Perspectives - Spring 2012

P ERSPECTIVES College of Business at the University of Illinois at Urbana-Champaign

Bright Ideas

How innovation powers success

Spring 2012

Volume 11, Number 1

My Perspective

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“OUR MEASURE OF SUCCESS AND PROMINENCE HAS ALWAYS BEEN IN NURTURING INNOVATIVE FACULTY AND AMAZINGLY TALENTED STUDENTS—AND THEN SENDING THEM WITH THEIR NEWFOUND KNOWLEDGE OUT INTO THE WORLD.”

his issue’s cover story focuses on a topic that is at the center of any successful business and at the heart of any great University—the exploration and implementation of new ideas. At ILLINOIS, we have a culture and an infrastructure that supports innovation, encourages curiosity, and fosters renewal.

That’s why periods of change, even if they create challenges, can also be times of tremendous growth and opportunity.

Difficult economic circumstances challenge us to think more creatively; leadership changes create opportunities for a new dynamic and a new energy.

At ILLINOIS, there is an abundance of leadership talent. Esteemed faculty members continue to make our campus their home and to bring in new ideas.

Chancellor Phyllis Wise is leading our campus with excellence and inclusiveness, and soon Robert Easter will steer our University with sage governance as its newest president. Both are ardent supporters of the College of Business, its students, and its faculty, and both balance innovation and tradition gracefully.

Our College continues to recruit experienced academicians who are at the top of their game. And former faculty and administrators who assume roles at companies, universities, and organizations across the globe continue to carry a loyalty for the College and an appreciation for their ILLINOIS experience no matter what their destination, all of which enhances the College’s reputation.

Our measure of success and prominence has always been in nurturing innovative faculty and amazingly talented students— and then sending them with their newfound knowledge out into the world. ILLINOIS remains a place where the best gather to explore ideas and their potential, and I’m proud to be among the leaders who call it home.

Larry DeBrock Josef and Margot Lakonishok Endowed Dean

SPRING 2012

Contents

2 AMPED UP

by Tom Hanlon How can companies nurture an atmosphere of innovation?

IT’S TAXING

WORK

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ILLINOIS Business professors explore the who, what, and why of tax cheating.

TAKING A GAMBLE

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by Cathy Lockman What does a recent ruling by the Department of Justice mean for the future of online gambling?

by Cathy Lockman Thinking creatively is the key to negotiating success.

CAUSE & EFFECT

by Cathy Lockman

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DROWNING IN DEBT

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The lightbulb has long been a symbol for breakthrough ideas.

Maybe that’s because its inventor, Thomas Edison, understood that for innovation to be successful it must strike a balance between the novel and the familiar. More than 150 years later, that strategy continues to power innovation, says James F. Towey Faculty Fellow Raj Echambadi.

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YOUR MOVE

Cause marketing has broad implications for today’s consumers, corporations, and non-profits.

ON THE COVER

by Doug McInnis Companies weighed down by debt that matured during the recent financial crisis are still trying to catch up with their peers.

PERSPECTIVES

by Doug McInnis

DEAN Larry DeBrock MANAGING EDITOR Tracy McCabe EDITOR Cathy Lockman CONTRIBUTING WRITERS Tom Hanlon Cathy Lockman Doug McInnis PHOTOGRAPHERS Tricia Koning Lou McClellan Paul Scudder L. Brian Stauffer Jerry Thompson DESIGNER Pat Mayer The University of Illinois at UrbanaChampaign is an equal opportunity, affirmative action institution.

Printed on recycled paper with soybean ink.

Amped Up Innovation is the energy that powers corporate success

“INNOVATION THINGS.

REALLY ENCOMPASSES THREE

FIRST,

YOU ABSOLUTELY HAVE TO

PUT THE CUSTOMER AT THE CENTER OF YOUR EQUATION.

SECOND,

THAT’S THE

LYNCHPIN FOR ME.

YOU NEED THE TECHNOLOGY TO

FULFILL THE CUSTOMER’S NEED.

BUT

IT

DOESN’T MATTER WHAT YOUR TECHNOLOGY IS OR WHAT YOUR CUSTOMER’S NEED IS UNLESS YOU HAVE SOME BUSINESS VIABILITY.

OTHERWISE, IT JUST DOESN’T WORK.” – RAJ ECHAMBADI

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PERSPECTIVES SPRING 2012

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lockbuster opened its first store in Dallas in 1985 and by the early 1990s was already worth billions of dollars. By 2001 the video rental giant was on CNNMoney’s list of the World’s Most-Admired Companies. But less than a decade later, Blockbuster filed for bankruptcy, having piled up $900 million in debt while withering under competition from Netflix, Redbox, and video on-demand services.

What happened? Raj Echambadi doesn’t hesitate with his answer: Blockbuster stagnated while its industry changed.

“You have to be extraordinarily innovative to survive,” says the associate professor of business administration and James F. Towey Faculty Fellow. “I call it the innovation imperative.”

He quotes John Chambers, the chairman of Cisco Systems: “The average life expectancy of a Fortune 500 company now is about 15 years. If you don’t change, you fall behind.”

Burning Bright “Innovation is one of those buzzwords in the marketplace,” Echambadi says. “Every company says innovation is on their agenda.” But, he adds, not all companies create a culture that helps innovation—and their organization—thrive.

“Innovation isn’t innovation until you create a product and make a profit from it,” says Jeffrey Carter, a 1984 graduate of the College and cofounder of the Hyde Park Angels, one of the country’s most active organizations in providing capital for startups.

“Too often people forget that you have to make a profit,” Carter continues. “If you don’t, then the market’s not validating your product, and you really don’t have innovation.”

“Innovation really encompasses three things,” says Echambadi. “First, you absolutely have to put the customer at the center of your equation. That’s the lynchpin for me. Second, you need the technology to fulfill the customer’s need. But it doesn’t matter what your technology is or what your customer’s need is unless you have some business viability. Otherwise, it just doesn’t work.”

That innovation doesn’t have to be complex; it just has to be viable. Carter cites the example of Starbucks, which began in Seattle in 1971 and today has more than 19,000 stores in 58 countries. Founded by two teachers and a writer, the story of Starbucks illustrates that the simplest ideas are sometimes the best. “All they did was set up a coffee shop,” Carter relates.

“Stuff doesn’t have to be super high tech. All you have to do is listen to people, get close to your customers. Figure out what their needs are and then build a business around them.”

Sometimes innovation comes from within, and sometimes it comes externally. Chambers’ Cisco Systems fits in the latter category. “Cisco just buys their innovation,” Carter says.

“They’re basically a buy-out firm posing as a tech company that innovates. And they do a good job of it.”

Netflix also excels in innovating from the outside. “The concept of mail order is nothing new,” offers Echambadi.

“However, mailing DVDs is new. Sometimes it is about creating something new. Sometimes it is about reconfiguring existing ideas in novel ways. That is what innovation is all about.”

Innovation is, by its very nature, not confined to predefined parameters. It has a life of its own, and it is up to each company to find and nurture that life.

ust innovative ideas be drastically different from existing products to succeed in the marketplace? Not always.

The electric light bulb is a perfect example. Thomas Edison’s strategy of blending novel elements, such as no soot and cleaner lighting, with the familiar elements of gas lamps, which were the standard at the time, demonstrated that he understood a profound innovation principle: hybrid strategies work better for breakthrough innovations. That’s why Edison introduced a 13-watt bulb, which was more similar to the intensity of gas lamps, even through he had a 40-watt version in his laboratory.

In a recent paper, Raj Echambadi, and his then-doctoral student Sangwon Lee, examined the look and feel of many breakthrough innovations. Their results showed that a

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breakthrough product designed to look similar to an existing product is likely to fare poorly in the market because consumers think that both products offer similar value. On the other hand, says Echambadi, a breakthrough product designed to be dissimilar to the incumbent product results in higher consumer evaluations. But the dissimilarity in design must be moderate.

“Too much deviation from the incumbent product causes consumers to discount the new product, whereas a moderate level of incongruity strikes a fine balance between the novel and the familiar,” says Echambadi. Bottom line, it appears that Edison was right all along: hybrid designs appear to work better for breakthrough products.

–Cathy Lockman

www.business.illinois.edu

When the Lightbulb Goes On

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Shining a Light on Idea Generation Of the 40 billionaires under the age of 40, 30 are Americans, and almost all of them are self-made, Echambadi says. There’s a reason for that: They are open to new ideas.

They aren’t afraid to dream, to risk, to try the unconventional.

Echambadi points to writer Samuel Beckett, who said, “Ever tried. Ever failed. No matter. Try again. Fail again. Fail better.”

This attitude, he notes, is the attitude of winners. They are not afraid to fail. The critical point, Echambadi adds, is to learn from your failures, know you will never have all the answers yourself—he debunks the lone genius myth that has followed Steve Jobs, Jeff Bezos, and other CEOs—and develop the right people and the system that enables them to be productive.

Watt’s Next?

“In 1990, the best companies came from the Western world,” Echambadi says. “They had the skills, the abilities, but with the Internet being a great leveler, now you have incredible companies coming out of the East.” He cites Haier, the Chinese company that is the third-largest consumer electronics company

in the world. “If you ask General Electric, they’ll say ‘I know how to compete with the Siemens of the world, but I’m unsure about how to compete with the Haiers of the world.’ These firms have cut their teeth in resource-constrained emerging markets and hence are adept at creating products that invert the priceperformance paradigms that we are so used to in the Western world.”

All of that puts an even greater emphasis on being innovative. And that need is equally shared among all companies, large and small. Each has its advantage. “Little businesses are more sleek,” says Carter, “but that being said, they can get crushed really easily, and they can’t afford a lot of mistakes. Big companies can make a mistake and have the working capital to survive.”

On the other hand, he adds, it typically takes bigger companies longer to innovate. “I have more bases to touch.

It might be more expensive, and I might have to change operations, change corporate culture. But with small businesses you can see a niche and fill it.”

Innovation Maturation hile innovation will look different within different companies, there are characteristics that are shared among most innovative companies. According to Raj Echambadi and Jeffrey Carter, there are 10 keys to nurturing innovation:

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Truly buy in to innovation.

“It all comes down to senior management buy-in,” Echambadi says. “They can’t just pay lip service to innovation.”

Listen to customers as you build your strategic vision.

“Successful innovators listen to their customers, number one,” Carter says. “They’re great listeners. They’re always learning. And, number two, they have a strategic vision.

They listen to what they hear and incorporate it into a strategic vision.”

Echambadi says that successful organizations have a constant focus on a cycle of creating a vision, executing it, envisioning the future, and executing again. You have to take your plan and execute it as close to perfection as possible, he says, but you also have to think about novel ways to serve your customers in the future. Certain companies put greater emphasis on envisioning the future than others. Google, for instance, gives its engineers one day of the week —20 percent of their work hours—to work on a project of their own choosing as a way for the company to develop its foresight capabilities.

PERSPECTIVES SPRING 2012

4

Hire a diverse staff.

“People often mistake what diversity really means,” says Carter. “It’s diversity of experience and opinion that is key.

If people are of different genders or ethnicity, that’s a bonus, but not required.”

Echambadi adds: “We often hire people who have similar characteristics to ours, similar life experiences, because we are comfortable with people who are like us. But you need people who have diversity in talent, in work experience, in functional orientation. That is the underpinning of a successful innovation strategy.”

Be open to new and fresh ideas.

“You don’t have to say every idea is a good idea; not all ideas are good,” Carter says. “But you have to be open to innovation. If you’re not open and willing to constructively consider it, then you’ll miss a lot. Sometimes you may hear something that goes against everything you’ve been taught and always believed, and you need to be open to think about it and not discard it.”

Those fresh ideas, Echambadi adds, can come from a variety of places, including young talent and talent from the outside. “You can’t be dogmatic,” he says. “A lot of times, managers develop heuristics, which can help us in all areas of our lives. But sometimes they can take us down a wrong trajectory. They can make you dogmatic in the sense that you think, ‘I know better, I have 20 years of experience and therefore this young chap who comes in, he doesn’t know what’s best.’ This is the antithesis of not being curious, not being open to new ideas.”

Echambadi says that all companies must learn to do more with less. “Large organizations have to be nimble, they have to be flexible,” he says. “Entrepreneurship is not relegated just to start-up companies. To me, it’s pretty much the same at a larger level.”

The playing field has been leveled as never before. Start-ups can enjoy amazing success, and towering corporations can crumble in astonishing speed.

As Echambadi puts it, Redbox and Facebook have shown exactly how Blockbuster and AOL should have played it 10 years ago. Polaroid and Kodak had digital capabilities in the 1980s, but they never commercialized it. They each paid dearly for that mistake.

The issue, he says, has nothing to do with size. It has everything to do with attitude.

And that attitude has to be customer-focused. “The best innovation doesn’t always win,” Echambadi says. “It’s the innovation that best fits the customer that wins.”

– Tom Hanlon

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“If you want your employees to be innovative, you have to give them the freedom to pursue ideas without fear of failure,” Echambadi says. “And second is the innate curiosity that they need to have. It boils down to those two things: curiosity to be innovative and the freedom to do what they want to do.”

Question conventional wisdom and your mental model.

Echambadi encourages all CEOs he talks with to question their conventional wisdom and their mental models.

“Think about Netflix,” he says. “It came out of questioning conventional wisdom. Mailing DVDs seemed crazy at the time. I can get a DVD in 10 minutes, and now I have to wait for three days? And they succeeded!”

The mental model, which explains a working process and offers an approach to solving problems, needs to be questioned, Echambadi says, because over time much is taken for granted—and the customer’s needs get lost in the process. Too often, blindly following that mental model leads to developing products that customers neither want nor need.

Foster the sharing of information.

Echambadi notes that IDEO, an international design and innovation consultancy, has a “Tech Box” in the centers of their offices, where they keep all of their toys and products.

“Anybody can go in there and look at the toy and say, ‘This is how they did it. Can I use this type of method in an existing product that I am designing?’ It’s a way of institutionalizing innovations and tacit knowledge,” he says.

INNOVATION UNTIL YOU CREATE A PRODUCT AND MAKE A PROFIT FROM IT. IF YOU DON’T, THEN THE MARKET’S NOT VALIDATING YOUR PRODUCT, AND YOU REALLY DON’T HAVE INNOVATION.”

–JEFFREY CARTER

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Retain tacit knowledge.

If key people move on, Echambadi says, you need to prevent their tacit knowledge from walking away with them. You need to systematize or institutionalize that knowledge so you can replicate it in future innovations, regardless of personnel changes.

Know how to execute.

This is where the rubber hits the road. “Really great entrepreneurs can execute,” Carter says. “They can take that innovative vision and turn it into a profitable business.

Most businesses fail because of the lack of ability to execute the strategic vision.”

Champion strategic renewal.

Last but certainly not least is a company’s ability to continually renew itself. “The greatness of a firm like IBM is that it strategically renews itself over and over again,” Echambadi says. He details a laundry list of the numerous inventions and areas of focus of the company, which not surprisingly has undergone several organizational changes since its founding in 1880. It has acquired companies, spun off companies, and sold off product lines, while reinventing itself successfully over the years.

“That’s the whole notion of strategic renewal,” Echambadi explains. “Their innovation has been so well articulated in their vision, and more importantly they have been able to systematize that innovation and therefore they are able to replicate the results.”

–Tom Hanlon

www.business.illinois.edu

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Encourage curiosity and offer freedom.

“INNOVATION ISN’T

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It’s Taxing Work I

f the government could reel in every dime taxpayers owe, it would be nearly $400 billion richer every year.

That’s enough to make a big dent in the annual deficit.

While some Americans underpay their taxes because of honest errors, the great bulk of lost revenue can be blamed on tax cheats, experts say. They include waiters and waitresses who don’t declare their tips, the rich who park their money in secret offshore bank accounts, and organized crime.

According to Don Fullerton, who served as deputy assistant secretary of the U.S. Treasury from 1985 to 1987 and is now a professor of finance at ILLINOIS, some of that money could be collected if the government simply hired more IRS auditors. Instead, the number of auditors has shrunk along with total IRS employment. Fullerton cites data that shows IRS staffing plunged by more than 30,000 workers between 1992 and 2010, while the U.S. population jumped by 53 million people.

Even if the decline in IRS workers can be attributed to reliance on technology that can track information more accurately and crunch numbers more quickly, Fullerton says that the bottom line is that there are fewer auditors chasing a larger number of tax cheats. Meanwhile, the yearly gap between what’s owed and what’s paid ballooned by $95 million between 2001 and 2006, according to newly released IRS data.

“When I was at Treasury, experts there reported a ten-to-one return for hiring an auditor,” says Fullerton, the Gutgsell Professor of Finance. “Spending $100,000 on an auditor would bring in a million dollars. It seems crazy not to do that. Instead, they just let people cheat.”

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PERSPECTIVES SPRING 2012

As a practical matter, there is a point of diminishing returns from beefed up collections. If the IRS hires ten auditors, it might bring in nearly $10 million, Fullerton says. But returns fall as the government adds auditors. “Eventually, you don’t want to spend another $100,000 on enforcement to get $100,000 in revenue. That would be too extreme. Good policy involves tradeoffs between costs and benefits. We’re always looking for that happy medium. With tax collection, I don’t think we’re there. Right now, too many people are cheating on their taxes.”

To Catch a Cheat While the public may blame corporate America and the wealthiest citizens for the tax gap, the evidence suggests otherwise. “The biggest problem is your next-door neighbor, and people don’t want to admit that,” says Brian Whitlock, an attorney and CPA with Blackman Kallick, LLP, Chicago and an adjunct lecturer in the ILLINOIS MS Tax Program in Chicago.

By and large, tax cheats are people who work in the cash economy, where the government finds income difficult, if not impossible, to trace, Whitlock says.

“It’s people who sell things at flea markets. It’s people who render services in what would be referred to as the black market,” says Whitlock. “The government doesn’t know where the money is, but it has its suspicions.”

There are some tax cheats the government is not likely to go after, even though it has a pretty good idea who they are. This group includes kids who make petty cash by babysitting or by cutting a neighbor’s grass. “The government isn’t going to make a lot of friends by going after all the kids in the neighborhood,” Whitlock says.

Cashing In The United States built its tax system on voluntary compliance, and, in fact, most people do comply, Whitlock says. “When there are problems with cheating,” he says, “it’s because people don’t think they’re going to get caught.”

Meanwhile, the government goes to considerable lengths to convince people that they will get caught. Each year, for example, the IRS ramps up its publicity machine as April 15 approaches. To the extent that the government scares us, it increases the level of compliance, says Whitlock.

“GOOD POLICY INVOLVES TRADEOFFS BETWEEN COSTS AND BENEFITS.WE’RE ALWAYS LOOKING FOR THAT HAPPY MEDIUM.

WITH TAX COLLECTION, I DON’T THINK WE’RE THERE. RIGHT NOW, TOO MANY PEOPLE ARE CHEATING ON THEIR TAXES.”

www.business.illinois.edu

–DON FULLERTON

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“People are afraid of getting caught.

If they weren’t, they would cheat,” he says. “We need to have some level of polite fear in the tax system in order to have a reasonable level of compliance. If you can’t convince the general populace to comply, then the system falls apart.”

The tax code includes reporting requirements that make it virtually impossible to hide certain types of income.

Banks report interest on savings accounts.

Investment firms report bond interest and stock dividends. Employers issue W-2 statements. Even eBay must now report certain transactions on a Form-1099, which covers miscellaneous income.

“NO ONE SHOULD HAVE TO PAY MORE IN TAX THAN THEY ARE REQUIRED BY LAW.”

–W. KURT MEIER

The cheat Sheet

On average, Americans underpay their taxes by 15 percent.

Individuals account for about $271 billion in unpaid income taxes before enforcement. Corporations account for just $71 billion in unpaid income taxes before enforcement.

Sole proprietors account for the bulk of tax cheating by individuals.

In 2006, the latest year for which data are available, individuals and businesses owed an estimated $2.7 trillion dollars in taxes. Of that, $385 billion was never collected.

The IRS had 84,711 employees in 2010, down from 116,673 employees in 1992.

Individuals and businesses underpay their taxes in three ways.They fail to file a return; they report less income than they actually made; and they underpay what’s owed.

Tax cheating occurs in multiple areas, including individual income taxes, corporate income taxes, social security taxes, and estate taxes.

Source: IRS data compiled by Don Fullerton, professor of finance, for the website of the Center for Business & Public Policy at the University of Illinois.

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PERSPECTIVES SPRING 2012

According to Norma Lauder, director of the ILLINOIS MS Tax Program, these requirements create a checks-and-balance system that gives the IRS more of a road map to identify potential tax cheats. “For those who receive dividends or interest, there is a way for the IRS to track inconsistencies between what the payors report and what individual taxpayers report,” she says. “This allows the IRS to leverage their resources in terms of more accurate targeting of audits and to get better results in terms of compliance in general.”

It’s cash payments that remain the big problem because they are so easy to hide. “I think the government would like to drive cash out of the economy,” says Whitlock. “The government would love it if we all used debit and credit cards. If we did, the government could find the income.”

Tax cheats look for ways to encourage cash payments so they can beat the system. For instance, some businesses and self-employed workers give discounts for cash payments in lieu of payment by check or credit card, says W. Kurt Meier, adjunct lecturer in the MS Tax Program.

Of course, some cheats get caught.

For instance, in 1990, baseball great Pete

Why Comply?

Tax Breaks or Tax Broke?

But the system is complex, and sometimes taxpayers or businesses cross the line while seeking tax breaks. For instance, Meier cites tax shelters that were extensively marketed to corporations seven to ten years ago. Top tax attorneys and CPAs developed them. But the IRS suspected many of these shelters crossed the line and began to investigate. “The IRS was very successful in shutting down shelters that were considered abusive,” says Meier. A number of businesses that bought them had to pay back taxes, interest, and penalties. A number of the firms that sold shelters were fined.

Lauder says the success of the IRS in this area is attributable to the fact that instead of focusing their efforts on finding and auditing individual taxpayers it required the promoters of the shelters to identify the individual taxpayers for them. “This is a much smarter strategy for the IRS because it allows them to make the most efficient use of their agents and still get to the heart of the tax issue.”

Because of that investigation, the IRS began to require more detailed financial data on corporate tax returns. The requirements were tailored so that corporations would be highlighting transactions that corporate officials themselves thought might be questionable.

“They were self-reporting in a way,” says

here are a variety of reasons why people don’t pay taxes. Here are some of the most common:

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Some people don’t make enough money. For example, last year a couple with two children earning less than $26,400 would pay no federal income tax because their $11,600 standard deduction and four exemptions of $3,700 each reduce their taxable income to zero.

Some people don’t think they’ll get caught. Those who do make enough money may “fudge” on their taxes by underreporting income— that is, not including cash payments they were paid but for which they didn’t receive a W-2 or 1099—or by taking advantage of tax loopholes that they aren’t entitled to.This might occur due to the belief that with so many taxpayers and so few auditors they’re unlikely to get caught as well as the erroneous assumption that in the event that the IRS does catch up with them, the penalties won’t be significant. Because interest on underreported income is calculated based on when it should have been paid, not on when it was discovered by the IRS, penalties can be substantial.

Some people are intimated by the tax code. While ignorance of tax policies or a lack of understanding on how to complete your 1040 form isn’t a legal excuse, no one can deny that it can be a frustrating and complicated process that can be intimidating to many people who feel unqualified to do it themselves and can’t afford to have someone else complete it for them. In an effort to help such taxpayers, the IRS offers free Volunteer Income Tax Assistance across the country for those who qualify.

Some people have an ethical objection.

There are various reasons why people object in principle to paying taxes. For instance, it may be their way of expressing a conscientious objection to funding war or of stating their lack of faith in the government. Some openly declare their unwillingness to pay; others pay a symbolic amount, such as $17.76 in a patriotic nod to the year the country was founded; some simply ignore their tax bill; still others make a donation to charity in the amount of taxes they would have to pay. All of these methods are considered tax evasion and are illegal. On the other hand, some show their objections by paying their taxes but also including a statement of protest along with their return and payment.

–Cathy Lockman

www.business.illinois.edu

Rose pled guilty to failing to report income from the sale of autographs and sports memorabilia. So the only safe way to lower the tax bill is to use tax credits, deductions, or loopholes. This practice is entirely legal, says Meier, a former IRS official. “No one should have to pay more in tax than they are required by law.”

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Encouraging Good Behavior

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hile some experts suggest that the tax gap can be at least partially closed by ratcheting up enforcement, either by hiring more IRS agents or employing even more sophisticated technology, others believe another theory has merit as well.

Jon Davis, the R.C. Evans Endowed Chair in Business and the head of the Department of Accountancy at ILLINOIS, believes that a social climate that encourages tax compliance can play an important role. Research that he conducted in 2002 with his then-doctoral students, Gary Hecht, now an assistant professor at the University of Wisconsin– Madison, and Jon Perkins, an assistant professor at Iowa State University, supports this theory.

“THE PROBABILITY OF AN AMERICAN TAXPAYER BEING AUDITED IS EXTREMELY LOW, AND YET THE MAJORITY OF PEOPLE IN OUR COUNTRY PAY THEIR TAXES. OUR ANALYSIS SUGGESTS THAT MUCH OF THAT BEHAVIOR IS ATTRIBUTABLE TO HOW THE INDIVIDUAL SOCIETY VIEWS TAX EVASION. SOCIAL NORMS ARE VERY POWERFUL.”

–JON DAVIS

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Their research examines the relationship between social norms, enforcement, and tax compliance dynamics. As you might expect, their model suggests that initially compliant populations remain compliant even when enforcement is decreased, but only up to a point. Once a threshold of lax enforcement is reached, there is a sudden transition where most people in the population evade. Once this happens, it is very difficult to use enforcement to drive the population back to its previously compliant state.

“In our country, compliance is fairly good, especially compared to other countries that also have a voluntary system and a similar enforcement regime,” says Davis. “So you have to wonder why it is that some countries are more successful in collecting taxes than others. When you think about it, the probability of an American taxpayer being audited is extremely low, and yet the majority of people in our country pay their taxes. Our analysis suggests that much of that behavior is attributable to how

the individual society views tax evasion.

Social norms are very powerful.”

So the key to reducing the number of tax scofflaws is likely twofold: establish social norms that favor compliance and then ensure consistent, strong enforcement. “To close the tax gap, it’s important to get to those groups within the society that accept noncompliant behavior and convince them to change their view about what is acceptable behavior,” says Davis.

Just how can we do that? Davis points to ideas like public service advertising campaigns that have been successful in encouraging behavior changes, such as those that convinced the public to “Keep America Beautiful,” “Take a Bite Out of Crime,” and that “Only You Can Prevent Forest Fires.”

And if we aren’t successful in changing the social norms of the noncompliant groups, what are other options for increasing revenue from taxes?

Davis has a suggestion. He says that although spending cuts are an important part of getting control of the country’s budget, it isn’t a complete answer to our nation’s fiscal woes.

“We have to raise more cash,” he says. “And from a political perspective,

“FOR THOSE WHO RECEIVE DIVIDENDS OR INTEREST, THERE IS A WAY FOR THE IRS TO TRACK INCONSISTENCIES BETWEEN WHAT THE PAYORS REPORT AND WHAT INDIVIDUAL TAXPAYERS REPORT.THIS ALLOWS THE IRS TO LEVERAGE THEIR RESOURCES IN TERMS OF MORE ACCURATE TARGETING OF AUDITS AND TO GET BETTER RESULTS IN TERMS OF COMPLIANCE IN GENERAL.”

there is no way to raise individual or corporate tax rates, and increasing estate tax rates won’t generate enough revenue, so I believe the best way to raise cash is to institute a value-added tax.” To illustrate the concept, Davis uses the example of a farmer who buys seeds, plants wheat, harvests it, and then sells it to a mill, at which time he is taxed on the net value he added.

When the grain is milled and sold to a baker, the mill pays a tax; when the baker sells it to a grocery store, it’s the baker’s turn to kick in.

While much of these costs are likely to be passed on to the consumer by way of higher product prices, Davis explains that a well-executed valueadded tax does have several benefits: it is not distortionary, which means no one good is impacted more than any other good; it does raise significant revenue; it is less costly to administer than some other forms of taxes; and it has high compliance rates.

“We’re one of a few countries that don’t have a value-added tax,” says Davis. “I think that in the next five or six years, it will be a very real possibility in the U.S. After all, we have to step up and meet our debt or our children will have to do it.”

–Cathy Lockman

Meier. “They were saying to the IRS, ‘I have something that may be in the gray area.’“ The fact that companies must now report these transactions has made it more likely that the companies will stay on the right side of tax law, Meier says.

As a side effect of the additional scrutiny, most corporate tax shelters have disappeared, he adds.

Reporting requirements are also tight for workers who get a W-2 form from their employers. “That’s why there is 99 percent compliance on wages and salary,” says Fullerton, the former Treasury official. “They can’t cheat.”

The reporting requirements for the self-employed aren’t nearly as strict, and that’s where much of the abuse occurs.

“They can fabricate receipts for expenses and fail to report cash actually received,” says Fullerton. “Or they can barter. They’ll say, ‘I’ll paint your house if you fix my plumbing.’ That’s supposed to be taxable income, but they don’t report it. There’s no way for the IRS to track that down. So you can see how hard it is for the government to get everything it’s owed.”

Lauder says it’s a situation that allows the taxpayers to play the audit lottery knowing that they probably won’t be audited and forces the IRS into the old game of randomly selecting individuals to audit and hoping for the

best. “It certainly is not efficient in terms of both auditors’ time or in terms of results, but until we get to a noncash economy that creates a paper trail there really isn’t a better way to capture this information or to encourage individual compliance.”

Jon Davis, professor of accountancy, agrees that the task the agency has is daunting, and yet, he says, “The IRS is the most efficient tax agency in the world.

They process 230 million returns and collect about $2.3 trillion. Under IRS Commissioner Doug Shulman, they have also undertaken initiatives aimed at increasing transparency on the business side and on regulating the tax-preparing industry by requiring competency tests for preparers.” Davis says the IRS is also studying the implementation of a real-time reporting system rather than a look-back system. “It’s too early to gauge the effectiveness of these initiatives, but the IRS is certainly taking aim at narrowing the tax gap.”

Fullerton says that the tax-complying public is relying on the government to do just that. “You don’t want to encourage people who are doing the wrong thing.

When one person cheats, somebody else pays.”

–Doug McInnis

www.business.illinois.edu

–NORMA LAUDER

11

Your move.

“FLEXIBILITY GETS DEALS DONE. WE TOO OFTEN DRAW LINES IN THE SAND OR EXPRESS RIGIDITY IN WAYS THAT END UP HURTING RATHER THAN HELPING US. AND BECAUSE MY INTERESTS MAY NOT BE DIRECTLY OPPOSITE YOURS, TRY TO USE THE WORDS ‘I’ AND ‘ME’ LESS AND USE THE COLLABORATIVE TERMS,‘WE’ AND ‘US’ MORE, WHICH CAN HELP SHIFT YOU FROM THINKING TOO MUCH ABOUT CLAIMING VALUE AND NOT ENOUGH ABOUT CREATING VALUE.”

– JEFF LOEWENSTEIN

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PERSPECTIVES SPRING 2012

THE WIN-WIN STRATEGY OF NEGOTIATION

Claim, Cultivate, Create Knowing he got that point across is music to Loewenstein’s ears. “Of course, there is an element of negotiation that is about advocating for your own outcome,” he says, identifying that goal as “claiming value.”

“But that’s only one of three important goals in the negotiation process, he explains. “Claiming value is mainly about using power and influence to satisfy our own interests today, whereas the second goal, ‘cultivating value,’ is about building relationships and reputations and so is more concerned with tomorrow than today.”

Some people try to claim value but don’t also work to cultivate it, and that’s a mistake, says Loewenstein. “Often the value to be gained from relationships and reputations is far more than what can be gained from the current deal. Do not be misled into believing you’re soft if you focus on developing partnerships, because when you’re looking long term, like seeking a promotion or a contract renewal, then cultivating value looms larger than claiming it.”

And so does the third goal, “creating value,” which Loewenstein says is about understanding the problem-solving aspect of negotiation. “This is really what makes negotiating interesting,” he says, “and yet it is the aspect that people have less of an intuition about.”

He explains that creating value is more than making a deal; it’s about sharing information, finding out about differences, and determining how each person can help the other. “When you find a way for one party to give something that’s cheap for them but quite valuable to the other party, you have created value.

Those are the negotiations where possibilities are opened up and people

come out feeling it was a creative process that was worth their time.”

Depending upon the type of negotiation taking place, one of these three goals may take precedence over the others, says Loewenstein, but all three are present. “It’s not useful to focus on just one of these goals.”

Starting the Conversation For Jared Melnyk, a 2006 finance graduate who is an insurance broker for Lemme Insurance Group, negotiation is part of his job every day. He picked up some pointers from Loewenstein’s presentation as well, crediting an exercise the professor shared about Super Bowl tickets with opening his eyes to the concept of creating value.

“It’s really straightforward when you think about it,” Melnyk says. “If someone has a pair of Super Bowl tickets they want to sell, there is a range of what people are willing to pay for them. A big fan might not have to think twice about paying thousands of dollars because their team is playing and they don’t want to miss seeing the game in person. Another person who has no interest in football might only be willing to pay $10 for them, forgetting that selling them to the big fan could yield a good profit. The example shows how you can create value by recognizing differences.”

For Melnyk it drove home the fact that “negotiation is a way to look at the value that you’re delivering to another

www.business.illinois.edu

f you’ve ever visited Groupon.com, you know they’re a creative and clever bunch of dealmakers. When Nolan Finn joined the company last year as a senior project leader, he found that Groupon’s creative philosophy also carries over into unique deals for employees, including unlimited paid days off.

In true Groupon fashion, a tongue-incheek post on the company’s blog states, “Employees get unlimited paid days off— everyone is encouraged to stay home whether they are bored or suffered an injury while working the steam-powered deal generator.” That might be a funny post, but it’s a serious work benefit. It’s also a company policy that can change the face of employment negotiations, by taking one often-used benefit off the table.

“I’m given a lot of flexibility in my job,” says Finn, a 2007 graduate in management information systems.

He recently attended a negotiation presentation made by Jeff Loewenstein, an associate professor of business administration at ILLINOIS, and came away thankful he works for a company that offers creative benefits. He also left armed with information about how to make the most of his personal and business negotiation opportunities.

“We talked about how as people we are conditioned to win, to find ways to beat others, to win the prize,” says Finn.

“But through a pretty straightforward arm wrestling example, we found that you can get a lot more if you don’t fight over it.

It really brought home in a practical way that there is often an opportunity to create a non-zero-sum outcome, but that may not be apparent if you approach negotiation in a way that is contentious.”

13

“YOU MAY VALUE THINGS DIFFERENTLY AND HAVE DIFFERENT GOALS, BUT NEGOTIATION GIVES YOU THE OPPORTUNITY TO OPEN UP A CONVERSATION ABOUT WHAT YOU VALUE SO THAT YOU CAN PRESENT SOLUTIONS AS A WIN-WIN.“

– JARED MELNYK

party or organization. You may value things differently and have different goals, but negotiation gives you the opportunity to open up a conversation about what you value so that you can present solutions as a win-win. This has been valuable to me as I negotiate with an underwriter on behalf of a client, and it has also taught me important strategies for times I need to negotiate on my own behalf.”

Loewenstein agrees that conversation is key. “I need to know enough about your business to see how I can bring value to our relationship. Oddly enough, we might discover something in the course of that conversation about what you really want that you did not even realize from the start. The goal of creating value leads us to realize that a major priority in negotiation is for people to really understand what they want and articulate it, and it is surprising how often people are not clear about what they themselves want.”

Add to that the fact that people often don’t think much about what the other party wants and you can see why negotiations go nowhere. Having a true conversation helps both sides create and also cultivate value.

• Test your assumptions. People often believe that negotiating on their own behalf makes them appear pushy or tell themselves: “If they believed I deserved a raise, they would already have given it to me.” Loewenstein says these assumptions “derive from guesses about what you don’t know but fear to be the case and are barriers to negotiation.”

Instead, see negotiation as the start of a mutually beneficial conversation.

fact, Loewenstein cites research from another ILLINOIS faculty member, Gregory Northcraft, the Harry J. Gray Professor of Executive Leadership and an expert on negotiation, that says that 80 percent of employers would rather see their employees negotiate in a professional way than not negotiate at all. “It’s a skill that employers value and a way they can gather useful information for the company,” Loewenstein says. “They also appreciate the initiative that it shows on the part of the employee.” And from a practical standpoint, research shows that those who negotiate end up with an average salary gain of 2 to 4 percent, which can really add up over your work life.

• It is okay to negotiate. Some people start at a disadvantage because asking for a promotion or a raise makes them feel greedy or selfish. But in most cases, employers view it as a positive sign. In

• Build a negotiation vocabulary.

If you are in a medical setting or a legal setting, you quickly realize people are using jargon to understand and communicate about what is happening.

“WE ARE CONDITIONED TO WIN, TO FIND WAYS TO BEAT OTHERS, TO WIN THE PRIZE. [HOWEVER] THERE IS

Good Advice With these three goals in mind, what are specific strategies that participants in negotiation should undertake to ensure success? Loewenstein offers this advice.

OFTEN AN OPPORTUNITY TO CREATE A NON-ZERO-SUM OUTCOME, BUT THAT MAY NOT BE APPARENT IF YOU APPROACH NEGOTIATION IN A WAY THAT IS CONTENTIOUS.”

– NOLAN FINN

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PERSPECTIVES SPRING 2012

Are You a Competitor or a Cooperator?

• Don’t cling to your positions, cling to your interests. People often do this unintentionally, says Loewenstein, because they haven’t yet embraced the three goals of claiming, cultivating, and creating value. “Flexibility gets deals done,” he explains. “We too often draw lines in the sand or express rigidity in ways that end up hurting rather than helping us. And because my interests may not be directly opposite yours, try to use the words ‘I’ and ‘me’ less and use the collaborative terms, ‘we’ and ‘us’ more, which can help shift you from thinking too much about claiming value and not enough about creating value.”

• Consider your counterpart’s cultural and social norms. Loewenstein says this is an issue that is increasingly on people’s minds. “The negotiation research and practitioner community have found that the basic framework for how we understand negotiations really doesn’t need to change. The changes come in how you get there.” Consider the norms for the different cultures, backgrounds, or age groups you are

You’re a cooperator if:

• You are motivated to engage in negotiation and consider it a powerful and influential position to be in • You focus on winning and getting your share • You work to maximize the difference between your outcome and the outcomes of others

• You prefer that others recognize your value and reward it • You value the exchange of information • You focus on maximizing results for each person in the negotiation

If you’re a competitor, you should: • Work to establish a win-win situation instead of just a one-sided win • Ask questions, listen, and respect the other party • Appeal to standards • Be careful to keep your word

negotiating with. What is respectful to one group might be considered a waste of time to another. What people talk about first can be their most important issue, their least important issue, or even what is non-negotiable. “The bridges you have to cross in these types of negotiations are ones of understanding the nature of communication within the organizational or social culture.”

Bargain Hunting If your task involves negotiating for a team rather than for yourself, such as serving as a union or management representative in a bargaining situation, there are additional challenges.

“In those cases, there are multiple negotiations at the same time that are

If you’re a cooperator, you should: • Ask for what you want instead of waiting for what you think you deserve • Not let yourself be intimidated by the process • Objectively assess your value • Focus on your goals and expectations rather than the bottom line • Imagine you are negotiating on behalf of someone else • Get written commitments during negotiation

interdependent,” says Loewenstein. “The process is so much more complicated because you have to negotiate with both your constituents and the other group.

There’s a lot of pressure because you have to discuss issues without giving away what you’re willing to accept as the outcome.”

But whether you’re negotiating for yourself, your employer, or for a team, there is one thing that stays the same.

“You still have to consider the three goals of claiming, cultivating, and creating value, and you have to know what you want going into the negotiation and what kind of outcome will be acceptable to you when the process is complete.”

–Cathy Lockman

www.business.illinois.edu

It’s no different when you are negotiating, says Loewenstein. “Talking about different kinds of negotiations using the same vocabulary can help you take lessons from where you are a stronger negotiator and apply them to areas where you are less confident. Also, if you’re talking to someone who isn’t using the same vocabulary, it really slows you down. We become much more efficient and productive negotiators when we understand and speak the same vocabulary.” That’s why it’s so important to take the opportunity to engage in negotiations whenever possible. The more you practice the art of negotiation, the better your negotiation vocabulary will be.

You’re a competitor if:

15

“A COMMUNITY WITH 10,000 SLOT MACHINES IS LOSING 10,000 CONSUMER JOBS PER YEAR—EVERY YEAR.THE U.S.

NATIONAL GAMBLING IMPACT STUDY COMMISSION REPORTED THAT ELECTRONIC GAMBLING VIA SLOT MACHINES AND THE

INTERNET WERE THE ‘CRACK COCAINE’ FOR CREATING NEW ADDICTED GAMBLERS.“

–JOHN KINDT

Q&A TAKING A GAMBLE L

ess than six months ago, the federal government considered all online gambling to be illegal. However,

a Department of Justice opinion, released late last year, has changed that position, stating that only online betting on sports is illegal. This decision leads businesses, state governments, and the public to wonder what legalized Internet gambling could mean for the economy.

John Kindt, professor of business administration and author of The Gambling Threat to Economies and Financial Systems: Internet Gambling, shares his opinions on the economic and societal impact of legalized online gambling and the recent Justice Department ruling.

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PERSPECTIVES SPRING 2012

Q

How does this ruling differ from previous opinions and legislation?

A

The Department of Justice (DOJ) opinion written on September 20, 2011 suggests that all Internet gambling (with the exception of sports gambling) could be considered legal. This DOJ opinion contradicts 60 years of legal precedents, beginning with U.S. Attorney General Robert F. Kennedy’s legislated Wire Act designed to curb organized crime and associated electronics supporting gambling activities. This DOJ opinion ignores the legislative history and purports to overrule other DOJ opinions, court cases, and even the 2006 Unlawful Internet Gambling Enforcement Act. Furthermore, this new DOJ opinion contradicts the recommendations of the Congressional Commission, specifically the U.S. National Gambling Impact Study Commission, which concluded that all Internet gambling should always remain criminalized. The fact that the September 2011 opinion was not issued to the public until December 23, 2011, the Friday before Christmas, was an obvious attempt to hide this DOJ opinion from the press and the U.S. Congress. The Christian Science Monitor has recently exposed significant alleged conflicts of interests between Internet gambling lobbying and this DOJ author and her associates.

What can the public, state governments, and businesses expect as a result of it?

A

No governmental entity, public group, or business should take any action predicated on this tenuous DOJ opinion.

Responsible gambling companies, as well as antigambling groups, recognize that this DOJ opinion could be withdrawn or overturned at any time. Interested parties, decision makers, and legislators should visit the “60 Minutes” website and view “Financial WMDs: The Bet That Blew-Up Wall Street” and “Slot Machines: The Big Gamble.” In the context of these exposes, Internet gambling in any form would create a speculative bubble comparable to the recent sub-prime mortgage crisis.

Q A

Q A

Blagojevich). The five new projected Illinois casino licenses worth $2.5 billion will be granted to licensees for $150,000 each. Since 1990, a net 100,000 people have been moving out of Illinois each year.

Businesses and their subsidiaries have also been leaving the state, as exemplified most recently by Caterpillar Company’s announcement to relocate 1,400 Illinois jobs in Georgia. Fortune 500 companies understand the negatives associated with government-sanctioned gambling. Legalized gambling creates enormous taxpayer costs of at least $3 for every $1 in new revenues. As people lose their money, legalized gambling creates new addicted gamblers (like drug addiction), new bankruptcies (increasing 18 to 42 percent), and new crime (increasing 10 percent per year every year around gambling facilities, according to an 8-year study published by Harvard & MIT).

Is the ruling likely to be challenged in any way? Does the ruling have the force of law or must Congress act to allow legalized online gambling?

The September 2011 DOJ opinion has created outrage on Capitol Hill, and Congressional backlash is building. Even pro-gambling interests are anticipating new legal action this year by the U.S. Congress to nullify the DOJ opinion.

Furthermore, the DOJ opinion does not have the force of law and could be reinterpreted, withdrawn, or overruled at any time—probably to address Congressional disfavor.

However, a reported $100 million lobbying campaign

by Internet gambling interests is apparently trying to leverage the DOJ opinion into misleading the public and legislative leaders.

Illinois has long relied on revenue from lottery ticket sales, casinos, and OTB business. Isn’t online gambling a natural extension of this form of revenue generation that can add to the state coffers at a time of significant budget crisis or is it actually a drain on the economy?

Economics 101 establishes that gambling is a drain on the economy. Illinois was one of the first states to get a lottery and casinos. Why would any state wish to emulate the bureaucratic decision making in Illinois, particularly the Illinois lottery’s suspect attempts to manipulate Internet gambling? Illinois has the worst budgetary problems of any of the 50 states—in large part due to legalized gambling. Nevada is number two. According to a 2012 report of the Institute of Government and Public Affairs at the University of Illinois, since 1976 the state of Illinois has had more crime/corruption than any other state (for example, guilty pleas/convictions for four of the previous six Illinois governors, as well as 31 Chicago Aldermen).

The original 10 Illinois casino licenses worth a total fair market value of $5 billion were granted to political insiders for $25,000 each (including one person recently convicted as part of the scandal involving Governor Rod

Q

What are the economic realities of legalized gambling?

Can it stimulate the economy through the development of businesses like Zynga, the gaming company that recently went public?

A

Gambling produces no product. A succinct way to visualize the socio-economic effects of gambling is to focus on electronic gambling devices/slot machines. Electronic slot machines account for 90 percent of the money that gambling facilities collect per year. Today, card games are used primarily to attract new players to the slot machines, which are the real profit center. Slot machines do not create jobs—the owners just dust them off and collect the money.

However, the money dumped into each slot machine averages $300,000 in lost consumer spending per year.

Money lost in slot machines is not going to buy cars and computers—or even the necessities of life like food, clothing, and healthcare. This lost $300,000 in consumer spending translates into one lost consumer job per year per slot machine. Accordingly, a community with 10,000 slot machines is losing 10,000 consumer jobs per year—every year. The U.S. National Gambling Impact Study Commission reported that electronic gambling via slot machines and the Internet were the “crack cocaine” for creating new addicted gamblers. The U.S. Congress held almost a decade of hearings on Internet gambling before 80 percent of the Congress voted to enact the stringent enforcement mechanisms in the 2006 Unlawful Internet Gambling Enforcement Act. Internet gambling lobbyists routinely refer to Internet gambling as the “killer application” of the Internet because it would place the very worst type of gambling in every living room, at every work desk, at every school desk, and on every mobile phone. People could easily “click their mouse, lose their house.”

www.business.illinois.edu

Q

17

C use

Y

ou might not be familiar with the term “cause-related marketing,” but if you’ve ever worn a LIVESTRONG bracelet, bought a pair of TOMS shoes, collected cereal box tops, purchased a paper shamrock at a Walgreen’s cash register, collected pink Yoplait yogurt lids, or dropped a toy in a Toys ‘R Us Toys for Tots bin, you’ve participated in cause marketing.

Now the fastest-growing category of corporate sponsorship spending, cause marketing is a powerful business strategy for both corporations and non-profit organizations—with companies spending millions of dollars on cause-related campaigns and charities collecting millions from these partnerships.

It all started in 1983 when American Express launched a campaign aimed at helping to restore the Statue of Liberty and Ellis Island. American Express guaranteed to donate 1 cent for every credit card transaction and $1 for every new card issued during the last quarter of 1983.

Not only did the company collect nearly $2 million that it was able to contribute to the restoration effort of the American landmark, but American Express put itself on the map as well, generating extensive positive publicity and realizing a 17 percent increase in the number of credit cards and a 28 percent jump in the use of those cards.

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PERSPECTIVES SPRING 2012

The success of that first cause marketing campaign turned a lot of corporate heads, and within a decade U.S. businesses and non-profits had widely embraced the concept. Cause marketing quickly began replacing “corporate charity,” which was becoming largely viewed by companies and their shareholders as an expense that had few tangible benefits. In contrast, the efforts of American Express and other early adopters of cause marketing proved that businesses could make those donations, incur those expenses, and get something in return. A more strategic form of philanthropy was born.

Ties That Bind Since 1990, when the amount of money spent by corporations on cause marketing campaigns stood at about $125 million, the outlay by corporations has increased significantly, reaching more than $1.5 billion in 2010. With thousands of companies, large and small, raising millions for national and international charities, these partnerships have exploded in the marketplace. And why not? After all, these alliances not only raise awareness of and cash for non-profits, they also create exceptional public relations opportunities for companies, establish them as philanthropic citizens, and, unlike earlier corporate charity efforts, actually help sell products and services.

General Mills, for instance, created the “Save Lids for Lives” campaign, producing special Yoplait yogurt containers prominently displaying the pink breast cancer awareness ribbon. For the last several years, General Mills has contributed 10 cents for each lid returned to the company to the Susan G. Komen Breast Cancer Foundation. Since the campaign began, more than $25 million has been donated by General Mills. That’s a lot of

money for breast cancer research and a lot of yogurt sales.

It’s a partnership that has synergy: a product whose target demographic is largely healthconscious women aligned with a nonprofit concerned with women’s health.

According to Tiffany White, associate professor of business administration, that synergy is key to a successful relationship.

“When companies engage in this kind of marketing effort, it signals to customers that in addition to their interest in profits, businesses also have a benevolent interest, that they have charitable, sharing intentions over and above making money,” says the Bruce and Anne Strom Faculty Fellow. “And when the company aligns itself with a cause that is related to their business and appeals to their target audience, it’s a winning formula.”

That certainly is true for the alliance between the Lance Armstrong Foundation and Nike, who in 2004 produced the yellow rubber LIVESTRONG bracelet. Each bracelet sold for $1, and all proceeds went to the foundation for cancer research. As an athlete, Lance Armstrong’s partnership with a sports apparel giant was a fit that resonated with consumers. But wearing the bracelet became more than a nod to the cause, it took on a life of its own, becoming a popular fashion statement as well. That success morphed into an entire line of merchandise that carries both the LIVESTRONG name and the Nike brand “swoosh.” To date, that partnership has raised more than $80 million for the cause.

But the donation doesn’t have to be that big or the product that trendy to win over consumers. White cites the positive consumer response to efforts such as Target’s Take Charge of Education Program, which funds educational

Effect bucket sold. Though $1.9 million was raised in the first week alone, a lot of feathers were ruffled over what many thought was an ill-advised partnership between a company that sells deep-fried fast food and a cause for which there is a link between excess body fat and low survival rates. In some camps, the negative publicity for both the company and the non-profit was louder than the positive impact of the donation and lingered long after the campaign ended.

“Such efforts have the potential to shed a bad light on both the company and the non-profit and make them both seem opportunistic,” says White.

Emotional Connections Partnerships that fall flat are definitely in the minority, and the substantial benefits of successful partnerships keep businesses keen on the concept. Not only can cause-marketing efforts generate extensive goodwill and publicity, help differentiate a company from its

“WHEN COMPANIES ENGAGE IN THIS KIND OF MARKETING EFFORT, IT SIGNALS TO CUSTOMERS THAT IN ADDITION TO THEIR INTEREST IN PROFITS, BUSINESSES ALSO HAVE A BENEVOLENT INTEREST,

competitors, and increase sales, they can also further the relationship with the customer.

“Such efforts appeal to consumers in a way that’s meaningful to them, and it’s much more of a collaborative effort with a more positive outcome,” says White. “Customers are enthusiastic about spending money at a business that shows they understand who their customers are and what they value. It helps build brand loyalty and trust and long-term, resilient relationships with customers. It validates their decision making and enhances the brand.”

Inger Stole, associate professor of communication, agrees. “When a company creates an emotional connection between its brand and the consumer, they are forging a relationship,” she says.

“Those that can sustain that connection rise to the top. Cause marketing suggested itself as a way to build that relationship by promising to fulfill more objectives than just supplying a product. It says that as a business we understand that Americans stand for more than shoes, or cigarettes, or cereal. That’s why the American Express campaign was so brilliant. Who can argue with the concepts behind the Statue of Liberty?”

THAT THEY HAVE CHARITABLE, SHARING INTENTIONS OVER AND ABOVE MAKING MONEY. AND WHEN THE COMPANY ALIGNS ITSELF WITH A CAUSE THAT IS RELATED TO THEIR BUSINESS AND APPEALS TO THEIR TARGET AUDIENCE, IT’S A WINNING FORMULA.”

–TIFFANY WHITE

Overexposed?

With relatively few risks and so many benefits for the business and the non-profit, and the feel-good connection for the consumer, isn’t everyone a winner when it comes to cause marketing?

In many ways, yes, say experts. But that doesn’t mean there aren’t pitfalls.

Stole, for instance, shares concerns that the practice of hinging important issues such as health care and education on the whims of marketing trends is problematic.

www.business.illinois.edu

programs of the customer’s choosing, and Panera’s Operation Dough Nation, which includes creating easy ways for customers to donate change to the local hunger effort as well as Panera’s donation of day-old food products to local agencies that serve the hungry.

“This complementary package of a smart corporate mind and a good corporate heart appeals to consumers and differentiates the business from the competition,” White explains.

Cause-marketing efforts that don’t have such a strong and sincere tie between the business and the charity, on the other hand, may find themselves the unwitting recipient of consumer backlash, no matter how generous the company’s intentions.

That’s what happened in 2010 when Kentucky Fried Chicken launched its Buckets for the Cure campaign, changing its traditional red buckets to pink and donating 50 cents to the Susan G. Komen Foundation for every

19

“WE MUST ASK OURSELVES IF THE EMERGING SYSTEM OF CAUSE MARKETING AND COMMERCIALLY DRIVEN PHILANTHROPY IS THE BEST AND MOST SUSTAINABLE WAY FOR SOCIETY TO ADDRESS FUNDAMENTAL SOCIAL ISSUES.”

–INGER STOLE

“We must ask ourselves if the emerging system of cause marketing and commercially driven philanthropy is the best and most sustainable way for society to address fundamental social issues,” she says.

As a communications expert, Stole is convinced that “from the corporation’s standpoint, there’s no doubt that cause marketing is an effective branding strategy,” but as a citizen, she’s concerned that “it makes the public feel that charities are well taken care of, and that’s just not the case.”

With corporations eager to support charities such as Susan G. Komen, Habitat for Humanity, and St. Jude’s Children’s Hospital, just to name a few, Stole says many smaller and less-popular causes find themselves struggling to raise funds. They want a piece of the corporate pie and spend a great deal of time and effort trying to determine how best to leverage their cause to marketers.

And when that doesn’t pan out, Stole says, these non-profits find themselves appealing to a public that may be less inclined to write a check because the sheer volume of cause marketing efforts, and their participation in those campaigns, make consumers feel they are doing their part.

The large number of cause marketing efforts and the public’s constant exposure to them can also be a reason for backlash.

Consumers may feel

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PERSPECTIVES SPRING 2012

overwhelmed by the appeals being made to them, no matter how important the causes, which may cause them to feel less generous and more suspect. Facilitated giving provides such an example, says Stole. This branch of cause marketing, which has been taken up by gas stations, drug stores, or other convenience shops, solicits small donations for popular causes at the cash register.

“People begin to ask, ‘How do I know that my donation is actually going to that cause,’” says Stole. Then there’s the fact that all those donations taken together become a contribution that has the gas station or drug store’s name attached to it, instead of the consumers who actually opened up their wallets. Add to that the angst that some consumers feel about being put on the spot to donate or explain themselves and you have a recipe for resentment.

An additional concern for the nonprofit and the corporate partner is what White describes as “co-branding contagion,” which is the association of one brand with another by virtue of its affiliation with the same organization, in this case, the non-profit. For instance, says White, a charity could lose the sponsorship of one partner by forging a relationship with a second corporation that the first does not want to be linked with.

“When companies sponsor important causes, consumers make attributions between the cause and the brand and all the cause’s partners, so brands always need to be mindful of what their actions and their associations with other brands signal to customers,” says White. There can be backlash if one company, for instance, has a reputation that by association

“contaminates” the other. “If the consumer has to stop and calculate the mental math of the brands’ relationship with each other and it doesn’t add up in their mind, it can be detrimental to the brand and the cause.”

Terri Helge, professor at Texas Wesleyan University School of Law, explains that there is an even more nebulous problem for the non-profit— and that’s the potential tax implications of such partnerships. “Despite the widespread success of cause-related marketing, the IRS has issued little guidance on acceptable practices by charitable organizations engaged in causerelated marketing,” she says. “This leaves the non-profits vulnerable to questions about their tax-exemption status.”

(For more information on the tax considerations of cause marketing, see the accompanying story on page 21.)

Going Viral What does the future hold for cause marketing and the landscape of nonprofit fundraising? “Social media will be increasingly used to facilitate cause marketing,” says White, “but it can be a slippery slope. When social media efforts are well done, they can be great assets, but they also have the potential to grow and go in the wrong direction and become hybrids of themselves, so it’s very important that they are strategically managed.”

Stole says the arena is likely to become even more elaborate. “I see much more use of social media to generate excitement about cause-related campaigns and more viral marketing beyond the purchase-triggered model. It’s too valuable a strategy for corporations to abandon it, but they have to renew and refresh their approaches, so that they continue to engage the consumer.”

–Cathy Lockman

F

or non-profits, the income that the charity is receiving. evolution from If the corporation is paying for the corporate sponsorship right to use the charity’s name to sell to cause-related marketing has its product, is this considered a the potential to create tax passive royalty of the charity’s mark challenges. Why would a charity or name or is it considered an have tax implications for money endorsement by the charity, which that is being donated to their then is considered advertising and cause? may be subject to tax.”

Terri Helge, professor Helge also explains that for a at Texas Wesleyan University charity to be tax exempt it must School of Law and a 1994 provide a public benefit and can ILLINOIS graduate in provide no more than an incidental accountancy, says the issue is private benefit, a vague concept that how cause marketing can blur leaves room for wide interpretation. the lines between non-profit and “The IRS is supportive of for-profit activities. charities, but they are aware that some charities are not complying “Corporations have historically invested marketing with the rules to maintain tax exemption. They are trying to dollars in furthering community causes, with the residual determine what is going on in the non-profit sector.” She says the effect of building the corporation’s goodwill,” she says. “But Congressional Budget Office has even issued a report on unrelated when the for-profit corporation also receives, in return for its business income tax (UBIT) suggesting a more aggressive approach support of the charity, the right to use the name or logo of to investigating charities that may not be adhering to tax the charity to directly affect the sale of the corporation’s regulations regarding UBIT. product,” that can raise questions about the appropriate tax Helge calls for the IRS to provide more guidance for charities treatment for the charity. on these issues, as the matter will only become more complicated “Cause marketing is on the IRS radar screen, and I as cause-marketing initiatives grow more successful and more would hate for charities to get caught because they were widespread. unaware. From the corporate side, there really isn’t much “A revenue ruling or Treasury regulation setting forth safe risk tax-wise because the money they’re spending generally harbor provisions for permitted cause-related marketing alliances is a proper business deduction. It really is falling on the would be mutually beneficial because it would reduce the charity to be sure they are complying with the laws.” administrative burden on the IRS of examining these arrangeHelge’s motivation for researching this topic stems from ments on a case-by-case basis, and it would allow charities to her time working with non-profits first as an accountant and more easily comply with the law,” explains Helge. “In particular, now examining it from the legal aspect. “I saw that smaller charities that smaller charities were looking at cause marketing cannot readily afford legal as an innovative way to raise funds without counsel to assist them in “DESPITE THE WIDESPREAD SUCCESS OF CAUSEasking for more checks or doing an active structuring complex fundraising campaign. They saw that larger licensing transactions RELATED MARKETING, THE IRS HAS ISSUED LITTLE charities were having a lot of success, and they would benefit.”

GUIDANCE ON ACCEPTABLE PRACTICES BY CHARITABLE wanted to take advantage of that opportunity, –Cathy Lockman ORGANIZATIONS ENGAGED IN CAUSE-RELATED too. However, unlike their larger counterparts, these charities often don’t have the benefit of MARKETING.THIS LEAVES THE NON-PROFITS legal advice, and since there is no clear guidance VULNERABLE TO QUESTIONS from the IRS, this leaves them vulnerable.”

ABOUT THEIR TAX-EXEMPTION Tax exemption for charities is based on the fact that the services they provide are different STATUS.” from those of the for-profit sector. “When the –TERRI HELGE lines between charitable activity and for-profit activity cross, the justification for special tax treatment for the charity weakens,” says Helge.

“The question may be what are the sources of the

www.business.illinois.edu

Charity Case

21

Drowning in Debt

Murky Waters The credit crunch that struck the corporate refinancing market in 2008 had been building for years.The following timeline shows how one thing led to another until the money just dried up.

2004-2006 U.S. interest rates rose from 1 percent to 5.35 percent.The rising rates began to impact the red-hot U.S. housing market.

2.26.2007 Former Federal Reserve Chairman Alan Greenspan warns a U.S. recession may occur by the end of the year.

2.27.2007 Stock prices fall on the Shanghai stock exchange.

U.S. markets follow suit as the Dow loses more than 400 points.

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PERSPECTIVES SPRING 2012

“BEFORE THE CRISIS, I THINK IT’S POSSIBLE THAT CFOS GOT OVERCONFIDENT.THEY THOUGHT

T

THERE WOULD BE NO MORE FINANCIAL CRISES. IT SEEMS LIKE FIRMS ARE MORE CAREFUL NOW IN STRETCHING OUT

Lessons Learned Weisbenner and colleagues Heitor Almeida, the Stanley C. and Joan J. Golder Chair in Corporate Finance, Murillo Campello, a finance professor at Cornell University, and then-graduate student Bruno Laranjeira conducted the research. They based their conclusions on an analysis of financial data from 1,067 firms, 86 of which had large amounts of debt maturing in 2008.

3.1.2007 New home sales suffer their sharpest drop in 13 years.

3.22.2007 Reuters reports that credit counseling services are overwhelmed as home-mortgage problems mount.

If the credit contraction had continued beyond 2008, still more firms with large clumps of maturing debt would have been hit, says Almeida. Fortunately, the credit squeeze began to ease in 2009, allowing those firms to reschedule their debt maturities, he explains.

“Before the crisis, I think it’s possible that CFOs got overconfident. They thought there would be no more financial crises,” Almeida says. “It seems like firms are more careful now in stretching out their debt maturities.”

Companies learned an important lesson, says Laranjeira, now a consultant with McKinsey & Company. “Leverage is important when analyzing a company. But debt maturity might be even more important, depending on the economic climate.”

The research was an outgrowth of observations made by students in one of Weisbenner’s classes. During the height of the credit contraction, Weisbenner asked groups of students to analyze the financial decisions of various companies. “One of the student groups highlighted the fact that some firms were having trouble refinancing debt that would come due during the credit crisis,” Weisbenner recalls. “And they noted that it was having a negative effect on their operations.”

The crisis produced two side effects that battered the general economy but hit some firms with particular ferocity.

One was a rise in interest rates. The other was a dearth of loan funds; no longer was credit available for the asking. Everywhere, the credit window began to slam shut.

4.2.2007 New Century Financial Corp, the biggest U.S. subprime lender, files for bankruptcy.

7.12. 2007 Bear Stearns discloses that investors will get little, and perhaps none, of the money they put into two of its hedge funds.

8.9.2007 The French investment bank BNP Paribas says investors can’t withdraw money from two of its funds.This triggers a further lockdown of credit.

www.business.illinois.edu

he sudden and severe credit THEIR DEBT MATURITIES.“ contraction that began in 2007 – HEITOR ALMEIDA had an especially damaging impact on companies with large amounts of debt maturing in 2008. It forced a sharp pullback in their business investment, which in turn helped to damage other segments of the economy and deepen the recession, according to research conducted by faculty at the College of Business.

In better times, the companies would simply have rolled the debt over. But the credit crunch, brought on by the collapsing housing market, shrank the pool of capital. To avoid default, these companies had to pull cash from elsewhere in their operations to cover the maturing debt.

“The firms drew down their cash balances; they drew down their savings accounts; they cut back on inventory,” says Scott Weisbenner, a James F. Towey Faculty Fellow and one of the ILLINOIS finance professors who conducted the research.

“But they also had to cut back on the life blood of their companies—their investment in facilities and equipment.”

While firms with less maturing debt slashed investment by 10 percent, firms that had 20 percent or more of their debt maturing in 2008 slashed investment by 30 percent, Weisbenner says.

The fallout then moved downstream. “The people who provide products to these firms suffered an economic hit as well,” says Weisbenner. They included building contractors, equipment makers, and software providers. In turn, those suppliers bought fewer raw materials from their vendors. “The impact trickled down to the broader economy.”

23

“[TO COVER MATURING DEBT ] FIRMS DREW DOWN THEIR CASH BALANCES; THEY DREW DOWN THEIR SAVINGS ACCOUNTS; THEY CUT BACK ON INVENTORY.THEY ALSO HAD TO CUT BACK ON THE LIFE BLOOD OF THEIR COMPANIES—THEIR INVESTMENT IN FACILITIES AND EQUIPMENT.”

–SCOTT WEISBENNER

“There were fewer people buying new debt offerings,” says Weisbenner. This particularly hit companies that had a lot of debt to refinance. “If your debt didn’t mature until 2013, you had time to ride out the crisis. But if your debt was due in a couple of months, you had to get the cash elsewhere.”

The problem could have been minimized by spreading out maturity dates on debt, explains Weisbenner. “We preach to individual investors, don’t put all your eggs in one basket. It’s the same for debt maturity. By having the debts come due in a lump, you are exposed to the risk that they may be difficult to refinance.”

He continues: “We were surprised going into our research by what we found. We thought that firms would have spread their debt out so they wouldn’t have to refinance some giant amount in one year. However, to be fair to these firms, nothing like this had happened in over 20 or 30 years.”

DEBT MATURITY MIGHT BE EVEN

Weisbenner learned how to minimize financial problems from his family’s Wisconsin farm, which raised hogs and grew corn to feed the hogs. On the farm, an ounce of prevention is worth many pounds of cure. “If you have a drought, you still need to feed the hogs,” he says. “So you have crop insurance.

24

PERSPECTIVES SPRING 2012

10.1.2007 Citigroup discloses subprime-related losses of more than $3 billion.

“LEVERAGE IS IMPORTANT WHEN ANALYZING A COMPANY. BUT

Not Living High on the Hog

9.14.2007 Depositors mount a run on Britain’s Northern Rock bank, pulling out more than one billion pounds.

Then you get paid when a drought happens. If you skip the insurance, you get hit really hard in drought. Either you have to borrow money to buy feed for the hogs, or you have to sell the hogs before they are fully fattened for market.”

As they robbed Peter to pay Paul, the impacted firms suffered in multiple ways from the credit crunch. Their profitability fell and stayed down compared to less-affected companies. Their stock prices fell disproportionately as well.

According to Weisbenner, everybody’s stock prices fell somewhat, but for these firms, stock prices fell about 10 percent more.

The researchers continued to follow all 1,067 firms as credit conditions and the economy began to improve.

They found that the companies that had cut back disproportionately on investment during the credit contraction began spending more than companies that were less impacted. “So they were playing catch-up,” says Weisbenner.

But in other ways they still lag behind. “If you look at the profitability for those firms that went through the worst financial shock, they still haven’t caught up with their peers.

This would suggest that the investments they missed were costly to them and that they’re still feeling the effects.”

–Doug McInnis

12.17.2007 Central banks make more cash available in an effort to stem the crisis.

MORE IMPORTANT, DEPENDING ON THE ECONOMIC CLIMATE.”

–BRUNO LARANJEIRA

2008 The credit crunch strikes companies seeking to refinance maturing debts.They respond by cutting investments in plants and equipment, thus worsening the crisis.

Sources:The University of Illinois College of Business, BBC, Reuters, Associated Press, The Wall Street Journal, and The New York Times.

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