The Challenge Dividend

Consumers Challenging Health Care Prices

By now most analysts agree that one of the main reasons health care costs are out of control is because it is not an efficient free market.  Businesses or government cover the costs of most health care spending, and consumers have no incentive to demand lower prices.  And for those consumers who have to pay their own way, it is difficult to decide whether or not a given procedure, doctor or hospital is right for them.  With a "broken" market, we don't benefit from the Challenge Dividend.  However improvements in the health care market seem to be finally arriving.

The move to market dynamics is happening on two fronts.  First, more employers are moving to insurance that asks consumers to cover initial costs.  These are usually lower-cost, high-deductible plans in which catastrophic needs are covered (e.g. surgery, disease), but consumers must pay for the basic costs out of their own pockets.  This is giving consumers the incentive to be smarter shoppers for the majority of their annual health needs. 

Second, information about health care prices and results is more freely available.  Open information flow is the key to any successful market; it means people can compare the competition and alternatives and make smarter choices.  Information also helps ensure that those with an information advantage (e.g. hospitals, doctors) cannot take advantage of the patient; say by recommending surgeries or brand name drugs that are not necessary. The simple fact is that health care providers have a financial incentive to recommend pricey procedures.

These small trends are starting to generate some interesting changes in the health care market.  Some examples are highlighted in a recent New York Daily News column:

• Private insurers like Aetna are now posting the prices they have negotiated with doctors and hospitals.  This gives consumers and the providers themselves a peek at the alternatives.
• For $7.95, a company called Healthgrades will send you the prices paid by 80 different insurers for 55 different procedures.
• 12% of Americans claims that they have negotiated with a doctor; and 61% of those who negotiated say they were successful.

By making prices public knowledge, combined with consumers picking up the bill, we can expect to see hospitals and doctors shifting their prices to stay competitive for what are essentially parity services.  An MRI, for example, is pretty much the same at any hospital.  There will be no place to hide excessive fees in a free market environment.  Heck, we might even see special packages and discounts like what has happened in the LASIK market and the market for surgery overseas ("medical tourism", a future topic here).

Health care will likely never be a perfect competitive market.  But recent trends make me very bullish on a future of both falling costs and rising service.  An open market will challenge doctors and hospitals to make decisions that are consumer-focused.  Expect to start seeing patient reviews of health care providers, a la Amazon and eBay.  And we will probably see this power of choice lead to a diversity of options - some hospitals will compete on, say, low cost, while others offer added amenities.

Like the markets of almost everything we are used to buying today, the best will prosper and the worst will go away.  Meanwhile we'll reap the dividends of lower prices, better services, and longer, healthier lives.

Sony Continues its Anti-Consumer Ways?

Way back in a previous post I promised to follow the developing next generation DVD format war between Sony's Blu-Ray and the HD-DVD standard.  More recently, I described how Sony is using Blu-ray in its PlayStation 3 in order to help the format get hold while defeating Microsoft's Xbox 360.  At the annual E3 convention, however, Sony announced that the PS3 would be priced at $600 and prospective consumers reacted very negatively. 

But recent rumors will disturb gamers even more.  Apparently Sony has decided to eliminate the market in "pre-owned" video games.

Here's the story according to the Games Radar website: "It seems that Sony is planning to adopt a licensing system that will mean gamers won't own the PS3 titles that they've paid money for. Instead, they will only be purchasing the licence to play the game and that the software itself will still be Sony property - meaning that the disc won't be the customer's to sell."

Hopefully this is just a rumor.  But if true, it would mean yet another anti-consumer move in a string of similar choices that has left the Sony brand in tatters.  Late last year, for example, Sony was found to have hidden spyware on its CDs to prevent unauthorized copies. Meanwhile, it has totally missed the market for MP3 players because it decided to wrap its players in copy protection (unlike Apple).

Sony's proprietary bias shows a failure to meet the challenge of both consumer demand and competitive pressure.  Today's consumer wants control of their use of media; in fact, they believe they have a right to watch, listen or play with content whenever and however they choose.  And the  pool of global, competitive electronics brands means that any consumer need is quickly met  But Sony seems more driven by its own interests to create a system that locks consumers into costly products with few choices. 

The launch of the PS3 and Blu-Ray technology have been called Sony's latest (last?) chance to re-seize market leadership.  The company could have put its consumers in the center and developed around their needs for a low-cost, exciting system that encourages news uses and experimentation.  Instead, they have filled the PS3 with features that primarily protect Sony's interests.

At this point I think the PS3 will already be DOA because of this approach.  The kids who buy/sell/trade used games are also the ones who play/buy/buzz the most in this market.  Meanwhile, gaming underdogs Microsoft and Nintendo are outmaneuvering Sony with systems that are lower cost and more gamer-friendly. 

Sometimes companies rise to the challenge of consumer needs and competitive pressure and make bold moves that succeed.  In Sony's case, the move is bold but the focus is off.  But that's OK, these same consumer and competitive pressures will provide an opening for other players to innovate and improve.

UPDATE: Gamespot gets word from Sony's PR rep in Europe that these rumors are false.  Interesting that they waited several months before denying this report.  All the while negative buzz spreads for the PS3 among gaming chat leaders.  And why is Sony North America silent?  Again, a pro-consumer bias would have Sony out on the front lines and engaged in the dialogue versus letting this story spread.

Feedback Helps the Stroke

For the second post in a row I'm dipping into the fertile ground of sports.  After a weekend playing golf with buddies in Hilton Head (Harbour Town 18th above), some of which are new readers here, I feel compelled to write about how the challenges of golf are forcing me to improve my game.

I find golf to be a unique and tough sport.  Just the physics of getting a small ball into a small hole from 400 yards away by hitting it with a stick four times (if I'm lucky) is amazing.  Then throw in unique course layouts, varying weather, water/sand/tree hazards, and the occasional gator.  Finally there is the challenge of the mental aspect of the game - you've got to think about your club selection, swing speed, and distance.  But you can't think too much, and either high or low emotions can kill you. 

But aside from the challenges of the game and learning the skill, perhaps the most interesting facet of golf is that it provides instant performance feedback.  You cannot mistake a good versus bad shot as it lands on the green or sails into the woods.  Every hole is rated on a degree of difficulty, and your score is matched against expectations (i.e. par).  Every round can be plotted against your history to derive a handicap.  And if that's not enough, you can wager against friends for some added pressure.  Golfers have no shortage of betting games to keep it interesting.

Feedback on performance is a very effective form of "challenge" that can lead to improvement.  By judging the quality of each shot, hole, and round, we are tracking our success and failure.  There is always room for improvement, and we use this feedback to improve our game.  Last weekend, for example, I started with a horrible front nine but experimented until I found & corrected my flaw and improved by eight shots after the turn.

Meanwhile, as entrepreneurs compete for the golfer's dollar, they too bring new technology that helps further analyze our swings.  Over at the Freakonomics Blog, Steven Levitt talks about how a new at-home golf swing analyzer is providing years of feedback in hours via a special driving mat, net and laptop software.

I didn't hit the ball great in Hilton Head, but I had a lot of fun and I can't wait to play this weekend on my home course to try out the improvements I discovered on the trip.  As the years go by, I'm confident that golf will provide endless challenges, and hopefully some improvement to my game.

The Wages of Wins

Sports are an obvious place to look for case studies on how challenge leads to improvement.  Every year in every league there is a new opportunity for teams to use innovation, experimentation and investment to reach championship glory.  A new book called The Wages of Wins brings deep research and analysis that disprove some of the "rules" most thought were true. 

In particular, the authors' research shows that there is no strong correlation between team payroll and team wins in major U.S. sports.  This is probably shocking to the fans who see small market teams struggle, who want their local team's ownership to invest in better free agents, or who see the Yankee's soaring payroll seemingly guarantee pennants. 

This news gave me the chance to dig out an old paper I wrote while getting my Economics degree at Duke.  Back in a November 1992 in a class called Labor Economics (Econ 155) I studied the question of whether Major League Baseball free agents were over-paid.  My answer was "Yes" based on the following:

• When teams bid on free agents they often fall victim to the Winner's Curse, essentially over-estimating how much revenue (or wins) a new free agent will bring.  This effect worsens when there are more teams bidding - a product of league expansion ("Implications of the Auction Mechanism in Baseball's Free Agent Draft".).
• An empirical study by Gerald Scully shows that the increase in winning percentage and revenue resulting from new free agents fell short of their salaries in the case of 28 of 44 players. ("Pay and Performance in Major League Baseball.")

I ended the paper here and was fortunately scored an "A", but I continued to be intrigued by the idea that teams would over-pay decade after decade.  Now, by combining this Econ 155 research with The Wages of Wins data that shows salaries do not drive wins, a theory starts to develop that fits with The Challenge Dividend: Players who are highly compensated are less challenged to improve - thus are not more likely to win.

The common sense argument is that if you get paid a big, guaranteed, long-term salary you simply have less motivation to put in the "110% effort" to improve and win championships.  Meanwhile, there are plenty of lower-paid players hungry to prove themselves and earn recognition that will put them in the big money with a similar long-term deal.  The latter are the ones with more to work for, more challenge to drive their improvement.  Today, sportscasters and fantasy sports nuts often say "He's in the last year of his contract" to explain unusually strong years

While there is not a lot of data on this question, at least one source shows promise.  Kevin Pelton in Hoopsworld.com analyzed the NBA and discovered that players in the last year of their contracts performed better than their previous year, on average, while those who signed new multi-year deals or were in the middle of such deals performed worse, on average.  Here's Pelton's chart from 2004, the first two columns show an Efficiency rating based on a combination of stats; and "Improv" shows the percentage that improved their scores (+.500 meaning better on average):

Group             03-04Eff  02-03 Eff  Improv  Count
---------------------------------------------------
Contract year       .469      .464     .536     69
New contract        .476      .477     .373     71
One-year deal       .455      .444     .492     63
Multi-year deals    .481      .490     .377    167

While the data might not be perfect, the theory seems to hold promise.  It suggests that both sports teams and Fortune 500 boards are better off linking pay to performance for their star players and CEOs, respectively.  When a big payout is not guaranteed but available to winners, the best will tend to do whatever it takes for championship results. 

Toyota Prius Meets the Challenge

A big focus of my upcoming book version of The Challenge Dividend will be to show how businesses succeed by embracing challenge and building it into their culture.  Hence the "dividend" that comes from challenge. 

One great case study comes from a recent Fortune article that presents five examples of how challenges were created by Toyota and resulted in its ground-breaking hybrid car.

• Set aggressive goals: Toyota dabbled with hybrid technology for 20 years until project leader Akirio Wada demanded change.  He gave the team 12 months to build a concept car, demanded that they raise the fuel-economy target to 100% improvement, and pushed for a production launch in only 24 months (about 2/3 the time of the average window).  This was even more challenging for a new and unproven hybrid engine and batteries.
• Encourage internal competition: Toyota asked for designs from separate teams based around the world.  This resulted in a diversity of ideas and created a rivalry in which each team wanted the recognition of winning.  They were also given only 2-3 weeks to submit designs versus the normal 2-3 months.
• Put the company's future at stake: Toyota leadership made it clear that this technology was critical to the future of the company, as rising oil demand would put pressure on prices and punish companies that did not plan today.  They watched competitors like Honda making similar moves into hybrid technology and became committed to winning now so that the company's future (and everyone's jobs) would be secure.
• Embrace new selling models: The company's dealers were worried about committing to purchasing the radical new car.  So Toyota effectively went around them by offering direct sales via the Internet.  This led to 37,000 initial leads and 12,000 orders before the product was ready.  This challenged old-school dealerships to wake up and embrace the innovation.
• Keep pushing the model: Toyota has not rested after racking up strong orders and waiting lists for the Prius.  Instead, it is giving itself the challenge of offering the hybrid technology on every model it makes.  This ensures that company stays aggressive and widens its lead.

My final takeaway from this story is that success for the Prius was not due to exact management guidance or a scripted rulebook.  Toyota executives set these challenges in place and gave the team the freedom to take risks and innovate.  They set the challenges and reaped the dividend of a liberated team's hard work and innovative thinking.

Getting back to my (future) book, one of the main conclusions will be that the embrace of challenge not only results in a dividend in the form of better profit, market share, and stock price for the subject company - but also in innovation, improvement and value for the world's consumers.  Surely the Prius hits the mark on both points; it gives back to shareholders in the form of long term market share and profit, and to consumers in the form of lower gas prices and a cleaner environment.  All because of a free market and the drive to win.

University in France

I don't dislike the French or France...really.  In fact, this remarkable country is a joy to visit.  Its food, wine, culture and history are breathtaking.  One of the other reasons I like France so much is that it has managed to hold onto a strong-willed culture that bristles at change.  This in turn provides me with much fodder for this blog!

Following up on a previous post about the French rejection of more market-oriented employment laws, the New York Times offers up a fascinating view of college life in France.  Ironically, the non-market structure of college in France is probably a leading driver of the youth riots that have stopped economic progress.

Here's one passage from the New York Times - probably a shock for those who went to college anywhere in the United States:

"There are 32,000 students at the Nanterre campus of the University of Paris, but no student center, no bookstore, no student-run newspaper, no freshman orientation, no corporate recruiting system.  The 480,000-volume central library is open only 10 hours a day, closed on Sundays and holidays. Only 30 of the library's 100 computers have Internet access.  The campus cafeterias close after lunch. Professors often do not have office hours; many have no office. Some classrooms are so overcrowded that at exam time many students have to find seats elsewhere. By late afternoon every day the campus is largely empty."

The troubles in French university education seem to stem from riots in 1968, sparked by a reaction against segregated dorms and the Vietnam war.  Eventually things got so bad that President de Gaulle was nearly forced from power.  Instead the government quelled riots by promising a near-free college education to anyone who passed a standard test.  As a result, the government is in charge of the schools and the huge supply of students means the value of a degree is small.

This is a sharp contrast to the university system in the United States, where the government has very little involvement.  Instead, we have a marketplace where thousands of schools compete for paying students.  Even "state schools" are mainly financed by student tuition and private donors.  These market dynamics mean that schools are constantly pressured to improve campuses, bring in the best professors, and ensure students have a great 4 years (so that they become life-long donors).

Sadly, the French seem trapped by a system that views college as a birthright- albeit a low-value one.  Attempts to free schools to act more independently in 2003 brought protests from students who feared they would be charged for what is already a lowly system. 

While this may be a surprising college experience to many in the U.S., we can draw a pretty close comparison in our K-12 school system.  Here, too, a free, government-run educational system has left us with crowded schools, millions of drop-outs, inconsistent teaching, a bulky bureaucracy, and low perceived value.  And, similarly, efforts to introduce moderate market-reforms (e.g. vouchers) have been met by stiff resistance from entrenched interests like teachers' unions.

In the end, both countries' efforts to "do good" via free education have led to failure.  It doesn't take a degree to figure out that competition is needed for both nations' educational systems to improve.

Forces of Change When Aid Withdrawn

The history of financial aid to developing nations has been one of the greatest tragedies of the past fifty years.  The legacy of these dollars is mainly corruption and swelling bureaucracies.  But wealthy nations continue to transfer billions of dollars to poor regimes.  However there are two examples where a lack of aid seems poised to drive change by forcing the people to demand better government.

The first example is the Palestinian Authority.  After electing Hamas into power a few months ago, the group quickly rejected the right of Israel to exist and promised to ramp up attacks.  Israel and Western nations in turn began to cut off millions of dollars in aid.  Today, the once arrogant Hamas regime is struggling, so much that some of its leaders are beginning to talk peace.

For example, the Times of Oman reports that Palestinian Health Minister, Bassam Hassim, said: " We as an occupied people are ready to talk to all sides in order to receive aid."  Not an olive branch but at least a leaf.  The Palestinian government is having trouble paying its 165,000 state employees.  On a side note, the fact that there are this many government workers in a country of only 4 million people suggests that something is wrong.  Time will tell, but once state employees start missing their paychecks we may see positive results of this new democracy in action.  Hamas officials may have to change their policies to keep their own jobs.

The second example is Zimbabwe.  Recall that in 2000 President Robert Mugabe chose to evict white farm owners from their land and redistribute it to "the people".  At the time, it was a blatant attempt to keep power; a classic page from the dictator rule book in which you find an enemy and promise giveaways to your supporters.  The result has been tragically predictable: a country that used to export food now relies on imports and unemployment abounds.

Now the Wall St. Journal reports that the country's annual inflation rate topped 1,000% last year.  There are regular shortages of sugar, cooking oil, and bread.  The cost of toilet paper is so high that one would be smarter to use actual dollars for its purpose.  Zimbabwe, too, is seeing requests for aid turned away. 

But this challenge and lack of aid may finally be forcing change.  For starters, Mugabe is starting to invite white farmers back to the country and their land.  It's a small step toward compromise driven by a restless and frustrated population. 

Overall, I don't necessarily advocate the withdrawal of all aid to developing nations, however we should use a Return on Investment model to monitor the results.  And if we disagree with the government's anti-democratic or anti-peace policies then we should quickly pull support.   After all, as seen in the examples above, this might just be the wisest move of all.

Gaming Competition Further Unfolds

In a post a few days ago I wrote of the war brewing between HD-DVD and Blu-Ray technology over the next generation of video players.  It looks more and more as though the key battle in this war will take place among rival gaming consoles, Microsoft's XBox 360 and Sony's Playstation 3.  Recent news suggests Sony could be facing defeat already both in this battle and the DVD war.

At the annual E3 show in Los Angeles last week, Sony surprised industry observers when it announced a $600 price tag for its Playstation 3.  That's 50% more expensive than the $400 XBox 360, which will have been in the market for a year and have a 10-million-household base when the PS3 finally launches.  It seems that the big gamble on including Blu-Ray drives is forcing the company to blow its budget.   Sony doesn't seem worried however; its Computer Entertainment head, Ken Kutaragi, said that "it's probably too cheap."  Ahh, arrogance...

Eric at the Business 2.0 blog suggests "If I were Bill Gates, I'd announce an Xbox price cut the day before the PS3 launches."  Not a bad idea - for either Microsoft or the consumer.  A price cut like this would effectively "load the pantry" of gamers (an old CPG tactic), and give them more money to plow into games.  With an investment in an Xbox system and library of cool games, why plunk down an extra $600-plus for a similar-performing Sony?

On a side note, if there are any buzz marketing firms out there working for Microsoft or Sony, I'd be happy to test drive a complimentary system and give an honest review!

Idol Dollars Suggest Ad Revolution

Today while listening to Joseph Jaffe's Across the Sound New Marketing podcast, I was blown away to hear the new heights that have been reached in pricing for 30-second ads.  This rising price amidst falling audiences suggests that something is broken - and the extortion going on in the market will likely be enough pressure to shift billions in ad dollars over the next few years.

Here's what $1.3 million for a :30 ad gets you today versus just a few years ago:

• 1998, Superbowl, 130 million viewers
• 2006, American Idol season finale, 30 million viewers

Yes, those numbers are correct.  Today advertisers spend the same as they did eight years ago, but for less than one-fourth of the audience.  The same money hits only 23% as many people to be exact.

In this blog I've called out several other industries where monopoly power and lack of competitive challenge leads to rising prices and less value.  Examples range from movie tickets to music to cable to health care to college tuition.  The formula holds in network TV advertising as well.  A few networks have the content and audience to demand soaring fees.  Advertisers feel as if they have no choice, so they keep paying and paying.

The good news for advertisers is that the market is very close to reaching a breaking point - driven by the pressure of the soaring costs.  The companies that advertise are themselves continually under "real-world" competitive pressure to reduce costs and create innovative products.  In turn, they are aggressively looking for ways to fight back against soaring ad prices.  For example, they are experimenting with online, producing their own content, and even partnering with Walmart to establish TV ad bidding markets. Eventually they will crack the code and networks sales people will be forced to do real work (somewhere else).

Since my day job involves New Marketing approaches, I'm clearly hoping to benefit from the challenging costs of network TV.  But I think every company and even consumers themselves stand to gain.  Instead of perfecting a :30 ad that consumers avoid watching, we advertisers are discovering the opportunity to create value-added messages that consumers actually want to see, hear and touch.  Everybody wins...except the networks.

Viva la revolucion!

Weekend Story Update

Two quick news items related to previous posts:

1. Building on a post a few weeks ago about challenge and improvement in the movie business, it seems that some theater owners are offering free admission to G and PG-rated family movies.  Pretty smart - take low-cost, previously released movies and bring in families who will undoubtedly plow their savings into over-priced concessions.  Not my cup of tea but I've got to give them credit for trying.  And, again, the consumer wins.  Thanks to the "How to Start a Two Bit Operation Blog" for the link.

2. I recently said some nice things recently about Microsoft working hard to please consumers and advertisers in the search marketing business.  However Science Addiction points out that the company may be slower to innovate due to a focus on its other products.  Unfortunately, they have decided that AdCenter can only be used with Internet Explorer - thus turning away the loyal users of browsers like Firefox and Mac.  These folks represent 15% of the market, and an even greater share of the  technology thought-leaders.  Further digging shows that by adjusting your settings to make Firefox look like IE, it works just fine.  In other words, Microsoft is forcing its advertisers to use IE, even though Firefox works.  That's not a good way to start the new business model.