It’s about time - Changes to regulations for credit card debt
The smartest behavioral economists in the world run credit card companies. I’ve always believed that. If you ever wanted absolute proof that the ‘rational actor’ model of economic behavior is completely unrealistic, you need look no further than the way the credit card industry makes money. They understand exactly how to get people to spend money (often, money they haven’t got) and extract the highest possible amount of profit out of their customers.
In a rational world, people would make decisions on the basis of what the economists call ‘expected utility’ theory. In other words, you’d assess the riskiness and desirability of an expenditure by weighing the value (to you) of an outcome multiplied by its probability of happening. But in the real world, nobody actually makes decisions that way - instead, they make judgments about the ‘utility’ (or benefit) to be gained by reference to some experience they have had in the past, and often weight probabilities in a non-linear fashion. In the case of credit cards, few people think about what might happen if an event they didn’t anticipate causes them to miss payments, while the immediate gains to buying something they want or need are a sure thing. A second rational idea in economics is that all future cash flows are subject to ‘exponential discounting’. That’s a fancy way of saying that if the math works out identically over time, people should not prefer one option over another if it’s time-value is the same. Totally not true. Firstly, we like immediate gratification. Studies have shown that people prefer getting $100 now over getting $110 in a week. Introduced delayed gratification, however, and their choices change—they prefer getting $110 in 11 weeks to getting $100 in 10, even though the value of waiting a week is $10 in both cases. Our strong preference for immediate gratification so dominates economic logic that it plays right into the hands of credit card issues—I mean, the whole thing is about buy it now. Finally, rational economists posit that people making decisions will gather all available information and base their decisions on it. Instead, what actually happens is that people over-weight easy-to-get information (such as what your sister told you about her great credit card deal), and tend to give more credence to information that is supported by lots of examples of others doing the same thing (witness all those souls who invested with Bernie Madoff because everybody else was investing with Bernie Madoff!). So when college kids get a credit card offer, they’ll believe the person making the offer and do what all their friends are doing—and Lord know how facebook and related resources are reinforcing this particular bias.
Which brings me to a very welcome bit of news in today’s Wall Street Journal
. Regulators, the article reports, are going to introduce rules that rein in some of the most egregious practices of credit card issuers. The two headliners are:
- Increasing interest rates on existing credit card balances
- Increasing rates on customers who have not fallen behind on their payments to the credit card company but who may have missed payments on some other bill - such as a phone bill
In my opinion, these new limits are long overdue. With their insight into human behavior, card companies have facilitated a great deal of foolishness on the part of their customers. I’m not an apologist for people who overspend - they should indeed pay their debts and pay the companies that effectively lent them the money interest. But I think changing the expense retrospectively, often when a consumer has absolutely no way of extricating themselves quickly from the revolving debt is not an attractive, fair, or customer friendly practice. And punishing people for failure to pay other people when they have been good customers of yours seems grossly unfair (and yes, I do understand the argument that failure to pay the phone bill means a consumer is in a riskier class - but you should have assessed their credit worthiness when you made the loan, not after the fact).
The Journal reports that the amount of revolving debt in the United States stands at $976.1 billion. That’s an amazing amount of money to be subject to practices that most people would agree defy any sense of fairness or good business practice.
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American carmakers and fleet rentals - an unfortunate relationship
Rich Karlgaard, writing a recent piece in Forbes made an observation that expresses something I have long believed. American carmakers have done themselves a nasty disservice by sending car rental companies their ‘fleet sales’ versions of their products. Why? Because those often low-frills, underpowered and difficult to manage autos are often the only time you’ll ever get much of the population behind the wheel of an American car.
When I was growing up, my family owned American cars. The logic at the time was that it was good to have an American car because then you wouldn’t have to wait for spare parts to be shipped in from all over the place. Then the Japanese and Germans started offering cars that were not only more fuel-efficient, but guess what? They undercut the American carmakers contention that local spare parts were a good thing by providing autos of such high quality that they didn’t need spare parts! Now that’s a concept. In my own, grown-up car-buying life, I’ll confess to not even being tempted by an American car (unless you count our Volvo as an “American” car because it’s owned by an American firm).
So when do I drive American? When I rent a car, and the experience has almost always been disappointing. Cars like the Ford Taurus sort of ‘fit’ me all wrong - I feel as though I can’t see over the dashboard. My husband, daughter and I ended up having to drive a HUGE American car on a visit to California last year, which we absolutely hated. It was the only one left at the car rental place - not the one we ordered. To add insult to injury, our hotel charged us extra for parking such a huge vehicle. Needless to say, our rental experiences have not encouraged us to go spend some time in a showroom.
It certainly seems to be a short-sighted strategy if the goal is to tempt people into giving your product another chance.
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The Big Three and Symbolic Chernobyls - will they never Learn?
Today’s headlines in most major newspapers have detailed the sad story of the CEO’s of the Big Three American automakers slinking off back to their offices—well, actually traveling back to their offices in private jets—after being turned down in a massive bailout request that would allow them to continue to operate, business as usual, courtesy of the American taxpayer. I am not a fan of this idea at all (for my views on this, see this post at Columbia Business School’s web site - Public Offering). Indeed, it was gratifying to note that Jack Welch isn’t a fan of this either (see his column in Business Week. But this post isn’t about that issue. It’s about the jets. It seems that the leaders of these companies really need to get out of those out of date buildings and get some external perspective.
One of the points I always emphasize in leadership seminars is that symbolism is one of the most powerful allies - or enemies - you can have as a leader. The old illustration of this was the contrasting behavior of Lee Iacocca then CEO of Chrysler, and Roger Smith, then of GM. Iacocca, in trying to reach agreement with the unions, famously said that he would work for $1 a year until things turned around. The union leaders felt this showed important solidarity with the troops and with their help and some government assistance, Chrysler was able to recover (for a while at least). Smith, on the other hand, saw what Iacocca had done and said to his folks, “guys, I feel your pain - so much that I’m going to cut my salary by 25%.” The amount he was cutting was more than a typical auto worker saw in a lifetime. Symbolic blowout.
My colleague, Don Hambrick, always reminds us that a symbol is an artifact that has meaning beyond its inherent substance. And that executives simply cannot escape from ‘symbolic fallout’ - the meaning that others attach to their actions, whatever their intentions were. Which brings me back to the auto-makers. For goodness sake, isn’t anybody in their organizations plugged in enough to what is going on in the economy to realize that flying around in corporate jets—particularly to ask for taxpayer assistance—is a symbolic disaster??? That cluelessness alone suggests they shouldn’t get the money. What if instead, all three of them took the best and nicest cars they make and drove them to Washington? You know, on roads. You know, like the rest of us? At least the symbolism would suggest that they like, enjoy and are proud of their products.
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- Posted Rita McGrath on November 21, 2008
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Management Techniques actually work!
If you didn’t catch the article by Scott Thurm in today’s Wall Street Journal, you should check it out.
He reports that researchers from Stanford University, the London School of Economics and the consulting firm McKinsey & Co. found that solid management techniques, yes, the kind we teach in business schools, actually make a difference to the performance of manufacturing plants. They found that better managed facilities employed management tools that helped them achieve better performance. It’s comforting to know that the research we do and the resulting tools and techniques can have a good performance effect.
Among the studies’ more intersting finding is that (for now) factories in the US are better managed than those in other countries. But - that gap could soon close, they warn.
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- Posted Rita McGrath on September 08, 2008
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So now CEO’s have to create value? How novel!
It was fascinating to read in this week’s Business Week that as easy money has evaporated in the world of private equity, that the CEO’s of these firms have to resort to the traditional practice of management - “making the companies they control more profitable” as the magazine says (November 5, 2007 issue, page 40). Astonishing. And perhaps gratifying, as we see evidence that the folks with purely financial know-how have come a cropper, to think that perhaps knowing how to actually run a company has value.
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- Posted Rita McGrath on October 29, 2007
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