My columns at Daily News and Analysis: How to Defeat Murphy’s Law in the Stock Markets

Daily News and Analysis, October 4, 2007
How to Defeat Murphy’s Law in the Stock Markets
Alex Gofman

Merck & Co recently announced that it has agreed to pay $4.85 billion to settle most of the claims that its painkiller Vioxx caused heart attacks and strokes in thousands of users. Although the settlement amount is almost twice as big as the GDP of Mongolia, it is substantially less than many analysts have expected.

In 2004, the news broke that one of the most powerful painkillers on the market, Vioxx, might be implicated in heart attacks. The following lawsuits, adverse publicity, less than optimal corporate responses by Merck and other drug companies in the pain-killer business had the inevitable impact on the stock prices of Merck and the “Big Pharma” in total. In just a few days Merck’s stock tumbled about 40% bringing down the whole pharmaceutical sector (to a lesser extent) and wiping out tens of billions of dollars in the sector’s market capitalization for shareholders. Investors lost fortunes, although some of the Big Pharma companies fared better than others. If one could predict what would be a reaction of investors in such crisis situation on a company by company basis…

On the other side of the conflict, if a company knows a possible response of investors and general public on some of the messages used by it’s PR in such crisis situation, it could have a tremendous impact on the brand image, finances and the future performance. But do they always know? Even some venerable corporations stumbled under the stress in a crisis because they were not prepared. A classic example of such unapt communications happened shortly after the launch of the Mercedes-Benz A-class in 1997 when one of the cars overturned during a test drive conducted by journalists in Sweden, triggering a major crisis for the car manufacturer. The reputation of Mercedes was at stake as the company was accused of producing unsafe cars. Early ill-equipped PR responses by Mercedes only succeeded in exacerbating the crisis, as they fumbled around with what they were going to say and then said the wrong thing at the wrong time.

Is it possible to be prepared to handle a potential crisis when, according to Murphy’s Law, anything that can go wrong, will? Going a bit further, is it possible to try to capitalize on the stock market during such tumult?

This is what the Rule Developing Experimentation (RDE), introduced in my previous articles (October 4, November 1), augurs to do. I could see some skeptical smiles on the faces of the readers saying, “Nobody could predict the stock market”. RDE does not predict the actual stock market performance. It quantifies the expected emotional reaction of investors to specific news and can even drill down the data on brand specific basis. For example, if the FDA (Food and Drug Administration, particularly empowered to oversee the safety of medications) announced that they discovered some new side effects in a flu vaccine, what would be the attitude of investors toward buying, holding or selling the stock of that company and other players in the sector? An astute and prepared investor could use this knowledge to his advantage with potentially huge profit. The ‘defendant’ would be anxiously sitting on the edge of the chair anticipating the answers on how different would be the attitude of the public if the right set of messages is promptly and confidently communicated. Is it possible for the company to ‘repair’ the damage and ‘engineer’ the public sentiments on the issues? Politicians have manipulated public opinions for ages, so why not?

Chance favors the prepared mind, as Louis Pasteur used to say. To be prepared to answer the questions, we can build a model of the consumers / investors minds using the RDE approach. It is not especially difficult, and a majority of businessmen could easily do that themselves.

Here is an example of the insights one could get from the model that was created at the peak of the Vioxx crisis. We searched the Internet for news and announcements about the case from media, FDA, public, experts and Merck itself. The messages were distilled to concise snippets (called elements), grouped by similarity into silos and put into an RDE tool for an automatic mixing and matching according to an experimental design. RDE created a set of vignettes representing a combination of the messages. A random group of investors was invited to participate in the online project and indicate their proclivity to buy, hold or sell the stock if they see the specific news (the details of the process could be found in Selling Blue Elephants book or at http://www.sellingblueelephants.com/ website).

The resulting regression model was so lucid that some experts called the approach a new behavioral economics sub-discipline. The data suggested that if, for example, investors read that The medication was pulled off the market after the company found the problem, the message would cause about 6% of them to change their attitude from buy to sell. But if the company communicated fast that It is in agreement with the FDA that this medication can be safely used for pain relief. Consumers should not exceed the recommended dose or take the product for longer than directed, this would effectively reverse the impact of the former news as, according to the model, it would increase the conditional probability of investors buying the stock by 6%.

The messages do not have a universal effect, much like fashionable cloth is attractive on models but often ludicrous on the majority of us. The messages are time and brand specific. The same message used by different companies in the same market environment will cause substantially different reaction. A model built in the midst of the Vioxx crisis showed that the message The manufacturer will continue to work with the FDA to sponsor a major clinical study to further assess this medication did not affect investors proclivity to buy the Pfizer’s stock while decreasing it by 10% for Merck. The same message in the same market conditions suggested an increase(!) in intended buying of Bayer and Wyeth shares by 6% and 7% respectively.

The easy and insightful results - what wins and loses, interactions between brands and messaging - give the stock analyst and the shareholder a sense of what people say they are likely to do. The vox populi, the feelings about each particular stock “in current time” in a specific situation, can then be compared against the suggestions of analysts, to determine where there are opportunities, where the analysts say one thing but the common voice of the crowd suggests something quite different. The same vox populi gives corporations a fair chance to prepare their PR for different crisis situations with suggested measured response.

As universal and resilient as it is, Murphy’s Law can’t be evaded, but its effects can be counteracted, neutralized and even utilized for profit with diligent preparation.

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Alex Gofman is VP of Moskowitz Jacobs Inc., a NY based company, and a co-author of the book Selling Blue Elephants: How to Make Great Products That People Want Before They Even Know They Want Them (www.SellingBlueElephants.com) written with Dr. Moskowitz and recently republished in India (it is also currently translated in twelve countries). He may be contacted at alexgofman@sellingblueelephants.com.