One of the common investment mantras is to buy companies with strong brands. The reason being a strong brand name will insulate a product from competitors causing the company that owns the brand to charge higher prices and earn above average returns. Whilst I am a fan of brands as an economic moat (Competitive advantage), I am unsure many people know what a strong brand actually means. Furthermore investors today are pacing too high a value on brands without understanding the consumer landscape has changed.
History Of Brands
Going back in time – say the 1800s – it is fair to say life was local. You didn’t experience a world more than a few dozen miles outside of your birthplace. You ate local produce. You wore clothes made by the local seamstress. Your house was built by the local lumber. In essence you personally knew the person making the products you used.
Then came the industrial revolution. And the world got just that little bit bigger. New methods of transportation were game changers. Railroads transferred goods farther and faster than ever before. And everything changed. Take the following excerpt from the book The Rise and Fall of American Growth:
“As America became more urban and as real incomes rose, the share of food and clothing produced at home declined sharply. New types of processed food were invented … Many American men had their first experience of canned food as Union soldiers during the Civil War”
This was one of the biggest breakthroughs in history. But it posed a problem. Consumers, for the first time in documented history, were disconnected from the production of their stuff. In times gone by ,a bad product was either your own fault or could be taken up face-to-face with a local merchant. But canned food was batched together by dozens of regional suppliers, none of whom customers knew or could even identify. Without accountability, quality was horrendous. Harper’s Weekly wrote in 1869: “The city people are in constant danger of buying unwholesome [canned meat]; the dealers are unscrupulous, and the public uneducated.” No one knew who to trust.
And this is when brands came in. It all started with the William Underwood Company which made a meat spread called Deviled Ham. People loved Deviled Ham. But the disparate production of canned meat gave the whole industry a reputation for inconsistency – sometimes rotten, sometimes watery, no two cans alike.
Underwood fixed this by creating a flaming red devil logo consumers could recognise. It added a tagline: “Branded with the devil, but fit for gods.”
The logo (brand) in essence recreated the familiarity that face-to-face commerce provided for most of history. No matter what part of the country they were in, consumers who saw the devil logo knew they were getting a specific product made by a specific company under specific quality standards. Consumers came to associate the devil logo with something they previously had none of: consistency.
In 1867 Underwood took the logo to Washington and filed the first federal trademark. It was the first brand.
The notion of a brand quickly spread hitting all sorts of industries. Take the Kerosene market where inconsistency was strife. John D. Rockefeller tackled this problem by branding his products with the Standard Oil tag. Rockefeller wanted customers to know that one can of his kerosene would be no different from the next.
From the above glimpse into history, it is important to know what a brand is. A brand does not necessarily mean a product is good, it means that consumers know exactly what to expect from them. Underwood and Standard Oil didn’t have the best products in the market, but built powerful brands due to consistency. Knowing what to expect. That’s the essence of a brand.
The concept of knowing what to expect is powerful. Julia Child – a multimillionaire author, chef and television personality – once asked her host to take her to the local McDonald’s. The host was horrified. Child explained: “I like McDonald’s. It’s always consistent.” McDonalds has a powerful brand. Likewise, you know exactly what to expect with every bottle of Coca Cola you open or every cup of coffee you have from Costa or every diamond ring you buy from Tiffany & Co.
The big insight on brands is that consumers hate surprises more than they enjoy the chance at perfection. Truly amazing companies combine perfection with consistency. Apple is a good example. But it is an exception, and consistency still drives the bulk of its brand. Motorola and Blackberry made some amazing phones. But they sold them in a lineup that included some awful phones. The distribution of outcomes widened. The brands diminished.
Coca-Cola learned this the hard way. Its infamous 1985 New Coke formula backfired and caused customers to revolt, leading Coke to bring back its original formula a mere three months later. The crazy part is that Coke conducted more than 200,000 taste tests, which overwhelmingly showed that people liked the taste of New Coke better than the original formula. The problem was, blind taste tests didn’t replicate the psychology buyers experience when buying soda in the store. In the real world, people didn’t care that New Coke tasted better. It didn’t taste like Coke. Which is what they expected.
The Internet – The Brand Killer
The internet has changed everything. It has created new distribution channels and more ways of being able to assess a products quality and consistency. Branding is important as it provides a level of consistency consumers crave. Consumers know exactly what to expect from ta branded product. If I were to go to a McDonalds in Japan, I would expect it to have the same quality as a McDonalds here in the UK. This is a huge point. Years ago, when people used to go on holiday to places they have never been before, they used to opt for safety when consuming food. They would visits the local McDonald’s instead of the local cafe as they would know exactly what quality of food they would get at McDonalds, whilst they would be stepping into the unknown at the local cafe.
Due to the internet being a huge feedback generator, travellers today can simply go on websites such as Trip-advisor to assess the quality of the food to expect at a local diner. This feedback makes a huge difference as people are know more willing to go into the local eateries as they know what to expect. The internet has levelled the playing field in terms of consistency. Now I am not saying people will stop going to McDonald’s or McDonald’s is a bad investment – all I am doing is informing you that times have changed and it is important to realise this when making investment decisions.
Another good example of feedback leading to people knowing what to expect is products sold on Amazon. Consumers are now willing to purchase non-branded products due to seeing other user reviews on Amazon. The reviews help in letting potential customers know what to expect.
Apart from crushing crushing certain brands due to the reduction of consumers going into the unknown, the internet is crushing other brands that simply had a distribution advantage.
I see a lot of branded products today falling behind simply because they were never truly brands that consumers loved and valued, but simply brands people had to buy because of a lack of choice. These products had a distribution advantage as opposed to having any intrinsic brand value. And with the advent of the internet, the distribution advantage these product had have disappeared.
A good example of this is the razor industry where Gillette used to dominate before the rise of the challengers. Gillette used to own a significant majority of the shaving market, and had massive gross margins (the difference between the sales price of the razor blade and the cost to make that blade). This high markup gave Gillette a big advertising budget, which further entrenched its position. Over time, the high margins and trusted brand name resulted in Gillette enjoying prime shelf space at the grocery store (not to mention low competition: you had only a few choices if you wanted a razor, most of them non branded). Before the internet and social media, it would have been difficult to compete with Gillette if you wanted to establish a razor blade startup business. Getting your products into the store would be difficult enough, let alone trying to go head to head with Gillette’s low cost production capabilities, economies of scale, and massive advertising budget.
But now, tech savvy companies like Dollar Save Club have grabbed nearly a fifth of the razor market and are growing rapidly. They provide a decent razor blade at a fraction of Gillette’s cost, and they deliver it more conveniently (they mail you refills automatically, saving you a trip to the store). These upstarts can compete by cutting out the middleman and can offer lower prices due to no retail markup.
Gillette’s market is being attacked by upstarts and they are succeeding due to providing better value to the customer. The customer no longer has to settle for overpriced razor blades, produced by a company that was living off an incumbent distribution advantage. In other words, I don’t believe Gillette had a “brand” that consumers demanded, it had shelf space at the grocery store with few customer alternatives.
Simply put, the reduction in the barriers to entry of distribution (in part because of technology), has mean that products can be sold directly to consumers on the internet without a middleman (i.e. a wholesale partner or retail store), companies can gain scale much more quickly and acquire new customers more cheaply, switching costs have generally declined, and the list goes on and on. These structural changes has meant that some brands investors thought were worthy of being highly valued are not.
Having said this there is the odd company such as Coca Cola whose distribution advantage cannot be crushed by the internet. One of Coca Cola’s greatest strength is its distribution network – you can find coke products being sold almost anywhere in the world. I once did a road-trip in Southern Africa and deep in the middle of nowhere there was small tiny shop and all it had was local home made food and a fridge with coca cola products stacked inside! Coca Cola has a network far better than any logistical company as that is what makes this company so unique. But on the whole, the structural changes that are happening have ensured that many ‘brands’ have lost their sparkle as consumers are willing to swap to generic own brand products.
Are brands as competitive advantage dead?
With the change of landscape the internet has brought about, there are some brands which will no more be able to command the pricing power they have in years gone by. Brands in the consumer staples industry are particularly susceptible to this.
Consumer staple products are items where the consumer wants the product to do a specific, simple job at fair price. Most people don’t have their personal sense of identity tied up in what shower gel they use, juice they drink or brand of razor they use. Would you think differently about your accountant if she used Surf rather than All brand detergent? A lot of investors today are making the mistake of placing high value of consumer staple companies without understanding the power of the brands the company in question possesses.
Now I am not saying all brands belonging to consumer staple companies are bad. They are certain brands which I still think are very valuable and will allow the companies that own them to earn above average returns for years to come. Cadbury’s – which belongs to Mondelez – is a good example of a powerful brand. I see many savvy shoppers who have switched to own brand products for many household items but refuse to switch their Cadbury’s chocolate of choice. I for one have tasted an own brand bar of chocolate and have absolutely hated it. From now on, its Cadbury’s or nothing. But Mondelez has other products in its portfolio where consumers are likely to switch – Oreo being an example – and you as an investor need to factor the different products and their brand powers when deciphering the earnings quality of a company.
Many investors are realising this changing landscape and that is why many consumer staple companies have started de-rating recently after many years of being highly rated. I still think that they are a select number of consumer staple companies that have a powerful portfolio of brands and these companies will continue to do well and build wealth for its shareholders.
Over the last year, I have become increasingly interested in identity brands. An “identity brand” communicates something about the owner of the product to themselves or the rest of the world.
The Ferrari brand for instance is valuable because it tells the owner of the car as well as the rest of the world something important about who that person is. Tiffany’s little blue box is similar. Starbucks coffee cups are the same. And we all know about the Apple fanboys. Whilst the above mentioned companies sure have quality products, they are primarily brands whose role is to signal to the product’s owner and the rest of the world a key element about who that person is.