Management Insights

Group Buying: A New Mechanism for Selling Through Social Interactions (p. 1354)

Xiaoqing Jing, Jinhong Xie

“Did you see the deal on Groupon?” is a question that can now be heard around the water cooler as Group Buying gains in popularity. A relatively new and unique Internet-enabled selling strategy, Group Buying provides consumers a discounted group price if they achieve a required group size and coordinate their transaction time. The authors suggest that Group Buying allows a seller to gain from facilitating consumer social interaction, i.e., using a group discount to motivate informed customers to work as “sales agents” to acquire less-informed customers through interpersonal information/knowledge sharing. Group Buying is more profitable than traditional individual-selling strategies when the information gap between expert and novice consumers is neither too high nor too low (e.g., for products in the midstage of their life cycle) and when interpersonal information sharing is very efficient. The authors also show that, unlike Referral Rewards programs, Group Buying requires information sharing before any transaction takes place, thereby increasing the scale of social interaction but also incurring a higher cost. The insight for management: Group Buying is optimal when interpersonal communication is very efficient or when the product valuation of the less-informed consumer segment is high.

Goodbye Pareto Principle, Hello Long Tail: The Effect of Search Costs on the Concentration of Product Sales (p. 1373)

Erik Brynjolfsson, Yu (Jeffrey) Hu, Duncan Simester

How does the Internet affect the relative profitability of “best sellers” and “niche products”? Many markets have historically been dominated by a small number of best-selling products. The Pareto principle, also known as the 80/20 rule, describes this common pattern of sales concentration. However, information technology in general and Internet markets in particular have the potential to substantially increase the collective share of niche products, thereby creating the Internet's “long tail” phenomenon: Niche products have a rising proportion of total sales. The authors analyze data collected from a multichannel retailer and show that the Internet channel exhibits a significantly less concentrated sales distribution when compared with traditional channels. The authors find that consumers' usage of Internet search and discovery tools, such as recommendation engines, is associated with an increase in the share of niche products. They conclude that this shift may partly reflect lower search costs on the Internet. For example, why would listeners rely on Billboard's “top 40” when they can sample thousands of songs almost costlessly? The insight for management: If these trends in technology persist, they portend an ongoing shift in the distribution of product sales as niche products become less niche.

Systemic Risk: What Defaults Are Telling Us (p. 1387)

Kay Giesecke, Baeho Kim

In diversified financial markets and economies, the probability of widespread independent defaults is low. However, the 2007–2009 financial crisis shows us that the interconnectedness of financial markets can lead to systemic risk. The authors develop dynamic measures of the systemic risk of the financial sector as a whole. They define systemic risk as the conditional probability of failure of a sufficiently large fraction of the total population of financial institutions. This definition recognizes that the cause of systemic distress is the correlated failure of institutions to meet obligations to creditors, customers, and trading partners. Their measures provide accurate out-of-sample forecasts of the term structure of systemic risk in the United States for the period from 1998 to 2009. The insight for management: Financial risk models should incorporate both individual institutional risk and systemic risk to buffer institutions against future uncertainties.

A Generalized Measure of Riskiness (p. 1406)

Turan G. Bali, Nusret Cakici, Fousseni Chabi-Yo

This paper proposes a generalized measure of riskiness that nests original measures pioneered in 2008. The authors introduce the generalized options' implied measure of riskiness based on the risk-neutral return distribution of financial securities. The authors provide asset allocation implications and show that the forward-looking measures of riskiness successfully predict the cross section of 1-, 3-, 6-, and 12-month-ahead risk-adjusted returns of individual stocks. The insight for management: The generalized measure of riskiness is able to rank equity portfolios based on their expected returns per unit of risk and hence yields a more efficient strategy for maximizing expected return of the portfolio while minimizing its risk.

The Benefits of Aggregate Performance Metrics in the Presence of Career Concerns (p. 1424)

Anil Arya, Brian Mittendorf

If an executive is rewarded for “putting out fires,” does that create an incentive to become a corporate arsonist? Many individuals' performance incentives are driven by a desire to shape external perceptions (and thus future pay). But smooth sailing gets less attention for the individual executive than does recovery from a tsunami. The authors find that when individuals' actions are driven by career incentives, an aggregate measure (e.g., group or team output) can sometimes alleviate moral hazard concerns and improve efficiency. The reason is this: Aggregation intermingles the contribution to performance of skill and effort. The entanglement increases the prospect that the market will attribute an employee's effort-driven contribution to transferable skills, so the employee exerts greater effort as a means of posturing to the market. Of course, the incentive benefit of aggregation must be weighed against the incentive cost because of information loss. Information loss from aggregation can reduce the market's reliance on the measure and thus diminish agents' desire to undertake effort to influence the measure. The insight for management: Individual measures of performance may be direct but may introduce some incentives for malfeasance that can be mitigated by aggregate measures.

Hedging and Vertical Integration in Electricity Markets (p. 1438)

René Aïd, Gilles Chemla, Arnaud Porchet, Nizar Touzi

How do vertical integration and forward markets affect energy markets? Forward markets and vertical integration are two mechanisms commonly used for demand and spot price risk diversification, but what is their impact on prices, risk premia, and retail market shares? The authors illustrate how these two strategies affect the French electricity market. They find that forward hedging and vertical integration both reduce the retail price and increase retail market shares. On the other hand, vertical integration restores the symmetry between producers' and retailers' exposure to demand risk, whereas linear forward contracts do not. The insight for management: Both mechanisms reduce price and increase market share, but vertical integration is superior to forward hedging when retailers are highly risk averse.

Risk-Neutral Models for Emission Allowance Prices and Option Valuation (p. 1453)

René Carmona, Juri Hinz

How should call options on futures contracts be priced on CO₂ emissions allowances? The existence of mandatory emission trading schemes in Europe and the United States, and the increased liquidity of trading on futures contracts on CO₂ emissions allowances, led naturally to the next step in the development of these markets: These futures contracts are now used as underliers for a vibrant derivative market. The authors develop a model for allowance futures prices and demonstrate its calibration to historical European data. The insight for management: Modeling approaches can help price call options written on futures contracts for CO₂ emissions allowances.

CEO Overconfidence and Innovation (p. 1469)

Alberto Galasso, Timothy S. Simcoe

Are the attitudes and beliefs of CEOs linked to their firms' innovative performance? CEOs often innovate to provide evidence of their ability. Overconfident CEOs, who underestimate the probability of failure, are more likely to pursue innovation. The authors examine CEO stock options exercised from publicly traded firms between 1980 and 1994 to study the relationship between a CEO's “revealed beliefs” about future performance and various measures of corporate innovation such as new patent creation. The authors show a positive association between overconfidence and citation-weighted patent counts. This effect is larger in more competitive industries. The insight for management: Overconfident CEOs are more likely to take their firms in a new technological direction.

Deriving the Pricing Power of Product Features by Mining Consumer Reviews (p. 1485)

Nikolay Archak, Anindya Ghose, Panagiotis G. Ipeirotis

User reviews of products such as digital cameras proliferate on Amazon.com and other websites. Such user-generated product reviews serve as a valuable source of information for customers making product choices online. But how can this highly unstructured data be used efficiently to increase sales and profits? Of course, the “number of stars” and the number of reviews are indicators, but the information embedded in product reviews is much richer and more detailed. Clearly a review is subjective and multifaceted (picture quality, compactness, ease of use, etc.), and the textual content of product reviews is critical to subsequent consumer choices. The authors use text mining to incorporate review text from 15 months of reviews on digital cameras and camcorders on Amazon.com. Because free-form text is messy, the authors clustered rare textual opinions based on mutual information and used expert opinion on the review semantics. The authors predict product popularity based on quantification of the information provided in the textual reviews. The insight for management: Textual data can be used to learn consumers' preferences for different product features and can be used for predicting future changes in sales.