Sunday, July 1, 2007

Share Investor: Takes a Bite-KFC

A very interesting article below about Warren Buffetts approach to brand names got me thinking about its local significance and Restaurant Brands Management of its KFC brand:


Brand names

Commodity companies
Warren Buffet distinguishes between commodity companies and non-commodity companies.

Commodity companies sell products or services that are undistinguishable from the products and services of other companies. Here the customer generally buys on price.

Take soap, for example. Different companies sell soap but their ordinary product is generally the same. The customer will buy from habit or personal choice but can swiftly change brands where there is a price advantage.

This makes the seller vulnerable to the trading practices of competitors and it has a limited ability to increase profits by raising prices. To stay alive, it must respond to its competitors.

Warren Buffett on commodity companies

In 1982, Warren Buffett said this about commodity companies, particularly those in industries that have surplus capacity:

‘Businesses in industries with both substantial over-capacity and a "commodity" product (undifferentiated in any customer-important way by factors such as performance, appearance, service support etc) are prime candidates for profit troubles.’

Non-commodity companies - continuing competitive advantage

Other companies produce a product or service that is so different from its competitors, or so special, that the customer, and the distributor, cannot do without it. This allows the company what Mary Buffett and David Clark call a "continuing competitive advantage". They liken a competitive advantage to a moat surrounding a castle. The moat stops enemies attacking the castle; the brand name stops competitors taking away customers.

Having a brand name is not enough. The brand name, according to Mary Buffett and David Clark, must be lasting – it will go on into the foreseeable future without costly maintenance. There is no real competition for the product. This is a sustainable brand name.

The Coke brand name

A good example of a continuing competitive advantage of this kind is Coca Cola. The customer generally asks for a Coke by name; they do not buy a ‘cola’. Coca Cola is a long time investment of Berkshire Hathaway and one that Warren Buffet has constantly said is never for sale.

Some companies can obtain a continuing competitive advantage by having a monopoly, or being part of a marketing structure that operates as a monopoly. A good example of this is Freddie Mac, The Federal Home Loan Mortgage Corporation, established by Congress to buy and securitize mortgages, reselling them to investors as guaranteed mortgage pass-through certificates. This was an earlier investment of Warren Buffett.

Brand name companies

There are also some companies that market commodity products so well that they distinguish their commodity product from that of their competitors and so put their own special ‘brand’ upon their product. They can achieve this by marketing, continuous improvement, by quality production and service, or in many other ways.

McDonalds sells hamburgers and, if truth be known, their hamburgers are no better than those of their competitors. McDonalds has made itself a brand name primarily through marketing, uniformity of product, and accessibility.

Gillette sells razor blades, not a unique product. It has become dominant in the market, and a brand name, because it markets itself well, continually improves its product – track the progress of the shaving tool) – and its products are reliable.

Warren Buffett on competitive advantage

In 1993, Warren Buffett had this to say about companies with a continuing competitive advantage:

‘Is it really so difficult to conclude that Coca Cola and Gillette possess far less business risk over the long term than, say, any computer company or retailer? Worldwide, Coke sells about 44 % of all soft drinks, and Gillette has more than a 60% share (in value) of the blade market.’ Leaving aside chewing gum, in which Wrigley is dominant, I know of no other significant businesses in which the leading company has long enjoyed such global power.’

Brand name advantages

Time, of course, has moved on since 1993 – market shares change and, arguably, computer companies may have entered the brand name field (for example, Microsoft). However, Warren Buffet’s point is that there are big advantages in having a brand name like Coke, or Gillette:

The customer knows the name and the product that the name represents
Distributors have to stock the product (can you imagine a supermarket without Coke)
The company can keep pace with inflation (or even jump ahead of it) with price rises;
The competitive advantage of a brand name company is also enhanced if the product needs continual replacement; food and beverages, razor blades, newspapers.

A brand name in itself is no guarantee of investment success. Conversely, a company can be successful without having a brand name.



May I pull out a paragraph for closer scruitiny that is relevant and an indication of how RBD "manage." the brands that they do:


‘Businesses in industries with both substantial over-capacity and a "commodity" product (undifferentiated in any customer-important way by factors such as performance, appearance, service support etc) are prime candidates for profit troubles.’

I would argue that RBDs brands are not the "non-commodity" businesses that Buffett continues on with in the following paragraph, simply because RBD management are not doing any of the above:


Non-commodity companies - continuing competitive advantage
Other companies produce a product or service that is so different from its competitors, or so special, that the customer, and the distributor, cannot do without it. This allows the company what Mary Buffett and David Clark call a "continuing competitive advantage". They liken a competitive advantage to a moat surrounding a castle. The moat stops enemies attacking the castle; the brand name stops competitors taking away customers.


KFC would sneak in on its uniqueness for sure but its "moatability" (I just love new words) if you like, is countered by RBD managements treating their brands in a commodity type way, that is to say, neglecting them.

It is clear to most what happens when you treat any company in a cavalier fashion and in the case of a "moat" company like RBD and its brands they have managed to break the dam down and the water is rotting those brands from the inside out.

The dominance factor that Buffett talks about really only applies to KFC. Pizza Hut and Starbucks are not dominant in their niche as they have many local and international competitors that consumers will go to. Product isnt that unique to these two food brands.

KFCs dominance though has and is being taken for granted by management. How can RBD let such a global brand with such an ingrained status in New Zealand culture to the current point of diminishing returns. For goodness sake they have a potential cash cow here.

Pizza Hut is sadly going into terminal decline in this country and its competitors look set to cut it into Ponsonby like peices of the pizza it throws at its customer.

Starbucks is muddling along at a snails pace compared to its interantional brothers but seems to be stuck in a rut.

I wont go into those two here.

How does one resurrect a brand?

KFC is currently in the process of being given yet another re-vamp. We all remember the most famous revamp over ten years ago, Kentucky Fried Chicken became KFC and we all forgot about the F word.

We didnt of course but that revamp worked for a time, then logos were changed, stores remodled several times for new "looks" and menus were changed.

My point is these things all worked, for a time, and it is clear they only work for a finite time because the keepers of the brand have had to continue to revamp and window dress.

What I think is lacking though is these things that Buffett talks about:

‘Businesses in industries with both substantial over-capacity and a "commodity" product (undifferentiated in any customer-important way by factors such as performance, appearance, service support etc) are prime candidates for profit troubles.’

Even with a business moat, a dominance in the industry and an identifiable brand in KFC . It just isnt going to work if you run your brand like a commodity product and therefore tarnish its image and therefore its cache.

At present they are focused on everything but the basics of maintaining a brand and in the process slowly killing it. Only KFCs uniqueness as a food product is keeping the punters coming through the door.

Great brands are made but they can also die if they are neglected.

Too much has been taken for granted by those at Restaurant Brands head office and all they need to do to resurrect the KFC brand is to treat it like the brand it is.

Stand behind it and back it 200%


C Share Investor 2007