Improve your executive decision-making with these economics-based strategies
Daniel Deneffe, Professor of Economics and Strategy at Hult and 23-time Professor of the Year across campuses, recently published articles in two of the world’s most respected business magazines: MIT Sloan Management Review and Harvard Business Review. Below, he explains what the articles are all about and how they relate to his teaching at Hult.
In both articles (with H. Vantrappen), I apply some of the things that I teach at Hult and in management consulting projects to deal with situations that many businesses face today. They illustrate how applying managerial economics and related fields can generate actionable and often out-of-the-box recommendations. Below are two summaries. If you’re inspired by what you see, click on the links to the articles.
Article 1: Why Pricing Decisions Need More Than Management Intuition, MIT Sloan Management Review, March 25, 2021
In this article, we describe six real-world challenges that many executives have faced in the past year and to which companies have often formulated quick, intuitive responses. On reflection, these intuitive responses are not always the best course of action and may make things worse. This article shows how applied economics allows executives to formulate more thoughtful ways to approach these challenges.
I explain Situation 1 of 6 in more detail here: When people are getting significantly poorer, as was the case during the COVD-19 recession, the intuitive response of companies is often to give temporary price discounts. When we evaluate this recommendation in more depth, a different conclusion emerges. Economists distinguish between normal goods and inferior goods: inferior goods are those for which demand increases as consumer income declines (for example, low-end phones or mass-market beers). For normal goods, the opposite holds. This means that the intuitive recommendation does not hold for inferior goods and companies should confine temporary discounts to their normal goods because demand for their inferior goods is going to increase regardless. This more thoughtful reflection is important for companies with numerous products within a given category. For instance, a food company I worked for had value-for-money pastas (an inferior good) and gourmet pastas in their pasta category. When the economy contracted (well before COVID), there was no logic to discounting the value-for-money pastas, as customers were beginning to buy more of these products anyhow.
The other five situations and their “intuitive” responses:
Situation 2: Uncertainty makes people reluctant to spend? Let’s lower prices.
Situation 3: Costs have gone up? Pass them on to customers.
Situation 4: The business is losing money? Raise prices to recover losses.
Situation 5: Customers are spoiled by free services? Go for value pricing.
Situation 6: Some businesses have been lucky enough to benefit from COVID-19? We haven’t, so we’ll just have to sweat it out.
The more thoughtful responses can be found in the MIT Sloane Review.
Article 2: How Airlines Can Cut Costs—Without Annoying Customers, Harvard Business Review, June 14, 2021
In this article, we dig deeper into Situation 5 above and apply it to one of the five most hated industries in the US, and one of the structurally least profitable ones: the airline industry. This industry has suffered so much during the pandemic but there are hopes that pre-pandemic airline travel levels may return soon. Profits will not necessarily follow if airlines keep on excessively focusing on increasing revenues by charging passengers for all kinds of ancillary services through “à-la-carte-pricing.”
Airlines can in fact use what we call “à-la-carte options” to reduce those costs that are under their control—without annoying customers. In fact, doing so can make customers equally well or better off and hence increase loyalty and revenues. It turns out that I have applied a similar options approach in other industries such as medical technology, chemicals, logistics and telecom so why not do so in airlines?
The à-la-carte options approach identifies services that the airline and its competitors provide free of charge and that have a sizeable variable cost component. It then offers customers the option not to use these services and rewards them with frequent flyer miles for doing so. The goal is to eliminate the abuse of these services. Frequent flyer miles have a high perceived value (people love miles, as we saw in the movie Up in the Air), even though the actual value is only about 1.3c per mile. Meanwhile, miles are very low cost to the airlines, with estimates ranging from less than $0.001 up to $0.01 per mile.
Here is an example: Business-class tickets offer passengers free access to lounges. Because they’re free, passengers are likely to visit the lounge even if visiting is just marginally more desirable than not doing so. That is fine if the airline or its partner own the lounge, since the cost of an extra passenger visit is small. However, if the airline does not own the lounge, then this third-party lounge charges the airline around $25 per visit. The airline could propose the following: “You are welcome to use the lounge. If you choose not to, we are happy to credit your account with 250 miles.” Assuming a $25 lounge cost per visit, the airline gains anywhere between $22.50 and $24.75 per passenger who chooses not to visit the lounge due to this option. This option doesn’t hurt a single passenger, as those who value the lounge can still use it at no charge. It is purely win-win.
For more details, please check out this article in the Harvard Business Review.
To sum up
The above two descriptions give you a flavor of how the economics-based thinking that I teach at Hult can improve decision-making. If you’re interested in a wider comprehensive approach to economics-based strategy, please do check out my book Fad-Free Strategy®: Rigorous Methods to Help Executives Make Strategic Choices Confidently (Routledge, 2020). It provides a comprehensive framework to make better strategic decisions based on materials that I have applied in practice and teach at Hult. But what I teach and do in practice is not necessarily simple. As one book reviewer puts it: “People who are adamant that strategizing should be very simple and easy won’t like this book. But most sensible businesspeople will love it.” I hope you appreciate the practical, applied, yet rigorous thinking.