Tag Archives: Finance

What Your Credit-Card Offers Say About You

See the original article on WSJ Experts page>>

credit_card_finances_gettyAs more and more personal data becomes available, businesses are now able to target customers in a personalized and sophisticated way.  On the bright side, that means you can get products and services that are tailored to your needs. As a result, you are much less likely to get catalogs featuring dresses your grandmother might wear. But, according to our research, the downside is that companies can also more effectively target your behavioral weaknesses, self-control issues or lack of attention to the fine print. We find that credit-card companies tend to offer those customers who are least able to manage the complexity of credit-card contracts, the most complex features and hidden charges.

As part of our research at MIT with my colleague Hong Ru, we recently studied over one million credit-card mailing campaigns that were sent to a representative set of U.S. households from March 1999 to February 2011. We devised algorithms to classify the terms of the credit cards and also the advertising material. Studying the wide variety of offers and who received which offer was illuminating. Credit-card terms offered to more financially sophisticated consumers differ significantly from those offered to less sophisticated customers, where educational attainment served as a proxy for sophistication.

The offers differed in both substance and style.  Less-sophisticated borrowers received offers with low teaser rates, more rewards, visual distractions, and fine print at the end of the offer letter. However, these offers also had more back-loaded and hidden fees. For example, after the introductory period, these cards have higher rates, late fees and overlimit fees.

In contrast, cards that are offered to sophisticated customers rely much less on back-loaded fees and instead have higher upfront fees, such as annual fees.  These cards tend to have higher regular annual percentage rates and often carry an annual fee, but they have low late fees and over-the-limit fees and are more likely to carry airline miles as rewards.

Not surprisingly, the worse the credit terms, the more likely they are to appear either in small font or on the last pages of the offer letters.  Similarly, offer letters with back-loaded terms contain more photos and less text, perhaps to distract from the details of the offer—what we refer to as shrouded attributes.

In fact, we found that banks seem to carefully monitor how the use of such shrouded attributes might affect the likelihood that unsophisticated customers will default on their debts. Our study showed that less-educated consumers who have lower default risk are more subject to back-loaded or shrouded fees. We also found that in states where there was an increase in unemployment insurance benefits that help borrowers maintain more stable cash flows in the event of a job loss, banks issued potential borrowers within that state more offers with lower teaser rates but higher late fees and default penalties. Banks also increased the flashiness of the offer letter, with more colors and photos, but moved the information about the back-loaded features to the end of the letter.

Taken together, these results suggest that credit-card companies realize that there is an inherent trade-off in the use of back-loaded features in credit-card offers: They might induce customers to take on more (expensive) credit, but at the same time, they expose the lender to greater risk if those consumers do not anticipate the true cost of credit.

So what’s the upshot of our study? First, you are lucky if you have a good education, since it means that the set of credit cards you get to choose from is already better from the start. But independent of your educational status, consumers should know that they have the power and information to choose well. Each credit-card offer in the U.S. must by law have a text box that contains all the relevant terms of the offer in one place; this is called the Schumer box after Sen. Chuck Schumer of New York.

So the best way to choose a credit card is to literally throw away all the marketing material at the front of the offer and simply focus on the real information in the Schumer box. This is true no matter what your income or education level.

Antoinette Schoar is the Michael Koerner ’49 professor of entrepreneurial finance and chair of the finance department at the MIT Sloan School of Management.

How much do natural disasters really cost corporate America?

See the original article posted on Fortune here>>

Sales growth of supplier firms directly hit by a natural disaster drops by around five percentage points, according to a study.

As spring begins in New England after record-setting snowfall this winter, the economic consequences of natural disaster are a common topic of discussion. We know it will have a big impact on New England, but will it affect other parts of the country? If so, who will be affected and how much?

We hear these types of questions a lot following any type of disaster whether it is weather related or not. For instance, the fear of contagion was at the root of the decision of the U.S. government to bailout Chrysler and GM in 2008. Surprisingly, Ford’s CEO Allan Mullaly himself advocated the bailout of his two competitors in front of a U.S. Senate committee, as he recognized that “the collapse of one or both of our domestic competitors would threaten Ford because we have 80% overlap in supplier networks and nearly 25% of Ford’s top dealers also own GM and Chrysler franchises.”

So the key question is: When a shock — like a natural disaster or financial crisis — hits a supplier, what really happens to the firms in that network? Is there a spillover effects? To address this issues, we studied the transmission of shock caused by natural disasters in the past 30 years in the U.S. within the supply chain of publicly traded firms. We analyzed a sample of 2000 large corporations and 4000 of their suppliers.

You’d think that at a firm level, shocks could easily be absorbed in production networks. Even when they face disruptions, firms are supposedly flexible enough to change their production mix or switch to other suppliers. However, our study showed that shocks cause significant effects in production networks.

First, we found that the sales growth of supplier firms directly hit by a natural disaster drops by around five percentage points. The customers of these suppliers are also disrupted, as their sales growth drops on average by two percentage points when one of their suppliers is hit by a natural disaster. This is a strikingly large effect. We also found evidence that customers with lower inventories are the most exposed to disruption affecting their suppliers.

Then we investigated whether the drop in firms’ sales caused by supply disruptions translates into value losses. Our study shows that supply disruptions caused a 1% drop in customer firms’ equity value. This effect is almost twice as large when the disrupted supplier is a specific supplier, meaning a supplier producing differentiated goods, generating high R&D expenses, or holding patents.

Finally, we looked at whether the shock originating from one supplier propagates to other suppliers of the same firm, which were not directly affected by the natural disaster. You might expect that firms would continue to buy from other suppliers outside of the natural disaster zone, or that the other suppliers would find alternative buyers. However, our research shows large negative spillovers of the initial shock to other suppliers. We found that other suppliers of a main customer see a drop in sales growth by roughly three percentage points.

These findings highlight the presence of strong interdependencies in production networks. In other words, production networks matter. When one of your suppliers or customers is experiencing a negative event, there will be important implications for you.

This research likely applies to contexts beyond natural disasters, such as strikes and financial recessions. More generally, shocks that originate in one part of the economy can be amplified because of the strong interconnections between firms.

As for the economic impact of the weather in New England this winter, there is good reason to think that the effects will be propagated to other parts of the economy through relationships that Massachusetts firms have with customers all over the country. But who will be affected and how much? We’ll have to wait and see.

Jean-Noel Barrot is assistant professor of finance at the MIT Sloan School of Management. Julien Sauvagnat is a postdoctoral researcher at ENSAE-CREST and is expected to join Bocconi University in September 2015.

Why the Internet did not kill RadioShack

See the original article posted on Fortune Insider here>>

Although the electronics retailer is the latest victim in the rise of e-commerce, several other missteps led to its demise.

We’ve seen the downfall of many bricks and mortar stores over the last decade, including Borders, Circuit City, and most recently, RadioShack — to name just a few. As e-commerce continues to rise, it’s seemingly becoming more difficult for traditional stores to stay in business.

It’s true that online shopping has significantly grown over the last 10 years. Even in the last year, we’ve seen a noticeable uptick. According to the U.S. Census, total e-commerce sales for 2014 in the U.S. were estimated at $304.9 billion, which is a 15.4% increase from 2013. However, plenty of bricks and mortar stores are still healthy. Is it fair to blame e-commerce for every store closing and bankruptcy?

As a U.S. bankruptcy judge on Tuesday said he would approve a plan by the electronics retailer to sell 1,740 of its stores to the Standard General hedge fund and exit bankruptcy, it’s worth taking a closer look at why RadioShack failed. E-commerce wasn’t the only culprit. One big mistake involved poor strategic decisions over its financials. Feeling undervalued, the retailer bought back $400 million in stock in 2010 when its net profit was $206 million. It did something similar in 2011 when its net profit had declined to $72 million and it did another buy back for $113 million. In the end, it spent more than $500 million trying to push up the stock price.

However, the company didn’t make enough money to finance the buy back and had to borrow money, which increased its debt-to- value ratio and left RadioShack vulnerable to a declining profits. Rather than buying back so much of the stock and taking on debt, it should have accepted the valuation, closed a few inefficient stores and avoided bankruptcy.

Another significant mistake was its decision to change its product market strategy. In prior years, RadioShack was known as the place to go for hard-to-find parts and components needed to build things. It also had knowledgeable staff who could help customers with high-level customer service. Customers were willing to pay higher prices because of this additional value. After all, there is a difference between getting helpful information in person and trying to explain an issue via the phone, an online chat, or a Google search.

When RadioShack changed its business model to sell finished products like laptops and phones, it lost that competitive edge. Customers could get those finished products from many other retailers and e-commerce sites at lower prices. And a higher-level of customer service wasn’t needed for those products.

While it’s too late for RadioShack, its demise offers some important takeaways for other bricks and mortar stores:

Find a competitive edge. If you offer a unique product, like RadioShack did with selling specialty components, don’t disregard that strength.

Be aware of price sensitivities. A big challenge for bricks and mortar stores is that they have to pay for overhead whereas online retailers don’t, allowing them to charge lower prices. Customers are more likely to price shop for larger and more expensive items, especially ones readily available online like phones and tablets. They tend to be less price sensitive about small and specific goods like the components previously sold by RadioShack.

Focus on customer experience. A big draw for RadioShack was its knowledgeable staff. When it moved to selling finished products, the need for that staff — and consumer willingness to pay higher prices — disappeared. Many people still value talking to a real person.

Looking ahead, it won’t be smooth sailing for traditional stores. But it won’t be all doom and gloom either if they can learn from the mistakes of retailers like RadioShack.

Andrey Malenko is the Jon D. Gruber Career Development Assistant Professor of Finance at the MIT Sloan School of Management.