Managerial Economics and Decision Sciences

  • Sandeep Baliga
    Sandeep Baliga
    Professor of Managerial Economics and Decision Sciences Sandeep Baliga Photo © Nathan Mandell

The Managerial Economics and Decision Sciences Department (MEDS) is a combination of the Managerial Economics, Decision Sciences and Operations Management Programs.

The faculty of the Kellogg School's MEDS department are world-renowned for their teaching concentrates on probability, work in game theory, decision theory, statistics and microeconomics. more...

Kellogg Insight presents articles on Managerial Economics & Decision Sciences

How Malls Die—and How Your Business Could Be Next: When retail-store locations go under, they drag nearby stores down too

The global financial crisis of 2008 might not appear to have much in common with a derelict shopping mall in your neighborhood. But both are examples of how financial distress can spread through markets like a contagious disease. Unlike global financial markets, the retail stores in a mall are primarily connected via their physical proximity to one another—a phenomenon that economists call “retail agglomeration.” But the connections within these local, brick-and-mortar “networks” can propagate economic shocks just as powerfully as the virtual networks that connected Lehmann Brothers and Goldman Sachs. And just as the failure of one investment bank started a domino effect that threatened its peers and competitors around the globe, the bankruptcy of a large retail location in a mall or shopping center puts neighboring stores at increased risk of failure as well.

Even if the local economic conditions are otherwise good, the loss of a single retail tenant exposes every other store around it to a potential cascade of ill economic outcomes.

Safety in Numbers

This effect is identified by economist Efraim Benmelech in the paper “The Agglomeration of Bankruptcy.” Benmelech, who directs the Guthrie Center for Real Estate Research at Northwestern University’s Kellogg School of Management, acknowledges that so-called “agglomeration economies” have been a feature of retail markets since long before any shopping malls existed. “In the diamond district in New York City, stores sell almost exactly the same thing right next to each other. And in the Grand Bazaar in Istanbul, the spice and textile stores are all on the same streets,” he explains. “This is a very old phenomenon.”

For good reason: historically, customers rarely have perfect information about what is on offer in a market. So the purpose of a physical market is not just to retail goods to customers, but to provide a convenient context for customers to learn about what they can buy. “They want to shop from several stores to acquire this information in one trip,” Benmelech explains. “So it makes sense for specialized stores to colocate next to each other, even if they are competitors.”

Domino Effects

The economic benefits of retailers’ physical agglomeration are obvious to anyone who has visited a shopping mall intending to purchase one item and found himself coming home with ten. But agglomeration economies are a double-edged sword. “What are the negative consequences of breaking this link between stores? And what is happening to the neighboring stores when a store shuts down?” Benmelech says. “When several stores leave the mall, that makes it less attractive to consumers, which weakens the position of the remaining stores. It’s a domino effect, and basically the mall dies. We wanted to evaluate that.”

This mechanism for “mall death” appears straightforward, but empirically proving a causal link—that the bankruptcy of one store actually causes the financial distress of its neighbors, rather than merely coincides with it—has been difficult. For example, the deterioration of a shopping center could be caused by declining local economic conditions, which would affect all the “agglomerated” stores in a certain location.

Benmelech and his collaborators were able to rule out this possibility by focusing on national retail chains that went out of business between 2005 and 2010 (including Circuit City, The Sharper Image, and Linens ‘n Things). Because these firms closed all their store locations in the United States simultaneously, the researchers could reasonably assume that any failures of neighboring stores “had nothing to do with local conditions or declining demand,” Benmelech explains.

Instead, “we show a domino effect where a negative shock to a retail environment, driven by the fact that some players are leaving the area, is leading to further economic deterioriation in that area. Stores would like to be next to each other, and consumers would like to go to malls with high occupancy rates. When this breaks down, it means that more and more stores close, which leads to a local economic decline.”

In addition, as you might expect, the researchers find that, in the wake of a closing national chain store, neighboring stores are more affected by the negative shock if they are less profitable. For example, any store within 50 meters of a bankrupt chain location would be at a higher risk of closing its own doors—but if that neighboring store were in just the 25th percentile of profitability, its odds of closing increase by 16.9 to 22.2 percent.

Shoring Up Defenses

This analysis can make bankruptcy agglomeration sound like a force of nature, wrecking stores based on location and blind chance the same way a tornado or earthquake might. Benmelech does not disagree, but he adds that increased awareness of the risk can still empower retail real-estate players. Mall and shopping-center owners, for example, would do well to carefully examine the financial stability of their larger tenants, because the failure of one of these “anchors” could threaten everyone else. Understanding how bankruptcy agglomeration works could also help those owners unlucky enough to experience it mitigate or even reverse its effects. “It may make sense to bring in a new tenant and offer him a very low lease, or even pay the tenant to come in order to stabilize the mall,” Benmelech says. “It may seem counterintuitive, but you will pay much more if you lose your other tenants.”

And as other sectors of the global economy become ever more integrated and networked, Benmelech adds, the lessons of bankruptcy agglomeration may apply far beyond the realm of retail. In a world of hyperconnected markets—both physically and virtually—some of our most basic business intuitions may need to be revised. “You’d think that if your neighbor closes their store, that’s good news because you can get their business,” Benmelech says. “But what we’ve shown is a nontrivial and nonintuitive lesson: it's not always true that I would like my competitor to fail.”

Editor’s Note: "The Agglomeration of Bankruptcy" will soon be published as part of the Guthrie Center for Real Estate Research Working Paper Series.

Artwork by Yevgenia Nayberg

Build a Better Brainstorm: How to capture all the ideas in the room

In recent years, typical business brainstorming has gotten a bad rap for a lot of reasons: It is ineffective. It is dominated by loudmouths. Most people think better alone. So why is brainstorming still widely utilized by businesses intent on idea generation? The answer has more to do with the inherent biases and shortcomings we do not see in brainstorming than what is observable in the process.

“Most people go through brainstorming sessions in which only half of the ideas that exist in the room get expressed,” says Loran Nordgren, an associate professor of management and organizations at the Kellogg School. “Very often the best ones don’t get expressed, and participants walk out feeling like it was a productive meeting.”

With that in mind, Nordgren recently designed the mobile app Candor as a handy way to generate, capture, organize, and evaluate ideas while bypassing some of the main obstacles posed by traditional brainstorming. With Candor, ideas are generated in advance and then discussed and evaluated in person—which increases the number and diversity of ideas that are brought to the table.

This process often feels counterintuitive or unnatural for people raised on group idea generation, but Nordgren is trying to overcome their resistance by showing them how effective the process can be.

“You want to let people think before they see what other people have thought about, and then you give them an opportunity to explain what they came up with,” Nordgren says.

“Once ideas are collected, there are really a lot of options. You can project all the ideas on the board via the website to see what everyone has done. You see it all simultaneously. It is a tool that makes a helpful practice easier to do.”

Anchors Away

Just why do all these great ideas never see the light of day via traditional brainstorming sessions? The answer lies in the structure of brainstorming itself.

Because we do not want to be rude, cut each other off, or all talk at once when presenting and discussing ideas out loud, we take turns. “There are a host of problems with that,” Nordgren says. But two main factors act to constrict idea flow in this scenario: anchoring and conformity pressure.

With anchoring, someone presents an idea and subsequent ideas gravitate in relation to the first. This reduces the diversity of the brainstorm and means that ideas presented early in the conversation have a disproportionate influence on the subsequent discussion. So our tendency to gravitate toward a good idea might just act to crowd out even better, more innovative ideas.

Conformity pressure is predicated on how we anticipate our ideas being received and how much mental energy we spend thinking about that reception. “Very quickly, we begin to get a sense of what ideas seem appropriate or not,” Nordgren says. “If the first person says ‘let's do charitable work,’ and my idea was ‘let's have a party,’ I may not share my idea, because I would take the first idea as a cue that my idea isn’t appropriate.”

Invisible Issues

Worst of all, neither of these factors is readily apparent in most brainstorms. What feels to everyone involved like a freewheeling session—“We captured new sales pitches for next quarter!”—may in fact be hamstrung by a combination of ideas that others then build upon and a subconscious pressure to conform to the ideas presented, no matter how unoriginal—“Wait, aren’t these pitches the same as last quarter’s?”

By allowing participants to separate generation from evaluation, Candor eliminates anchoring and conformity pressure. There is nothing to drag subsequent ideas toward the immediate orbit of what has been said and nothing to shy away from for fear of saying the wrong thing.

Being able to sort the captured ideas makes it easy to see which are gravitating into groups—and which are the gems. There is also nowhere for brainstormers to hide. “When you get people into groups, there is a lot of social loafing,” Nordgren says. “But when you ask them to do this individually, you're maximizing the brain power of each person.”

Functionality Matters

Perhaps fittingly, it takes some collective intelligence to design an app that takes advantage of collective intelligence. In response to feedback from early users, a series of video introductions has been added to Candor’s website. Additionally, several features of the app have been tweaked in an updated release to give users more choice in when and how to share brainstorms.

“The ability to go live and easily share all the aggregated information with everyone else, and not just through the creator of the discussion, is a big advance,” Nordgren says.

Other tweaks made the app simpler for inexperienced users. “In version 1.0, we gave people the option of selecting the color of their idea cards,” Nordgren says. “This was kind of a throw-away decision that one of the app designers suggested as a little customization.”

“A lot of people—and understandably so—imagine that color choice is communicating something. We didn’t mean that at all, but users have invented theories about what the colors mean,” Nordgren says. “It has become clear that each element has to be super-clearly articulated to everyone, because when you’re generating ideas, all these things have an evaluative content.”

It may seem impossible to account for the myriad ways an app and its design elements function, but Candor itself may prove to be the most effective tool for improving future versions of Candor. One needs to look no further than the app’s name, which is the crowdsourced result of an idea-generation session using the app.

Artwork by Yevgenia Nayberg

For Better or for Work: Insights from intimate relationships could soon find their way into the office

Can research on marriage help us sustain a more satisfied work force?

Eli Finkel wants to know. Widely recognized for his work on intimate relationships, in 2013 he joined the Kellogg School as a professor of management and organizations. He also remains a professor of psychology at Northwestern University’s Weinberg College of Arts and Sciences.

Finkel’s new business ties arise from a strong hunch that the relationships we build with people share some key similarities with those we build with organizations. “Principles or phenomena that have interested me are interesting to me in other contexts too,” says Finkel. And the business world may soon have reason to return the interest.

Motivated Cognition

Consider, for one, the value of commitment in the workplace. Management scholars have identified links between commitment to an organization and positive outcomes, both for the organization and for individuals (findings that should come as no surprise to anyone). But does this commitment actually change how we interpret our experiences at work—and therefore how we respond to everyday challenges?

Here is one of many places where studies on intimate relationships may prove relevant. “There’s a lot of research in the marriage literature, the dating literature, and the close-relationships literature more generally that really emphasizes the importance of commitment,” says Finkel. Research suggests that the degree to which people strongly agree with statements like “I’m determined to make this relationship last forever” does in fact seem to predict a relationship’s duration.

Why? In part, we can thank a phenomenon known as “motivated cognition”: a tendency for us to perceive events in ways that align with our goals. Partners in a committed relationship are motivated to unconsciously champion their relationship’s strengths and to discount its weaknesses—in other words, explains Finkel, “to overweight the extent to which their relationship is better than everyone else’s relationship.” And the rose-colored lenses get even rosier when a relationship comes under fire. Remind a college student in a committed relationship about just how few college relationships withstand the test of time, and they will describe their own relationship as stronger than if it had not been questioned.

If these properties also hold true for our commitments to organizations, this could have a big impact on how employees respond to setbacks at work or job offers from a rival firm. A more committed workforce would obviously be a boon for organizations. But for individuals, commitment might be more of a mixed bag.

“Feeling like the place you work has value, and is the sort of place you’d like to stay, is probably healthy for people on average,” says Finkel. So long as a job is a good fit for your skillset, pays fairly, and aligns with your worldview, feeling motivated to see your organization in its best light may be key for finding meaning in what you do and flourishing professionally. But there’s a point where motivated cognition may become self-defeating for employees. “There are personal risks to employees who are blindly committed to a company that is not committed to them,” says Finkel.  Motivated cognition could give employees the mistaken belief that they would never be happier, more fulfilled, or better compensated elsewhere, leading to a workforce more susceptible to exploitation.

Staying Satisfied

Commitment is by no means the only parallel to be made between our business lives and our personal ones. Another example: the risks associated with “helicopter helping”—where the assistance we provide others actually torpedoes their ability to achieve on their own—could apply as easily to our coworkers as it does to our spouses and children. But perhaps few of Finkel’s studies have as much potential to rock the business world so immediately as his recent work on preserving marital satisfaction.

Over time, marriages have a stubborn tendency to decrease in quality. Even well-adjusted couples can find themselves in a downward spiral of “You upset me, so I’ll upset you,” which leaves both partners increasingly distressed. But in a 2013 study, Finkel, along with colleagues from Villanova University, Redeemer University College, and Stanford University, tested whether it was possible to disrupt the mounting dissatisfaction.

Participants—120 married couples from the greater Chicago area—individually assessed the quality of their relationship along a number of dimensions: satisfaction, love, intimacy, commitment, and the like. Every four months, participants completed the same questionnaire; they also described the most significant spat that had occurred between them in the intervening months.

Sure enough, over the course of a year, “marital satisfaction was down in our study, just like in every other study,” says Finkel.

But then, as the study entered its second year, half of the participants received an additional set of instructions: to describe the conflict from a “neutral third party” perspective, to identify obstacles, and to consider how the obstacles might be overcome. The instructions were given just thrice, in months 12, 16, and 20. And the manipulation was short. “On average, people wrote for a total of seven minutes,” says Finkel. But the intervention worked. “Among people in the experimental condition, as you get to year two”—when the additional exercise kicked in—“the trend diverges.”

That is, the simple reminder to consider conflicts more neutrally curbs the decline in marital satisfaction. “Couples who completed the extra writing task had just as much conflict as those in the control condition, and the conflict was just as severe,” says Finkel, “but they simply didn’t become as angry and upset about it.” 

Finkel’s intervention is already starting to make its way into clinical practice and couples counseling. So might a similar technique—asking employees to consider organizational conflict from a respected, neutral perspective—lead to greater satisfaction in the workplace?

At least some management research identifies a “honeymoon” period after a new employee comes on board, followed by a dip in job satisfaction. An intervention like Finkel’s has the potential to arrest the decline. Sure, some staffers may pooh-pooh the exercise as pointless or absurd, but “it’s not exactly a big time commitment,” Finkel points out, and it might just lead to a more satisfied work force.

“One thing that amazed me about the results of our first study,” says Finkel, “is that the intervention not only made people happier in their marriages, it made them happier with their lives in general. If workforce interventions have similar results, that’s an astounding return on a 21-minute annual investment.”

Artwork by Yevgenia Nayberg

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