Branding: A debate; is it really a competitive advantage?
Let’s define the term ‘competitive advantage’, what does it mean? There’s unfortunately many definitions, confusing a vital tenant of investment theory. Bruce Greenwald of Columbia University defines it as “being able to do what rivals cannot.” We can extend on this in such a way to suggest that having a competitive advantage will enable a firm to earn abnormally high returns.
Interestingly, competitive advantages when defined in this light, can both be thought of as the same as barriers to entry.
There have been volumes written on this topic and since we’ve only got circa 300 words, we’ll need to be a little briefer – let’s now ask, is branding a competitive advantage?
The answer is well technically, no. It’s a differentiation strategy that many firms will attempt to use to save their products from the label of ‘commodity.’ For branding to be a competitive advantage, it would need to provide the firm’s profitability a shelter from competition.
Bruce Greenwald & Judd Kahn in Competition Demystified (2005, Penguin Group) provide an excellent example of this concept. Most people will have heard of Mercedes-Benz and instantly understand its association with high quality. Would you believe that despite this, its profits as a manufacturer is not unlike that of its competitors?
There was a time when this wasn’t the case, in fact, Mercedes-Benz earned profits well above that of its cost of capital (circa the years shortly after Word War II). As per the usual case in capitalism, excess levels of profitability attracted competing firms (BMW, Lexus & Jaguar to name a few) through the 1970’s and 1980’s.
This did not mean that the price of Mercedes-Benz cars plummeted, actually they remained at premium levels. However, the competition did reduce the volume of Mercedes Benz car sold which naturally reduced revenues and increased overall fixed costs per car sold – a double whammy for net profit margins.
Branding of course is a differentiation strategy that we look for when identifying the next ‘wonderful’ business and there are many that come to mind…but are not investable. Downside risk analysis highlights the fact that competitors could replicate a particular branding strategy rendering bleak prospects for future earnings.
Perhaps it’s wise to leave ‘Benz’s’ in the garage rather than your portfolio.
Scott Shuttleworth is an analyst at Montgomery Investment Management. To invest with Montgomery domestically and globally, find out more.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
INVEST WITH MONTGOMERY
Lynton
:
Brands are assets.
Apple, Coca Cola, Cadbury, Virgin, McDonald’s.
Like any asset they must produce a return on capital.
This is possible via enjoying an infinite useful life, unlike tangible assets which degrade, become out dated and fully depreciate.
Brands and their strength, as long as they are continually invested in (with human capital as well as cash) and managed like assets, can be a source of sustainable competitive advantage.
The art and the science here is making them unique and hard to replicate – not easily done!
Lucas Hainsworth
:
I would say that it’s a way for companies with little in the realm of tangible assets, to have high intangible assets recorded on a balance sheet.
Branding started as a way of differentiating your products, so when you go to the general store on your horse and cart, you would see “XYZ butter” and know that “XYZ butter” is better than whatever.
Fast forward to 2015 and you have people with obsessions for brands, don’t care that Burberry is made in China etc.
If it doesn’t have a sincere impact on the product or item to perform its function, then it is not a competitive advantage, but one that is about trend and taste. And these are fickle.
How many companies carry huge “goodwill” or intangible assets only to be written down when the shtf. Look at VET as a prime example.
Sam
:
Hi Scott,
Thanks for the article, personally I believe that ‘branding’ is really only a reflection of a business’ success in R&D and whether this translates to a competitive advantage is due to the products economic importance to buyers.
A good example is John Deere, which has historically had the highest level of R&D amongst its competitors, this has continued to keep the 175 year company’s products relevant. Additionally it is the products high economic importance to farmers (reliability is paramount during harvesting) which enables John Deere to charge above market prices for its products.
Joe
:
Coca Cola.
Sure they have another huge competitive advantage in terms of their distribution network. But most people would buy coca cola over home brand cola. And the main reason is their branding, which is a key advantage.
And what ‘branding’ means in real terms is psychological presence and association with concepts such as ‘premium’, ‘happiness’, ‘great taste’, driven by years and years and billions of dollars of marketing. As much as I’d love to think that people are rational and aren’t impacted by marketing spin, the more I learn, the more I realize this isn’t the case.
Branding can be degraded as competitors up their marketing spend and build thier own brand. But this is still a barrier to entry, as it takes a lot of money.
So yes, branding is a competitive advantage, albeit one that can be chipped away at. Come to think of it, pretty much all competitive advantages can be chipped away at…no?