Tat Y. Chan

Strategic Management of R&D Pipelines with Cospecialized Investments and Technology Markets

The theoretical literature on managing R&D pipelines is largely based on real option theory making decisions about undertaking, continuing, or terminating projects. The theory typically assumes that each project or causally related set of projects is independent. However, casual observation suggests that firms expend much effort on managing and balancing their R&D pipelines, where managing appears to be related to the choice of R&D selection thresholds, project risk, and whether to buy or sell projects to fill the pipeline. Not only do these policies appear to differ across firms, they also appear to vary over time for the same firm. Changes in management policies suggest that the choice of R&D selection thresholds is a time-varying strategic decision and there may be some type of vertical interdependency among R&D projects in different stages. In this paper we develop a model using dynamic-programming techniques that explain why firms vary in their R&D project-management policies. The novelty and value of our model derives from the central insight that some firms invest in downstream cospecialized activities that would incur substantial adjustment costs if R&D efforts are unsuccessful whereas other firms have no such investment. If transaction costs in technology markets are positive, which implies that accessing the market for projects is costly, these investments lead to state-contingent project-selection rules that create a dynamic and vertical interdependency among R&D activities and product mix. We describe how choices of R&D selection thresholds, preferences over project risk, and use of technology markets for the buying and selling of projects differ by the state of the firms pipeline, the magnitude of transaction costs in the adjustment market, and the magnitude of technology costs. These results yield interesting managerial and public policy implications.

Measuring the Lifetime Value of Customers Acquired from Google Search Advertising

Our main objective in this paper is to measure the value of customers acquired from Google search advertising accounting for two factors that have been overlooked in the conventional method widely adopted in the industry: 1 the spillover effect of search advertising on customer acquisition and sales in off-line channels and 2 the lifetime value of acquired customers. By merging Web traffic and sales data from a small-sized U.S. firm, we create an individual customer-level panel that tracks all repeated purchases, both online and off-line, and tracks whether or not these purchases were referred from Google search advertising. To estimate the customer lifetime value, we apply the methodology in the customer relationship management literature by developing an integrated model of customer lifetime, transaction rate, and gross profit margin, allowing for individual heterogeneity and a full correlation of the three processes. Results show that customers acquired through Google search advertising in our data have a higher transaction rate than customers acquired from other channels. After accounting for future purchases and spillover to off-line channels, the calculated value of new customers using our approach is much higher than the value obtained using conventional method. The approach used in our study provides a practical framework for firms to evaluate the long-term profit impact of their search advertising investment in a multichannel setting.

Compensation and Peer Effects in Competing Sales Teams

This paper examines how compensation systems impact peer effects and competition in collocated sales teams. We use department store sales data to show that compensation systems influence worker incentives to help and compete with peers within the same firm, which in turn changes the capability of the firm to compete with rivals. Compensation also affects how salespeople impact peers at collocated competing firms, thereby impacting market competition. Moreover, compensation influences how salespeople strategically discount prices in response to peers. Our results suggest that heterogeneity in worker ability enhances firm performance under team-based compensation while hurting individual-based firms and that peer interactions are critical considerations in designing sales force incentive plans and broader firm strategy. This paper was accepted by Bruno Cassiman, business strategy.

An econometric model of location and pricing in the gasoline market

The authors propose an econometric model of both the geographic locations of gasoline retailers in Singapore and price competition among retailers conditional on their geographic locations. Although market demand for gasoline is not observed, the authors are able to infer the effects of such demand from stations’ locations and pricing decisions using available data on local market-level demographics. Using the proposed location model, which is based on the assumption of social welfare maximization by a policy planner, the authors find that local potential gasoline demand depends positively on the local demographic characteristics of the neighborhood. Using the proposed pricing model, which is based on the assumption of Bertrand competition between retail chains, the authors find that retail margins for gasoline are approximately 21%. The authors also find that consumers are willing to travel up to a mile for a savings of

Decomposing Promotional Effects with a Dynamic Structural Model of Flexible Consumption

.03 per liter. Using the estimates of the proposed econometric model, the authors answer policy questions pertaining to a recent merger between two firms in the industry. Answering these questions has important policy implications for both gasoline firms and policy makers in Singapore.

The Economic Value of Online Reviews

In this article, the authors offer a methodology to decompose the effects of price promotions into brand switching, stockpiling, and change in consumption by explicitly allowing for consumer heterogeneity in brand preferences and consumption needs. They develop a dynamic structural model of a household that decides when, what, and how much to buy, as well as how much to consume, to maximize its expected utility over an infinite horizon. By making certain simplifying assumptions, the authors reduce the dimensionality of the problem. They estimate the proposed model using household purchase data in the canned tuna and paper towels categories. The results from the model offer insights into the decomposition of promotional effects into its components. This could help managers make inferences about which brands sales are more responsive to stockpiling or increase in consumption expansion and how temporary price cuts affect future sales. Contrary to previous literature, the authors find that brand switching is not the dominant force for the increase in sales. They show that brand-loyal consumers respond to a price promotion mainly by stockpiling for future consumption, whereas brand switchers do not stockpile at all. The authors also find that heavy users stockpile more, whereas light users mainly increase consumption when there is a price promotion.

Consumer Search Activities and the Value of Ad Positions in Sponsored Search Advertising

This paper investigates the economic value of online reviews for consumers and restaurants. We use a data set from Dianping.com , a leading Chinese website providing user-generated reviews, to study how consumers learn, from reading online reviews, the quality and cost of restaurant dining. We propose a learning model with three novel features: 1 different reviews offer different informational value to different types of consumers; 2 consumers learn their own preferences, and not the distribution of preferences among the entire population, for multiple product attributes; and 3 consumers update not only the expectation but also the variance of their preferences. Based on estimation results, we conduct a series of counterfactual experiments and find that the value from Dianping is about 7 CNY for each user, and about 8.6 CNY from each user for the reviewed restaurants in this study. The majority of the value comes from reviews on restaurant quality, and contextual comments are more valuable than numerical ratings in reviews.

Structural Models of Pricing

Consumer search activities can be endogenously determined by the ad positions in sponsored search advertising. We model how advertisers compete for ad positions in sponsored listings and, conditional on the list of sponsored ads, how online consumers search for information and make purchase decisions. On the consumer side, assuming that users browse information from top to bottom and adopt a sequential search strategy, we develop a two-stage model of consumer search whether to click and whether to stop the search that extends the standard sequential search framework in economics literature. On the advertiser side, it is very difficult to fully specify the optimal strategies of advertisers because the equilibrium outcome depends on variables that researchers do not observe. As we have an incomplete model of advertiser competition, we propose using the necessary condition that, at equilibrium, no advertiser will find another available ad position more valuable than the one it has chosen. Using a data set obtained from a search engine, we find that consumers can be classified into two segments that exhibit distinct search behaviors. For advertisers, the value of search advertising comes primarily from terminal clicks, which represent the last link including organic results clicked by an online user. We also demonstrate that the value of ad positions depends not only on the identities and positions of the advertisers in sponsored listings but also the composition of online consumers who exhibit distinct search behaviors.

What Happens When Manufacturers Perform the Retailing Functions

In this chapter, we fi rst describe how structural pricing models are different from reduced-form models and what the advantages of using structural pricing models might be. Specifi cally, we discuss how structural models are based on behavioral assumptions of consumer and fi rm behavior, and how these behavioral assumptions translate to market outcomes. Specifying the model from these fi rst principles of behavior makes these models useful for understanding the conditions under which observed market outcomes are generated. Based on the results, managers can conduct simulations to determine the optimal pricing policy should the underlying market conditions (customer tastes, competitive behavior, production costs etc.) change.

Dynamic Pricing in a Distribution Channel in the Presence of Switching Costs

This study examines the effect of a relatively new channel structure on price and sales in a large department store, which in recent years has switched the management of many of its product categories from a traditional retailer-managed system to a manufacturer-managed system. We find that the change caused overall retail prices to decrease. However, there was significant heterogeneity in the response across brands. For the cell phone category that we study, brands with a high market share and inelastic demand have not changed prices. For another watch category, while retail prices of relatively low-end brands decreased, prices of premium brands even increased substantively/substantially after the change. In addition to sales increases due to lower prices we find that the system switch further caused the sales to increase by 9 – 10 percent for the cell phone category and 11 – 17 percent for the watch category. These results are consistent with the previous theoretical predictions. We believe that our results provide important academic and managerial implications due to the increasing prevalence of the manufacturer-managed system in the retail industry.