October 25, 2005

Is a strong brand a profitable franchise ? - comments / thoughts/ cases

I had posted my thoughts on the difference between a brand and franchise. Initially my understanding was that they are the same and a strong brand equates to a good franchise (franchise can be defined as a business which earns more than its cost of capital and has a sustainable competitive advantage).

However I have seen cases where the two are not the same ( ex : titan, Mercedes etc, general motor brands etc).

I put out a question asking for comments and got replies from bruce (see below) and from george who has put his thoughts on his website Fat Pitch Financials.

I am listing a few criteria which came to my mind after I got the comments from bruce and george

So here goes
A strong brand would equate to profitable franchise if price is not the key differentiator or is not key factor in the purchase decision. I can think of the following cases

  • Low value purchase v/s high value purchase (borrowed from george’s post on his website). I cannot think of anyone putting as much effort in buying a cola v/s buying a car. As a result a strong brand can charge more for a product

  • A complex purchase decision requiring substantial information to asess the true price of a product. For ex: high end electronic products – A bose system ?

  • Emotional association with the product – Disney products / Barbie dolls – try giving a child a regular lower price but equally good doll and you will understand what I mean

  • Social proof / Association tendency – High prestige product which confer a social status on the owner . Ex : tiffany’s

Ofcourse the above are not sufficient for a strong brand to be a profitable franchise. Cost structures and other factors would also be important for the business to be a profitable franchise.

Now why go through all this in trying to distinguish between a franchise and good business (with or without a brand). If I remember correctly, warren buffett in his annual report has written about newspapers as very strong franchise with a kind of a toll bridge business model. Later with internet and other media, he commented that newspapers were still good businesses, but not bullet proof franchise. In the same section he also did a rough valuation exercise of a good franchise v/s good business and showed how strong franchises are worth more than good businesses.

Please share your thoughts on the above topic.

Comments :
Bruce said...
Here's my abstract opinion (there are a LOT of ways of looking at this one question). A brand/franchise/whatever is something which signals a contract with the customer. It's a popular solution to the prisoner's dilemma problem that plagues all economic transactions to some extent. Game theory deals with this subject very well.A vendor spends a great deal of time and money developing an easily recognizable public image that is protected by law (from having other vendors use the same image). That image slowly becomes a reputation, but it also signals a commitment from the vendor not to cheat the customer quickly and then run away. The average consumer must keep track of a very large and growing number of brands and franchises. They don't want to have to do the enormous work to validate a vendor every time they want to make an economic purchase. A brand/franchise allows them to make quick decisions, often in unknown places. So in a sense, a brand/franchise becomes a contract between the buyer and the vendor. The cost in establishing the brand (and also the value in not destroying it) is a fuzzy guarantee placed into the public by the vendor.When you have a comodity product or service, that brand becomes less important. Someone stands by the side of the road with a rock that you want to buy. They have no brand, but all you want is a rock which is easily verified during the purchase. Anyone spending lots of money to establish a brand is at a cost disadvantage to someone who just gathers rocks and stands at the side of the road. For that reason, comodity markets are won by whoever has the lowest cost. If the market demands 10,000 rocks, then you essentially line up the vendors from lowest cost to highest cost. You start with the lowest cost and work your way up until you buy 10,000 rocks (well, it's more complicated than that due to the supply/demand curve). The market price essentially becomes the highest cost rock among the 10,000.So call it a brand or franchise or whatever, it's really a sort of contract. It's very important that the law upholds the property rights of the brand or everything breaks down. In fact, it's always important for property rights to be upheld for economic activity to be efficient and effective. India has come a long way over the years and I suspect it will become a very major economic superpower so long as it continues on the path of free markets and property rights.
7:02 PM
Bruce said...
What makes a strong brand? Well, one view is covered very well in The 22 Immutable Laws of Marketing. But a better answer is to look at your own behavior and where you rely on brand. Buffett made some comments about Coca Cola that make a lot of sense. One type of very good brand is small, repeat purchases that are almost habit.When you look at what a brand is all about (a contract), then you can ask yourself when is that contract valuable from the vendor's perspective. One good thing is lots of confusion and doubt in the minds of customers. Another is a long delay before the customer finds out whether what they bought was good quality vs poor quality.
9:47 AM
George said...
This is a very interesting topic. I posted my comments about it over at my blog, Fat Pitch Financials. It would be nice to put together a set of criteria by which to gage how likely a brand will lead to a franchise.
8:04 PM


Abhi said...

I take a simple approach while evaluating weather brand contributes to stronger franchise.
In my observation I find that in certain industries brand plays important role in adding
1) Customer loyalty
2) Ability to price inflation
3) Better ROI on branding and marketing efforts.

A good example is Starbucks coffee. It has very loyal customer base. I find it very interesting that people are willing to pay $3.00 for a coffee and even if they increase the price by 10 cents to price inflation people do not stop drinking Starbucks coffee.
Another example would be soap - Dove or Olay.
In soft drinks it would be – Coke.

Hence it is very important to grow the brand.

While there are other industries where you have brands but having a brand is matter of competing and survival. Brand becomes a necessity than really giving the franchise a premium product.
Take for example Laptops or PC industry.
It is very important people to buy a laptop or PC from known company like Dell or HP for dependability and service. But this is just not enough. Price and features are also a factor.
Hence we find that for a company branding has become a necessity to compete and survive.

We find that brand
1) Does not really contribute to Customer loyalty in a meaningful way
2) Apart from need of brand there is usually a price war.
3) Bad ROI on branding efforts.

Some more examples would be in Hardware industry
Like television, speakers, etc
Sony and Phillips are a brand but other than brand they have to have attractive pricing or more features.

Auto industry is very interesting as well; you will see both the above conditions occurring. Branding matters in high priced luxury cars. There are repeated buyers of Mercedes and Lexus cars. While for low end cars like Toyota or Honda, branding is must for most consumers for dependability and service but price war is always on.
Here branding effort needs to be maintained and is really a expense

In my observation Branding efforts connected to personal use (skin care), consumption (snacks or soda) and creating emotion experience ( high end Hotel resorts) and entertainment plays important role and better ROI if done right.

Hiren said...

Depedns upon what you consider an established brand to be. sometimes multinationals take upto 5 years to establish a brand. Many brands are are hoaxes and are shown to get franchise money.

Rohit said...

abhi - very interesting points from you

hiren - surprising point . frankly i am not aware of such examples, but it would be important to watchout for such cases. do you know of any such cases ?