Vol. 19, No. 19

Feb. 10, 2000

Marketing prof advises caution
comparing companies

Analogy can be a useful but misleading tool for those venturing into the stock market, according to new research by a University of Delaware business professor. “Analogy can be driven by surface features. You see an apple, you think of a red ball, the two look the same but aren’t. The same thing can happen when an investor compares a new company to one with which he or she is already familiar,” Jennifer Gregan-Paxton, who teaches marketing at UD, said. Along with Jane Cote, assistant professor at Washington State University, Gregan-Paxton examines the phenonema in “How Do Investors Make Predications? Insights from Analogical Reasoning Research,” soon to be published in The Journal of Behavioral Decision Making. “Previous work on investor decision making has focused almost exclusively on information specific to the company being judged. Every decision is viewed as a novel event, disconnected from the investor’s existing knowledge,” the researchers write. In their article, they argue that investors frequently use existing knowledge as a basis for generating predictions about a company’s future. They propose that investor predictions are based, at least in part, on knowledge gleaned from comparable situations involving other companies. To test their theory, the researchers devised a study in which experienced investors predicted the outcome of a company’s strategy after reading about the experiences of other companies that had implemented similar ones. The researchers were looking for answers to two questions: first, whether knowledge gleaned from previously encountered companies influenced investor’s predictions and, if so, how investors use their knowledge of other companies’ experiences when predicting the outcome of an unfamiliar company’s strategy. To answer the questions the researchers recruited 259 experienced investors from investment clubs affiliated with the National Association of Investors Corp. (NAIC). Most NAIC members are skilled investors who consistently equal or outperform the Standard & Poor’s 500 stock index. Most use a structured approach to stock selection focusing on a fundamental investment strategy that emphasizes analysis of a company’s past financial performance, evaluation of its managerial skill and assessment of future profitability. During a regular monthly investment group meeting, participants were asked to study three companies that had offered their products for sale via the Internet either successfully or unsuccessfully. Information on a fourth company that also planned to offer its products for sale via the Internet also was presented. The potential investors’ task was to make a prediction about the success of the fourth company’s Internet strategy and to answer a series of questions related to the method of prediction and type of information used to make it. The investors were given information consistent with the type of information they would compile for a stock selection guide. Information was provided on the fictional Green, White and Yellow companies’ product, typical customer, rational for adopting an Internet strategy, techniques used to promote the Internet strategy, financial performance trends with five years of key financial statistics, relative position within the industry and the outcome of the Internet strategy. The Green Co. sold used college textbooks to college students, the Yellow Co. sold professional women’s clothing, the White Co. sold batteries to electronics hobbyists. All three had recently initiated Internet marketing. Those participating in the study were asked to compare the experiences of these three companies with a proposal for Internet marketing by the Blue Co., makers of hand-held tools. At first glance, the tool company looked remarkably similar to the battery company in terms of product, customer profile, rationale for adopting an Internet strategy, promotional techniques, financial trends and position within the industry. Such similarities could lead investors to believe that, like the battery company, the tool company could successfully adopt Internet marketing. Key to the success of such a plan, however, is the customer base and its familiarity with the Internet. In that respect, the battery company and the used textbook company were successful in adopting Internet marketing because their audiences were Internet savvy. In contrast, the customer base for the clothing company–women–had relatively little Internet access at the time the study was conducted. For that reason, the clothing company was not successful in Internet marketing. Potential investors who followed that line of thought could also see that Internet marketing might also be inappropriate for a hand tool company that appealed to arts and crafts hobbyists. Predictions on the battery company’s success were split about equally among the investors participating in the study. Those results Gregan-Paxton said should send a warning to investors to be careful about what they read and how they interpret facts. “In the cases in our study, the battery company and the tool company seemed very similar but the most important factor– the customer base and its familiarity with the Internet–was vastly different. Investors need to be aware of this when using comparisons to make judgments. They need to be aware that they are using a strategy than can easily mislead them. The bottom line is to be aware of the basis of the comparisons you make. Just because a ball is red like an apple doesn’t mean that it will taste good,” Gregan-Paxton said. –Beth Thomas