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.
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