Are Brands Really A Competitive Advantage?

When it comes to analysing businesses, finding out if a particular company you are interested in has an economic moat (or competitive advantage) is one of the most important things. This is because firms with economic moats are able to earn outsized profits for long periods of time due to mean reversion not really affecting them. There are a number of economic moats to look for and if a company has one of these, you can be sure that the company in question will continue to earn higher than normal profits for a long time to come.

One of the most common economic moats people look for is ‘Strong Brand Names’. If a company has a strong brand name, consumers are more willing to pay the extra price for it as opposed to buying any other similar product. Starbucks is an example of a company with a strong brand name. That is why the company has higher operating margins than any other coffee chain.

The problem is these days investors think that just because a company has an arsenal of brands under its portfolio, than that company has an economic moat. I can’t even count the number of times I have read analysis of companies where the writer claims the company has an economic moat due to its products being branded. It just baffles me. May be I should spell it out : ’Not All Brands Are Created Equal; For A Company To Possess An Economic Moat It Needs To Have Products With A STRONG Brand Name.

At the recent Berkshire Hathaway Annual meeting, Warren Buffet explained that consumer behaviour is more difficult to judge now than it used to be. I think that this is in part because people aren’t as beholden to consumer brands as much as they used to be. Or, put differently, I think many companies that people thought had a brand really just had a distribution advantage that came from being a big incumbent with the largest market share for many years. The high gross margins led to bigger advertising budgets, which further entrenched these market leaders. Gillette used to own its place in the centre of the grocery isle in every supermarket or grocery store. This advantage is eroding, as distribution costs have plummeted. The internet and social media have lowered the cost of getting products to market and reduced the time required to get to scale. They’ve cut out the middleman in many cases, allowing small upstart companies to sell directly to consumers and avoid the typical retail markup.

In the case of Gillette for example, it was quickly found that consumers had no loyalty to the brand once online start-ups like Dollar Shave Club began to pop-up. The problem with Gillette is that it took advantage of its dominance and market share and created a parasitic relationship that led to above average profitability in the near term, but it also led to customers feeling exploited, and when a competitor came along that offered more value to customers (in the form of better products and/or lower prices), the alienated customers were quick to leave.

Contrast the above with the experience customers feel at Amazon Prime, which continues to provide more and more value to customers through wider selection, greater convenience, and prices that more often than not can’t be beat. This extreme customer value makes it more and more difficult for a competitor take customers away from Amazon’s platform.

As an investor, you need to assess whether or not a company’s brand is a sustainable competitive advantage. The way to do this is to see whether the customer feels like the product or service that you’re selling is a good deal. If not, the company will no longer be able to rest on the laurels of barriers to entry, high distribution costs, incumbent advantages like shelf space, bigger advertising budgets, switching costs, or just about any other advantage that you used to enjoy in years past. It’s much easier to start a business, sell directly to consumers and build a product brand using social media. This allows smaller businesses (and other small like-minded upstart companies) to collectively compete against much larger brands, despite having much lower advertising or distribution resources.

I think the advantages that used to be relied on by big incumbents like Gillette or Kellogg’s are eroding. Consumers have more options to choose from, better information on products, and receive more value for the price paid.

High margins and consumer brands are still very valuable, but I think the key is determining whether a company’s perceived brand comes from its market share, distribution, or advertising budget, or whether it comes from providing customers with great value. I think the former category will see their brands lose value. The latter category will still face plenty of competition, but I think it’s much harder to dislodge a company with the best value proposition to the end customer.

Knowing what to expect. That’s the essence of a brand.

Branding is more powerful than ever today, because consumer options have proliferated. Distribution channels have multiplied. There used to be four news channels. Now there are millions of blogs. The grocery store used to stock three types of toothpaste. Now Amazon offers 4,119.

For consumer staple and consumer discretionary companies to stay relevant in this world requires building a strong brand. But we often mistake brand for two of its cousins: marketing and design. The most important thing about a brand is that you can’t create one. You can create a marketing campaign. You can create a slick design. Both are tremendously important. But brand has to be earned through repetition, convincing people that what they experienced yesterday is what they can expect to experience tomorrow. It’s hard, and it can take a long time. But it’s sensationally powerful.

When you realize how much of a brand is just a tight distribution of outcomes, you see that powerful brands can be built on top of subpar products. Julia Child (a famous American chef) 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.” Premier Inn is a powerful brand. You know exactly what you’ll get: A pitifully no-frills room, identical in every city. Same with Domino’s. It is not the best pizza in the world. But it’s pretty good every time, from Manila to Miami. That’s enough to make it the best-selling pizza in the world.

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 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 biggest branding challenge 150 years ago was signalling to customers that you could promise consistency – selling in. Today the biggest challenge is keeping that promise in a market where it’s easy to grow big quickly by sacrificing consistency – selling out. Look at how many companies are shrinking products to save an extra dime. Sooner or later, customers will notice and will switch.

Quality falling with quantity is visible in almost every industry. Health care satisfaction falling as hospital networks combine. Banks losing focus as they merged into behemoths. Blogs posting garbage as they seek clicks and volume. It seems to have picked up over the last decade, as technology makes scaling easier than ever.

Maybe we’ll look back and realise that the best way to grow big is to have a powerful brand, and the best way to build a powerful brand is to be good all the time rather than great some of the time. As an investor find companies that are consistent. Find companies that own brands people can’t live without. Find companies like Apple and Starbucks whose customers think they are a gods send. Find companies like Colgate-Palmolive whose consumers purchase its products without really thinking. Find companies whose brands and ingrained in society.

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