Of Brand Moats and Product Life Cycles

Today we will discuss more about two things. Brand moats and Product Life Cycles and their relevance in stock picking. 

Brand moats create strong entry barriers and sustainable product demand. So even if a perfect substitute of a certain product is available in the marketplace users will still prefer to wait for their particular 'brand' because of perceived superiority and comfort in their favorite brand. So this creates a huge entry barrier which is very difficult, if not impossible for new entrants to break.

Let's understand this with an example from Prabhakar Kudva in his blog, where he is talking about GSK and their popular brand Horlicks,

"...Consider this. If you're a parent and you want to your kid to drink milk twice a day, would it be mixed with anything but Horlicks/Bournvita or Complan? 

No other random brand will do. 

The parents especially nowadays are super sensitive about what their kids consume. Not only that even kids are very conscious of their favorite brand and once they like one brand nothing else will do. 

These are competitive advantages built over decades to create brands like Horlicks which ensure that no other competitor can just come in and take away market share.

Like Buffett says even if i give you 10,000 Cr and ask you to make all the kids who drink Horlicks drink something else in the next 5 years, you won't be able to do it......"

So evidently we have seen that companies with strong brands will command a premium in the market place for the simple reason of sustainability of market share. It doesn't take a genius to guess that Coke or Pepsi would continue selling in large numbers or a Gillette will supply large number of razors in 2020 as well. 

Next we come to the second aspect of it, Product life cycle (PLC). What's critical to understand is that along with the brand moat product life cycle or PLC creates a critical differentiating factor when one comes to the replacement demand.


In simple terms -
along with selling your old/established products to new customers (category A)
and new products to old customers (category B),
how frequently are you selling your old products to your old customers(category C) 
- that will make a key difference.

Amongst the companies with strong brand moat, the ones with the shortest PLC ( FMCG - HUL, ITC, Nestle, P&G, GSK) will have the highest premium. The market premium narrows down as we move to players with shorter PLC (Razors - Gillette) to medium PLC (Inner wear - Page Industries, Footwear - Bata) to moderately long (Cookware - Hawkins/Prestige, Car batteries - Exide/Amara Raja) to longest PLC (Tiles /Pipes/Sanitary ware). 

The shorter the PLC in effect creates that much better demand visibility or in other words brings in that much higher predictability of sales and earnings, which is why the market gives them a premium as compared to sales of a exotic tour operator (like Cox & Kings where the category itself is discretionary to a large extent ). 

Hence, while researching for stock ideas we need to focus on companies that are curving out niches for them by establishing strong brands and have the added support of shorter PLCs.

Another key aspect to highlight is new product launches even in new categories, which piggybacks on existing established brands for their success. And it works way better than new launches, shows a recent Nielsen study

"....Is it possible for consumers to accept a hair oil brand as a skin care lotion? 

Parachute Advansed, the leading hair oil brand from Marico, has managed to make this transition based on insights from research firm – Nielsen. 

Extensions of existing FMCG brands are five times more successful than launching a new brand in India, claims a study done by Nielsen...

....shows that in addition to promoting brand equity, brand extensions can grow incremental sales up to 38 per cent and contribute as much as 30 per cent to the parent brand’s sales...."

Strong established brands can be used to venture into new categories. As done by Horlicks (biscuits), Nestle (Maggi extensions) or even a non FMCG player like Prestige (Induction Cookers).