Saturday, September 23, 2006

The Opening Salvo in a New Health Care Battle?

I am most intrigued by WalMart's new drug-pricing strategy: $4 per prescription for up to a 30-day supply for a generic version of the drug. The program is being rolled out in Florida, but the company appears to have plans to go nationwide. Right now there are almost 300 drugs available at the $4 rate, covering some of the more common ailments (diabetes, cholesterol, high blood pressure, depression).

Many people are focusing on the "corporate social responsibility” aspects of WalMart's move. Under pressure from commentators for its "poor" treatment of employees (not providing health care for part-time employees, for example), this move certainly will give the company some community goodwill. That is fine. But I suspect there is more to the story than that. And I suspect there is more to this than simply WalMart's ability to cut costs out of the chain of distribution.

What intrigues me the most about this pricing program is precisely that it has the hallmarks of a PROGRAM: it is almost like consumers are enrolled in a WalMart prescription drug insurance plan or program. Many health insurance plans offer similar sorts of prescription drug policies --– for instance, each prescription will cost $5, or $15. But those deals have traditionally only been offered with health insurance, which of course requires a large up front cost. Here is WalMart essentially offering Blue Cross- level prescription drug pricing, but offering it to anyone, including the uninsured, without any subscription price!

The other programmatic aspect of the pricing policy is that all drugs are being offered at the same low price of $4. From WalMart's point of view, that cannot be optimal pricing when you look at it on a drug-by-drug basis. Some drugs have higher marginal costs to WalMart and should be priced higher, again if you were looking at the drugs individually. Clearly, WalMart is viewing this as a package deal, and they must have some research supporting the idea that consumers will value greatly the certainty of the $4 price for any drug.

With more consumers going to WalMart pharmacies, the company will have even more bargaining power with the pharmaceutical manufacturers: the ability to move WalMart-level volume from one manufacturer to another does wonders for the ability to extract price concessions. But the real question is to what extent this represents WalMart taking a shot at the United States' very high-cost health care business model? Maybe as they move beyond just 300 drugs, they will start charging a monthly premium in order to get the $4 per prescription pricing? That starts sounding like an insurance plan, but of course it is really not different from Net Flix' DVD plans or even Amazon's new pricing for shipping (pay an annual amount and get free two day shipping). And what if WalMart decides that it could also start hiring doctors and nurses and providing basic health services? Wouldn'’t that be something? Anyone want to bet that WalMart could provide many health care services at much lower prices than our nearby hospital or doctor’s clinic -- with probably very similar quality?

Thursday, September 14, 2006

A Simple Math Question

Here is, I believe, a great math question for any kids in grades 8 or case you have to ever prove the relevance of math to your kids.

So I had a great time today out at my beloved camp on a remote lake in New Hampshire. Unfortunately, the pump in my septic system burned out so I had to get the guys out to replace it. I was there, of course, to oversee the process.

It turned out that because of the tendency towards freezing temperatures in this area, the piping that goes from the septic pump to my leach field would empty back into my pump tank once the pump shut off (which it does automatically, through a float mechanism). Since the leach field is 100 yard from the tank, this is potentially a lot of liquid coming back into the tank after the pump shuts off. One could envision a situation where the pump would be on more or less continuously: the tank would fill, the pump would turn on from a float mechanism, it would pump until the level in the tank went down to a certain point and then shut off, all the liquid in the 100 yards of 2 inch piping would run back into the tank, at which point the pump would turn back on....You can imagine the electricity bill from this endless do-loop, as well as imagine how long the new pump would last under such circumstances.

So two math questions emerged. How much liquid will 100 yards of 2 inch piping hold? (Let's assume that the 2 inches is the internal diameter, not external.) Two, what is the capacity of a pump tank that is 4 feet in diameter and 5 feet tall? And last, if the pump turns off and on in a range of 2 feet vertically, how much liquid will be pumped out in one pumping?

All this should help us figure out if the back draining of the water in the pipe will simply fill the tank enough to turn the pump back on, or if that is an issue we can ignore and go to sleep.

Good math stuff. What I haven't gotten into is the really interesting thing, which is how we used a little logic and a little knowledge of electrical circuits to figure out that there has to be a short somewhere between the house and the pump. Now I get to dig up the cable and find if our theory is true! Ah, the pursuit of truth! I love it.

Business Schools and "Business and Society"

Yes, it has been too long since my last post. Too busy, plus I suppose there has not been that much in the news of late to stimulate me. We did definitely have some record cold the other night in northern New England, and oil and gas prices appear to be starting their predicted decline. But not enough excitement to warrant anyone's time.

Here is an issue, though. It is somewhat close to home, and I generally don't like to write about things that are Tuck School related, but this one does have some generality that makes it OK.

I am Faculty Director of the Allwin Initiative for Corporate Citizenship at the Tuck School. I am currently trying to define just what this Initiative should be and do. It is sort of like a Center, if you know what centers at universities tend to do. But it has lacked clarity in its area of focus and its mission, and I think it has suffered somewhat from taking on a bit too much of an "advocacy" role. If there is one thing I feel strongly about, it is that academic institutions should advocate only for the truth, not for any particular value system. If you look across business schools and even universities, you will see many centers or programs in environmental areas or in corporate social responsibility generally where it is real clear that the institution has taken a stand on what the proper policy of either corporations, individuals, or governments is. That kind of advocacy bothers me. I think we should stand for the pursuit of knowledge and of truth and not much else.

That said, any modern business school has to have some kind of organizational structure that facilitates students and faculty in exploration of issues that, in the language that I find most illuminating, lie at the intersection, or interface, of business and society. The trick is in defining this area, and the activities that the organization will engage in, in ways that are true to the "pursuit of truth" ideal but that also stimulate student, faculty, and broad audience excitement. There can be no doubt that in today's cultural environment, there are many MBA students who want to discuss those issues that fall in the arena known as "corporate social responsibility." The discussion just has to be consistent with our pursuit of knowledge and truth rather than advocacy (if you don't understand the difference, go watch Al Gore's movie...).

So here is some language that I wrote this evening that attempts to define the area of focus for the Allwin Initiative for Corporate Citizenship at Tuck (and yes, the name may not be perfect either). Reaction is welcome.

The Allwin Initiative focuses its attention on the intersection between business and broader society -- where issues of the overall impact of business activity on social welfare, of corporate objectives and responsibility, and of ethics, citizenship, and leadership become paramount . Rather than defining the precise areas where the Initiative will work, we prefer to set the defining characteristics of the areas that are most interesting and relevant for us. These defining characteristics are three-fold: first, the topic should be one that involves a large potential impact on society; two, the topic should be one that is mainstream, in that a typical Tuck MBA student would be likely to encounter such an issue in their career; and third, the issue should involve a situation where laws, regulations, and/or cultural norms are non-existent, poorly defined, or changing. The first two conditions are self-explanatory, but the third needs clarification. We wish to work in areas where the quality of management, leadership and knowledge will make a large difference. At the intersection of business and society, it is those situations where it is unclear what should be done -- what the right course of action is -- that are important to highlight for both Tuck students as a learning experience and for faculty as scholars, for research purposes. When regulations, laws and cultural norms and expectations are lacking in clarity, that is when the value-added from leadership and from knowledge will be greatest.
It will be useful to note just a few specific topics that meet these criteria at this point in time. Part of our desire to state only the defining characteristics rather than particular areas is our belief that the world is always changing, and the topics that are relevant today will not be tomorrow. We should also note that situations of classic market failure – in the formal economics sense – will almost always be of potential interest to us, but that there may be topics that are not clearly classic market failures, but will still be of interest to us. To put it differently, conditions of market failure are sufficient but not necessary to create interest by the Allwin Initiative. Here are four examples of topics that would currently meet our tests for interest and relevance:

The case developed by a certain Tuck professor of a cement factory being constructed in Vietnam. There are issues of environmental damage and cultural damage. Both of these issues could be construed as classical market failures, with the cement factory not being made to bear the cost of damage to the environment and to cultural artifacts and sacred areas. There are also issues related to the exposure of banks and other lenders due to possible liability from future laws and regulations. There are important embedded questions for the plant managers, for the banks and lenders, for non-governmental organizations, and for governments. The issues are common in large scale economic development projects in the developing and developed world and are therefore mainstream.

There has recently been much criticism of WalMart, in regard to its effect on communities; its employment practices; and even its effect on international trade and our relations with China. Questions concerning the impact on broader society of new business practices and organizational forms, like those related to WalMart, are prime fodder for the Allwin Initiative. Note, however, that it is not at all obvious that these issues are ones of classic market failure. They are instead questions on the overall impact of business on broader society that get to the heart of the role of free enterprise and market economies. Note also that the laws, regulations, and customs surrounding the role of "“big box"” retailers are definitely in a state of flux, not just in the US but globally.

• Another traditional topic for an entity like the Allwin Initiative would be the impact of plant closings, perhaps especially when brought on by a merger or acquisition. This is a topic that falls clearly in the realm covered by “corporate social responsibility” as typically defined, and would be of interest to the Allwin Initiative. These issues are definitely mainstream for Tuck students, and there can be no doubt that the laws, regulations and customs around issues of plant closings and employment reductions are in flux.

One last one, and one that we used at Tuck as the theme for the Halpern Lecture on Business Ethics in 2006: the topic of executive compensation. There is a lot of interest of late in this topic, and it is clearly important (with recent academic papers calculating the relatively large fractionof corporate earnings that actually go to compensation for top executives). Laws and regulations concerning executive compensation are also in flux.

We believe that by studying situations like these, from both a student perspective and from a scholarly/faculty perspective -- and in both a traditional academic learning environment as well as a more active, experiential learning environment -- we can add to knowledge and we will be better able to prepare our students to be effective managers and leaders of tomorrow'’s organizations.

Friday, September 01, 2006

The Decline of the Mainstream Media and the Theory of Informational Cascades

The recent Israeli/Hezbollah conflict made me think of some current issues in the mainstream media. While I do think that my game theoretic analysis of this recent conflict was good -- and may end up being right on yet -- it certainly did not answer all my questions. As that conflict went on, additional questions and issues emerged. One that has been written about in the blogosphere a fair amount concerns the way that Hezbollah seemed to control the battlefield of the media. While Israel may have gained some strategic advantage from the conflict (granted that the final outcome is still unclear) I don't think anyone would argue with the view that Hezbollah won the communications war.

So let's put this into a broader context.

And I do want to give the Economist credit for its cover story this past week, "Who Killed the Newspapers?" There was not too much to follow inside the cover, but a few points were made.

Since the onset of the TV (geez, I remember our first black and white!) the newspapers have fought for market share of readers and of advertisers. The recent Internet-based economic changes have further affected the market position of not only newspapers, but the whole "mainstream media," TV and news magazines as well. Richard Posner had a great review article in the Sunday New York Times a while back, laying out very well how the new technology destroys the old economies-of-scale model of the old media business (see here).

The point is that the old business model of the TV news service, newspaper, or news magazine is seriously suffering. They are now seriously losing readers and advertisers to the Internet.

Whether this is the correct response or not, I don't think there can be argument over the proposition that the mainstream media are cutting their investigative journalism budgets. In the face of declining revenues and profits, a natural reaction is to cut the number of reporters.

So we have a situation where the amount of true investigative reporting in the industry, worldwide, has declined. This now sets us up for situations where information cascades and "rational herding" will occur more frequently. Once I explain these, you ask yourself if you do not agree that we are seeing more herding and cascades in the media.

A good link to the theory of informational cascades and herding is by Ivo Welch at Brown, here.

Let me briefly describe the theory. I think informational cascades are the easiest and most illuminating. Suppose you are uncertain about something, say whether a news story is true or not. You have some private information on whether the story is true or not, and so does everybody else. You don't observe other people's information directly, but you do observe how other people behave -- say, whether they choose to pass the story on to other people. If other people only pass on stories that they believe are true, then when you see someone passing on a story, you should rationally infer that their information supported the truth of the story. With fairly reasonable underlying assumptions on the structure of the information, once you observe even two people pass the story on, you will have to rationally assume from that point on that the story is true. You will therefore pass the story on, and now the next person has seen three people act as if the story is true. They will have even more reason to disregard their own information and act just like everyone before them...hence the term informational cascade.

A key point, of course, is that those two people who made the initial decisions to pass the story on could have had bad information (this is all in a world of uncertainty). No matter, once they decide to pass the story on, everyone thereafter will behave in the same way. So we will get a lot of false stories passed on as truthful, and everyone will believe them to be true!

And not to get ahead of ourselves too much, but suppose you know that this is how the world is operating, and you (Hezbollah) decide to be those two people who make the first decisions that everyone else is going to use to infer what is actually going on...

This is the theory of informational cascades. The theory of rational herding is very similar; the term herding refers to the tendency of people to make similar decisions under conditions of uncertainty. Herding can be reinforced by other incentive issues. For example, in the investments world, managers of mutual funds might "herd" not only because they are watching one another, but because their compensation is based on relative performance. If I know what other fund managers are doing in terms of stock picks, then if I mimic that, I cannot go too far astray in my performance.

I think the applications to the media industry are now apparent. With the decline in resources devoted to true investigative reporting, the tendency towards informational cascades and herding are stronger. Nobody really knows what is going on, so when we see someone with some information, we will rationally believe it. I cannot yet present data to support my claim, but my casual observation is that "herding" is more rampant in the media than before. It seems that one story or one fact has much longer and stronger "legs" than ever before. Deaths in Iraq are one example; someone puts out the data on how many were killed, and everyone reports that story. The craziness over Mr. Karr who confessed to killing Jon Benet Ramsey is another good example. Does anyone want to write a paper with me that would create some measure of "herding" for the media and show that it is negatively correlated with the resources devoted to investigative reporting by the mainstream media?

Two further observations. The first is really important, I think. In a world with less investigative reporting by the Fourth Estate, the ability for governments or other organizations and individuals (read Hezbollah, OBL, etc.) to influence people's beliefs is enhanced. I hinted above how someone like Hezbollah could start an informational cascade. Does that story describe pretty well what happened in the recent Lebanese conflict? I think so. Any country that enters into a conflict without a grand strategy of controlling the media is in for a real battle. Israel certainly lost the battle for world opinion, and increasingly, it appears to have done so on the basis of just a couple stories that were exaggerated.

Amazingly, in this new world of technology, we are getting less information being produced, yet more (false) consensus in the world on what is truth, and therefore worse decisions being made.

The second observation related to an earlier post of mine on the tendency for bloggers to simply link to other sites (see here). Bloggers are not yet fully replacing the investigative reporting role of the mainstream media. They (and I) are serving at best an analytic role, trying to opine on the facts that we assume are being collected by others. This is a classic free-riding situation! Who is going to start collecting the information that the old-style reporters used to collect? Discovering the economic model that will support bloggers actually doing more primary data collection will be a challenge, but the potential economic rewards could be huge.