PLSC 270: Capitalism: Success, Crisis, and Reform
|Transcript||Audio||Low Bandwidth Video||High Bandwidth Video|
Capitalism: Success, Crisis, and Reform
PLSC 270 - Lecture 8 - Mortal Life Cycle of a Great Technology
Chapter 1. Video: Former CEOs of Polaroid [00:00:00]
Professor Douglas W. Rae: While we get settled, in our, as usual, gradual fashion, I’m going to turn on one of the videos involving the last two CEOs of Polaroid, and then after that, we’ll get into our normal routine. What did you think of those guys? Did you like them?
Professor Douglas W. Rae: Great. We’re going to see part of each slide — there we go.
Chapter 2. Case Discussion: Polaroid: Creation and Destruction Inside the Family Camera [00:07:24]
We’ve got two cases this week, Polaroid and Enron. They are two cases of dramatic success and then dramatic failure. In understanding capitalism, think back to everything we’ve done so far. The idea of abrupt change, of equilibrium always being dislodged, equilibrium always disrupted, and the cardiothoracic systems case from the end of last week was exactly such a story, and Polaroid is very much such a story. Enron has a darker cast to it. It entails the darker side of the human soul. And we’ll hear about that from Jim Alexander, who lived right through the middle of it, on Wednesday.
This is a tracing of the sales volume of Polaroid from 1957 until the firm’s demise. One of the things you can — that is of interest about this diagram, is that the sales at death were not dramatically below their all time peak. So sales alone don’t tell you enough to understand what happened. This is the stock price, and this is — what are stock prices about? What are the drivers? I’m not asking for anything fancy here. What are the drivers — yes, back left.
Student: It’s expected future dividends.
Professor Douglas W. Rae: Okay, expected future earnings, along with some special sauce having to do with future strategy to maintain share price.
Student: Interest rates.
Professor Douglas W. Rae: How would interest rates play into this?
Student: Basically, formulaically, the expectations —
Professor Douglas W. Rae: Okay — just for those of us who are from Illinois, spell it out a little at a time. Who’s from Illinois here? I apologize. Hell, I should have said Indiana, I’m from there. Okay, spell it out for us.
Student: A lower interest rate will yield a higher stock price because there will be less of a tradeoff between spending today and what you get tomorrow.
Professor Douglas W. Rae: Well, sort of. Jim do you want to help with that?
Jim Alexander: They really are a projection of future cash flows to the shareholders, it’s just that it used to be in the 1950s, 1960s, and 1970s, dividends that were the bulk of those assumptions, and today it’s a rare company that makes more than 1% or 2% dividend yield on the stock price. So really it’s a projection of earnings which is encapsulated. When you look at that chart, what you see is the typical problem with a lot of growth stocks and that is people buying onto a whole new paradigm and then extrapolates for decades and you end up with a stock price that really bears no resemblance to current earnings.
Professor Douglas W. Rae: And an increase in interest rates, how would that view —
Jim Alexander: That would — an increase in — all of the things being equal — an increase in current interest rates would lower the stock price because you would have to be compensated for the extra time value of money involved.
Professor Douglas W. Rae: Thanks. Sales, this is a curve in red that we saw in the first slide, with long term debt superposed. Sales reads on the left axis and debt reads on the right. Anything learned from that slide? Come on guys, this is not a curve ball.
Student: Polaroid didn’t have any debt until relatively recently in the last second. Pretty much starting during the recession of the recession of the 1980s
Professor Douglas W. Rae: Was the debt likely to be important there toward the end?
Student: Well, yeah, because they filed for bankruptcy.
Professor Douglas W. Rae: They did. And what was the precise event that caused them to file? It’s the 10Q filing in the case, did anybody notice that?
Student: A takeover attempt.
Professor Douglas W. Rae: No.
Professor Douglas W. Rae: Seaconch.
Professor Douglas W. Rae: Not really. It was related to 9/11. What happened was, they failed to make a scheduled payment on the debt and that triggered an avalanche of adverse results, drove the stock price close to zero, and how does the firm end up? What becomes of it? It gets — sold?
Student: Sold to the private equity companies.
Professor Douglas W. Rae: Sold to private equity, and how much of its value do you think is — of its peak value is there at the end when it’s sold to private equity? You don’t have to give me a number, just give me a lot/a little —
Student: I think 20%.
Professor Douglas W. Rae: I think less, it sold for $265 million at that end stage. Now what was the value proposition? I guess that’s a hint. What would have caused you — here is a Polaroid Pronto, which hasn’t made a picture in a lifetime, what would it have cost — I probably bought over the years three or four of these cameras. I was never terrifically happy with them. Any of you ever own one? You’re all way too young — almost all. Tell us —
Student: Yeah, I got one as a birthday present as a novelty for like, three months.
Professor Douglas W. Rae: How old were you?
Student: I was eight.
Professor Douglas W. Rae: So you probably didn’t have an independent account for buying film? Do you have any memory of how the film’s price compared — well you didn’t buy the camera.
Student: No, I didn’t know anything about the pricing. I just liked that it came out instantly.
Professor Douglas W. Rae: Okay, did anyone own one at an age older than eight? Back center —
Student: I had my grandmother’s old one. I was 11.
Professor Douglas W. Rae: I can guess what you paid for the camera.
Student: I mean it was a hand me down, and I took, like, ten pictures, and I asked my mom to buy more and she was like, “No, we’re just going to get a disposable.”
Professor Douglas W. Rae: Okay, so the sales metaphor in the case, anybody remember what analogy do they draw in the marketing strategy?
Student: I think it was razor and blade.
Professor Douglas W. Rae: Razor and blade, help us understand that.
Student: Yeah, basically the current interest of the company that sells razors, they’re not making that much money on the actual price of the razors, some could argue that they can even give that to you. Their profit really comes from that people have to buy blades in order to use the razor.
Professor Douglas W. Rae: Okay, great. Can we think of any other analogies in marketing strategies? Here in the alligator shirt.
Student: Printers and ink cartridges.
Professor Douglas W. Rae: Printers and cartridges. You’ve noticed that the printers sell for nothing, and the cartridges cost your firstborn child. It’s not a bad strategy because most of us try to minimize the initial cash outlay when we buy something and then you get hit in the back of the head by the maintenance of it. And that was the strategy for Polaroid, and it was in some periods a very successful strategy.
What’s the value proposition? We get two dimensions here, let’s put them together, actually. The quality dimension, I think this is 1948; this is the first Polaroid camera on the retail market. It was much too — I was nine at the time, so I can empathize with you guys, but I was nowhere near rich enough to purchase a Polaroid Land camera. It was a very upscale, fancy idea. But I did see pictures made with it, and they were sepia tone and muddy; very low contrast. They were very bad compared with what could be produced by conventional photography. The question was — let’s think about three kinds of consumers, and this was largely a consumer product. It had scientific and business applications, and industrial applications, but from Land’s point of view all the way the real darling was the amateur photographer. Let’s use indifference curves in this space, so we’ve got speed on the horizontal dimension and quality on the vertical dimension, and a person who says, “I’m indifferent between all these outcomes,” how would we describe that person’s preference?
Student: A professional. If he’s indifferent to speed; there’s a [Inaudible] of quality.
Professor Douglas W. Rae: I’m unable to locate you. Where are you? Wave. Oh, hi. It would be a professional or perfectionist. The model might be Ansel Adams, somebody who makes wonderful pictures and is willing to wait, and is virtually indifferent to the time dimension, so that person is trying to climb in this direction, indifference curve over indifference curve. This person — Tim what’s this person up too? They’re trying to go out that way as fast as they can.
Student: They’re trying to get faster and faster pictures.
Professor Douglas W. Rae: Yeah, cheap thrills, just like our friend back here when he was eight. All they want is speed. How many customers do you think fit either of these descriptions? A few fit the first description, a few fit the second description, but most are more like this. They have a tradeoff, which I’ve simplified with straight lines, they probably would actually bow in toward the origin like this, but these people want some combination of speed and quality. The central drive for the Polaroid Land Camera from 1948 all the way to the end, was to do as well as possible in competing for the business of these people who were trading off the two dimensions. The SX-70, which was in some ways, the high point of Polaroid’s history and in other ways the low point. Anybody remember what was wrong with the SX-70?
Student: It had battery problems.
Professor Douglas W. Rae: It had — how — do you remember from the case how the battery was related to the thing?
Student: Not really.
Professor Douglas W. Rae: I think Jim Alexander and I are the only people here who ever experienced this. The battery was included in the film pack, and for the first couple of years they made it, about half the batteries were no good. If you spent a premium for the film pack and the battery wouldn’t make the camera run, you were likely to be an unhappy customer. They had a very high complaint rate about that. Does anybody remember what they did to resolve the battery problem?
Student: They manufactured their own batteries.
Professor Douglas W. Rae: Yeah, they went into the battery manufacturing business, which is as we’ll see in a minute, is an integration move, where they reduce their reliance on outside suppliers but create a whole set of new problems for themselves, because it turns out it’s not very easy to manufacture batteries well. The Polaroid SX-70 had gained enormous ground on conventional photography on the quality dimension. It was a lot better than the old Polaroid, but it was still — nobody drunk or sober would argue that the pictures produced by the Polaroid SX-70 were as good as those produced by a conventional single SLR, single lens reflex 35mm camera with competent processing. They were in a position where they had a deficit on the quality side, which they never actually overcame. They did better and better on picture quality but they never really got to where they matched conventional photography. The — I’ve drawn this so that they’re on a higher indifference curve for this particular consumer than the conventional photography. There were several problems lurking in that. One of them — how could this have happened? Without any improvement in either the film or the camera on the conventional side, the conventional photographic technology gained ground on the speed dimension and a gained a lot of it.
Student: With the advent of the one-hour photo.
Professor Douglas W. Rae: Okay, so the one photo processing took three days, or five business days, and brought it down to an errand. You drop the film off, go have a cup of coffee, come back, so that conventional photography with no internal improvement was closing the speed gap, and diminishing total demand for instant photography. Now there’s an incident about this stage between Polaroid and Kodak. Anybody remember how that goes? How had — had Kodak played any part in Polaroid’s business? Any cooperative part in the early years?
Student: It manufactured the camera.
Professor Douglas W. Rae: Yeah it — Kodak was manufacturing for Polaroid. As it manufactured it learned the secret sauce and then went into the business, competing and competing effectively against Polaroid with a tricked up reconfiguration of Polaroid’s technology. Polaroid responded with a lawsuit. They won the lawsuit. They nonetheless got screwed. How could that be? They win the — they get a billion dollars in damages, or just a little short of a billion dollars in damages, and yet Polaroid’s theft is all but lethal to them.
Student: I think it took them a lot of time and effort to fight that case, and when they finally got the reward, it wasn’t as much as they expected. Then there was also this comment later that they kind of wished that Kodak had — that they had merged with Kodak and that didn’t happen, and that is because Kodak did not — had too much of an ego.
Professor Douglas W. Rae: Both sides had a lot of ego. That’s a — you got it. What was needed was an immediate intervention. The case went on almost fifteen years and while it was going on, Kodak was eating into the competitive position occupied by Polaroid. There’s, of course, something else going on here and that’s the emergence of digital. Digital photography, with one important asterisk, trumped everything. It didn’t stand still, it traced a path, and it’s still on that path of virtually continuous improvement. A $200 digital camera now is as good as a $10,000 digital camera a decade ago. The — hands up if you use a digital camera? Yeah, everybody. On average my guess is that your digital cameras are about like that? They’re tiny, are they hard to work? Do the batteries fail? There’s only one thing they don’t do very well and what’s that?
Student: Take pictures in the dark.
Professor Douglas W. Rae: Well, they actually do that better than conventional cameras, but no camera does that very well. What’s — my mother hates them, why would a ninety-five year old —
Student: They don’t print.
Professor Douglas W. Rae: They don’t print. Her idea of a photo is something you hold in your hands and it’s not a real photo unless she can hold it in her hands, put it on the coffee table, show it to her friends from the coffee table, and Edwin Land actually agreed with that. It was — part of his infatuation with the original Polaroid idea was that you make the picture, wave it for a minute until it dries, and hand it to the people who are in the view.
Chapter 3. Polaroid: Vertical Integration [00:28:43]
Now we’re going to go back to the case in this informal way in just a minute, but I’m going to talk about integration here, because vertical integration is a huge part of the Polaroid story, and it’s an important part of most corporate stories.
Vertical integration is the — think of the dimension that starts with raw product ore coming out of a mine, sugar cane coming out of a field, bananas coming out of a rain forest. And then there is a progression toward a manufacturing or processing plant, or perhaps a series of manufacturing steps. Then the distribution of the product to wholesalers, and from wholesalers to retailers, and from retailers to the family picnic. And a full story of vertical integration looks like this; everything is in the corporate box from beginning to end. The plus of that is obvious. The trouble you might have with your suppliers is completely eliminated, and the ability to direct the details of every step is seemingly unlimited. The downside — there are at least two obvious downsides. One is a lot of companies are good at the front end without being good at the back end. If they go from the front end, from marketing a retail product all the way back to the first steps of its production, they may well screw up because it’s just not what they do well. That’s one difficulty.
Another difficulty is governance. The management of a vertically integrated company is a very complicated process, and it tends, as with the railroads we saw a week ago, it tends to bloat the administrative apparatus, make it have many dimensions from top to plant floor, and presents serious challenges. Now that’s only half the story. The other half of vertical integration has to do with ideas. There’s a — what I just talked about has to do with physical stuff, material things. There is also an intellectual track or ideational track, which starts with dreams or ideas drawn on the back of a napkin, and then invokes science and engineering, and design, and a marketing plan. It is in effect the brains behind the lower box and with Polaroid you had a fully integrated company. Now they didn’t do mines and fields, but you had a high degree of vertical integration in the ideas process, and almost as high a degree of integration in the material process. So you end up there. Now —
Chapter 4. Polaroid: Why Did the Company Fail? [00:32:30]
W hy did this company fail? Let’s start with — I’ve got warm calls. Amed, why do you think the company failed?
Student: They failed because of the capabilities and beliefs of the 1980s that influenced their strategies. They couldn’t — they were more technology driven and not market driven, and reasons, and so forth — because of senior management.
Professor Douglas W. Rae: Okay, who was this Edwin Land guy?
Student: A scientist who —
Professor Douglas W. Rae: He was scientist. When does he get his start as an inventor? Does anybody from remember the case?
Student: It didn’t say.
Professor Douglas W. Rae: Pardon.
Professor Douglas W. Rae: Harvard College, he’s an undergraduate, and he invents Polaroid filters; clever lad. He gets fixated, I think, on a certain view of how you do wonderful things and it focuses on long, costly, time consuming research. Lindsey Jackson, anything to add to that?
Student: About Land?
Professor Douglas W. Rae: About Land or about the causes of failure.
Student: Well, I could just go off of Land’s — it was genius what he was able to do. He was so technology driven, and he was able to create such a successful company, and at a certain point he didn’t have any competition — or no real competition —
Professor Douglas W. Rae: No direct competition.
Student: And because this technology was driving and proved to be successful, as the company grew older they got fixated onto something that technology was going — result in and drive them, so they were hesitant change.
Professor Douglas W. Rae: That’s terrific. So we combine an initial fixation on a very intellectualized R&D process, which is very slow and mildly contemptuous of marketing, and we combine that with a wildly successful market product which was not designed by careful analysis of consumer indifference curves. It was designed by Edwin Land’s passion for this product. He correctly guessed, he lucked out, he correctly guessed that it would command an enormous consumer market, and sure enough, it did. We’ve got a kind of path dependent story there. Ben Chu? Is there anything left to talk about on this, or are we done?
Student: When Polaroid was developing its newer technologies, it’s important to realize that it’s not that they were stuck in the Stone Age. They were trying to develop — they made forays into digital imagery, but they still were — they were still shackled by the idea of making money with razor blades, marketing strategy, and really making money with printing on film.
Professor Douglas W. Rae: Absolutely. There’s a wonderful quote toward the end of the piece you guys read, do you remember it? Here it is. They’re talking about what a wonderful and highly marketable device the digital camera is, and the — this is a marketing person talking to a senior executive, and the senior executive’s response is, “Where’s the film? That’s where the money is.” Of course there is no film, and there is no money in film. All the money is in the hardware. That was a hard idea for Polaroid’s top management to square with the initial model based on razors and razor blades.
There’s another idea that appears in — this is one of the papers cited at the end of the case. There’s another idea there that may be important and it’s called bounded rationality. Hum if bounded rationality is a familiar concept. We should stop and talk about it. Edwin Land, let’s say his IQ was 290, since they divide by age I think he would have had to be about age three when it was measured for that to be even logically possible, but let’s suppose he’s the smartest guy in the world. He nonetheless thinks in bounded rationality. What that means is in order to get started thinking about something, you have to explicitly or implicitly make a bunch of assumptions. Those assumptions are typically arbitrary. You can’t examine every aspect of every assumption and ever get anything done intellectually. It’s a true statement.
The task of managing a company is exceedingly complex. Edwin Land and Mack Booth and the other people — you have this very messy chart here that I took down from the case — none of these senior executives was ultimately able to think in a way that was effective, because the bounding assumptions prohibited it. What’s so hard about this? What would make it hard to run Polaroid or Ford Motor Company? What — yes —
Student: Because the assumptions that they — Polaroid to begin with was basically a research driven company, and the assumptions that they were making the benchmark, was that Polaroid is a research driven company, which in effect, was not correct, because as the markets were changing, it sapped all flexibility to be nimble and respond to the competition instead.
Professor Douglas W. Rae: Okay, great. Is there an analogy in what happened to them in anything about the cardiothoracic systems case? What was the — I thought Karen did a — Sharon did a fabulous job of teaching it. Why was it that the two-artery strategy for cardiothoracic systems had to be abandoned? Do you remember? Some of you said it. Well it is this, that the companies who were making the devices for non-surgical intervention, the stints, and the little balloons, and all that stuff were what kind of companies? Huge, well-funded companies, which were not going to let somebody come in and take market share without developing a new step of competitive device.
One of the very hard things about running a big company is that you have to be aware of all the other players out there who may be doing something to damage your market. They probably aren’t even trying to damage your market; they are probably not even thinking much about you, but instead trying to develop their own boundedly rational idea of their company. In this case Polaroid was badly bitten, both by one hour film processing and by digitals, and in the case of the one-hour film processing, it wasn’t even the processors so much who were in competition with Polaroid, but the conventional film people, such as Kodak.
Part of the story then is bounded rationality; part of it has to do with drawing the wrong lessons from early success. Part of it has to do with something totally irrational, which was the commitment to a founder figure. Is it generally the case that brilliant engineers run huge companies which produce the products based on their ideas? It’s not generally the case. I mean, we can all name cases, but in general, the engineers who create devices are forced out of top management and replaced by people who are general managers. That’s what happened at Polaroid, but it happened too late. It happened much too late.
Chapter 5. Polaroid: What Could Have Been Done to Save the Company? [00:42:47]
Now if you were going to save Polaroid, let’s say in the 1980s, let’s suppose you are Mack Booth and it’s your task to give this company the best chance of preserving its value going into the future, what would you do? What they did do was a hell of a lot of R&D on a long string of projects which failed. Some of them were artistic or engineering successes, but none of them were economic successes. Polar Vision was a disaster, Helios was actually a really good product, but they didn’t manage to recoup their investment. What would you have done? If your — are you ready?
Student: I’m actually visiting.
Professor Douglas W. Rae: I’m going to cold call you anyway. The nice thing is you don’t have anything at risk. Well you didn’t read the case, so that’s unfair. Are you —
Student: I am in the class.
Professor Douglas W. Rae: Okay, good. What might you have done to save this company?
Student: I really do agree with what Booth said. He said that he would have probably merged with Fuji and kind of use the best aspects of both, because Fuji was moving forward, hopefully digital, and they were still kind of doing instant photography. Because one of the things that they were still, I think, fixated upon was instant photography, what the founder founded, so they were — because that kind of cult, and if they weren’t really moving on towards other things and improving on it.
Professor Douglas W. Rae: Okay, so a merger might well have been the best play. Now why would it — what would make it hard to do?
Student: I think it’s the culture of the company that they would — it’s the whole ego trip thing, they don’t really — kind of like they had to cheat and the vertical integration was part of the reason they were so proud of it.
Professor Douglas W. Rae: Oka,y so part of it is culture. I think that debt of theirs would have weakened their bargaining position. Yes.
Student: Rather than mergin a company, I think that Polaroid could have done something along the lines of what IBM is doing now, become a completely research based company, cut out their marketing, cut out their consumer processes, and just research for Fuji, research for, conduct new research designs for other companies who are in the consumer field. So cut down on your vertical integration.
Professor Douglas W. Rae: Okay, that might actually — that makes a certain kind of sense. Talk a little more and defend the idea.
Student: Because at the end of the day, the whole company culture was driven towards cutting edge research. A lot of their successful products were because they were able to invent and create products that were successful on lines of, not success of marketing, not successful marketing strategies, but they were able to create products which were ahead of the curve in terms of technology. Since the whole market, the industry was moving towards the addition of platform, perhaps they could become leaders of developing these technologies with the improved digital products in the future.
Professor Douglas W. Rae: Okay, that’s a very interesting suggestion. Yes.
Student: I still think that the merger wouldn’t go well because of the vertical integration that Polaroid had in place. They had huge facilities and machines designed for peak times and sales. And these fixed costs would have been a big problem for Kodak, so I think they wouldn’t merge with them.
Professor Douglas W. Rae: That might well be. I mean they might have liquidated those through private equity and kept intact the rest.
Student: I think they were specialized on the films of Polaroid.
Professor Douglas W. Rae: Yeah, okay. Let’s turn to Enron now. Enron is another innovation company. Jim, can you come up for just a second? I didn’t warn him about this. Jim, as I said to those of you who were here at the beginning of shopping period, Jim was Chief Financial Officer of Enron Global Power & Pipeline, and saw the process from the beginning. He came from a long career in investment banking before that. Culture of innovation at Enron, was it important from day one when you were arrived there as a consultant?
Jim Alexander: Yes, it was a culture of innovation that was impressed upon the organization by Ken Lay, because he was trying to avoid the mindset that was typical of natural gas pipelines at the time, which was very much a monopoly rate based rate of return, it doesn’t matter if you make any money kind of a mindset, and he went way overboard in reversing that.
Professor Douglas W. Rae: Okay, was Ken Lay a famous manager, and was Enron receiving prizes, for example, from The Harvard Business School as the best run company in the country?
Jim Alexander: Yes, I’ve always thought that —
Professor Douglas W. Rae: Jim is a graduate of Yale College and HBS, so we whipsaw him here a little.
Jim Alexander: One of those things I’ve always thought people ought to do though is in terms of looking at industries in decline is to look at plaudit’s from HBS and the percent of graduates from HBS going to a given industry.
Professor Douglas W. Rae: Okay, so the case for Wednesday is “Innovation corrupted,” it’s an HBS case, and it was in that packet of three which you got a week ago. Please read it with care. Jim and I will do this interrogatively; we’ll sit together and talk it through, and turn to you intermittently for help in solving Enron’s dilemmas. I’d like to meet briefly with the graduate students who are in this course at the — at now.
[end of transcript]Back to Top
|mp3||mov [100MB]||mov [500MB]|