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Why Strong Consumer Brands Matter

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Every month, we will take a look at one important trend or concept in the business (and, for our purposes, investing) world. First we will examine it, and then spend the month looking at companies that can benefit - or be challenged by - the trend or concept going forward.

Hopefully, we can identify some attractive stocks to consider, as well as some to stay away from!

For January, we will focus on one of the 6 durable economic moat factors. This one is probably near and dear to all of us in one form or another, yet it is possibly also the one that is most difficult to quantify economically.

We're talking about the CONSUMER BRAND INTANGIBLE ASSET competitive advantage.

So, what exactly is a consumer brand intangible asset, why is it important to customers and companies, why is it such a durable competitive advantage, and how can companies ruin this advantage? Let's check it out...

What Is A Consumer Brand?

At its most basic, a consumer brand is a symbol.

If you think about it in this context, understanding what a brand is isn't difficult.

Symbols are used to communicate complex concepts or values in a simple way. Nations use their flag as a symbol for the values and beliefs of their governments - think of what you associate an American flag with, vs. one of Nazi Germany, or Soviet Russia. Religions use concrete, unmistakable symbols to represent their values and beliefs (e.g. the cross for Christians, or the Star of David for Jews). Symbols have been important to organizations all throughout human history.

It is easy to see how this extends to a business, which is just an organization for generating cash. The golden arches of McDonald's (MCD), or the blue-and-white propellers of BMW (BAMXF) are just symbols.

What is important, though, are what these symbols stand for. While the American flag communicates the ideas of personal freedom and free enterprise, the golden arches communicates "cheap, fast, consistent meals".

Brands are a way for companies to communicate with their customers in a simple way - to reach customers looking for what you are aiming to provide.

Take the automobile market, for example. BMW has tailored (through marketing and product design) their brand image to be "performance". Mercedes-Benz = "luxury". Kia = "value". Tesla (TSLA) = "sustainability". And so forth. Any customer shopping for a vehicle can easily associate their desires with a brand image - and disassociate with brands that do not match their wants.

Why Brands Are Important

We've already touched on probably the most important aspect of a brand - communication - in the previous section.

But there are a couple additional advantages, as well.

For one, brands act as a stamp of quality in commodity industries.

Consumers often trust what they know or have heard of, over unfamiliar brands or products. For example, take diapers. There is no shortage of companies that make diapers. But a new parent is not familiar with the product. They go to the store and are confronted with several different diaper options. Why do they choose Pampers? Because other parents they know use them. Because of the smiling mothers in the numerous Pampers marketing messages they have encountered. The brand has been established as high quality and trusted.

A similar brand advantage is lowering search costs for consumers.

People have a limited amount of time, and they don't want to waste that valuable time researching and comparing, for example, toothpaste brands. They want to grab a tube of toothpaste and get on with their life. They see Crest, they've used Crest all their lives, their parents used Crest, who cares about Colgate, Crest works for them. So they grab it, waste no more than a few seconds on it, and get on with their life.

On the company's side, both of these advantages help them as well. Both of the brands mentioned above are owned by Proctor & Gamble (PG). By acting as a trusted stamp of quality, P&G gained a new Pampers customer at the cost of a competitor. And by lowering search costs, it encouraged automatic repeat Crest purchases, setting up a recurring revenue model that is so attractive in business. A true "win-win".

What is even better is that P&G can price Pampers and Crest a little bit above the pricing of their competitors, and consumers will still gladly pay for the piece-of-mind. This falls right to P&G's bottom line in the form of higher margins and cash flows, which they can then invest back into marketing and product development to start the cycle over again.

It is this positive feedback loop that makes strong brands such a durable competitive advantage over competitors with weak or no branding.

How To Ruin A Brand

Any durable moat advantage can be ruined by crappy management, and brand is no exception.

The surest way to ruin a strong brand is by either not living up to or changing what the brand has been established to communicate.

Perhaps one of the most visible examples of a ruined brand over the last few years has been Chipotle (CMG). For years, the brand quite literally stood for "food with integrity". Sustainably sourced, fresh, no artificial ingredients.

Or, for short, "healthy" fast food.

The problem is, the image of "healthy" fast food takes a big hit when your company is suffering wave after wave of food safety outbreaks, including major e-coli incidents in 2015 and ongoing small but well-publicized norovirus outbreaks in the 2 years since then.

Chipotle didn't live up to its brand image. Customers no longer trusted the brand, same store sales plummeted, and the company's stock followed suit, costing both co-CEO's their jobs in the process.

A counter-example in the same consumer space is McDonald's. For most of this decade, the company struggled to grow same store sales. To "fix" it, they tried to expand the menu, improve food quality, and add healthier menu items - none of it worked.

However, under CEO Steve Easterbrook, who took over in early 2015, the company has seen a remarkable turnaround. Why?

Because Easterbrook returned the company to its promised brand image. He instated all-day breakfast, something frequently requested by customers and a brand strength. He brought back the Dollar Menu. He simplified the overall menu, pushed digital ordering, and began offering delivery, all in the name of speeding up service.

In short, Easterbrook is trying to bring McDonald's back to its promise of "cheap, fast, and consistent". And, no surprise, it is working to reinvigorate the company - and stock.

Brands, Brands, Brands, Brands

In January, MagicDiligence will focus our business model reviews and commentary on firms with well-known consumer brands. We will also touch upon some instances of "brand illusions"... situations where there appears to be a strong consumer brand, but where in actuality it provides little competitive advantage to the company.

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