When his firm decided to introduce a Christmas menu into their restaurant chain, one of my students decided to test the profitability of the change by introducing it in only half the restaurants in his territory. By comparing sales changes at these restaurants (the "experimental group") to changes at restaurants that did not introduce the menu (the "control group"), he concluded that the change did little to increase overall sales, despite the apparent popularity of the menu.
This inference was possible only because my student constructed what economists call a difference-in-difference estimate of the change. The first difference is before vs. after introduction of the menu; the second difference is between the experimental and control groups.
The difference-in-difference methodology controls for other unobserved factors that might have accounted for the change. The FTC has released a number of studies following up on merger enforcement decisions to try to figure out whether they did the right thing. For two consumated oil mergers, FTC economists Dan Hosken and Chris Taylor (article
) and John Simpson and Chris Taylor (article
) found that prices in cities affected by the merger did not increase relative to prices in control cities. In the time series graph below, the three lines represent gas prices of the experimental city (Louisville) relative to gas prices in three control cities (Chicago; Houston; Arlington, VA) for the Marathon Ashland gasoline merger. The vertical line represents the date of the merger. By comparing prices before and after the merger, we see the merger had no effect, or that the FTC was correct to let it through without a challenge.
FTC General Counsel (now Commissioner) Bill Kovacic
coined the term "Enforcement R&D" to describe the practice of government agencies following up on their decisions to improve policy (article
I would like to hear stories from readers about how, or if, their organizations test decisions.
NOTE: This post is copied from our old, almost defunct blog, Management R&D.