Dan Siroker – Director of Analytics, Obama Presidential Campaign – Keynote Speaker at SoCon 10

FYI – Dan Siroker, Director of Analytics, Obama Presidential Campaign, will be a keynote speaker at SoCon 10, January 29-30, 2010.

SoCon is a conference on Social Media and Social Networking held in the Atlanta area every year since 2007. I attended in 2008, and I highly recommend it for anyone interested in this space.

Here is how SoCon describes this year’s conference:

“In the first three years, we introduced social media, user-generated content, blogs, podcasts, video logs, social networking, wikis, Twitter… but nothing stands still. Find out what you have to know in 2010 to stay ahead of the learning curve. Find out who is doing great stuff; who has great, innovative ideas. Network and learn — and maybe even partner with — independent content producers, new media pros, academics and people from across the spectrum of marketing, public relations, legal, human resources, and executive ranks.”

On the same day that BusinessWeek lauded Subway for the success of its discount $5 footlong sandwiches, the National Franchise Association (NFA) sued Burger King Corporation over the legality of requiring franchisees to charge no more than $1 for the Double Cheeseburger. The Subway success story features a pricing strategy built from the bottom where the initiative and innovation of a single franchise owner led the way. The local profit optimization of the franchisees directly support the global profit optimization for Subway as a whole. The unfolding drama at Burger King features a pricing strategy commanded from the top against the expressed desires of the majority of franchisees. The global profit optimization that has convinced management to plow ahead appears to violate the local profit optimization of the majority of franchisees. The dispute has now devolved into a lawsuit filed in the U.S. District Court Southern District of Florida on November 10, 2009. The class action complaint starts with the following introduction:

“This action arises out of a dispute between NFA, on behalf of all owners of franchised Burger King restaurants in the United States (the Franchisees), and Burger King Corporation (BKC) concerning BKC’s actions in compelling the Franchisees to sell a food product known as the BK Double Cheese Burger (DCB) at no more than the maximum price of $1.00, and BKC’s claim that it has the legal right to dictate price points under the respective Franchise Agreements (the Franchise Agreements) previously entered into with the Franchisees – even if those prices are below the Franchisees’ cost and cause them to incur a loss on sale of the product.”

The core of the complaint is as follows:

“The provision of the Franchise Agreement at issue is Section 5, addressing ‘Standards of Uniformity of Operation.’ It provides that ‘BKC shall establish, and cause approved suppliers to the BKC System to reasonably comply with, product, service and equipment specifications.’

While these provisions address standards of uniformity for various operational issues, including menu items, hours, and uniforms, nothing states that BKC has the right to impose mandatory price points for product sold by the Franchisees. The dispute between the parties is triggered by the position recently taken by BKC, contrary to decades of practice, that the general language of Section 5 gives it the power to set prices for its independently owned franchises…Since at least the 1960′s (if not back to the beginning of the BKC franchise system itself), BKC never attempted to unilaterally impose or require a price point for products sold by Franchisees, and did not take the position it had the right to do so under the Franchise Agreements.

After the formation of [the NFA] and a Marketing Advisory Committee in 1989 and shortly thereafter, BKC did not attempt to set, much less enforce, mandatory price points for its franchisees without the agreement of a supermajority of the franchisees.”

Burger King has responded that “the litigation is ‘without merit,’ particularly after an earlier appeals court ruling this year showing the company had a right to require franchise owners to participate in its value menu promotions.”

The legal issues will likely get resolved by determining which contracts are legally binding and what are the conditions for enforcement. I am much more concerned with the strategic and economic issues.

The price cut on the DCB is dramatic; the drop from $2 to $1 positions the DCB below McDonald’s DCB priced at $1.19. The gross margin loss of -10% is significant; the DCB costs on average $1.10 to make. The complaint notes that no other item on the BKC value menu loses money. Based on this loss, franchisees rejected the first proposal in 2008 and rejected it twice by vote this year.

In “$1 deal may boost profits,” the Miami Herald describes an analysis generated by a franchisee that concludes that the $1 DCB is a money-loser:

“…financial models run by one Illinois franchisee and circulated among franchisees across the country suggest that [the $1 DCB] won’t drive enough sales to offset the margin pressure. The franchisee models suggest that the bottom line impact for restaurants would be a loss of between $489 and $930 depending on the percentage of total sales generated by the value menu.”

However, management has its own analysis (and assumptions) showing the $1 DCB is a winner. Again, from the Miami Herald:

“Based on numbers Burger King provided to franchisees, the company projects that the double cheeseburger will lead to a 5-percent increase in restaurant sales. That will translate into an increased bottom line profit of $365 per restaurant based on $105,000 in sales, according to the analysis.”

How could the franchisees and management come to completely different conclusions on the merits of this pricing strategy? Soda and fries make the difference. Soda and fries are higher-margin items. If the cheap DCBs generate extra sales traffic that buys soda and fries, then it is possible to make up the loss in profit from the DCB. In fact, BKC management is relying exactly on this dynamic. The McClatchy-Tribune reported on Nov 13, 2009:

“During an 18-month test, the $1 double cheeseburger had a negative impact on gross profit margin, Burger King said, but restaurants increased gross profit because consumers added high profit items like sodas and fries.”

In “Burger King’s battle cry: $1 burger,” the Chicago Tribune reports how the local optimization can invalidate the attractiveness of a mandatory $1 DCB promotion:

“John McNelis, president of the real estate division of Mirabile Investment Corp., owner of more than 40 Burger Kings in the Memphis, Tenn., area [states]: “…in some price-sensitive markets, you are just selling a bunch of double cheeseburgers…”

The cheap DCB pricing strategy works if soda and fries are “complementary products” to the DCB. However, if these products are truly complementary, then the more profitable pricing strategy is to make sure that DCB-buyers purchase soda and/or fries by bundling the products into one offering. In other words, customers can only buy the DCB for $1 if they also buy soda and/or fries for a price that generates a profit for the entire bundle. Without this bundle, BKC is using a loss-leader strategy in the hopes that the extra foot traffic will behave in a profitable way.

I suspect that BKC is not bundling the $1 DCB with soda and fries because the bundle would work counter to its efforts to attract increasingly price sensitive customers (high demand elasticity) and would obscure its price positioning versus McDonald’s. Putting the reported analyses aside, I suspect that when BKC runs its global optimization, it finds that it has enough markets with customers who will buy the bundle on its own merits. Absent profits, BKC could still justify the program based on customer retention in the hopes that customers stay loyal to the brand even after the money-losing promotion ends (a much shakier proposition in the highly competitive fast-food category). The franchisees run a series of local optimizations and find too many individual franchisees who lose money to make the program worthwhile as a mandatory offering. Apparently, there are enough of these profit-losing franchises to motivate the lawsuit (according to the class action complaint, about 75% of franchisees belong to the NFA). Indeed, the diversity of markets explains why most discount promotions amongst franchises include the caveat “at participating locations only.” The local optimization typically dominates the global optimization.

Burger King’s August 25th conference call to discuss fiscal fourth quarter 2009 earnings provides additional clues into management’s rationale for implementing a mandatory $1 price point for the DCB (quotes from the transcript provided by Seeking Alpha).

Management describes how it used controlled experiments to measure the potential success of a $1 DCB:

“…we have probably now well over 40 markets in the country that are on $1 Double Cheeseburger and we’ve actually seen a pretty steady check performance…And we’ve really been pleased with what our plans were for check dilution versus what’s really happening in those markets.

…there’s no question that the $1 Double Cheeseburger through its adoption in increasing amounts of markets in the U.S. has helped to improve traffic. So we have seen month-to-month-to-month improvements, a narrowing if you will on our traffic losses nationally and we have certainly seen the markets that have adopted the $1 Double Cheeseburger move into some very strong performance as it relates to traffic.”

Burger King management is eager to reduce losses in traffic. It is probably no surprise to anyone that discounting a burger by 50% will drive increased traffic. There is no indication here that the promotion is actually making money, only that it is losing less money than expected.

Again:

“…we modeled for some GPM [gross profit margin] dilution in the business case for $1 Double Cheeseburger but so far all the test markets have been outperforming in terms of GPM dilution. In other words it has not been as deep as we originally thought. What you really kind of see happening is the effect of this discounting is sort of offsetting the price increases that we’ve taken in the past which would kind of cause for the level check if you will that you’re seeing.”

There is no explanation here that sales of sodas and fries are specifically making up for the profit loss on DCBs. Instead, it seems that price increases on a variety menu items have given BKC the extra cushion it needs to justify using the DCB as a loss-leader. Management does not provide details on these price increases, but, in general, they seem odd given the existing competitive environment and sluggish economy. All together, it seems that traffic is the prime motivator for the promotion – with the assumption that short-term profit-losses will somehow give way to longer-term profit gains.

Finally, it seems competitive pressures are forcing Burger King to take extreme measures:

“…we have to be aggressive on value for the money. There’s no way you can turn on a television set and look at any retail brand in any space and not hear language that talks about price points and value. And we’re no different. Now our value for the money equation also includes talking about a superior tasting product with flame-fresh taste. It includes featuring our superior size versus McDonald’s on our Double Cheeseburger. And yes it’ll continue to pound on the $1 access.”

In the end, BKC’s global optimization is apparently not convincing enough for the franchisees who are presumably more concerned with their individual local optimizations. Certainly, the NFA should not have filed its class action complaint if BKC’s market tests demonstrated comprehensive profit gains from a preponderance of successful local optimizations. A global optimization that delivers average profit gains across the system is insufficient to justify a franchise-wide, mandatory pricing strategy. If this averaging is indeed the true source of the conflict, it is akin to averaging the net worth of Bill Gates and your home town and concluding that your home town would be filled with millionaires if Mr. Gates moved in.

This lawsuit will be fascinating to follow as it could provide additional insights and clarity into BKC’s pricing strategy and the actual data used to justify it.

Subway’s $5 footlong promotion has become a nationwide hit. In “The Accidental Hero,” BusinessWeek writer Matthew Boyle describes how the promotion grew from just a few franchises in Florida to become a top-10 fast-food brand this year. The story demonstrates how a small, local idea can become a nationwide success. The story also powerfully displays some key analytic lessons on the application and use of demand elasticity and controlled experiments to improve business performance in a sustainable way.

Demand Elasticity
Subway’s $5 footlong promotion was so popular, so fast, that it caused inventory shortages throughout the company. This surge in sales volume generated more revenue AND profits starting with the pioneering franchise: “…food costs did rise as a percentage of sales, but that was offset by the overall boost in volume and the increased productivity of …employees, who had less down time. Even after adding two new staffers, [franchisee] Frankel made money on each $5 sandwich.”

In other words, the footlong sandwich used relatively more expensive food than the typical sandwich, but sales volumes increased the proportion of time employees spent making sandwiches versus standing idle. The biggest bonus likely came from the incremental demand created by the promotion. The new demand created by the promotion directly added to revenues and profits. The lower pricing brought new customers to stores and (presumably) encouraged existing customers to buy more sandwiches. Subway discovered that these sandwiches have very high demand elasticity (for reasons described in the article), meaning that the percentage increase in demand was very high relative to the percentage change in price. The menu of higher pricing had prevented Subway from tapping into a hidden reservoir of demand. (Note that food service consultant Dean Dirks speculates that Subway’s promotion is actually a money-loser).

Controlled Experiments
Subway managed to execute this powerful pricing concept without analyzing past transaction data. Instead, Subway used the more direct approach of controlled experimentation.

Controlled experimentation allows a business to try out an idea in a well-defined place and time. This setup facilitates convenient data collection and fast analysis of the data. If the idea works in the controlled setting, then expand the trial into a slightly larger controlled setting. Repeat the process until the recipe for success (or failure) appears sufficiently confirmed and understood.

In Subway’s case, the numbers spoke loud and clear. Profits and revenues soared for Frankel soon after launching the promotion at his two franchises in Miami. It ran for a year before it was tried at another Florida location, this time in Ft. Lauderdale: “On the first day of the promotion, the store nearly ran out of bread and meat. Sales doubled.” Next, the promotion expanded throughout South Florida and met more success. Despite this winning record, Subway’s franchisee marketing board still voted down a proposal to expand the promotion nationwide. Additional successes from “Washington to Chicago” finally convinced the board to approve nationwide expansion.

Key Lessons
The article does not count how many controlled experiments Subway has run in the past that began successfully and yet ended in failure. We also do not know how many “bad” ideas the board must endure at every meeting. (Many stories about success in business suffer from “survivorship bias” where only proven winners make it to the front page and the losers of the past are long forgotten). However, a key lesson in this story is that ideas for change are strengthened when backed by evidence and data. Subway was fortunate to own an infrastructure conducive to running and maintaining controlled experiments and fortunate to stumble upon an idea whose success was so undeniable. Even if your business is not similarly fortunate, applying the lessons of pricing to demand and of generating evidence through experimentation will certainly drive measurable improvement in your business.

The Atlanta Journal-Constitution reported on September 26, 2009 that “despite more than a decade of effort and millions of dollars, Georgia’s system for tracking the progress of public school students remains deeply flawed.” The article describes a very tortured and wasteful process that has yet to yield any meaningful analysis or change in Georgia’s public schools. Georgia’s experience contains many lessons applicable to any business that can use data analysis to improve business performance:

1. Maintain consistent leadership over projects implementing tools for data analysis. It is all too easy to continue to rely on the gut instincts and subjective assessments of the past. Strong leadership is required to break down old habits, evangelize the benefits of sustainable, data-driven approaches to running the business, and even challenge special interests who do not want mistakes revealed by evidence and facts.
2. Do not leave staff to wallow in the misery of collecting and managing data. Their time and effort is very valuable, and it is better spent analyzing the data and developing recommendations from it.
3. Build analytic systems that track changes over time and place. This is the only way to monitor performance and to develop benchmarks that serve as the basis for improvement.
4. Integrate systems across groups and divisions as much as possible. This leverages effort and creates larger potential for creating strategies that are optimal for the entire business and not just specific entities.
5. Carefully assess the make vs buy decision. If the company lacks the skills and/or the will to see an implementation through to its successful conclusion, then hire a firm that demonstrates those capabilities AND can train staff to maintain and use the system for the foreseeable future. Make honest assessments about whether or not the company truly has the resources to hire the correct staff and buy the correct hardware for making an analytic system work. Understanding the return-on-investment (ROI) of making data-driven decisions will help focus make vs buy decisions.

Follow these steps, and your business will be well on its way to executing data-driven strategies for improving business performance.

This weekend, my alma mater, Stanford University, played football at Wake Forest. I was fortunate enough to make the trip although Stanford was not fortunate enough to win. I was also not fortunate enough to eat lunch before attending the game, paying $9.50 for the privilege of enjoying a small pepperoni pizza and an ice-loaded soda. I lamented with my friend the high cost of participating in a captive audience (the stadium does not allow outside food or beverage, but, of course, I cared more about attending the game).

Businesses love captive audiences because they provide a marketplace full of consumers who care more about an experience than its price. Moreover, a captive audience typically has no good alternative to the products and services offered for the duration of its “stay.” During a recession or economic slowdown, a captive audience can be an important and effective tool for protecting price points and maintaining profits. In the case of the college football stadium, the price of admission is relatively low ($17), while the price of staying is relatively high (in the form of concessions, seat rentals, and other products).

Investments in product quality can also help a business create a captive audience. Establishing a reputation for high quality products also translates into a strong brand name. A strong brand name consumes mind share in a marketplace – the captured audience – and constructs a higher barrier for competitors trying to win over customers. Most importantly, high product quality generates the goodwill in the marketplace that leads to the strong willingness to pay required to protect price points (and profits). These dynamics are particularly powerful during an economic slowdown where customers are extremely motivated to reduce expenditures.

There are a few required elements for high product quality to provide the kind of captured audience described here. Market and product analysis can verify how strongly a company scores on these elements.

1. “Good enough” is not sufficient to accomplish the customer’s goals.
2. Adequate substitute products do not exist and/or are extremely difficult to develop.
3. Investments to sustain high product quality are not prohibitive in cost.

Trina Solar understands these concepts. Trina Solar operates in an industry where projects cost a lot of money, project financing is tight, competing products are in high supply (quickly becoming commoditized), and pricing pressures abound. However, during its last earnings conference call, Trina Solar emphasized its advantage in this environment due to its reputation for high product quality, an extremely important characteristic in the solar marketplace. A substantial portion of Trina’s business has also been in small markets (Belgium and Italy) where it is considerably easier to construct the “captured audience.” Trina now looks to leverage its success into larger markets like China and the U.S. If the company continues to deliver on its promises of high quality (at lower costs even), it should continue to capture larger market share…and audiences.

Barbara Kahn, Dean of the School of Business Administration at the University of Miami, appeared on Nightly Business Report August 25, 2009 to comment on the new book “Free: The Future of a Radical Price” by Chris Anderson. Kahn rightly points out that even when consumers seem to be getting goods and services for free, they are actually exchanging something other than money that can be just as valuable like “…their time, loyalty or trust.” Kahn notes that “Free television isn’t free; it costs your time and attention and that’s valuable to advertisers. Facebook users invest their network of friends, which ties them to a system and that is valuable.”

In these examples the consumer is not paying money, but the companies providing the “free” services are leveraging the consumer’s contribution to generate revenues and profits from other sources, primarily advertising. We live in an economy based on exchange and very rarely is only one party the sole contributor to that exchange.

The “tragedy of the commons” (Garrett Hardin, 1968) is a concept in economics that describes how a group of self-interested individuals can destroy a shared (and free) resource. Hardin’s classic is example is a group of herders who destroy a pasture as each herder maximizes his/her number of grazing cows to make the most use of the shared (common) pasture. The tragedy is that the destruction of the pasture is in no one’s interest even as maximizing use of the pasture may be in each individual’s interest. It seems Twitter may have brought the tragedy of the commons to the internet.

In “Can Twitter Be Saved?,” Mark Gimein writes that Twitter will collapse from the sheer volume of users and messages if users do not focus and reduce the number of their feeds, and if Twitter does not develop some automated tools for helping users filter out the garbage from the useful. Gimein’s description of the typical Twitter behavior strikes me as a classic tragedy of the commons scenario: users (herders) barrage their followers with messages in an effort to attract the limited and finite resource of attention (the pasture). Access to this attention is free and messages effortlessly accumulate for all to peruse, so it is no wonder that many users liberally sprinkle “Twitter-space” with chatter and, in parallel, follow as many users as possible in an effort to attract as large an audience as possible.

While charging for anything on the Internet is tantamount to heresy, Twitter may be forced to set up some kind of fee structure to have any hope of constructing a more useful (and efficient) experience as the number of users appears ready to engulf the entire planet. Here is one example of what Twitter can do (my own unsolicited advice):

1. Charge a small fee to join, say $10/year; perhaps even charge $50-100+/year for corporate accounts where identity is authenticated and validated by Twitter. This fee mainly captures some of the immense value that people get out of the service and provides some funds to develop the automated tools that Gimein recommends. It also gives users one extra sense of ownership and, perhaps, an incentive to act responsibly. Of course, venture funding could easily replace subscription funding but only in the short-term. Someday, Twitter will need to generate sustainable revenues from something (even if it is charity!).
2. Charge a very small fee for messaging. There are many ways to do this, but the fairest method would be to charge something like a penny for each tweet past some high daily or weekly threshold. This provides the financial incentive to focus messages.

One might reasonably ask why Facebook does not face a similar problem with a tragedy of the commons. I suggest that Facebook is not a commons where anyone can and will attempt to siphon off a user’s precious attention. On Facebook, users typically only accept links to friends and family and people one or two degrees separated from that closed network. Because users either know or know of everyone in their network, there is an automatic incentive to ration attention-grabbing activity. Users are their to share their lives and to participate in the lives of others. There exists a huge incentive to focus one’s network on the things that really matter in one’s life and not to drown those moments and memories with trivialities and incessant self-promotion. Facebook does not need pricing to encourage self-regulation: it has self-interest working in lockstep with group-interest.

The NYT describes the growing importance of statisticians to solving more and more of our social and business issues. The article makes clear the rapidly increasing importance of statistics, especially in making sense of the immense amounts of data we can now collect, track, and store: “The new breed of statisticians…use powerful computers and sophisticated mathematical models to hunt for meaningful patterns and insights in vast troves of data.” The author tells the poignant story of a woman trained in anthropology and archaeology who went on to get a Ph.D. in statistics because of her interest in doing data analysis for her work.

In my graduate department at Stanford University (Engineering-Economic Systems at the time, now named Management Science and Engineering), we had a saying: “Mathematical Modeling for Human Solutions.” We took pride in taking the tools and techniques of math and statistics to solve practical problems. The article correctly points out “though at the fore, statisticians are only a small part of an army of experts using modern statistical techniques for data analysis. Computing and numerical skills, experts say, matter far more than degrees. So the new data sleuths come from backgrounds like economics, computer science and mathematics.”

I was particularly encouraged to read that Peter Orszag, Director of the Federal Office of Management and Budget, has a keen interest in using statistics to drive sound policy.

In other words, if you are not taking advantage of data analysis to address some of your most vexing problems, you are probably going to get left behind!

On Monday, the Atlanta-Journal Constitution reported that the state of Georgia is considering scrapping its annual sales tax holiday due to budget issues. One legislator expressed his support for the program by claiming: “‘It’s one of those things that spurs people to spend money that they may not otherwise spend. It goes directly to citizens and helps local businesses.’” Right after this quote, we learn, unfortunately, that “…Neither the state nor the Georgia Retail Association have a way to track results of the sales tax holiday.” In other words, lacking data, we could make an claim equally valid to the politician’s that all a tax holiday does is drain the state budget since consumers will simply plan their shopping around the given event.

Without data, we can have no impact. How can anyone really know whether or not a tax holiday not only works or is even worth its cost to the state budget? Certainly, everyone enjoys tax-free shopping, but the cost may outweigh the benefits if, for example, the state is not able to fund other important projects or increases taxes somewhere else to make up for the revenue gap.

These lessons apply in business as well as government. Without data to measure performance, business plans and strategies are subject to the whims of “gut instinct” or personal biases and subjectivity. One person’s success can easily be another person’s failure and power relationships may win the day instead of what actually improves profits.

How could the state of Georgia attack this problem? The first step is the collection of the retail data. This data needs to be daily so seasonal and cyclical patterns can be accounted for. The second step is to consider controlled experiments. For example, run the state holiday on different dates in different counties, skip a year, or change the dates around from year-to-year. In other words, establish a set of data than can be used as the control for comparison of performance. If the quantity of data or the number of stores present large obstacles, establish the data points for select stores that have an established record of sales in the local community. At this level, every effort should be made to track the specific items that consumers purchase as well.

I strongly suspect that if the state of Georgia applied some simple analysis to this program, the results will surprise them!

Disney has increased prices at Walt Disney World despite experiencing a drop in revenues last quarter. In its earnings reported July 30, the company had this to say about operating income: “Lower operating income at the Walt Disney World Resort was primarily due to decreased guest spending and lower corporate alliance income recognition, partially offset by lower costs. Decreased guest spending was driven by lower average daily hotel room rates and lower average ticket prices, which included the impact of promotional programs such as our Buy 4, Get 3 Free program.”

So, how can Disney raise prices right after experiencing these kinds of declines in customer spending? Clearly, the company has a lot of confidence in its branding and large mind share when it comes to family entertainment at theme parks. In fact president and CEO Robert A. Iger said as much: “While a tough global economy impacted our performance in the quarter, we remain encouraged by the relative strength of our business…That strength is the result of Disney’s combination of strong brands, consistent business strategy and the steps we’ve taken to make our businesses more efficient without sacrificing quality.”

More importantly, I suspect that Disney discovered that their promotions did not significantly increase foot traffic into the theme park. In other words, demand for Disney World remains relatively inelastic, even in this recession. It appears that Disney will be better served getting more revenue out of the core group of consumers who attend its theme park for many more reasons beyond price.

Disney’s stock dropped 4% on the day in response to the poor earnings and revenue report. I will be checking in again next quarter to review the impact of these price increases.