pro-vides ballast for a giant ship. “We see real value in beingbroadly based,” said Weldon, who has spent his entire30-year career at J&J. “Having a mix of businesses pro-vides some stability.” (p. 6).

One of the components of a brand, especially forretailers, is service. After all, why spend your money in a

place that isn’t going to treat you right, especially whenthere are so many options – online and offline. Butthere’s a trick. There are different ways retailers canoffer help to shoppers, and the relative effectiveness of“different” has to do with psychology, expectations, andfeelings. Eric A. Greenleaf, Vicki G. Morwitz, andRussell S. Winer investigated the varieties of help onlineand offline and conclude which are most effective intheir article, “Helping Hands” (p. 42). Their conclu-sion: Customers don’t always want to hear the words:“Can I Help You?” Like Greta Garbo, some prefer to beleft alone. And online and bricks-and-mortar shoppingare two different worlds. “Since web shopping involvesconsumer experiences that are very different from storeshopping, it is not clear that help strategies that workwell in face-to-face retail encounters will work well onthe web.”

or most brands, success means avoidingcontroversy. Nobody wishes to offend apotential customer, after all. But two of thebiggest brand names in financial services –Fannie Mae and Freddie Mac – are quite

controversial. The two companies, which occupy thenot-so-neutral ground between the government and pri-vate sector, have grown into massive forces in the hous-ing markets – and in the House and Senate inWashington. But they have faced questions about theiraccounting, influence, and relationship to the govern-ment. Lawrence J. White, in “The Trouble With Fannieand Freddie” (p. 36), thinks some reform is necessary,and that the companies would thrive as purely privateentities. “Given their substantial brand names and theirimpressive collection of human and intellectual capital,they would likely continue to innovate and prosper,” hewrites.

One of the great things about a magazine is that itoffers readers the opportunity to dip into the content attheir own leisure, and on their own terms. And this issueof Sternbusiness is full of unconventional wisdom aboutthe use and misuse of brands. All readers will findplenty to sample.

D A N I E L G R O S S is editor of STERNbusiness.

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14 Sternbusiness

After Martha Stewart’s conviction, the prospects of the company she founded

and built, Martha Stewart Living Omnimedia, looked bleak. By tying her per-

sonality so closely to that of the company’s many lines of business, Stewart and

her management team left the whole enterprise vulnerable. There’s plenty we

can learn from the rise and potentially avoidable fall of this brand icon.

By Peter N. Golder

A Very Bad Thing

Sternbusiness 15

n March 5, 2004, MarthaStewart was convicted ofconspiracy, obstruction of

justice, and lying to investigators who had been probing herstock sales in biotechnology company Imclone. Earlier that day, amid speculation she would

be acquitted, stock in Martha Stewart Living Omnimedia (MSO) traded as high as $17. Soon after her con-viction, the stock sank as low as $9.25. The damage to the Martha Stewart brand cost her company 46 percentof its total value – or $433 million.

Martha’s legal travails have been thoroughly dissected. But their impact on the company’s brand has receivedless attention. Did the company have to lose 46 percent of its peak value that day based on a single conviction?No. Did the company have a sound branding strategy in place at the time? No. Was there something the com-pany could have – and should have – done differently to avoid suffering such a huge impact as a result ofMartha’s guilty verdicts? Yes.

O

them. Just as FedEx is tied to reliableovernight delivery, and Disney is tiedto family entertainment, MSO couldhave tied itself primarily to stylish,aspirational, up-scale living – muchas Ralph Lauren has done. Then, itsefforts could have been directedtoward reinforcing associations withthese attributes, rather than associa-tions with Martha Stewart. Thisapproach creates value in a company,rather than value in a personalbrand.

Second, adapt brand names overtime. As one example, the magazineMartha Stewart Living could havebeen re-titled Living by MarthaStewart, and eventually just Living.Over time, Living could have beentied to those attributes the companywanted to own. Then, should MarthaStewart “the person” encounterproblems, Living “the brand” couldlive on. Advertisers wouldn’t haverun from a magazine called Living asquickly as they ran from a magazinenamed for a convicted felon.

Third, introduce sub-brands (part1). In MSO’s magazines and televi-sion shows, it would have been veryeasy to introduce guest experts in avariety of areas – gardening, cooking,decorating, etc. The best guestexperts could then have been turnedinto regular features. In the best-casescenario, some could have even beenspun off into their own televisionshows and magazines. And MSOcould have owned the rights to thesenew properties. Of course, such astrategy would have been a big diver-gence from “All Martha, All theTime.” In contrast, Oprah Winfrey’ssuccess in launching the Dr. Phil tel-evision show demonstrates how sucha strategy could have been imple-mented.

Fourth, introduce sub-brands(part 2). Licensed merchandise pre-

television program would take a hia-tus for the 2004-2005 season.

The impact on magazines is sub-stantial, but not quite as bad as tele-vision. Earlier this year, MarthaStewart Living reduced its guaran-teed circulation from 2.3 million to1.8 million. Even more important,advertisers fled. Total ad pagesdropped from 1,887 in 2002 to 1,234in 2003. While the impact on mer-chandise has been minimal thus far,it’s likely that a reduced media pres-ence will eventually lead to lower rev-enue here too.

MSO has to hope that eventuallyits branding strategy can take prece-dence over Martha’s legal strategy.Even now, the Martha Stewart brandis likely the most valuable asset of thecompany. Thus, it has to hope thatMartha Stewart the person can helpto revive Martha Stewart the brand.Whether or not her convictions areupheld, Martha Stewart must find away to re-connect with her customersin a way that incorporates and sub-sumes these legal events into thepublic’s broader perception of her.

For Martha Stewart herself, theoptimal strategy is to continue tofight the legal battle. Yet, this person-al strategy is at odds with the bestbrand strategy. The right brandstrategy will likely incorporateacknowledgment of her conviction,contrition, and an appeal for forgive-ness. The sooner this strategy isimplemented the better. Then MSOcan begin to diversify its brand port-folio from the strongest possible base.People may be willing to wait to for-give the person, but they won’t waitto forgive the brand.

PETER N. GOLDER is associate professorof marketing at NYU Stern. He wishes tothank Alina Dijur, MBA ’04 and CeciliaDones ’04, for their research assistancein preparing this article.

sented another opportunity for devel-oping sub-brands. With such a widevariety of licensed merchandise, dif-ferent attributes are relevant for dif-ferent products. Therefore, the com-pany could have developed brandsfor different groups of products: onebrand for kitchen products and a sec-ond brand for bed and bath products.Over time, these sub-brands couldhave been converted to primarybrands.

Now What?From the time it went public in

1999, MSO realized the importanceof moving away from Martha Stewartthe person. Unfortunately, it nowfaces the task of doing so, out ofnecessity, and with a dramaticallyweakened brand. The best futureopportunities to diversify are likely tobe with licensed merchandise,because the appeal of these productshas relatively more to do with theproducts themselves than withMartha Stewart the person. In con-trast, the media properties, especiallytelevision, are much more closely tiedto Martha Stewart herself. After theverdict, stations dropped her televi-sion shows and newspapers droppedher columns. The flagship televisionprogram went from reaching 90 per-cent of U.S. households to only 50percent. More recently, the companyannounced that her main syndicated

Sternbusiness 17

“The best future oppor-tunities to diversify are

likely to be withlicensed merchandise,

because the appeal of these products hasrelatively more to do

with the products them-selves than with Martha

Stewart the person.”

18 Sternbusiness

THE SCARLET

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hen companies fail – because of misjudgment, misdeeds, or even bad luck – leaders’ names and rep-

utations stand to be indelibly smeared. They get fired and have a hard time finding work elsewhere. Those

who do get rehired tend to do so in lesser capacities or at smaller firms. It is difficult to imagine Dennis

Kozlowski of Tyco or Jeffrey Skilling of Enron ever working again. Even executives who have been labeled

as simply bad managers, such as Jill Barad of Mattel, become marginalized.

For CEOs who get branded with the Scarlet F – for failure – it’s all part of the “settling-up” process.

Settling-up is an essential, but often overlooked, premise of agency theory developed by University of

Chicago finance professor Eugene Fama. Corporate owners (principals) can rely on the fact that managers

and directors (agents) will be motivated to do their very best by the prospect of future adjustments to their

compensation – adjustments, or settling-up, that will be based on prior performance. Executives who perform

well build good reputations and get better jobs and higher pay in the future. Meanwhile, the markets dis-

seminate word about the failings of those who perform poorly, and their prospects are accordingly diminished.

But the settling-up process for corporate elites can be exceedingly imprecise. Peter Lynch, the investment

guru and vice-chairman of Fidelity Management and Research Company, was a director of two of the most

visible corporate collapses of the 1990s – Morrison Knudsen and W.R. Grace. Yet his name was rarely

invoked in conjunction with these failures, and he went on to enjoy great acclaim after their occurrence. And

sometimes corporate leaders are penalized far out of proportion to their culpability. Lloyd Ward served as

CEO of Maytag for only 15 months. He was replaced in November 2000, after being blamed for the 59 per-

cent drop in Maytag’s share value; he lost prestigious corporate directorships and has not found a compara-

ble position. But Ward served at Maytag during very difficult times for the appliance industry. And Maytag’s

performance was worse under some other CEOs who somehow avoided stigmatization.

W

Executives and directors associated with corporate failures

can get branded for life. But the stigmatization process is

not always rational or efficient. Why are some executives

tarred with failure while others seem to be Teflon-coated?

By Batia M. Wiesenfeld, Kurt Wurthmann and Donald C. Hambrick

healthy industries areunexpected. As a result,they provide strong signalsof leader ineffectivenessand contribute to greaterstigmatization. In con-trast, failures that occur inhostile contexts can belargely assigned to envi-ronmental factors andtherefore result in lessleader blame.

Social psychologicalresearch suggests thatstigmatization is greater tothe extent that observersperceive that the individ-ual was able to control orprevent the offendingattribute. And so individ-ual-level factors such asan elite member’s position,tenure, and actions willinfluence attributions ofcontrol and blameworthi-ness.

For example, execu-tives at failed firms experi-ence greater stigmatization than dooutside directors. Outside directors’professional identities are notstrongly invested in the company onwhose board they serve. Becausetheir contact with the organizationand their access to information islimited, outside directors are notheld to the same standard of in-depth understanding about compa-ny affairs as executives.

Among executives, the higher youare, the harder you fall. Senior-mostexecutives (CEOs, COOs, andCFOs) who are associated withfailed firms experience greaterstigmatization than do lower-levelexecutives of the firms. Increasinghierarchical position in an organiza-tion brings increasing access toinformation, formal decision-mak-ing authority, and individual power.Leaders with greater access to infor-

mation are better able to foresee theconsequences of their decisions andactions. And those with greaterauthority and individual power havegreater control and ability to over-come resistance by less powerfulopponents within the organization.

Tenure matters, too. The longeran elite’s tenure at a failed firm, thegreater the stigmatization he or shewill experience. When executivesand directors are relatively new to afirm, the degree of control they areable to exert over organizationaloutcomes is constrained. With time,executives and directors accumulatethe information they need toempower them to make importantdecisions. Greater tenure also putsthem at the helm over an extendeddecision-making period, givingthem more influence over bothstrategy and performance.

And it’s better to beincompetent than corrupt.Elites accused of ethicalmisdeeds that lead to firmfailure will experiencegreater stigmatization thanwill those accused of busi-ness misjudgment. Ethicalmisdeeds – insider trading,fraud, misleading and dis-honest actions, sexual mis-conduct, and abuse ofpower – will be even morestigmatizing than simplelack of ability, because awillful misdirection of effortis far more controllable thanis a mere lack of skill.

Cognitive BiasesObservers are not fully

rational in how they viewthe influence of leaders onorganizational outcomes.Observers frequently engagein a “romance of leader-ship.” Even though corpo-

rate failures may stem from anynumber of factors – including envi-ronmental jolts, long-institutional-ized structures and systems, evenaccidents – observers tend to blameleaders.

he assignment of blame isan interpretive processrather than a black-and-white calculation. And

like other stigmatizing stereotypes,the act of blaming leaders is subjectto bias. We anticipate that there aretwo prevalent mental short-cuts, orheuristics, that shape observers’stigmatization of elites.

The first is the availabilityheuristic. People tend to view infor-mation that comes most easily tomind, such as vivid and recent infor-mation, as the most reliable and rel-evant. As a result, it will be moreavailable in the sensemaking

Sternbusiness 21

T

process. Social psychologists, forinstance, have observed that peoplemay be stigmatized merely by theirproximity to a negatively evaluatedobject or person – even if there is noapparent relationship between them.

nd so elites who are pres-ent at the firm during thevisible phase of a failurewill experience greater

stigmatization than those whodeparted earlier. Since these leadershave to explain the failure event inspeeches, on television, in newspa-per articles and formal announce-ments, and sometimes even in for-mal testimony, they will be per-ceived to be much more closely asso-ciated with the failing firm thanleaders who have already departed.By contrast, leaders who departprior to a perceived failure do not

serve as the human face of the firm inpublic forums in which the failure isexamined, making them less avail-able in observers’ minds. For exam-ple, Gerald Levin, the CEO of TimeWarner, engineered the eventuallydiscredited merger with AOL. But heannounced his resignation sevenmonths before a 59 percent collapseof the combined company’s marketvalue, and thus received far less crit-icism and stigmatization than did theother top executives who were pres-ent at the collapse, notably formerAOL CEO Steven Case.

In addition to timing, size mat-ters. Failures of large firms affectmany people – employees, cus-tomers, and suppliers. Large corpo-rate failures are vivid because theyare relatively rare and surprising.When big companies fail, observersare likely to conclude that seriouserrors in leadership must haveoccurred. And that increasesobservers’ tendency to attributeblame to corporate elites. For exam-ple, both Xerox and its much small-er competitor, Global ImagingSystems, Inc., lost 52 percent oftheir market value between May of1999 and May of 2000. The lossesat Global Imaging received relative-ly little attention. But Xerox CEORichard Thoman was widely andvehemently criticized in the pressand forced to resign after only a year

in office.

RepresentativenessBias

Another heuristic asso-ciated with stereotypesis representativeness.Observers make judg-ments, in part, by takinginto account the degree towhich a specific event cor-responds to a broader cat-egory of occurrences intheir minds. Instances that

are representative of a broader cate-gory of events will lead observers toperceive that all of the features ofthe broad category apply to the newinstance, far out of proportion to theactual degree of correspondence.

As a result, elites who have beenpreviously associated with otherfailed firms will experience greaterstigmatization upon a firm failurethan will those without such priorassociations. Observers will perceiveleaders who have been associatedwith past failures to be representa-tive of the category of causes for

firm failure. If a failed company isaccused of using dubious accountingstratagems that resemble (evensomewhat) the accounting strata-gems of already notoriously failedfirms – like Enron – then the focalcompany and its leaders are readilyplaced in the same category as theearlier offenders.

In addition to the cognitive bias-es, there are critical emotionalprocesses that cause stigmatizationof elites to deviate from what mightrationally be expected. For corpo-rate leaders, we can expect thatschadenfreude – or pleasure in oth-ers’ misfortune – will exert an emo-tional influence on stigmatization.After all, schadenfreude is motivat-ed by observers’ desires to feel betterabout themselves by comparingthemselves to less fortunate others.And observers may obtain a feelingof justice in seeing the lofty broughtdown to earth.

he more that an elite’sprevious success andstatus is viewed asundeserved, the morelikely his or her pain

will trigger schadenfreude. And sothe more an elite leader has beenportrayed as ruthless or arrogant,the greater the stigmatization he orshe will experience upon firm fail-ure. For example, Al Dunlap openlyacknowledged his take-no-prisonersstyle of leadership, including drasticlayoffs at Scott Paper and atSunbeam; he wrote a book about hisexperiences entitled Mean Business.Once Sunbeam’s performance beganto decline, those who observed theindifference he seemed to haveabout firing people were eager tohelp speed his fall from grace.

Additionally, corporate elites whoare seen as selfish and greedy arelikely to inspire resentment. Thegreater an elite’s compensation, rel-ative to peers and to others in the

22 Sternbusiness

THE SCARLET F

“Elites who are present at the firm during the

visible phase of a failurewill experience greater

stigmatization than thosewho departed earlier.”

T

A

focal firm, the greater the stigmati-zation he or she will experienceupon firm failure. Observers maygrudgingly tolerate high executivecompensation when firm perform-ance is good. However, once per-formance falters, the appearance ofunfairness will inspire anger andindignation. Observers will takegreat pleasure in seeing such elitescut down to size.

Elites who are associated withfailed firms during periods ofmacroeconomic malaise will experi-ence greater stigmatization thanthose associated with failed firmsduring periods of macroeconomicvitality. In periods of widespreadeconomic trouble, many socialactors will be dissatisfied with theirown lot, and comparing themselvesto less fortunate others may beamong the few available ways forpeople to derive a (perverse) form ofhappiness. As the old adage goes,“misery loves company.”

Social CapitalSome corporate executives and

directors possess much more socialcapital than do others. They may siton multiple, influential boards, ormaintain close personal friendshipswith lots of influential people, orhave prestigious educational andmilitary credentials. These aspectsof social capital can also function asa stigma buffer. The greater thesocial capital of an elite associatedwith a failed firm, the less thestigmatization he or she will experi-ence.

Executives and directors whohave high levels of prestige tend tobe perceived as competent, credible,and trustworthy. Observers arereluctant to view such individuals asinept, careless, or self-serving.Furthermore, high-status leaderswill be more likely to be excused forhaving many important things on

their minds that mightjustifiably absorb theirattention. What’s more,fellow elite membersoften make the deci-sions through whichtangible devaluationoccurs. When they feelbound by the bonds ofloyalty and friendship,these elites will be moti-vated not to ostracizefailed elites; and theymay be unwilling toimpose the devaluation that other-wise seems warranted.

ndividuals who possess socialcapital are also able to grantfavors to those upon whomthey depend. These favors cre-

ate a diffuse, generalized commit-ment among individuals throughnorms of reciprocity. Such obliga-tions may be “called in” when anindividual with social capitalrequires them, such as when his orher career is at risk – thus providinganother countervailing force againstthe effects of stigmatization.

Our elaborated model of settling-up has widespread practical impli-cations. People need to be awarethat they are likely to face consider-able career loss if associated with acompany failure. And they will seekeither compensation or insurance forthis risk. Thus, some portion of thehigh pay that executives and direc-tors receive can be thought of ascompensation for bearing extremecareer risk. Similarly, the fact thatelites may seek some form of insur-ance for the event of their stigmati-zation helps to explain the large sev-erance agreements that executiveshave been seeking in recent years.

Beyond building social capital,there are things an executive can doto mitigate his or her eventual riskof stigmatization and devaluation. Aperson may intentionally adopt a

style of humility, and even carrythis philosophy over to his or herpay package.

Ultimately, however, the factthat cognitive and affective biasesplay such an important role in thestigmatization and devaluationsprocess throws into question themarket efficiency of settling up. Ifsome elites are not sanctioned tothe full extent they should be – say,simply because they are associatedwith relatively obscure companies,or because they have a lot of socialcapital – other elites in similar situ-ations will implicitly be allowed toengage in unsound behaviors. Onthe other hand, if some elites arepunished more harshly than theirbehaviors warrant, then some tal-ented individuals may be unwillingto become executives and directorsof companies. If leaders are undulytimid and risk-averse because theyfear failure and the stigmatizationit brings, then investors and societywill ultimately pay the price.

BATIA M. WEISENFELD is associateprofessor of management at NYU Stern.K U R T W U R T H M A N N i s a doctoralstudent at Columbia UniversityBusiness School.D O N A L D C . H A M B R I C K is profes-sor of management at the SmealCollege of Business Administration atPennsylvania State University.

Sternbusiness 23

“High-status leaders will be more likely to be excused

for having many importantthings on their minds thatmight justifiably absorb

their attention.”

I

he market for luxurygoods is booming –locally and globally. Inthe U.S. alone, 2.2million individualshave liquid portfolios

of over $1 million. And tens of mil-lions of less well-heeled consumersroutinely splurge on high-end prod-ucts. But the market relies more onpsychology than sheer consumerutility. In order for luxury goodsmakers to crack the market andmaintain a hold on finicky con-sumers, they have to convince peopleto pay far more for something – apair of shoes, a bottle of wine, or awatch – than they need to. After all,why would otherwise economicallyrational people spend thousands on awatch when one that costs only $10tells time just as accurately?

Rolex, the Swiss watch companythat will celebrate its 100thanniversary next year, knows theanswer. Over the past century,

Rolex has built and defended astrong position in the high-endwatch market. And it has remainedindependent even as many com-petitors have sought the shelter ofconglomerates. Today, Rolex is thelargest single luxury watch brand,with revenues of about $3 billionand annual production of between650,000 and 800,000 watches. Thesecret to its success: a strategy thateschewed fashion and emphasizedperformance, brand purity, andcontinuity.

By the standards of the time-keeping industry, Rolex is a relativenewcomer. The pocket watch firstemerged in the early 1600s. In the18th century, innovators incorpo-rated jewels into the design toreduce the friction of turningpoints and thus improve accuracyand reduce wear. According toFrank Edwards’ Wristwatches: AConnoisseur’s Guide, Berguet in1810 made a watch for the Queen of

Naples to be worn on the wrist. AtLondon’s 1861 Crystal PalaceExhibition, Patek Philippe featureda watch with a diameter of only8.46 millimeters.

In the 19th century, England,Germany, and France became earlycenters for wristwatch manufacture.The United States also played a vitalrole in the evolution of the industry.The Waterbury Clock Co., foundedin 1857, brought mass production tothe industry, and drove the price ofpocket watches down sharply.Switzerland, however, was the sourceof the highest quality watches.French Huguenots, who settled inSwitzerland in the late 16th century,formed the nucleus of the Swissindustry. The Swiss concentratedtheir efforts on watches rather thanclocks. And by the early 20th centu-ry, the label “Swiss Made” began toindicate quality, and Swiss firmsbegan to dominate the middle andhigh-end of the market.

W h a t M a k e s R o l e x Ti c k ?

By David Liebeskind

T

24 Sternbusiness

Luxury brands can rise and fall quickly.But by following a strategy of brandpurity, continuity, and performance, theleading Swiss high-end watch makerhas withstood the test of time.

Sternbusiness 25

High PerformanceThe company that would eventu-

ally become Rolex was founded inLondon in 1905 by a 24-year oldBavarian who was orphaned at age12. Hans Wilsdorf founded the com-pany with his brother-in-law,William Davis, and coined the brandname Rolex. He felt the name sound-ed like the noise a watch made whenit was being wound. It was also easi-ly pronounceable in different lan-guages and short enough to fit on theface of his watches. Wilsdorf ulti-mately moved his company toGeneva in 1919.

The period between the twoWorld Wars was a difficult one forSwiss watchmakers, as they had tocontend with successive economicand political crises. But in this peri-od, Rolex began to build its reputa-tion for performance. In 1914, aRolex watch was awarded a Class Aprecision certificate from the BritishKew Observatory, an honor previ-ously reserved exclusively for marinechronometers. In 1926, Wilsdorfdeveloped and patented the firsttruly water-resistant watch, theOyster. The watch was strapped tothe wrist of Mercedes Gleitze as shemade her pioneering 15-hour swimacross the English Channel. Rolexcapitalized on the event by using it inadvertisements, and by building dis-plays in jewelers’ windows that fea-tured a watch submerged in a smalltank of water.

By World War II, the Rolex brandhad gained such prestige that BritishRoyal Air Force pilots bought themto replace the inferior watches thatwere issued to them. Pilots capturedas prisoners of war frequently hadtheir Rolexes confiscated, but when

pilots wrote to the company describ-ing their experiences, Rolex replacedthe watches free of charge. Americanservicemen learned of Rolex whilestationed in Europe, thus helping toopen the lucrative U.S. market to thecompany.

In the post-war era, as the com-pany set its sights on expansion,Rolex continued to build its high-performance reputation. In 1945,Rolex introduced the Datejust model,the first chronometer with an auto-matic date changing mechanism.Eight years later came theSubmariner, which was both water-resistant and pressure-resistant to adepth of 330 feet. And Rolex contin-ued to find even more dramaticopportunities to demonstrate itsunique performance characteristics.Sir Edmund Hillary wore a Rolexwhen he climbed Mt. Everest in1953. The watch became the keyinstrument to measure time at sport-ing events.

Continuity Amid Change Before his death in 1960, Hans

Wilsdorf placed ownership of Rolexin the hands of the WilsdorfFoundation, which would assure thecompany’s independence. In 1962,Rolex’s board appointed 41-year-oldAndré Heiniger, who had worked forWilsdorf for 12 years, as managingdirector. In 1992, Patrick Heiniger,a 32-year-old lawyer, who hadserved the company for six years asmarketing director, succeeded hisfather. André stayed on as chairmanuntil 1997, when he became chair-man emeritus. In Rolex history,there have been only three managingdirectors.

In the post-war years, watchesbecame both cheaper and more reli-able. In 1950, a Norwegian bornengineer, Joakim Lehmkuhl deviseda more dependable inexpensivewatch by making significantimprovements to pin-lever technolo-gy. It was marketed under the brandname Timex. In 1968, prototypequartz crystal watches were intro-duced. These time pieces wereextremely accurate and eventually

would be inexpensive to produce.The new quartz technology allowedfor both analog and digital readouts,and opened the door to new func-tions like calculators. By the end ofthe 1970s, about half of the watchessold worldwide were based on quartztechnology, and Hong Kong hademerged as a major center for watchproduction.

Rolex was reluctant to join thequartz wave, but did come out witha limited number of models. In spiteof threatening new technologies, aproliferation of low-cost producers inthe Far East, and economic ups anddowns, most of the luxury brandssurvived in one way or another. ButRolex thrived in the face of disrup-tive technologies. In an era whenaccuracy and dependability were nolonger the exclusive province of pre-mium products, Rolex developed aseries of attitudes toward defendingand building its position in the high-end market.

Even as watches became mass-produced commodities, Rolex con-tinued to emphasize craftsmanshipand quality. It used materials such asgold, platinum, and jewels. And itcontinually improved its movementsand added new functions to itswatches: the ability to tell the date,the day of the week, and the time indifferent time zones. As a result ofthis greater complexity, Rolex’swatches were made with a greatersense of old-fashioned craft. An inex-pensive quartz watch produced witha great deal of automation hasbetween 50 and 100 parts; a RolexOyster chronometer has 220 parts.

Maintaining Demand Rolex also maintained its brand

image by limiting production, evenas demand rose. For luxury goods,scarcity in the marketplace caninfluence value, spur demand, andcontribute to collectibility and long-term appreciation. And a companythat can pitch its product as aninvestment can frequently chargea premium. Finely-made luxurywatches tend to appreciate in valueover time. The Complete Price Guide

“Today, Rolex is thelargest single luxury

watch brand, with rev-enues of about $3 billionand annual production of

between 650,000 and800,000 watches.”

26 Sternbusiness

to Watches (2004 edition) lists thevalue of a 1936 Patek PhilippeCalatrava in 18-karat gold at$700,000. Rolex watches have heldtheir value well, too. Price guides forcollectors indicate that almost allolder Rolex models are valued abovetheir initial selling price. Most col-lectible Rolexes sell in a range ofbetween $1,500 and $20,000.

Rolex has also taken pains toensure that its watches are soldonly in appropriate venues. Thecrystal prism that indicates a storeis an “Official Rolex Dealer” ishighly prized. Rolex looks fordealers with high-end images, rel-atively large stores, and attractivelocations that can provide out-standing service – such asTourneau. At one point, Rolex gotinto a dispute with Tiffanybecause the venerable retailer wasimprinting its name on the Rolexwatches it was selling. WhenTiffany refused to stop, Rolexdropped Tiffany as an official jew-eler. In the 1990s, as part of aneffort to control sales of theirgoods in the so-called gray market,Rolex cancelled agreements withabout 100 dealers.

Rolex has also focused on main-taining the purity of its brand. Manyluxury-goods makers have used theiroriginal product as a springboard.Cartier and Mont Blanc, for example,have bet that the equity of theirbrand built on a single product willpull sales for a variety of luxurygoods. And some brands havelicensed their brand to other manu-facturers, thus ceding some controlover the products appearing undertheir name. But Rolex makes onlywatches, and it has never licensed itsname.

What’s more, many watchbrands have responded to compe-tition by merging into conglomer-ates over the last few decades.LVMH Moët Hennessy LouisVuitton, the world’s largest luxurygoods company, with annual salesof more than $15 billion, includesvenerable watch brands such as TagHeuer, Zenith, and Dior

Watches. CompagnieFinancière Richemont,the world’s third largestluxury goods maker,owns watch brandssuch as Cartier, Baume& Mercier, Piaget,Jaeger-LeCoultre, andOfficine Panerai. Well-known brands Movado,Patek Philippe, andBreitling remain essen-tially independent. Byplacing control of thecompany in the handso f a f ounda t i on ,Wilsdorf guaranteedthat Rolex would havethe means to withstandthe pressure to affiliatewith a larger companythat has a range ofinterests and markets.

Rolex also maintainsits brand purity bycombating counterfeit-ers. Today, many copiesare so good that only anexpert can tell the dif-ference. And while con-noisseurs will certainlynote the differencebetween a $5,000 Rolexand a $25 knock-off,the existence of largenumber of counterfeitsinevitably affectsdemand at some level.Rolex likely spends more moneypolicing fakes than any other brand.

In the future Rolex will no doubtface stiffer competition as innovativeentrepreneurs search for new ways toattack its markets. And the large lux-ury goods conglomerates enjoy cer-tain advantages over an independentfirm like Rolex. They have restruc-tured operations to take advantageof size and significantly reduce cost,enjoy synergies in advertising andmarketing, and are more willing toengage in open discussions in tradeassociations to learn from the com-petition. The conglomerates mayalso be more willing to source fromAsia, where labor costs are consider-ably lower than Switzerland.

But as it approaches its 100thanniversary, Rolex is sticking to itscore strategy of independence, conti-nuity, and brand purity. The compa-ny’s attitude has allowed it not just tosurvive decades of technological andeconomic upheavals, but to thriveamid them. Even in today’s massive,global luxury-goods market, anindependent company that clearlydefines its market niche and relent-lessly sticks to its strategy can rise tothe top.

D AV I D L I E B E S K I N D is an adjunctprofessor of management at NYU Stern.

R O L E X T I M E L I N E

1905 – Hans Wilsdorf and his brother-in-law, William Davis, found watchmaking firm in London

1908 – Rolex brand created

1910 – Rolex obtains first official chronometer certification in Switzerland for a wristwatch

1919 – Wilsdorf forms Montres Rolex SA in Geneva, Switzerland to be close to Bienne, where his precision movements are crafted

1926 – Rolex patents Oyster design for a waterproof watch

1931 – Rolex introduces the Oyster Perpetual, the first waterproof & self-winding watch

1945 – Rolex introduces their first Datejust model, the first chronometer with an automatic date changing mechanism

1950 – Rolex creates the "Turn-O-Graph"

1953 – Rolex introduces the Submariner, the first automatic diving watch that is water resistant to 100 meters

1956 – Rolex launches the Day-Date model

1960 – Rolex founder Hans Wilsdorf dies

1963 – André J. Heiniger succeeds Hans Wilsdorf as head of Rolex

1978 – The Oyster Perpetual Date Sea Dweller is introduced, waterproof to a depth of 1,220 meters

1992 – Patrick Heininger becomes managing director

Sternbusiness 27

Tatsuro Toyoda, a 1958 alumnus of NYU Stern, knows what it

takes to build a global auto brand. He has worked in the family

business — Toyota Motor Corporation — for more than a half

century, and served as president from 1992 to 1995. Throughout

his long, eventful career, Mr. Toyoda carried with him lessons

learned at NYU Stern from Professor W. Edwards Deming. As an

apostle of quality control, Professor Deming worked with many

Japanese companies in the 1950s and 1960s, including Toyota.

By following his statistical quality control techniques,

Japanese manufacturers like Toyota

built up a reputation for quality that

enabled them to penetrate distant

markets.

At NYU’s Commencement Ceremony

on May 13, 2004, Mr. Toyoda received

an honorary Doctor of Commercial

Science degree. At a dinner with NYU

Trustees on the evening of May 12, Mr.

Toyoda reflected on his career, and on

his experience at NYU Stern.

C A R T A L K

Tatsuro Toyoda 1928 Born in Nogoya, Japan, the son of Kiichiro Toyoda, founder, Toyota

Motor Corporation

1953 Joins Toyota after earning a degree in mechanical engineering fromthe University of Tokyo

1956-1958 Attends NYU Stern, studying statistical inference with ProfessorErnest Kurnow and statistical analysis with Prof W. Edwards Deming

1958-1974 Works in domestic and international marketing at Toyota Motor Corporation

1974 Named director of Toyota Motor Corporation

1984-1986 Heads joint venture with General Motors in California

1992 Succeeds brother Shoichiro as company president

1995 Named vice chairman of Toyota Motor Corporation

1998-present Senior advisor to the board of Toyota Motor Corporation

28 Sternbusiness

Dean Thomas Cooley hosted a celebratory lunch-eon at NYU Stern in honor of Tatsuro Toyoda, a1958 Stern alumnus who received an honoraryDoctor of Commercial Science degree at NYU’sCommencement Ceremony on May 13, 2004. Pictured from left to right are Professor Eitan Zemel,W. Edwards Deming Professor of Quality &Productivity and chairman, Department ofInformation, Operations & Management Sciences;William R. Berkley, NYU Trustee, chairman of theStern Board of Overseers and chairman and CEO,W.R. Berkley Corporation; Mr. Toyoda; Dean Cooley;Mrs. Toyoda; Diana Deming Cahill, founding trusteeof the W. Edwards Deming Institute and daughter ofW. Edwards Deming; Professor Ernest Kurnow, Mr.Toyoda’s former Statistics teacher at Stern and aformer colleague of W. Edwards Deming; and Yi Lu,a doctoral candidate in Statistics who currentlyholds the W. Edwards Deming Fellowship.

Thank you, President Sexton, and good evening.I am honored to be here tonight with NYU Board Chair Martin Lipton, the NYU

Trustees, fellow honorary degree recipients, and other distinguished guests.It is a great honor to receive the honorary degree of Doctor of Commercial Science.When I came to the United States for the first time in 1955, we didn’t sell any vehicles

here. It was two years later, in 1957, when our first vehicle – the Crown – was shipped tothe United States.

Unfortunately, at that time, Toyota vehicles were not comparable to the "Big Three" interms of quality and driving performance. Since then, we worked hard to produce a bet-ter car for this great country.

I had the fortune to attend a class taught by Dr. W. Edwards Deming during my daysat the NYU Stern School of Business. Many Japanese companies followed ProfessorDeming’s advice, and substantially improved their quality control in manufacturing andother areas. His landmark work is widely acknowledged among Japanese companies –and one of the most prestigious awards in Japan is the Deming Prize.

When I was a student at NYU, our annual new car sales were less than 300 units. Lastyear, thanks to American customers, we sold over two million cars and trucks in the NorthAmerican market, and our four assembly plants in North America built more than 60percent of those vehicles.

From the beginning of our operations, we have sought to contribute to society throughour investment, employment, and corporate citizenship activities. In recent years, we havefocused on safety and environmental initiatives. For example, our advanced technologyhybrid gas-electric vehicles achieve high mileage and reduce emissions.

I, and my colleagues at Toyota, owe a debt of gratitude to America. And we will workhard to repay it by continuing to provide jobs and investments here, and by building saferand more environmentally friendly vehicles.

My time at NYU taught me about American consumers and their tastes. This knowl-edge came in handy 20 years ago when I was asked to head Toyota’s first vehicle assem-bly plant in the United States, New United Motor Manufacturing, Inc., or NUMMI as wecall it. Located in Fremont, California, this joint venture plant with General Motors is stilla thriving success some two decades later.

When I returned to Japan after NUMMI, I was named president of Toyota MotorCorporation – and I continued to pursue my dream of making a positive contribution tosociety.

I want to thank NYU for giving me a good foundation in business and in my personallife – that served me well in my career with Toyota.

It is a sincere privilege to have been chosen to receive the honorary degree of Doctorof Commercial Science from this great university.

I am deeply touched.Thank you.

W. Edwards DemingBorn in Iowa, and educated at the University of

Wyoming in Cheyenne, W. Edwards Deming receivedgraduate degrees in physics and mathematics from theUniversity of Colorado and Yale University.

But the scientist would make his mark in a differentfield: Statistics. In the 1940s, Deming was an adviser tothe Bureau of the Census, which was starting to use sam-pling techniques to count the U.S. population. In 1946,Deming joined the faculty of what is now the NYU SternSchool of Business as a professor of Statistics, and start-ed a consulting practice to advise companies and institu-tions on the use of statistical quality control. While he did-n’t find many clients among American businesses,Deming quickly learned that Japanese companies wereeager for his expertise.

He was convinced that the use of statistical methodscould help Japanese companies rebuild, improve quality,and compete in global markets. In 1950, he delivered aseries of eight day-long lectures, which were attended bymany top Japanese business and industry leaders. He toldthem that "Japanese quality could be the best in the world,instead of the worst." Deming returned to Japan severaltimes in the 1950s, ultimately helping to train some20,000 engineers in statistical methods and directly influ-encing Japan’s remarkable postwar recovery. Almostinstantly, Deming became something of a folk hero inJapan. And in 1960, Emperor Hirohito bestowed onDeming the Second Order Medal of the Sacred Treasure.

Even as Japan continued to rise as a global manufac-turing power, Deming’s teachings on the need for workercooperation and continuous quality improvement werelargely ignored in the U.S. It wasn’t until the 1980s, whenU.S. industry aimed to recapture ground lost to Japanesefirms, that Deming’s ideas were discovered in his homecountry. The author of several books and more than 150papers, Deming died in 1993 at the age of 93.

Sternbusiness 29

30 Sternbusiness

ersonal aircraft userepresents by far themost costly and fastestgrowing fringe benefitenjoyed by chief exec-utive officers of major

corporations. In 2002, more than 30percent of Fortune 500 CEOswere permitted to use companyplanes for personal travel, upfrom less than 10 percent adecade earlier.

Several factors have con-tributed to this growth. The riseof fractional aircraft ownershiphas dramatically reduced the up-front costs of access to corporatejets. And in the wake of theSeptember 11, 2001 terroristattacks, many executives havechosen to escape the hassles andperceived danger of flying on majorairlines by using private jets.

Corporate jets regularly inspirecriticisms of managerial excess byjournalists and shareholder activists,and they frequently seem to symbol-

ize corporate cultures of excess. AtAdelphia Communications, thebankrupt cable company whose topexecutives have been convicted offraud, prosecutors charged that thecompany jet was used to ferry cor-porate founder John Rigas to Kenya

on a safari and to deliver aChristmas tree to one of Rigas’daughters. At Enron, according toBethany McLean and Peter Elkind,authors of The Smartest Guys in theRoom, members of CEO KennethLay’s family were known to use thecompany’s jet fleet as a sort of per-sonal taxi service.

But Adelphia and Enron provideonly anecdotal connections betweenthe use of jets and potential damage

to shareholders. I set out to deter-mine if there was, in fact, an empir-ical link between CEOs’ use of cor-porate jets and corporate perform-ance. The results were striking. Inthe short-term, shareholders reactnegatively to the news that CEOs

are using corporate jets. WhileCEOs who fly on such aircraftmay arrive at their destinationquickly, their stocks lag. Theshares of companies whoseCEOs use private aircraft under-perform the market by morethan 400 basis points per year.

Perks and CompensationIn a sense, this effort was a mat-

ter of putting two theories of execu-tive behavior and compensation tothe test. In their classic 1976 study,Theory of the Firm: ManagerialBehavior, Agency Costs andOwnership Structure, Michael C.Jensen and William Meckling, of theUniversity of Rochester, usedperquisite consumption by man-

Sternbusiness 31

FLIGHTS OF FANCYA top of the line corporate jet can cost a company up to $35 million.

But a new study shows that when chief executive officers trade in first-class

commercial tickets for private planes, the cost to shareholders can be far greater.

By David Yermack

P“Corporate jets regularly

inspire criticisms of managerialexcess by journalists and

shareholder activists, and theyfrequently seem to symbolize corporate cultures of excess.”

ILLU

STR

ATIO

NS

BY

JU

D G

UIT

TEA

U

32 Sternbusiness

agers as the basis for their formalmodel of the agency costs of outsideequity in a public corporation.When an owner-manager sells stockto the public and reduces his owner-ship below 100 percent, incentivesincrease for the manager to expendcorporate resources for personalbenefit. Jensen and Meckling’smodel seems to predict that perkconsumption by a CEO should varyinversely with his fractional owner-ship of the company (that it wouldrise as a CEO’s stake in the publicly-held company he runs falls). Theyalso suggest a manager’s personaltastes and the difficulty of monitor-ing the manager’s actions wouldinfluence perk consumption.

In his 1980 paper, AgencyProblems and the Theory of theFirm, University of Chicago FinanceProfessor Eugene Fama took a morebenign view of perquisites.“Consumption on the job” by man-agers amounts to a form of compen-

sation that can be offset throughadjustments in salary or other formsof pay. Fama described the interac-tion between managers and theirboards of directors in terms of adynamic of “ex post settling up,” inwhich the manager’s wage is regu-larly revised to account for his per-formance and his personal con-sumption of company resources.Fama’s model implies that perk con-sumption represents an agency costonly to the extent that its value

exceeds the subsequentconsequences to themanager from ex-postsettling up wage revi-sions. Fama’s theory,then, appears to predictan inverse associationbetween perk consump-tion and compensation,controlling for otherattributes that affectcompensation such asindustry, performance,and experience. In otherwords, perk consump-tion would fall as com-pensation rises.

I tested both theoriesby investigating theprevalence of a majorperk – the use of corpo-rate jets – and thenmeasuring its relation-ship to other factors suchas overall compensation,CEO characteristics, andshareholder return. Datafor this study was drawnfrom a panel of 237Fortune 500 companiesbetween 1993 and 2002. The finalsample had 2,340 observations,with most firms appearing in thesample for 10 full years. Thoseobservations covered 485 individualCEOs, a small handful of whomserved more than one term with thesame company. The sample firmshad median annual sales of close to$7 billion, median total assets above$10 billion, and a median marketcapitalization close to $8 billion.

Table 1 contains data on thecharacteristics of the CEOs in thestudy. The typical CEO was about58 years old, with a mean ownershipof about 1.5 percent of the firm’sshares. CEOs received mean cashsalary and bonus compensation ofabout $2.1 million, and additional

annual income from stock optionand restricted stock awards. Stockoptions delivered a large, skeweddistribution of compensation, with amean of $4.5 million and a medianof $1.6 million.

t is impossible to measurethe tastes and performanceof CEOs directly. However, Iwas able to collect two vari-ables about the backgrounds

of my sample’s 485 CEOs that onemight expect to exhibit correlationswith their perk preferences: politicalaffiliation and education. First, Ichose CEOs’ political affiliations,which can be observed from data-bases of donations maintained bythe Federal Election Commission.I classified CEOs as either

FLIGHTS OF FANCY

“...aircraft use is by farthe largest disclosedCEO perk, appearingmore than twice as

often as the next mostpopular item, financial

counseling...”

Table 1

CEO Variables MeanAge 57.4Years as CEO 6.9Ownership fraction 1.48%Founding family member 15%Salary $870,000Annual bonus $1.24 millionStock option award $4.48 millionRestricted stock award $710,000

Political Affiliation PercentageDonor to Republicans 55Donor to Democrats 19Donor to both parties 19

Education Level PercentageNo college degree 6College only 37MBA graduate degree 38JD or LLB 10Ph.D. 5Other graduate degree 10

I

Sternbusiness 33

Republicans or Democrats if a clearmajority of their donations weredirected to one party’s candidates ororganizations. Fifty-five percent ofthe CEOs appeared to beRepublicans and 19 percent,Democrats. An additional 19 per-cent donated fairly evenly to bothparties, and the rest had no record ofpolitical donations. Second, I choseCEOs’ educational backgrounds,which were provided by Forbesmagazine’s annual executive com-pensation surveys and supplement-ed when necessary by online newssearches. Six percent of the sampleCEOs had no college degree, but amajority had attained a graduatedegree of some type.

Measuring PerkConsumption

Next, I measured CEO perk con-sumption – a complex and occasion-ally difficult task. The primarysource of information was the com-panies’ annual proxy statements.Data on perks usually appear inproxies as a footnote to column (a)of the Summary CompensationTable, headed “Other AnnualCompensation.” The total value ofperks must be disclosed based upontheir “aggregate incremental cost”to the company, but only if the totalexceeds the lesser of $50,000 or 10percent of the executive’s salary plusbonus. Companies must itemize thecost of any individual perk, such aspersonal aircraft use, if it exceeds 25percent of the overall perk total,assuming that the total exceeds the$50,000 threshold. The structureof the Securities and ExchangeCommission’s disclosure rules causesdata for CEOs’ personal aircraft useto be censored. For example, assum-ing the CEO earns at least $500,000salary plus bonus, firms never haveto disclose aircraft use if its cost lies

below $12,500 (equal to 25 percentof the $50,000 overall threshold).From reading a large number ofproxy statements, it is evident thatseveral disclosure loopholes limit thetransparency of perk consumptiondata.

ven so, I was able toamass a large amountof data on CEO perks,which is described inTable 2. Perks are

rank-ordered according to the fre-quency of their disclosure.Companies use certain euphemismsto describe personal aircraft use,such as “travel expense” and “cor-porate transportation.” I generallyassumed that such language refersto airplane or helicopter travelrather than limousines, trains, orboats, unless disclosures indicateotherwise. As Table 2 indicates, air-craft use is by far the largest dis-closed CEO perk, appearing morethan twice as often as the next mostpopular item, financial counseling,which includes tax preparation,estate planning, and the cost of rep-resentation in contract negotiations.

The median cost to the companyof CEO’s personal aircraft use, when

disclosed, is a little more than$50,000. While costs of operatingdifferent aircraft vary greatly, TheNew York Times, using data fromExecutive Jet Inc., the leading time-share company, in 2001 estimatedthe hourly cost of leasing an eight-person Cessna Citation V aircraftwas $10,000 – or $2,500 per personif the CEO on average travels withthree other passengers. A CEO with$50,000 in reportable aircraft usewould therefore spend about 20hours per year in the sky, enoughfor perhaps three round-tripsbetween New York and Florida, forexample.

What determines whether a CEOhas a higher propensity to use cor-porate aircraft? I used a Tobitregression model to analyze how thecost of CEO aircraft use in eachfirm-year is related to a range ofexplanatory variables. Among thevariables I chose were CEO stockownership, compensation, the ageof the CEO, whether or not he wasa member of the firm’s foundingfamily, education level, and politicalaffiliation. The regression modelincludes control variables for sizeand capital structure.

Table 2Perquisites Required for CEOs

Category Observations Frequency

Personal use of company aircraft 346 14.6%

Financial counseling 161 6.8%

Company car and local transportation 94 4. 0%

Relocation and housing expenses 54 2.3%

Country club dues 46 1.9%

Medical care exceeding company plans 20 0.8%

Personal or home security 6 0.3%

E

hen I ran the mod-els, the estimatesfor the excessc o m p e n s a t i o nresidual were neg-

ative. That provided some supportfor Fama’s theory about perk con-sumption, since it implies that aCEO’s compensation is adjusteddownward when his perk consump-tion increases. But the effect wasvery small. The result implied thatan additional $1,000 in perks con-sumed by the CEO leads to a reduc-tion in compensation of 10 cents, aneconomically negligible amount.

The Jensen-Meckling theory ofperks predicts that CEOs trade offthe value of perk consumptionagainst the reduction in personalownership value entailed by thatsame consumption. When I estimatedthe model, the CEO ownership vari-able provided evidence of the pre-dicted negative association with perkconsumption. The estimates implythat increases in ownership act as acurb against perk consumption atboth low and high ownership levels,but that greater ownership providesprotective cover that CEOs use toextract greater perks over a middleownership range. The overwhelmingmajority of CEOs in this sample lay

in the low ownership range. Again,the effect was very small. The mar-ginal effect implies that a 1 percentrise in CEO ownership leads to a

$5,030 reduction in perk consump-tion, which seems quite small com-pared to the cost of the additionalequity investment – $201 million inthe mean sample firm.

Older Frequent FliersVariables associated with CEO

tastes and preferenceshave clear impactsupon patterns of corpo-rate aircraft use. OlderCEOs are more likelythan younger ones tomake personal use ofcompany aircraft. Thispattern may arise dueto increasing frailty ofCEOs as they age, or itmay represent oppor-

tunism by CEOs who consumeperks heavily near the end oftheir careers with reduced fearsthat ex post settling up wage revi-

sions will permanently impacttheir compensation.

CEOs from founding familiesalso use corporate aircraft withabnormally high frequency, perhapsindicating that founders do not rec-ognize boundaries between personaland corporate property as clearly asnon-founders. Political affiliationhas some impact upon perk con-sumption, but in a non-partisanway. CEOs who make no politicaldonations are the heaviest users ofcorporate jets, while CEOs whomake donations to both parties arethe lightest users. CEOs who clearlyare Democrats or Republicans fallsomewhere in the middle.

Finally, the education variableresults were striking. CEOs with theleast education (no college degree)are the heaviest aircraft users, whilethose with the highest advanceddegrees (Ph.D.s) are the lightest.

34 Sternbusiness

“While CEOs who fly on such aircraft may arrive at

their destination quickly, theirstocks lag. The shares of

companies whose CEOs use private aircraft under-perform

the market by more than 400 basis points per year.”

WFLIGHTS OF FANCY

CEOs who hold MBAs or other mas-ters degrees are somewhere inbetween, and CEO-lawyers havesignificantly higher aircraft use thannormal, though not as high as non-college graduates.

Shareholder ReturnsHow does aircraft use affect stock

prices? In my 1993-2002 sample of237 firms, 63 companies disclosedno CEO aircraft use for either of thefirst two years and then began dis-closing it for some future year oryears. I calculated the mean cumu-lative abnormal stockreturns (CAR) for these 63firms beginning two weeks –or 10 trading days – prior tothe statement date of theproxy in which corporateaircraft use was first dis-closed. I extended the eventwindow until one day afterthe filing day because somefirms may post their documentsafter the market closes. The results:stock prices exhibit essentially zerochange until one week before theevent day, at which point they beginto trend downward, with the meanshowing a CAR of -1.99 percent.

loss of 2 percent in mar-ket capitalization wasworth about $150 millionfor the median firm in the

sample, far in excess of the disclosedincremental cost to the company of aCEO’s personal aircraft use. Ifshareholders view the entire corpo-rate aviation activity of a firm as adeadweight cost that yields no com-pensating benefits, and if one factorsin additional costs for storage, main-tenance, fuel, and operation of theplane, then the dollar loss in share-holder wealth could approximatethe true present value cost to thefirm of acquiring an aircraft andmaking it available to the CEO for

both business and personal travel.The CAR results indicate that

shareholders do not welcome thenews that firms permit CEOs to usecorporate aircraft for personal trav-el. When I ran regressions that tookinto account compensation andownership levels, I found that share-holder reactions to CEOs’ corporatejet use are mitigated if the CEOearns lower compensation. This pat-tern is consistent with Fama’s per-spective, that perks are benign if off-set by reductions in other forms ofcompensation.

Long Term LossesShort-term, stockholders plainly

view the use of a corporate jet as anegative. Next, I assessed the ongo-ing market performance of firmsthat permit their CEOs to have per-sonal use of corporate aircraft.Again, the results were negative.The results indicate that firms withCEO aircraft use under-perform themarket by more than 400 basispoints per year, equal to a shortfallof about $300 million in marketcapitalization each year for themedian sample firm.

Given that these performanceshortfalls equal hundreds of millionsof dollars per company per year, itwould be difficult to argue that thedirect costs of perk consumptionalone could explain the gap. Eventhe most expensive jets don’t costseveral hundred million dollars. Oneclear possibility is that these man-

agers who use jets frequently alsorun their firms inefficiently, tolerat-ing waste, excess overhead, oruncompetitive cost structures. WhenI ran regressions of firms’ return onassets against the aircraft usedummy variable, as well as dummyvariables for industries and years, Ifound a negative associationbetween profitability and the air-craft use variable, and a strong, sig-nificant negative associationbetween the aircraft variable andsales per employee. These regres-sions indicate that firms with high

CEO perk consumptionalso tend to be over-staffed relative to the com-petition, as they achieve$30,000 to $40,000 less insales per employee.

The inverse relation-ship between CEO aircraftuse and company per-formance appears surpris-

ingly strong and much larger thancould be explained by the direct costof the resources consumed. It couldbe that CEOs who consume exces-sive perks may be less likely to workhard, less protective of the compa-ny’s assets, or more likely to toleratebloated or inefficient cost structures.High executive perks might alsooccur due to weak corporate gover-nance.

For many in the world of busi-ness, the corporate jet is the ultimatesign of arrival. When they’re able tofly in a Gulfstream IV out ofTeterboro Airport in New Jerseyinstead of having to wait in line toboard a Boeing 737 at La Guardia,many executives feel as if they havefinally made it. For shareholders,ironically, this moment frequentlysignals it’s time to head for the exits.

DAVID YERMACK is associate professorof finance at NYU Stern.

Sternbusiness 35

“CEOs from founding families also use corporate aircraft with

abnormally high frequency, perhaps indicating that founders do not recognize boundaries between

personal and corporate property as clearly as non-founders.”

A

TheTroublewithFannie andFreddieFannie Mae and Freddie

Mac have parlayed the

advantages they enjoy as

government-sponsored

enterprises to grow into

massive financial power-

houses in the market for

residential mortgages in

the U.S. Have they grown

too big? And do the bene-

fits that they deliver to the

public fall short of the

potential costs they hold

for taxpayers?

By Lawrence J. White

n the past year, there has been a great dealof debate about the special status,accounting policies, and the influence ofthe Federal National Mortgage Association(Fannie Mae) and the Federal Home Loan

Mortgage Corporation (Freddie Mac). The twoentities, which enjoy federal government chartersand an array of implicit and explicit privileges,have grown into gigantic, publicly traded firmsthat wield enormous influence on the U.S. capitalmarkets and housing market – and hence on theAmerican economy and the political system.

Many national leaders, from Federal ReserveChairman Alan Greenspan to the heads of largecommercial banks, have raised questions aboutFannie and Freddie. Have they grown too largeand unwieldy? Are they disrupting housing andcapital markets? Might they be a future source ofsystemic risk? And if so, what can be done aboutthem? Answering these questions requires a care-ful consideration of the companies’ roles and neteffects, and some speculation as to what theworld would look like if the two were to lose theirspecial status.

Fannie Mae, created in 1938, and FreddieMac, created in 1970, are federally chartered cor-porations, or government-sponsored enterprises(GSEs). They share narrow federal mandates: toprovide finance for single- and multi-familyhousing. And while they are both publicly tradedcompanies, at each company, five of the 18 direc-tors have been chosen by the President, and thetwo companies enjoy an array of special privi-leges. Fannie and Freddie are the only two enter-prises that have received this special housingfinance charter from the federal government.

Both companies have grown rapidly in thepast two decades, as the data in Table 1 indicate.As of year-end 2003, Fannie and Freddie had$1,010 billion and $803 billion in assets, respec-tively. Ranked by assets, they were the second-

I

Sternbusiness 37

and third-largest “private” enterprisesin the U.S. In addition, there areabout $1,300 billion outstandingpass-through mortgage-backed secu-rities (MBSs) that carry Fannie’s guar-antee, and $769 billion guaranteed byFreddie. With market capitalizationsof $75 billion and $43 billion, respec-tively, as of early 2004, Fannie andFreddie ranked among the 60 largestpublicly traded companies.

he companies have beenable to grow so rapidlyin part due to their sta-tus as GSEs, which con-fers several advantages

that rivals don’t enjoy. Although theirprospectuses explicitly note that thegovernment does not guarantee thesecurities they issue, the securitiesmarkets act as if the firms’ directlyissued debt and MBSs may well carrya federal guarantee. Fannie andFreddie thereby enjoy lower financingcosts than do AAA-rated corporations– but not quite as low as the U.S. gov-ernment itself. The two firms aresubject to lower capital (net worth)requirements for holding residential

insurance. The U.S. Department ofHousing and Urban Development(HUD), as well as HUD’s Office ofFederal Housing Enterprise Oversight(OFHEO), regulates the companies.

The GSE status of Fannie andFreddie gives them clear advantagesover non-GSEs. Because of their“agency” status, Fannie and Freddiecan issue debt at interest rates thatare about 35-40 basis points less thancould an otherwise similar non-GSE.Their MBSs similarly carry a yieldthat is about 30 basis points lowerthan non-GSE MBSs. On the otherside of the ledger, Freddie andFannie’s mortgage purchase activitiesappear to have reduced conformingmortgage interest rates by about 25basis points.

Pioneering New MarketsThe companies’ participation in

the residential mortgage marketstakes two forms. First, they buy andhold residential mortgage assets intheir own portfolios; they fund thesepurchases overwhelmingly with debt.Of Fannie’s $1,010 billion in assets at

mortgages in their portfolios than arebanks and thrifts, and are exemptfrom state and local taxes. Their secu-rities are exempt from the Securitiesand Exchange Commission’s registra-tion requirements and fees. They canborrow from the U.S. Treasury anduse the Federal Reserve as their fiscalagent. Their MBSs, when held by U.S.banks and thrifts, carry a capital (networth) requirement of only 1.6 per-cent, rather than the capital require-ment of 4 percent that the underlyingmortgages themselves would requireif held by a bank or thrift.

Fannie and Freddie are also sub-ject to major limitations. They arerestricted to the business of providingresidential mortgage finance; theycannot originate mortgages. They canonly finance mortgages that are at orbelow a specified maximum (“con-forming”) loan size that adjusts annu-ally with an index of housing prices(in 2004 that limit is $333,700 for asingle-family home), and the mort-gages must have a 20 percent downpayment or have a third-party creditenhancement, such as mortgage

1980

1985

1990

1995

2000

2003

$57.9

99.1

133.1

316.6

675.2

1,009.6

Totalassets

Retainedmortgageportfolioa

MBSsoutstanding portfoliob

$55.6

94.1

114.1

252.9

607.7

901.9

$0.0

54.6

288.1

513.2

706.7

1,300.2

Table 1:

Balance Sheet and MBS Data, Fannie Mae and Freddie Mac, 1980-2003(in billions of dollars)

Fannie Mae

1980

1985

1990

1995

2000

2003

$5.5

16.6

40.6

137.2

459.3

803.4

Totalassets

Retainedmortgageportfolioa

MBSsoutstanding portfoliob

$5.0

13.5

21.5

107.7

385.5

660.4

$17.0

99.9

316.4

459.0

576.1

768.9

Freddie Mac

a Includes repurchased MBSs. b Excludes MBSs that are held in portfolio.Source: OFHEO.

T

38 Sternbusiness

The Trouble with Fannie and Freddie

year-end 2003, $902 billion (89 per-cent) was invested in mortgage assets;of Freddie’s $803 billion in assets,$660 billion (82 percent) was inmortgage assets. Their liabilities werecomposed of 96-97 percent debt andonly 3-4 percent equity.

econd, they purchase resi-dential mortgages fromoriginators, create securi-ties (MBSs) from bundlesof the mortgages, and

swap the securities back to the origi-nators or sell the securities toinvestors, with guarantees on theMBSs as to the timely payment ofinterest and principal. By doing so,Fannie and Freddie have created alarge national secondary market inresidential mortgages and revolution-ized the mortgage market.

A few decades ago, mortgagefinance was largely a vertically inte-grated process. Banks and thriftsoriginated residential mortgages,which were financed almost entirelyby deposits, and kept the mortgagesin their portfolios. Federal depositinsurance, provided by the FederalDeposit Insurance Corporation(FDIC) to banks and the FederalSavings and Loan InsuranceCorporation (FSLIC) to thrifts, pro-vided guarantees to the depositor/lia-bility holders.

The activities of Fannie andFreddie have created a second, verti-cally disintegrated process. Banks stillmake mortgages, but they frequentlysell them to Fannie and Freddie.Banks and thrifts also purchase MBSsand hold them in their portfolios,thereby gaining a more liquid mort-gage asset with a credit guarantee andlower capital requirements, and thepotential for greater geographicaldiversification than could be achievedfrom local mortgage originations.

As of year-end 2000, Fannie andFreddie’s mortgages-in-portfolio plusMBSs outstanding together accounted

ing and especially home ownership,the ethos of public policy has been(and continues to be) “too much isnever enough.”

A Contingent LiabilityFannie and Freddie are exposed to

at least three types of risks. First iscredit risk. On all of the mortgagesthat they hold in their portfolios andon all of their MBSs, Fannie andFreddie are exposed to the risks ofdefault by the mortgage borrower.Second is interest rate risk. On all ofthe fixed interest rate mortgages thatthey hold in their portfolios, Fannieand Freddie are exposed to the riskthat interest rates will rise, which willdecrease the value of their assets.Further, the risks are asymmetric:Since all mortgage holders have theoption to pre-pay, interest ratedecreases are often accompanied bywaves of pre-pays and refinancings atlower interest rates. As a result,Freddie and Fannie do not experiencecomparable capital gains. Third isoperational risk. This is the risk ofpoor management, bad judgments,and employee fraud.

As would be true for any well-managed company, Fannie andFreddie take extensive measures tocontain these risks. But if the capitalmarkets are correct in their belief thatthe federal government would standbehind Fannie and Freddie’s obliga-tions in the event that either were infinancial difficulties, then creditorsneed not worry about suffering hugelosses. Instead, the federal govern-ment is at risk. In essence, then, theimplicit guarantees that Fannie andFreddie enjoy comprise a contingentliability, or implicit cost, for the feder-al government – for 2003 the annual-ized figure was around $13 billion.

The size of this contingent liabilitydepends on external factors, such asthe volatility of interest rates andhomeowner defaults, and partially on

for the following percentages of thevarious categories of residential mort-gages: 39 percent of the $5.6 billiontotal of all residential mortgages; 40percent of the $5.2 billion total ofall single-family (one-to-four units)mortgages; 48 percent of the $4.4 bil-lion total of all single-family “conven-tional” mortgages (that were notinsured by the Federal HousingAuthority or the VeteransAdministration); 60 percent of the$3.5 billion total of all single-familyconforming mortgages; 71 percent of

the $2.8 billion total of all fixed-ratesingle-family conforming mortgages.

The special status that Fannie andFreddie enjoy is part of a much largermosaic of long-standing public poli-cies to encourage residential housing.Owner-occupied housing is largelyexempt from capital gains taxes.Owner-occupiers can deduct mort-gage interest and real estate taxes ontheir income tax returns. Rental hous-ing enjoys accelerated depreciation. Ahost of federal, state, and local subsi-dies and tax advantages exist that areintended to spur construction ofrental housing. The government alsodirectly provides rental (“public”)housing. Thrifts and other deposito-ries that focus on residential lendingreceive favorable funding through theFederal Home Loan Bank System. Itis perhaps only a slight exaggerationto claim that when it comes to hous-

“Although theirprospectuses explicitlynote that the govern-

ment does not guaran-tee the securities theyissue, the securitiesmarkets act as if thefirms’ directly issueddebt and MBSs maywell carry a federal

guarantee.”

S

Sternbusiness 39

internal factors, such as the size of thecompanies’ securities issuance and thequality of their hedging. But the gov-ernment only recognized the need tolimit its exposure through heightenedregulation of the companies in 1992,when Congress established core capi-tal requirements for Fannie andFreddie and created OFHEO withinHUD to set capital requirements andconduct formal examinations ofFannie and Freddie.

The Larger ContextThe evaluation of the net or bal-

ance of Fannie’s and Freddie’s rolesmust be made in the larger context ofhousing policy in the U.S. The govern-ment puts great store in boosting thepercentage of households that owntheir own home. That figure is seen asan important social indicator. In thefourth quarter of 2003, it stood at arecord 68.8 percent. In the 1990s,the goal of extending home owner-ship deeper into the ranks of “low-and moderate-income” householdsbecame more important. And so in1992, Congress gave HUD the powerto set goals for Fannie and Freddie toextend their mortgage purchase effortsto encompass more low-and moder-ate-income households.

There are serious theoretical argu-ments to support the claim that homeownership provides positive externali-ties (spillover effects) for society andthus to support the encouragement ofhome ownership, and a recent body ofempirical research has begun to vali-date those arguments. Owners tend tomaintain their homes better than dorenters, and are more likely to becomemore involved in their communities.Also, home ownership has traditional-ly been an important vehicle forhousehold saving and asset accumu-lation. But there clearly are limits.Because of the substantial transac-tions costs in buying and selling ahome, as well as the inherent riskiness

lower – about 10 percent – than itotherwise could be. More recent stud-ies have supported that finding.

Reforming Housing FinanceFannie and Freddie borrow for less

than would otherwise be the case.They cause conforming mortgages tocost/yield less than would otherwisebe the case, thereby increasing thedemand for residential housing. Andthey create a contingent liability forthe federal government.

Is it worth the price? We shouldstart by assuming a zero-sum worldand then look for positive externali-ties that would justify the special gov-ernment treatment that Fannie andFreddie receive. While GSEs do lowerthe cost of home ownership modestly,most of the encouragement they pro-vide must be to induce householdswho would be owner-occupiers any-way to buy a bigger/better appointedhouse and/or to buy a second house.In 2002, when the Fannie/Freddieconforming mortgage limit was$300,700, the median sales price fora new home was $187,600 and themedian sales price for an existinghome was $158,100. The median 80percent mortgages would have been$150,080 and $126,400. Thus,Fannie and Freddie are financingmany homes that are far above medi-an levels.

As a result of legislation passed in1992, HUD was instructed to set spe-cific goals for Fannie and Freddie tohelp create more affordable housing.The GSEs were to focus on low-andmoderate-income borrowers, house-holds with less-than-median incomes,and to focus geographically on under-served areas such as low-income andhigh-minority census tracts.

Over the course of the 1990s,Fannie and Freddie met these goals.But the extent to which these effortshave induced Fannie and Freddie toexpand home ownership, beyond

of a home as an investment, homeownership may well be inappropriatefor households with high mobility,unstable employment, and irregularincomes.

s a result, it wouldseem that the bestprogram would be afocused one thatencourages thosehouseholds whowould not other-

wise buy (but for whom it is a closecall) to purchase a home. This focusshould be on would-be first-time low-and moderate-income household buy-ers. But virtually all of the policy toolsused to encourage home ownership,including the basic Fannie/Freddieprogram, are quite broad and blunt.So our society effectively spends agreat deal of time and resources sub-sidizing home ownership for house-holds – especially middle-and high-income households – who would buyand own anyway but who are therebyencouraged to buy larger and betterappointed homes and to buy secondhomes.

That the panoply of encourage-ments causes the stock of housing tobe inefficiently larger than would oth-erwise be the case is evident.Northwestern University professorEdwin S. Mills in 1987 estimated thatthe U.S. housing stock was about 30percent larger than if the encourage-ments were not present. With anexcessively large housing stock (andinsufficiently large stock of other pro-ductive capital), he found that U.S.aggregate income was substantially

“Freddie and Fannie’s mortgage purchase

activities appear to havereduced conforming mortgage interest rates by about 25

basis points.”

A

40 Sternbusiness

The Trouble with Fannie and Freddie

what otherwise would have occurred,is unclear. Detailed studies indicatethat the targets may be sufficientlybroad so that meeting them is not astrain, and that these GSEs’ effortswith respect to low-income house-holds and areas tended to lag behindthose of local portfolio lenders. What’smore, such efforts to lean on Fannieand Freddie to make loans involveplacing pressure on an organization totake actions that are believed to beunprofitable, and that thereby raspagainst the grain of a profit-seekingenterprise.

Observers have noticed two otherpotential advantages from the govern-ment chartering of Fannie andFreddie. First, Susan E. Woodward ofSand Hill Econometrics has arguedthat the (implicit) government guar-antee permits Fannie and Freddie toissue a blanket guarantee on all theirMBSs that removes issues of creditrisk from the minds of MBS investors.And that eliminates the transactionscosts of credit/information research inwhich MBS investors would otherwiseengage. While this argument is surelycorrect, the gains are likely offset bythe contingent liability of the federalgovernment, as well as the monitoringcosts of OFHEO.

he other potential posi-tive advantage arises inthe context of Robert VanOrder’s model of “duelingcharters.” Van Order, the

former chief economist at FreddieMac, reminds us that depositories thatfund residential mortgages and holdthem in portfolio also have a govern-ment guarantee, in the form of federaldeposit insurance. If the depositoriesare inherently a less (socially) efficientmeans of financing mortgages thanare the GSEs, then the expansion ofthe GSEs at the depositories’ expensereduces social inefficiency. However,though the innovation of mortgagesecuritization has clearly revolution-ized mortgage finance and would per-

moderate-income households. Thiswould be a far more direct way ofaddressing the positive externality ofhome ownership. The encouragementshould apply both to reducing downpayments and interest costs. The costsof the program would, and should, beexplicit. Further, as a way of reducingthe costs of housing more generally,governments at all levels ought tofocus on supply-side considerationssuch as modifying restrictive landzoning (which reduces housing supplyby limiting the ability to build single-family houses on small lots and limitsthe building of multi-family units),modifying building codes that unnec-essarily raise housing costs withoutadding to housing safety, and avoidingrestrictive international trade policiesthat raise the prices of importantinputs into housing, such as lumber.

general rationalization ofU.S. housing policy maywell be a quixotic goal,however. Public andpolitical sentiment shows

few signs of turning away from thenotion that more housing is always agood thing, even if middle-and high-income households are the primarybeneficiaries. If privatization ofFannie and Freddie is not a realisticpolitical option, then rigorous andvigorous safety-and-soundness regu-lation must be pursued, so as to min-imize the federal government’s con-tingent liability. But so long as theGSEs exist in their current form, thegoal of expanding home ownershipwill be pursued only indirectly as partof a larger mosaic of programs, subsi-dies, and tax breaks. DisentanglingFannie and Freddie from that largerframework will not be easy. But it is atask that is worth attempting.

LAWRENCE J. WHITE is Arthur E.Imperatore Professor of Economics atNYU Stern, and was a board member ofthe Federal Home Loan Bank Boardfrom 1986 to 1989, in which capacity hewas also a director of Freddie Mac.

sist even without the favored status ofthe GSEs, the assumed inherent supe-rior efficiency of Fannie and Freddiemay not be valid. Thrifts are likelyholding more MBSs today because theMBSs enjoy regulatory advantageswhen it comes to meeting capitalrequirements.

Modest BenefitsIn sum, the positive externalities

and thus true social benefits providedby Fannie and Freddie are surely pos-itive but modest. If the status ofFannie and Freddie could be consid-ered in isolation, the policy recom-mendation to privatize them – i.e.,remove all explicit/formal and implic-it government support – would be aneasy one. Given their substantial

brand-names and their impressivecollection of human and intellectualcapital, they would likely continue toinnovate and prosper, with their rela-tive funding costs a bit higher than iscurrently the case, their MBSs yield-ing a bit more, and the costs for homebuyers of obtaining a residentialmortgage rising a bit. Freed of therestrictions that accompany their cur-rent status, Fannie and Freddie wouldlikely vertically integrate into relatedareas, such as mortgage and titleinsurance, and expand horizontallyinto related areas of finance, such asauto loans and jumbo mortgage loans.And in turn, the government’s contin-gent liability would disappear.

In their place, the federal govern-ment should institute a targeted pro-gram to encourage home ownershipfor first-time buyers among low-and

“The special status thatFannie and Freddie

enjoy is part of a muchlarger mosaic of

long-standing publicpolicies to encourageresidential housing.”

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HELPING HANDS

Recommendations often involveproviding information impersonally,and do not necessarily involve per-sonal or Internet contact. By con-trast, we define consumer help as anencounter where a retailer represen-tative explicitly provides aid to aconsumer regarding a consumerneed, product attribute or attributeimportance, or a purchase decision.And while help-seeking and help-giving have been investigated exten-sively in the fields of psychology,education, child development, for-eign aid policy, and organizationalperformance, the existing marketingliterature has given relatively littleattention to the question of con-sumer help.

Consequently, we set out toinvestigate which types of consumerhelp affect consumer satisfaction –in stores and online – how thesestrategies affect actual sales, andwhether the best online strategiesdiffer from the best in-store strate-gies. Researchers have generally dis-

tinguished three types of help: helprequested by the person beinghelped; help offered by the helper,while allowing the recipient toaccept or decline the help; and helpimposed by the helper without firstasking for permission.

Help StrategiesIt is fairly simple to create strate-

gies for each of the three help types,both online and offline. Consumerscan request help in a store fromsalespeople, while Internet con-sumers can request help by sendingan e-mail or clicking a help icon tostart a help “chat.” Store salespeo-ple can offer help by asking con-sumers whether they would like tobe helped, while online retail per-sonnel can pop open a window inthe consumer’s browser and offerhelp. Store salespeople can imposehelp by giving consumers help with-out first asking for permission, whileweb retailers can impose help usingan instant message window.

People have both positive andnegative reactions to receiving help.And consumers’ decisions onwhether or not to seek help, andtheir reaction to help, can be viewedas the result of the relative weightgiven to the perceived costs andbenefits. Requested help has apotential advantage over offered orimposed help since it allows thehelped person to maintain autono-my and control. But past helpresearch has shown that in face-to-face help encounters, people aremore likely to have a more positivereaction when help is offered thanwhen it is requested, because otherfactors outweigh the potential posi-tive aspects of requested help.Requesting help may increase feel-ing of indebtedness to the helpprovider, and it can reduce self-esteem. People are also less likely torequest help if their request isobserved by other people.

These factors, which have beenidentified in contexts outside of the

44 Sternbusiness

consumer realm, are also likely toincrease consumers’ perceived“cost” of requested help in face-to-face encounters. And so our firsthypothesis holds that in stores, ahelp encounter that uses imposed oroffered help will lead to higher con-sumer satisfaction than anencounter that uses requested help.

Our second hypothesis holds thatcustomers will have more satisfac-tion with a retailer when theyrequest help during Internet shop-ping than during shopping in astore. Computer contact omits manyof the visual elements that can forman important part of interactions inface-to-face encounters and makesrequested help less attractive to con-sumers. Other consumers cannotobserve consumers who make helprequests over the Internet, and peo-ple are more likely to request help ifthey remain anonymous to thehelper. The lower level of personalcontact in Internet help also increas-es the psychological and social dis-tance between the consumer and thehelp provider. At the same time,consumers are likely to still appreci-ate the greater autonomy, freedom,and control that requested helpgives them.

Our third hypothesis holdsthat imposed help will gener-ate greater satisfaction instores than on the web.Imposed help generallyrequires the greatest level ofmonitoring of consumers byretailers. Retailers of eitherkind cannot make a reason-able attempt to impose helpwithout first observingcustomers. This need formonitoring may signal toconsumers that they arebeing observed. If con-sumers believe that this mon-itoring invades their privacy,this can lower their satisfac-tion – particularly in onlinesettings. While consumers

have long accepted that employeesin most kinds of stores, which arepublic spaces, may observe theiractions as a prelude to offering orimposing help, people usually usethe web in the privacy of their homeor office. Many consumers are con-cerned that web monitoring invadestheir privacy. And so our fourthhypothesis holds that the impact ofimposed help on satisfaction willdepend on the extent to which theimposed help leads consumers to beconcerned about their privacy.

e tested thesehypotheses with astudy involving 135undergraduates at auniversity in thenortheastern U.S.

Participants read one version of ahelp encounter with a salesperson ina bookstore or bookseller website.They were asked to “imagine thatyou are actually in this shopping sit-uation” and then asked how theywould react. In all scenarios, theparticipant was shopping for afriend’s birthday present and wastrying to choose between books bytwo of the friend’s favorite authors.Participants were either told theywere shopping in a store operated by

Barnes & Noble, one of the largestretail booksellers, or on Barnes &Noble.com. The description of thehelp encounter with the salespersoninvolved either requested, offered,or imposed help. The scenarios forall three types of help contained thesame help from the Barnes & Nobleemployee.

Participants were asked to reporttheir satisfaction, on a numericalrating scale. Participants alsoreported how many books they hadpurchased for themselves or othersduring the past month. They werealso asked whether during the shop-ping experience they were “worriedabout your privacy” and whetherthey “thought your privacy wasbeing invaded.”

The ResultsComparisons among participants

showed that when shopping in astore, satisfaction with the retailerwas higher when help was imposedthan when it was requested (seeFigure 1). The comparison betweenrequested and imposed help is sta-tistically significant, while the com-parison between imposed andoffered help is not significant,although in the correct direction.

Sternbusiness 45

Retail Store Web

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Figure 1

Satisfaction with Retailer(Adjusted Means from ANCOVA)

Thus, our first hypothesis was par-tially supported. We also found thatsatisfaction in the requested helpcondition was higher for the websitethan the store, supporting our sec-ond hypothesis. By comparison, sat-isfaction with imposed help washigher for store than for web shop-ping, supporting our third hypothe-sis. It is interesting to note that therank order of satisfaction for thethree types of help in web shoppingwas precisely the reverse of theirrank order in store shopping. For in-store, the rank was: imposed,offered, and requested. For online,the order was requested, offered,and imposed.

hen we testedthe hypothesisthat privacyconcerns affectthe relationshipbetween shop-ping context andsatisfaction for

imposed help, we found, as expect-ed, that the average satisfaction forweb shoppers was significantlylower than the average for in-storeshoppers. The concern score whenimposed help was received in webshopping was significantly greaterthan when this help was received instore shopping. These results sug-gest that, in general, web help gen-erates higher privacy concerns thanin-store help, and that imposed helpon the web generated the highestprivacy concerns of all.

AdvanceNotification

Why is that thecase? Consumers’expectations forretail shopping mayinclude help, buttheir expectationsfor web shoppingmay not. If con-sumers are offeredhelp during web

shopping, this creates a discrepancywith their expectations that leads tosurprise. Unpleasant surprises canlower consumer satisfaction. As aresult, we set out to examinewhether providing web shopperswith advance notice that help maybe provided would reduce privacyconcerns, and in turn increase cus-tomer satisfaction. Doing so mighttend to reduce feelings of unpleasantsurprise and invasion of privacy atthe time the consumer is helped.

However, we expect that theimpact of advance notification onsatisfaction will vary across thethree types of help. If consumersperceive a type of help as unusual,novel, and opposite to their expecta-tions, advance notification can beexpected to have greater impact.Specifically, we hypothesized thatconsumers will perceive imposedhelp as the least normative, andmost unusual type of retailer help onthe web; offered help as more nor-mative; and requested help as themost normative. Thus, we expectthat advance notification will havethe greatest impact on satisfactionfor imposed help and the leastimpact for requested help.

To test these hypotheses, wedesigned a second study, with 132undergraduates at a university inthe northeastern U.S. who had notparticipated in the first study. Thisstudy used the same book-shoppingscenario, but included the followingadvance notice condition as a vari-able: “The Barnes & Noble home

page mentions that their sales agentsmight flash a message on yourscreen to help you with your pur-chase decision,” while the conditionswithout advance notice did not con-tain this sentence.

n examination of compar-isons between satisfactionwith and without notifi-cation, for each type ofhelp showed that, as pre-

dicted, advance notification had thegreatest positive impact on satisfac-tion for imposed help, and a lesser,but still marginally significant,impact for offered help. But con-trary to our expectations, advancenotification actually decreased satis-faction in the requested help condi-tion, although not significantly. Onepossible explanation: notifying con-sumers that they might receive helpcreates an expectation that they def-initely will receive help. When theyneed help, but have to request it,this expectation is not met, resultingin lower satisfaction.

Influencing SalesMarketers must also consider

whether providing help has a directinfluence on sales. In a third studywe analyzed actual data from a well-known, general merchandise retailerwith both store and web operations.The retailer’s website includes anonline help facility that lets con-sumers request help by initiating alive, instant messaging conversationwith a retailer representative, byclicking on a live “chat” icon. Thisfalls under our classification ofrequested, online help. So wehypothesized that the higher satis-faction associated with requestedonline help would make consumerswho requested help using the onlinechat facility more likely to purchasefrom the web retailer than con-sumers who did not.

The data were provided by amarket research firm that recordedthe web usage of a large panel of

46 Sternbusiness

HELPING HANDS

“Requesting help may increase feeling of indebtednessto the help provider, and it can

reduce self-esteem. People are also less likely to

request help if their request isobserved by other people.”

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consumers from August 2002 toJune 2003. During this time, pan-elists made 60,057 site visits to theretailer’s website, and purchasedduring 815 of these visits. We deter-mined that panelists had requestedhelp during 363 site visits. And wefound there was a signifi-cant connection betweenhelp and sales. The propor-tion of consumers who pur-chased during a site visit ifthey requested help duringthe same visit was 38.3 per-cent. That was significantlyhigher than the proportionthat purchased when notrequesting help during thesite visit – only 1.13 percent. Wenote that we can’t infer causalityfrom this test. It is possible that con-sumers who request help are alreadymore likely to purchase. The meannumber of the retail site’s web pagesviewed by panelists who requestedhelp (46.8) was also significantlygreater than the mean numberviewed by those who did not requesthelp (13.5). The results suggest thatconsumers use requested help tobroaden, rather than narrow, theamount of information they obtain.

ur studies have shownthat the effectivenessof consumer helpstrategies in increasingconsumer satisfactiondepend, in part, on theshopping context.

Firms can use these results to helpdesign their help strategies. Forexample, retail stores can encouragesalespeople to offer or impose helprather than waiting for consumers torequest it. Internet firms, by com-parison, should rely more onrequested help. If they do wish to useimposed or offered help, web retail-ers should give consumers advancenotification that they may be helped,to alleviate their privacy concerns.This notification, however, should bephrased in a way that encourages

consumers to still request help ifthey need it, so that they are not dis-appointed if they decide to requesthelp.

Since consumers who requesthelp tend to look at more web pagesthan those who do not, it is impor-

tant that the web representativesproviding help be knowledgeableabout the product line and the siteitself, so that consumers can obtainthe information they seek to expandtheir web shopping.

Other FactorsA number of factors not investi-

gated in this paper might also affectconsumer reactions to help or theirwillingness to request help, and areareas for future research on con-sumer help. For example, willing-ness to seek help can be affected byhow the person in need of help per-ceives the physical attractiveness ofthe potential helper, and whetherthe two have the same or differentgenders. Males are often less willingto seek help than females, but aremore willing to help. This behaviorhas implications not only for retail-er’s in-store help strategies, but alsofor the picture and name of thehelper that consumers see in anonline-help facility.

Web retailers might also developcapabilities for asking shoppers, atthe beginning of a site visit, whichtype of help they would prefer toreceive. For example, web shopperswho are allowed to choose which admessage they will view are moreresistant to later information contra-

dicting those ads, and have higherpurchase intentions, compared toshoppers who were not allowed tochoose among ads. Similarly, reac-tions to help might become morepositive if consumers are allowed tochoose from a menu of help types.

While most consumer helpin stores and on the Internet isprovided by human beings,automated help systems forInternet retailers exist that donot require human interven-tion, such as ActiveBuddy.Given that peoples’ propensi-ty to seek help is affected bywhether they believe a com-puter is providing the help,

there is a need to examine the poten-tial advantages and disadvantagesof such help systems, and identifycontexts where automated help ismost effective.

Just as companies have combinedonline and off-line retail strategies –so-called clicks and mortar – thereare signs that retailers are takingboth approaches. Liveperson hasdeveloped software that allowsretailers to use decision rules orintelligent agents to decide whetherand when to provide offered orimposed help to web shoppers, butthen connects consumers who con-sent to help to a real person for fur-ther assistance. Consumers may alsobe less likely to feel that their priva-cy is invaded by offered or imposedonline help if they know that theweb retailer’s decision to contactthem is the result of a computerapplying an automated rule, and notbecause a human being was moni-toring their behavior.

ERIC A. GREENLEAF is associate pro-fessor of marketing at NYU Stern,VICKI G. MORWITZ is associate professoro f market ing at NYU Stern , and RUSSELL S . WINER is the DeputyDean and William H. Joyce Professor ofMarketing at NYU Stern.

Sternbusiness 47

“Comparisons among partici-pants showed that when shop-

ping in a store, satisfaction withthe retailer was higher when

help was imposed than when itwas requested.”

O

an you make a ton ofmoney and build abrand that racks up aquarter of billion dollars

annually in sales if you knowabsolutely nothing about businessand management? In their occa-sionally hysterical new book,Shameless Exploitation inPursuit of the Common Good,Paul Newman and A. E.Hotchner, say you can – but onlyif you give the profits away.

The tale of how two middle-agedmen whipped up the $250-million-a-year Newman’s Own food empirefrom scratch starts in 1980, inWestport, Connecticut. Newman wassomewhat obsessed with salad dress-ing. He took an oil-and-vinegarcocktail of his own design every-where he went, “not just as a tastepreference, but also as a defenseagainst those insufferable artificialadditives.”

Newman and A.E. Hotchner, anovelist and biographer of ErnestHemingway, wanted to market a mixthey had stirred up in Newman’sbasement. But they knew thatcelebrity-related products frequentlyfailed at the consumer box office.And so did industry professionals.“No offense, Mr. Newman,” onemarketing consultant said, “but justbecause they liked you as ButchCassidy doesn’t mean they’ll likeyour salad dressing.” His droll

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48 Sternbusiness

response: “Maybe we should call itRedford’s Own.”

But Newman’s star status helpedout. They held – and won – a tastingtest at the kitchen of “a local catererwe knew named Martha Stewart.” InSeptember 1982, when the all-natu-ral salad dressing was formally intro-duced at a bar in New York – withNewman and his wife, JoanneWoodward, providing the entertain-ment – film reviewer Gene Shalitshowed up. The bushy-mustachedcritic raved.

Newman’s Own had another sell-ing point that proved more powerful

than Paul Newman’s blue eyes.From the outset, the foundersagreed to give all profits to charity.Sales caught on, fueled by the rapid

introduction of spaghetti sauce.Newman’s Own grew steadilyand, um, organically – addingpopcorn, lemonade, and cookiesto the product mix, which nownumbers 77.

In its first 20 years, Newman’sOwn has earned – and given away –$150 million. The biggest benefici-aries of the empire of lemonade,popcorn, and vinaigrette have beena string of camps created byNewman’s Own that serve childrenwith cancer.

“There are three rules for run-ning a business; fortunately, wedon’t know any of them,” the co-authors protest. But they knew atleast one. A company competing in amarket dominated by giant, deep-pocketed brands – Kraft, Ragu, andOrville Reddenbacher – needs anedge. And the goal of any successfulbrand manager is to have the targetaudience develop positive associa-tions with the brand. What betterway to do so than to give away yourprofits to a good cause?

DANIEL GROSS is editor of STERNbusiness.

Salad CourseBy Daniel Gross

endpaper

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