Download Grabber-Holder Dynamics

MS&E 201
Professor Edison Tse
Class Notes
Grabber-Holder Dynamics
People do not always make choices based on rational analysis. People's decisions
are often based on impulsive emotion. Marketing researchers point out that many
consumers have impulsive purchasing behavior. In fact, it is this behavior that fuels the
whole advertising industry. Let us distinguish between two groups of consumers: the
first group makes their decisions based on emotion and the second group uses rational
analysis. When a new product is introduced into the market, the producer will create an
exciting advertising program to articulate the perceived need for the product. However,
no one has tried the product before and therefore rational analysis on the product is
difficult, if not impossible. Therefore, the second group of consumers whose decisions
are based on rational analysis will take a "wait and see" attitude. However, if the
advertising promotion is exciting enough and if there are attributes to the product that can
arouse people's curiosity, then it will "grab" some of the consumers in the first group to
try out the product. We refer to these attributes as the "grabber" of a product.
If some of the people who tried the product can actually derive value from using
the product, then rational analysis can be performed on the usage of the product. This
will not only transform the people who have tried the product to become loyal customers,
it will also provide a basis for the second group of consumers to buy the product.
Anything that can allow the consumer who tried the product to actually derive value will
"hold" the sale of the product. We shall refer to this as the "holder" of a product. The
grabber of a product is usually physical, visible and easily identifiable, but the holder of a
product is rather subtle and not easily identifiable.
Let us define x(k) as the number of consumers in the first group who are grabbed
by the excitement of the product at time k, y(k) as the number of the consumers in the
second group who first try the product at time k, and z(k) as the number of loyal
customers at time k. We have the dynamic model
x(k) = g(k)
y(k+1) = z(k)
z(k+1) = z(k) +x(k) + y(k)
MS&E 201
Professor Edison Tse
Class Notes
where g(k) is the grabber effect at time k,  represents the "word of mouth" effect, 
represents the percentage of old loyal customers remaining loyal,  represents the
percentage of people in the first group who can derive benefit from the product and 
represents the percentage of people in the second group who can derive benefit from the
product. Notice that y(k) is influenced directly by the number of loyal customers who
can assess the value of the product. We shall refer to the above model as a grabberholder dynamic model. We can rewrite the above equation into a state model
 y (k  1)  0    y (k )  0 
 z (k  1)       z (k )   g (k )

 

 

The eigenvalues of the dynamic system are given by
 = ( ± (2+4)1/2)/2
Since  and  are positive, both eigenvalues are real, and the largest eigenvalue is given by
* = ( ± (2+4)1/2)/2
and * is greater than 1 if
( + (2+4)1/2)/2 > 1
or
 + (2+4) ½
or
(2+4) ½
or
2+4
or
> 2
> 2–
> 4 - 4 + 2
 > 1 – 
MS&E 201
Professor Edison Tse
Class Notes
One can view  as the strength of the holder effect for the product since  represents
how the satisfied customers can induce other new customers to try the product, and 
represents the percentage of all those who have tried the product and find the product
useful. Therefore, the above inequality implies that if the holder effect is greater than the
percentage of loyal customers dropping out, then the dynamic system will create a
perpetual growth once the grabber is introduced in the initial period. If the above
inequality is not satisfied (the holder is too weak), then in order to maintain growth, the
company needs to continuously create new grabbers. Let us examine a few cases using
this simple grabber-holder dynamic model.
McDonald's Systems
McDonald's was not the first fast food chain, and the founder of McDonald's was
not even a restaurant operator before he started the McDonald's System. Fast food chains
existed way before the McDonald's System. But all of them grew to a certain size and
stopped. McDonald's was the first to break the growth pattern and enjoyed hypergrowth
shortly after it had started. The question is why McDonald's succeeded while others
failed. It turns out that the franchising policy practiced by the conventional fast food
chains results in a grabber-holder dynamics with an eigenvalue less than 1, whereas the
franchising policy practiced by McDonald's results in a grabber-holder dynamics with an
eigenvalue greater than 1.
The "product" in the fast food industry is the "secret" of fast food processing and
operation. The conventional fast food chains approached the business by selling the
rights of practicing these "secrets" in different geographic regions. So, a fast food
franchiser would parcel out different regions in the United States. The main "buyers"
were investors who would buy rights in big or small regions. Those who had bought
rights in the big region would split the region into subregions and sell the rights of each
subregion to smaller investors. This is like a wholesale-retail model where the product to
be sold are the rights to operate in a small town or city. This "distribution" model creates
MS&E 201
Professor Edison Tse
Class Notes
a high price tag for the rights to open a franchise fast food store. The franchiser made
additional money by requiring the franchisees to buy material from the franchiser who
marked up a big percentage. All this increased the operating costs of the franchisee and
therefore only a small percentage of them made a profit. This implied that  was small.
Some of those who worked very hard in order to make a profit would find it easy to drop
out of the operation when something slightly better came along. Therefore, the parameter
 was small, and 1-  was big. If a franchisee had to work very hard to make a marginal
profit, then it was not something that others were eager to buy into. This implied that 
was small. The end result is that the eigenvalue for the grabber-holder dynamic was
probably less than 1. To keep the business growing, the franchiser had to "pump" in a lot
of grabber effort which soon ran into diminishing returns. This explains the limited
growth pattern of most fast food chains before McDonald's.
The founder of McDonald's took the business approach of ensuring that the
franchisee made money before McDonald's made money. He sold a franchisee operation
one at a time. The entry cost was very low and he passed all the savings in bulk
purchasing to the franchisee. He recruited owner-operators instead of investors who
hired others to run the store. The early people that he recruited were not restaurant
operators but were individuals who were excited by the opportunity of owning their store,
willing to work hard and care for the store. This policy, combined with the clean
operation and standard menu with quality food, led to the quick success of early
franchisees. This increased  The fair treatment of the franchisees gained their loyalty
to McDonald's. This allowed McDonald's to set standards that the franchisees would
follow. This increased  and reduced 1- . (In the early years, 1-  was close to zero.)
Very quickly, it was spread around that owning a McDonald's store was like owning a
gold mine. Existing owners requested a second store, friends and relative of existing
owners called McDonald's headquarters and requested becoming a franchisee. The
parameter  was much greater than 1. The result was that the eigenvalue of the grabberholder dynamic was greater than 1.
Instead of putting effort into increasing the grabber, McDonald's focused on
building the infrastructure to solidify its holder. The first step was to get into real estate
MS&E 201
Professor Edison Tse
Class Notes
where it would go and find appropriate new locations for the sites of franchise operations.
It then negotiated to lease (and later buy) the property, built a standardized unit, and
subleased (later leased) it to a new franchisee. The rent structure was a fixed minimum
with a percentagever sales. McDonald's found a way to grow with the franchisees
without imposing unfair costs on them. To maintain the quality standards, it developed
standard food preparation and processing procedures. Later on, even its advertising
program was focused on increasing its franchisees' profits which in turn increased its
profits.
VCR: Sony vs. JVC
An American company called Ampex was the first to introduce the video tape
recorder. It was a very big "box" and sold for $100,000 or more. The customers were the
TV stations who wanted to record a program and broadcast the playback at a later time in
a different city. Sony wanted to develop one for home use. However, the technology
was not ready for the home use market and Sony decided to enter the industrial market in
order to improve the video technology which would eventually be applied to the home
use market. The whole concept behind the product was "time shifting": allowing people
to tape the program at one time and play it back at a different time. For use in
broadcasting, picture quality was the key factor. At that time, the "information content"
were TV programs normally one hour long. Sony introduced an industrial product, and
instead of using reel-tape, it used a cassette—hence the name VCR (videocassette
recorder). Sony's product was very successful and soon overtook Ampex in the
industrial use market. Sony's success in the industrial market allowed it to finance and
further develop the VCR technology so that it could reduce the size and the price of the
product. Eventually, Sony became the first to crack open the VCR home market. The
product was the Beta format machine which was reasonably compact, had good picture
quality and allowed up to one hour recording (longer recording time would greatly reduce
picture quality).
MS&E 201
Professor Edison Tse
Class Notes
The vision projected by Sony's advertising promotion was "watch your favorite
TV programs at the time you want." This attracted a lot of electronic fans to buy the
product. Many of them liked the product and this started to attract conventional
consumers who knew very little about electronic products but wanted to take advantage
of the "time shift" concept. However, to take advantage of the "time shift" concept, the
user needed to know how to program a VCR to start recording automatically at a
specified time when the user wasn't there—a task which is trivial to the electronic fans
but exceedingly difficult for ordinary consumers. This implied that  was small because
of the skill requirement to make the VCR useful. In the beginning Sony held the
monopoly in the market, and people did not have another product to switch to.
Therefore,  was large and 1-  was small. The word of mouth effect was nominal
because some found it useful while some did not. Sony's sales were successful but were
not taking off exponentially.
When Sony introduced the home use VCR, Hollywood movie companies sued
Sony claiming that VCR recording would infringe on the copyright of their movies.
Sony won the battle in the court. The movie producers began to look for ways to benefit
from the VCR: how about putting movie titles on video cassettes and selling them. At
the same time JVC was developing its own VCR. It developed a new format called VHS
which was slightly bigger than a Beta format machine, slightly inferior in picture quality
but with a two hour recording time. JVC also licensed its VHS format to almost all TV
manufacturers in Japan (other than Sony) and the US. Movie producers found that it was
more convenient to put their movie in VHS format than Beta format. However, movies
were not like music records, not many people wanted to buy them. Instead they wanted
to "borrow" them for a day or two. A new business sprang up in the US: video rental
stores.
A new vision was emerging: watching your favorite movies at home. Since no
setting of automatic time recording was required, many ordinary consumers found a new
use for the VCR in watching pre-recorded movies. Many people bought a VCR just for
watching rental movies. The Beta format, being a one-hour format, was not as
convenient and therefore less valuable to movie watchers as compared to the VHS
MS&E 201
Professor Edison Tse
Class Notes
format. Relatively, the  and  for VHS were larger than the  and  for Beta. Those
who already owned a Beta machine wanted to buy a VHS machine, and therefore the 
for Beta started to decrease, and 1-  started to increase. Those who owned a VHS were
happy with their machines. Therefore, there were more people needing a VHS machine.
JVC's extensive licensing strategy allowed for this increasing demand to be met by the
many manufacturers. Because of the economy of scale, VHS was also cheaper than Beta.
So, comparatively, people derived more value from VHS than from Beta. The increase in
VHS owners induced movie producers to put more titles into the VHS format instead of
the Beta format. All these further increased the  and  for VHS and eroded the  and 
for Beta. So the eigenvalue for the VHS dynamic was getting bigger and bigger and for
the Beta dynamic was smaller and smaller. The growth of VHS was so fast that Sony did
not have time to launch a credible response. Eventually, Sony introduced a two-hour
tape, but it had already lost the major market share. By that time, tape length was no
longer the critical factor. Instead, market share was the major factor that influenced the
movie producers to put their titles into VHS format. Sony could not reverse the tide and
decided to discontinue the Beta format.