Professor Dan Ariely was recently named to Fortune’s list of “Ten New Gurus You Should Know,” for his innovative work in behavioral economics.

In honor of the Thanksgiving holiday, we thought we’d share some of Dan’s thoughts on why we over-value things we own. (Duke basketball fans are sure to enjoy this one, too.)

Duke Strategy Professor Will Mitchell argues that rather than bailing out firms, we should build stronger businesses and employees via reorganization and education.

Recently, I filed a post on the value of allowing firms to reorganize, while using public resources to support education rather than bail outs. Today, let’s look at an example of the success of this strategy, which is right here in North Carolina.

Learn from North Carolina. North Carolina is a great example of the success of education and reorganization. I have been here eight years. In that time, the state has largely lost its tobacco and textile industries, and has lost much of its historical furniture manufacturing base. Rather than being in a deep slump, however, the state is one of the most dynamic economies in the country. The reasons are simple to state, even if somewhat complex to implement in practice.

1. Allow low margin business to go abroad. Rather than remaining stuck in what had become low margin businesses, the state allowed businesses that had become globally uncompetitive to move operations to Asia and Mexico or simply to fail. This unquestionably has disrupted some communities and been painful for many individuals. But, because of the next four points, most people and communities have been able to adapt and thrive

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Duke Strategy Professor Will Mitchell’s insights on business failure.

Times are tough and businesses are going bankrupt. I do not need to remind anyone that we are in a tough economic period – in the U.S. and throughout the world – and that many firms have either failed or on the point of failing. In the U.S., the American Bankruptcy Association reports that business bankruptcy filings were up more than 40% in the first half of 2008 versus the same period in 2007, to more than 18,000 filings. The third and fourth quarter statistics will almost certainly be even worse. Several high-profile cases involving the possible failure of U.S. auto manufacturers are front and center in the media, as well as here in discussions on this Duke Research Advantage blog.

Failure hurts more than shareholders. In addition to shareholders, bankruptcy clearly causes losses for employees, suppliers, and the communities in which a firm operates – whether the bankruptcy involves full dissolution (Chapter 7) or is part of business reorganization (Chapter 11). Each of us can look at our local communities and at friends and families to see the losses and hurt that business failure can cause.

Should we keep failing businesses from failing? So, the big question is how hard we should seek to avoid business failure? Like most questions of this sort, the answer depends on who the “we” is.

Avoid failure by creating profitable value. People throughout a firm have every incentive to bust most parts of their bodies – and especially their minds – to find the resources they need to stay in business. Of course, the best way to stay in business is to create value that customers want to pay for, even in tough economic times (see the four-part series that Rich Burton and I posted last week). Profitable value is by far the best drug for business survival. It is my job as a teacher in a business school classroom to help students gain the skills that they need to keep their companies alive by creating profitable value.

Is the economy better off if we use public subsidies to keep failing firms from failing? But what if a firm’s best efforts to create profitable value fail – should the firm lobby for and receive public support to stay afloat until times get better? After all, isn’t the public welfare better served by keeping a firm going – to provide jobs, keep firms in the supply chain alive, and support local communities? Moreover, even a struggling firm often has components that are highly valuable, whether desirable products, long term R&D activities, organized supply chains, and complex distribution systems. Business failure might appear to threaten to throw out the valuable components along with the struggling parts of the business. Should we conclude, then, that the economy is better off if we provide public subsidies that keep struggling firms alive, especially firms that historically were strong, in hopes that they will return to strength when the economy recovers?

Perhaps surprisingly, that answer is usually “no.”

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I appeared on Business News Network November 24, 2008 to talk about how the U.S. tax payer got shafted by the deal to save Citigroup.

While there is no doubt that federal intervention was necessary, the terms of the deal were terrible for the government. The real cost is not just this deal but the precedent it sets.

View the clip

Remember October 1, 2008? Citigroup announced it was acquiring Wachovia with the help of the FDIC. You had to be strong to do a favor to the government like that.

Citi was also a recipient of $25 billion in the first tranche of the $125 billion TARP money.

However, we know now Citi was not healthy. On Friday, Citi stock closed at $3.77 implying an approximate market cap of $19 billion  – just a few weeks after the Treasury had injected $25 billion in capital.

This implied that the government was throwing $25 billion at something that was worth -$6 billion! It is the classic throw of good money at bad.

I am fully aware that some type of intervention was necessary. Citi falling would have created even worse chaos in markets.

But the injection of a further $20 billion and huge government guarantees on troubled assets is a spectacularly bad deal for the American taxpayer.

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Duke Strategy Professor Scott Rockart explains why some companies should pursue conservative expansion during the downturn.

Should firms respond to the current economic times with a protective logic of contraction? Many analysts are recommending that firms cancel plans that were already marginal and find ways to reduce operating expenditures. While self protection through contraction may be a virtue for many firms, leading firms may find that a broader and longer perspective calls for increasing, rather than reducing, expenditures.

Why might increasing expenditures be beneficial for leading firms? Read the rest of this entry »

This is the final installment in a four-part series of postings by Strategy Professors Will Mitchell and Richard Burton. Mitchell and Burton outline four principles for leading your business as an opportunity driven strategist in tough times, rather than falling into purely defensive positions that are destined to be overwhelmed by economic pressures.

PRINCIPLE 4. MOTIVATE YOUR PEOPLE

We have already told you that part of principle 2 is to “invest in your people”. So, why are we coming back to people? Well, we were reminded about the importance of motivation by a recent talk to the graduating Global Executive MBA class at Duke University by Ferdinando Beccalli-Falco, the CEO of GE International. Mr. Becalli-Falco’s core point was that you will not survive tough times without the commitment of your people.

In our experience, when times are good, the second thing that comes out of our mouths, after “we are customer focused,” is usually “our people are our most valuable resource.” But most of us do not really practice the people mantra. We take advantage of the rising tide to succeed as businesses despite under-performing in how we motivate and build on our employees’ insights. We do not have that luxury when times are tough.

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Image courtesy of flickr/The ConsumeristThe TARP has failed to stop the meltdown in credit and equity markets. Almost all of the big nine banks that received the TARP injection are in worse shape now than before TARP.

Take Goldman Sachs. Around the time of the TARP equity injection announcement, it was trading for about $120 per share. It is currently below $60.

That’s not as serious as some others. Citi’s current market cap is about $25.7 billion and they received $25 billion from TARP – so the TARP cash is 97% of their market value! They are not alone. Morgan Stanley’s market cap is $10.2 billion and they took $10 billion from TARP.

TARP has not worked – as implemented.

It is urgent that we move to a different strategy.

Secretary Paulson said November 20, 2008, in describing his leadership, that he needed to “be pragmatic enough to change plans when facts and conditions change.”

We need the Secretary of the Treasury to change direction on two key policies.

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Duke Professor Dan Ariely is the author of a nice op-ed in today’s New York Times. Ariely explains his research showing that large bonuses don’t always lead to the best performance.

Anyone want to share your thoughts and experiences related to bonuses and motivation?

This is the third installment in a four-part series of postings by Duke Strategy Professors Will Mitchell and Richard Burton. Mitchell and Burton outline four principles for leading your business as an opportunity driven strategist in tough times, rather than falling into purely defensive positions that are destined to be overwhelmed by economic pressures.

PRINCIPLE 3. STAY OUTWARDLY FOCUSED

When times are tough, the temptation is to hunker down and focus inwardly, trying to cut costs and protect our traditional core. But tough times create advantages – firms that find ways to reach out for those advantages while protecting cash and reinforcing current advantages will both flourish in the tough economic times and create platforms for growth when times get better.

Now, we can hear you saying that it is easy for us to say “stay outwardly focused”, but is this really realistic when you have to protect cash and reinforce our current advantages. Nonetheless, firms that keep one eye beyond their walls in tough economic times will find powerful opportunities.

We stress three points about staying outwardly focused: Sources of opportunities parallel your needs for investment, outward focus reinforces principle 2, and outward focus creates opportunities for selective expansion even in tough times.

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