The Long-Tail Value Of Supreme Brands

By Stephen D. Simpson, CFA | September 25, 2012 AAA

The way tech companies like Apple (Nasdaq:AAPL) and drug companies like Pfizer (NYSE:PFE) fight to defend their patents, you'd think that success in business is impossible unless you can lock up your best ideas behind walls of patents and copyrights. While these legal protections for innovation are indeed important, a host of companies have demonstrated that there are considerable rewards to be wrung from brands and reputations protected by little more than the consumer's ongoing preference for the real McCoy and the value of the trademark.

Familiar Brands that Stretch Back for More than a Century
Investors probably don't have to think too long or hard to come up with several examples of century-old brands that continue to generate strong profits and returns for their owners. Coca-Cola's (NYSE:KO) signature brand harkens back to the 1880s, while PepsiCo's (NYSE:PEP) Pepsi is about ten years younger (and Frito-Lay, which is also owned by PepsiCo can trace its separate origins back to the 1930s). Kellogg (NYSE:K) wasn't the first breakfast cereal, but like Post (NYSE:POST), it's history goes back over 100 years.

It's worth noting that these brands have continued to build value long after patent protection would have expired. In most cases, these companies never even attempted to patent their inventions - relying instead on secret formulas, brand-centric marketing and an "accept no substitutes" approach to advertising.

SEE: 6 Branding Tips For Small Business Owners

Plenty of Younger Examples as Well
It's not just century-old brands that highlight the shareholder value that can accumulate over time with popular consumer (and in some cases, industrial) brands. The Nike (NYSE:NKE) brand is roughly the same age as I am, and a virtual synonym for athletic shoes. While Kimberly-Clark's (NYSE:KMB) Kleenex extends back almost 90 years, Xerox's (NYSE:XRX) copiers are less than 60 years old, but the company's name is synonymous with photocopiers, photocopies and photocopying. Likewise many Investopedia readers pre-date the launch of McDonald's (NYSE:MCD) as a franchise concept, but phrases like "McJob," "burger-flipper," and "do you want fries with that?" are firmly ensconced in the American lexicon (albeit not in a positive way).

Are Brands Better?
If you look at the double-digit returns on capital of companies like Coca-Cola, McDonald's or Nike, you may wonder why companies even need to bother with patents. After all, a patent only covers an invention for about twenty years or so, and in securing a patent, a company is basically telling everybody how to do whatever it is they wish to protect. Consequently, once that patent expires, any newcomer can create pretty much an exact copy of that patented product - as Big Pharma investors know all too well.

SEE: The Power Of Branding

By comparison, trademarks can endure indefinitely, so long as the owner does not abandon that trademark or allow it to become "genericized." Even then, however, it's not necessarily the end of the brand's value - terms like "xerox" and "band-aid" may be used generically by most people, but Kimberly-Clark and Johnson & Johnson (NYSE:JNJ) still own those respective brands and can, have and will sue companies that try to use them as their own.

So how is it that companies can build such valuable products and reap decades of cash flow from products that have relatively little legal protection? A lot of it has to do with the enduring value of a brand. Apple needs patents (and needs to enforce those patents) in part because its product cycles are so short and actual product development can be exceptionally expensive. Even here, however, brand value matters - Apple is a brand with a certain cache and reputation, and many customers happily pay more for MacBooks, iPhones and iPads, because of the Apple logo on them.

SEE: A Primer On Investing In The Tech Industry

How Companies Build Brands, How Brands Build Value
Patents provide protection today, but brands can protect a company indefinitely, allowing them to reap above-average margins and returns that their peers simply can't match. This, however, doesn't come easily or cheaply. Tech and drug companies spend millions, if not billions, on R&D to discover, design and develop products that are legitimately distinct from rival goods. Brand-based companies spend billions convincing you that their products are distinct from rival goods (whether they are or not).

Once a brand is in place, it can create a lucrative "halo" for a company's future business. Many customers are loyal to Apple, Nike and Coca-Cola and will continue to buy those products for the majority of their lives, or at least until there's a customer experience so negative that they shop around or abandon the brand altogether. Not surprisingly, these companies' products are typically more expensive than those of rivals, even though the cost of manufacturing is the same or lower.

In other words, some of the above-average returns earned by Coca-Cola or Nike today can be traced back to decades of positive consumer experiences, earned reputation and marketing that have established these companies' products as distinct and valuable in some fashion. These above-average returns aren't always bulletproof (customers will turn to generic/store brands when times get tougher), but a long-lived branded product really can sell itself in many respects.

The Bottom Line
It's not altogether surprising that many of the leading products in categories as diverse as soda, beer, soap, razors and cereal have been around for a century or more. Our tastes don't change all that quickly, and something that appealed to consumers in the 19th century is still likely to appeal to a lot of people today (even if the product needs to be altered somewhat over time).

What is surprising, though, is just how much value companies can pull out of brands that are so well-established as to be veritable bedrocks of the culture. Although nobody has any interest in a 25-year old computer, or a second-generation TV set, consumers can stick with brands for their entire lives. Even if that only allows for a few extra percentage points of incremental price, those percentages add up over time and the owners of seemingly immortal brands have a better-than-average chance of reaping above-average returns on capital and free cash flow.

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