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Cool products

GEOFF COLVIN: At first these sunglasses seem simply far too cool for me to be wearing. But in fact they're much more than that -- they're also an MP3 player that can store a couple hours worth of music. It goes in there, little buttons on top to control it. These were chosen by FORTUNE as one of the 25 best new products of 2004, and they symbolize a major trend -- the growing importance of design in corporate success. From computers by Apple to can openers at Target, superior design increasingly means big money for companies and investors who understand the trend.

Marco Iansiti is a professor at the Harvard Business School who teaches product development and the importance of design. He joins us from New York. Virginia Postrel is a New York Times economics columnist who wrote The Substance of Style: How the Rise of Aesthetic Value is Remaking Commerce, Culture, and Consciousness. Virginia, who are the champion companies at using good design to really pay off?

VIRGINIA POSTREL: Well, I actually think the touchstone is one that we won't have any objects to talk about, which is Starbucks. Starbucks is not just selling coffee, not even expensive coffee. They're selling a multi-sensory, aesthetic experience. You go into this place, you would like to be in this environment, and then the customers have created a social space because they like to be there, and then that extends the corporate strategy.

COLVIN: So it's that whole creation of the color, the design of the furniture, the placement, the whole experience.

POSTREL: Every bit of it. Everything the customer sees, hears, smells, tastes is supposed to say this is quality, and also it has a very specific sort of corporate identity, which some people don't like, and then people start competing coffee houses with a different aesthetic, because aesthetics is about meaning as well as other things.

COLVIN: Well, and it seems to have worked awfully well for them. Marco, you teach the world's highest-powered business students about the role of design in product development, and I can imagine that some of them might be skeptical. Are they?

MARCO IANSITI: They're actually pretty excited about it. I think we've been at it for awhile. I think 10 years ago we had to work really hard and lift great weights to get people to pay attention, but I think right now we have a lot of evidence that design is just great business and it really helps companies differentiate themselves in all kinds of different ways, and the students are actually quite excited about it.

COLVIN: How do you get the students to appreciate the importance of it?

IANSITI: Well, there's nothing like talking about great products or putting a great product in front of them, or even better putting a really poorly designed product in front of them and showing off all the different frustrations. It becomes clear very quickly that these things are really important to customer satisfaction, which we teach them is pretty important in itself.

COLVIN: We have some products here, because FORTUNE recently published an article on the best designed products of 2004, and good design can mean different things to different people, and it really does. Now here is a product that was one of the champion products. These are bamboo plates. They're intended to be used only once. They're intended to be disposable. They're made from organic bamboo. They are more expensive than paper. They're about a dollar apiece. On the other hand, you can get plastic plates that cost even less than these. Virginia, why are these good designs?

POSTREL: Well, I think there are two reasons. First of all, to designers within the design community there's a big emphasis on sustainability and environmental values today, and so design students even are often evaluated in part on whether they include that in their projects. But what I really think makes this work is that it's beautiful. It's more aesthetically pleasing than a plastic plate or a paper plate, so you're willing to pay more, even if you couldn't care less about the environment. And so it's a coming together of two things. First of all, the appreciation of beauty for its own sake, as opposed to just the function of being able to throw it away, and the other thing that I think designers are realizing is that the way to sell sustainability is not to sell it as a hair shirt but rather to sell it as something that's cool and sensorially pleasurable.

COLVIN: Marco, you were on the judging panel for these best products of 2004, and I gather that you particularly like these sunglasses with the MP3 player. Now, what makes them good design?

IANSITI: I think for once they're very innovative. People have been talking about wearable computing for a long time, and it makes it sound like Star Trek, and people have been trying to visualize computers on people as part of their clothing in various ways. I think what these people managed to do through their design is really to make it very natural and find something innovative and exciting that's comfortable to wear, that works well, that doesn't look like it's just a separate computer on something, but it's really integrated with the functionality of the sunglasses. It's an interesting concept, it's a new idea, and it's well executed, and they're cool, as you said before.

COLVIN: Well, coolness seems to enter into this quite a lot, but functionality too, as you mentioned. Now here's another product completely that was another winner on the list of best-designed products. It's a glass that is insulated. I don't know if this comes through. I don't know if you can see it, but in fact this is a glass within a glass. It's a single piece of blown glass, but it's two layers, the inner glass and the outer glass. And as a result, even though it has hot coffee in it, the outer part is only mildly warm. It will keep the coffee hot for a long, long time. You can set it down on things, and since the bottom isn't hot, it doesn't condense and it won't leave rings and stuff like this. Highly functional, yet it doesn't have a single moving part. Marco, what makes this really good?

IANSITI: Well, again it's a wonderful idea. It's got great simplicity and performs a very useful function, and it's beautiful. And when you put all those things together, that makes it a great design.

COLVIN: Virginia, here's something that I don't know if you'd call beautiful, and yet it has something to be said for it. This is a new line from Tupperware that is sort of interesting. What's cool is if you take the top off, when you want to use it, you use it like this, but when you don't want to use it, when you want to store it or you don't have to fill it up, it collapses. It collapses like an old top hat, so that it's almost flat.

POSTREL: This is great for storing in kitchen cabinets. I sort of like this idea because my little plastic containers are always falling down on my head. But the other thing that's true of both the glass and the Tupperware container is that they're great examples of a trend that we've seen even in high-end appliances, like the Duet washer/dryer from Whirlpool, which is real technological or technical innovations, functional innovations, an insulated glass, a collapsible container, a washer/dryer that saves energy, saves water, but combined with the coolness factor.

You want to play with the Tupperware thing, you know? If it doesn't work as a container, you can give it to your kids and they can use it as a toy. You want to look at the glass. It's beautiful. And similarly people will buy these washers and dryers who wouldn't buy them just to save energy or to save electricity, because they're cool.

COLVIN: Marco, what has changed in the business world that has made design strategically important to companies in a way that it didn't use to be?

IANSITI: Well, two things. I mean first of all you've had tons of failure due to poor design, poorly executed products. People have experienced pain as a result of bad design choices and under investment in this space. And the second things is obviously the success stories.

You know, everybody knows about Apple and what they've managed to do with design and IBM and other companies. Again it's the argument that it's good business, that actually when you solve design problems in an elegant way, when you do it what Virginia said, which is follow trends in a way that's still exciting to consumers and it's differentiating for the company, it makes for a great business model, and the evidence speaks for itself.

COLVIN: Virginia, does this have something to do with a response to the commoditization of so many different things? I mean functionally a lot of products are virtually identical.

POSTREL: That's right. And they're really, this is a strategy that's an alternative to doing the low-cost strategy. The low-cost strategy is still out there, it's still going to be out there. There will always be people who just care about functional performance for the lowest dollar. But a lot of companies don't want to be in that space. They don't want to be selling commodities. So if you are Target and you have to fight Wal-Mart, you're not going to be able to do it on price. Give me a break. So what do they do? They differentiate in part on design.

COLVIN: And their can opener works the same as Wal-Mart's can opener, we presume, but it's cooler.

POSTREL: Right. Well, their can opener is probably an Oxo can opener actually, which is another great company that started working on functional design, designing things with fat handles to help people with arthritis. And then it turned out that these were really aesthetically appealing to people. So people who have no problem with can openers just like it because it's neat looking.

But I talk in my book about GE Plastics, which is selling into, not to the consumer, but to the people who make the things for the consumer. And what they see is if you don't want to be a commodity producer, how much plastic can we sell you for how little, they need to innovate, so they innovate special effects plastics, colors, textures. They innovate color choice, they have all kinds of color management services that they offer. And all this allows them to make more money and allows their customers to make more money by differentiation.

COLVIN: Marco, one sign of the growing importance of design in corporate America is this fact that surprised me, which is universities now have more candidates for the MFA degree, Master of Fine Arts, than for the MBA degree, Master of Business Administration, the students you teach. Is this a good thing?

IANSITI: Thank God. I think it's a very good thing. I mean I think it's good to have an abundance of people that specialize in skills that really add values for design, and it's great to have more of them than the people managing. It's a wonderful thing. I mean it's good that there are more engineers than MBAs. I think that there are different roles for the different communities. And design is such a critical differentiator. It's really a pleasure kind of to see the design community and the design profession growing.

COLVIN: Virginia, what happens whenaesthetics become such a large and important part of what businesses do? This is unexplored territory. We really haven't been here before. What's going to happen next?

POSTREL: Well, there's some very interesting cultural clashes that you see within organizations. For example, I was at Procter & Gamble probably a year or so ago, where the CEO and some of the higher level people are very, they're emphasizing the importance of design and the importance ofaesthetics, not just design and function, but let's have a good package here that appeals to people.

And yet this is a company that traditionally is based on research and marketing to find very traditionally mass advertising. So there is some culture clash there, and yet it's very compatible because all of this that we're talking about assumes product quality. All of this, we're not talking about putting a bad product in a pretty package. We're talking about high quality products in the traditional sense, but additional qualities being added to them, qualities of meaning and of pleasure.

COLVIN: It's a good point, because some of us have observed for a long time that the quality revolution of the past 15 years has raised the standard in so many product categories that most products are pretty good and pretty similar.

POSTREL: Absolutely. I mean the place where you can really see that is in automobiles, because we've had a couple of cycles where we've gone, you know, if you think about back to the 1950s, at that point people thought that the automobile had reached its quality peak and it was all about, you know, all aboutaesthetics, tail fins.

Then lo and behold, suddenly reliability and gas mileage became important, and we had this whole quality revolution, and suddenly everybody had to compete on that. And now even, I was just in a rented Kia for a few days, and it was a great car. I mean if you took that car back to 1970, people would think, wow, this is high quality, and that's probably one of the lowest quality cars on the market today.

COLVIN: It really has been a revolution, and it will be interesting to see where we go from here, but quite possibly at least a much better looking world ahead, yes?

POSTREL: I hope so.

COLVIN: Virginia Postrel and Marco Iansiti, thanks so much.

IANSITI: You're very welcome.

Morningstar

KAREN GIBBS: Individual investors have few choices when looking for trusted, reliable information on the mutual fund industry. One of the most popular places is Morningstar research, which is the premier data provider on more than 16,000 mutual funds for millions of investors.

But how reliable is Morningstar's data? Will a Securities and Exchange Commission civil investigation make Morningstar's planned IPO dead on arrival? And just who are these guys anyway who hold so much sway over your portfolio?

Nicholas Stein, a writer at FORTUNE magazine, has been asking the same question. Mark Hulbert has followed the company for years and is editor of the Hulbert Financial Digest.

GIBBS: Well, Nicholas, Why are they so influential?

NICHOLAS STEIN: Primarily it's this star system that they've come up with, which gives mutual funds between one and five-stars, based on past performance. And, you know, Americans have become increasingly used to figuring out whether they want to go to a restaurant based on if it gets five-stars or whether they want to go to a movie, whether it's highly rated. And so Morningstar came along at the right time with this very easy system that investors could use to figure out whether to put their money in one fund versus another fund.

GIBBS: Mark, what about that star rating system? It caused a lot of people to chase performance.

MARK HULBERT: It turns out my research suggests that the five-star funds have not outperformed the market, and perhaps even more questionable about the value of the rating system, the five-star funds haven't done that much better than say the four star funds or the three star funds.

GIBBS: Why is that?

HULBERT: There's a lot of research, not just mine, that suggests that three years worth of returns are actually very, a very poor guide to what will be performance in the future. So it turns out ironically, if they had focused on shorter term performance or focused on longer term performance, my research suggests they would probably have done better than by focusing on the three, or heavily focusing on the three years that they do.

The reason is that there are two major strands in the research about performance. One is known as momentum. It turns out you can actually outperform the market by focusing on shorter-term performance. The other strand of the whole performance literature is you want to look at ability. You want to look at a period of time that's long enough so that you can separate, so to speak, the men from the boys.

It turns out that three years is too short in order to do that. And if you were to look at performance over 10 or a longer period of time, then you're starting to get a long enough period where those who have beaten the market over that longer period of time truly have ability, or at least it's a good chance they have ability. By looking at three years or by heavily focusing and basing the rating system on three years, I think what Morningstar is somewhat in between both of those two extremes

GIBBS: That does raise the question about very few investors look at a mutual fund and think about investing in it without first checking that star rating from Morningstar. Is that a good idea? Is that healthy?

HULBERT: No, and I think Morningstar, to their credit, has been much more nuanced as the years go on in trying to urge investor not to rely solely on their rating system. But it's one of these things that when the cat's out of bag, it's a little hard to put it back. I mean they've been so successful in encouraging investors to focus on the rating system, it's hard for them to also at the same time tell them no, it's only the beginning of the research process rather than the end.

» Behind Morningstar: Hulbert, Stein outtakes

STEIN: If I could just add that the fund industry in a way has become addicted to Morningstar's ratings. They pay Morningstar licensing fees in order to use their ratings in marketing materials, advertisements, and they plaster them every way they can, because they know how much they reach the end customer for those funds. And that's sort of one of the issues that Morningstar has, is that they will always come out and say don't rely solely on our ratings, we have a lot of research behind this, you know, trying to temper the ratings and fill in some of the nuances and the gray areas. But then you flip open that magazine, and you just see we got five-stars, and it kind of blinds the investor to anything else.

GIBBS: What about their business model? How does Morningstar make money?

STEIN: Well, they don't make money very well. I mean that's sort of the ultimate disconnect with Morningstar is that they went after the small investor, really seeing that as a way to offer something that no one had ever offered before. The problem is, as it's been demonstrated, small investors aren't really willing to pay very much money for investment advice. I mean for example, with Morningstar they have more than three million people who are registered on their web site, but less than five percent of those people will ante up the $100 a year for all of the research and the services that Morningstar provides.

And so what's happened is you have this company that's set itself up as the watchdog of the mutual fund industry, when in fact now most of their revenues and all of their profits come from the very industry that they're trying to be the watchdog over, because the area that they went for, the small investor, just hasn't really panned out as a reliable source of revenue for the company.

GIBBS: Mark, where else can individual investors look for research on mutual funds?

HULBERT: One I would draw attention to is the Value Line Mutual Fund Survey, which is published by Value Line Inc. out of New York. It's perhaps better known for their Value Line Investment Survey, which ranks individual stocks and has a ranking system for those stocks that goes back over 30 years, in fact nearly 40 years right now, and it has a record that's very enviable.

In fact, a number of academic researchers have suggested that the Value Line ranking system is so good that it can't be dismissed as mere chance, even though perhaps some of their inclination is to try to do that. But anyway about 10 years ago Value Line also got into the mutual fund ranking system. They're not anywhere near as well known as Morningstar in the mutual fund ranking system, but my research suggests that their top rated funds have performed better than the top rated Morningstar funds. So that would be one source.

GIBBS: Mark Hulbert, Nicholas Stein, thanks for joining us.

Market summary

GIBBS: Well, this certainly wasn't a five-star week on Wall Street. The Dow (Jones Industrial Average) lost 49 points this week, despite lower crude oil prices and a stronger dollar.

Dow Jones Industrial Average

Nasdaq

The Nasdaq (Composite Index) gave back 20-points in anticipation of a Fed rate hike this coming Tuesday that could raise borrowing costs, while the S&P (500) shed a little more than 3.

S&P 500

Next week

COLVIN: That's our program… Next week, it's the battle of the Big Boxes. The World's largest retailer, the Beast of Bentonville, better known as Wal-Mart, is taking it on the chin this holiday season. Who's gaining from Wal-Mart's misfortune? So long, we'll see you next week.