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In a world of exploding product choice, consumers increasingly need to cut through the noise to make informed purchasing decisions. Brands can help. They facilitate information processing and reduce the risk of making the wrong decision. Strong brands have historically outperformed the broader equity market and are likely to continue to do so.
Brands serve three main purposes: facilitating information processing, reducing the risk of making the wrong decision, and social signaling.
People generally do not make purchasing decisions based solely on the functional attributes of a brand. Research has revealed that most people in most buying situations make purchase decisions intuitively; that is, they rely on their mental auto-pilot to make quick, effortless and associative decisions that require very little energy. Brands can become part of people’s mental auto-pilot if they succeed in becoming embedded in memory structures that are triggered to fire in certain situations. Consequently, in order to be effective brands need to be recalled easily and effortlessly in buying situations. They need to trigger the right mental cues at the right time in the right place. Only then do they stand a chance of being part of the typically small set of product alternatives that is being considered during the buying process.
Being able to easily push the right mental buttons at the right time is not sufficient to be successful, however. In addition to the ability to successfully prime consumers’ minds, brands must also be easy to buy in a physical sense. That requires presence, relevance and prominence. Easy mental and physical availability are the key attributes of effective brands.
Being effective is one thing, but what makes a brand so special that it can justifiably be called ‘strong’? In addition to easy mental and physical availability, the ability to charge a price premium for essentially the same product in terms of relative functional performance distinguishes strong brands from brands that are merely effective. This pricing premium roughly corresponds to the extra economic value that strong brands generate for their owners.
The combination of excellent mindshare, shelf share and pricing power is the main prerequisite for becoming a strong brand company, in our opinion. In addition, the addressable market needs to be large for a strong brand to amount to significant economic value. Therefore, in line with for instance Interbrand, we require companies to be internationally active to a significant degree in order to be included in an investable universe of strong brand companies. Finally, these features should be reflected in high industry-relative market shares and profit margins.
Figure 1. Characteristics of strong brand companies
Strong brands have historically outperformed the broader equity market
In the past investors have rewarded the superior earnings power of strong brands with superior stock returns. Several studies based on Interbrand’s well-known annual list of the world’s 100 most valuable brands have found that investing in strong brands would have outperformed the broader equity markets.
Figure 2. Strong brands have outperformed historically
Will strong brands continue to outperform in the future? We think chances are they will. Once a brand becomes embedded in a person’s subconscious mind and memory structures have formed around it over time, it becomes very difficult to change, let alone erase, those memory structures. That is why we can still remember many of the advertising slogans of our youth. Mindshare is long-lasting and extremely powerful. It is also why brands are the source of some of the most durable competitive advantages that companies can build. Investors tend to systematically underestimate the longevity of this competitive advantage, in our view. In addition, we feel that investors generally underestimate the strategic options, such as line and brand extensions, that flow from having a successful brand. In our view, these two sources of underappreciation should ensure the continued outperformance of strong brands in the future.