Is the power of brand in decline? Charles Somers, global sector specialist – consumer March 2014 With the rise of social media, today’s companies have much less control over their online image. The likes of YouTube, Twitter and TripAdvisor give the consumer the means of broadcasting their views on a scale never before possible. What’s more, with new and niche companies able to garner world-wide recognition via a video that goes viral, the authority of traditional advertising media has been diminished. This has important implications for global consumer companies, for whom brand is so crucial. Charles Somers investigates how this is impacting the consumer sector and what it means for investors. A quiet but symbolic shift occurred in 2013: for the first time, the internet became the primary medium for Americans (measured in hours used), overtaking TV and leaving radio and print trailing even further behind. The internet opens up huge opportunities for most companies, but it also comes with problems. The difficulty for companies is that they have much less control of their online image than in older media because consumers are able to broadcast their views via social media and websites such as TripAdvisor. Charles Somers

Loss of control of brand online The extent to which companies can lose control of their brand online is shown by recent examples of PR campaigns being hijacked. McDonalds’ twitter campaign in 2012 is a famous example, but the Cheerios GMO (genetically modified organism) storm is also instructive. When General Mills put up a Facebook app asking what Cheerios meant to people and delivering the answers in the distinctive Cheerios font, images like the one below were created by anti-GMO campaigners (40,000 of them). Figure 1: Anti-GMO campaign targets Cheerios

Source: www.newhope360.com

Talking Point Is the power of brand in decline?

Just over a year later, General Mills has been forced to pledge that original Cheerios will go GMO-free. In the meantime the effect on Cheerios’ growth and market share has been pronounced. This is shown in the graph below which shows sales growth deteriorating since the incident started in November 2012: Figure 2: Cheerios’ year-on-year sales growth has deteriorated

Source: Nielsen’s Scantrack enhanced AOC, Berstein analysis

Although less organized, the negative online publicity around aspartame has also been intense and detrimental to diet sodas. Note how the increase in internet searches on the subject corresponds to a fall in volume growth of diet sodas in the US: Figure 3: Carbonated soft drink sales growth

Figure 4: Google search traffic for “aspartame”; max = 100

Sources: Goldman Sachs Americas Beverages report, Sep 2013

Despite multiple reviews of the evidence by the US Food and Drug Administration (FDA) and European Food Safety Authority (EFSA), the negativity around aspartame endures, and will likely drive incumbents to accelerate their initiatives around natural sweeteners such as Stevia. The rejection of the overwhelming majority of scientific evidence around aspartame is indicative of a general mistrust of the food system, especially on the part of those who are active online. In this environment it is difficult for food companies and other brands to make a science-based message heard and accepted, let alone control the agenda as they have done historically through more concentrated (and undemocratic) media. Tellingly, the data from Bernstein, illustrated in figure 5 overleaf, show that active internet users are more distrustful of the food system than other members of the public.

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Talking Point Is the power of brand in decline?

Figure 5: More active internet posters (70%) are becoming more distrustful of the food system than others

Source: Berntein US food survey, 2013

Barriers to entry declining A corollary of established brands’ inability to control the message is the ability of new (or revived) brands to gain a following and establish themselves in consumers’ consciousness. One driver of this trend is the breakdown of the historical relationship between dominant brands and “modern” staples retailers such as supermarkets and hypermarkets. Until recently, bricks-and-mortar retailers have found it most profitable to devote their precious shelf space to the two or three leading brands in each category (higher velocity, better buying terms) along with their private or store brands (higher gross margin). The rise of eCommerce with its almost infinite “shelf space” has enabled new brands to gain distribution and when this is combined with savvy marketing (often also over the web) it can allow them to establish a significant foothold in the market which would have been much more difficult in the pre-internet age. The following examples are from consumer electronics, but apply equally to most consumer goods. Figure 6: Greater product offering online versus bricks-and-mortar

Source: http://sloanreview.mit.edu/article/from-niches-to-riches-anatomy-of-the-long-tail/

The result of infinite shelf space and the more rapid brand-building that is enabled by social networks and other new media is a shift in market share in eCommerce compared to offline retail. This is illustrated in the table overleaf which shows that the top three brands on Amazon are often smaller players which have gained market share online.

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Talking Point Is the power of brand in decline?

Figure 7: Top brands overall versus on Amazon

Source: Berstein. Companies shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell.

With eCommerce penetration still below 5% in most consumer staples categories it is probable that current trends are dominated by early adopters who have a tendency to be more experimental; hence as penetration expands, more established brands may recover online market share amongst a more mainstream audience. However, brands should not take this for granted. Indeed, the success of some smaller brands online has encouraged bricks-and-mortar retailers to be more experimental in their assortment. Younger consumers less trusting of brands The declining influence of major brands seems most noticeable among the younger generation. According to surveys, consumers of the Millennial generation – those born between roughly 1980 and the early 2000s – are less loyal to brands than those brought up pre-internet. This is illustrated in figure 8 which shows that Millenials are more likely to purchase generic names instead of dominant brands. As the economic power of Millennials increases this presents a further threat to brands’ dominance. Figure 8: Generational differences: proportion of respondents who are buying more store brands

Source: Acosta sales & marketing, September 2013

This may not be surprising given that the Milliennial generation are the “online generation” and the most prolific users of social media. Interestingly, the below market research shows that advertising has less influence over purchasing decisions for Millennials compared to the baby boomer generation:

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Talking Point Is the power of brand in decline?

Figure 9: Top purchase influencers by category and generation

Source: Radius Global Marketing Research

Individuality and connoisseurship increasingly valued over “belonging” A further example of fragmentation in categories is the desire of consumers to demonstrate individuality and connoisseurship through their choice of products, particularly where they are seen in public places. Two examples are the movement away from logoed product in luxury goods (which has been particularly impactful for Louis Vuitton and Gucci) and the growth of craft beers, which has been detrimental to the established mainstream brewers in the US. Private Label At the opposite end of the scale, retailers globally are trying to distinguish themselves through their private label products. Two examples that spring to mind are 7&i in Japan and Walgreens in the US, both of which operate in relatively advantaged segments of food and drug retail. They have both singled out private brands as key drivers of their strategy, in 7&I’s case making it the number one point in its third quarter strategy presentation. Trends in the US are slow-moving, but both there and internationally the fastest growing FMCG (fast moving consumer goods) retail formats are led by private brands – for example organic or natural grocers in the US (also featuring nonmainstream brands) and convenience stores in Japan. In the UK, the threat is coming from two directions as the fastest growing formats are hard discounters and the high-end, both of which assert their core attributes (value and quality respectively) through their store brand products. Investment implications While consumer brands may be losing some of their power, and as a consequence their value, I am not arguing that there has been any kind of tipping point – this is a gradual process. For example, the interbrand rankings since 2000 are a model of stability for FMCG brands – the only one to have dropped out of the top 20 is Marlboro. The point is illustrated on the following chart based on Nielsen data, which shows category concentration declining but very slowly:

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Talking Point Is the power of brand in decline?

Figure 10: US market concentration (based on average HHI) by category: a slow decline

Source: Nielsen’s Scantrack enhanced AOC, Bernstein analysis *HPP = high pressure processing

Nevertheless, brand owners should not be complacent: the impact can still be material, especially in the context of consumer staples where a 1% revenue miss relative to expectations is considered a major event. Taken to its logical conclusion this theory implies lower valuations for consumer products companies. If we accept that the value of a company is the discounted value of its future cashflows, and that returns above the cost of capital will eventually be competed away, then the decline of brands should affect companies’ valuations via a higher discount rate (greater volatility of returns) and a shorter competitive advantage period. The following box summarizes the strongest trends: 

Loss of control of the brand image online: o Favors companies that understand and utilize digital media o Favors advertising agencies with a strong (and integrated) digital offering o Hurts companies which lack strong and consistent brand image

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Lower barriers to entry for small brands; growth of private label: o Favors small/medium-sized listed companies, and large companies prepared to invest behind lesser brands o Favors companies with stronger eCommerce strategy o Rewards genuine innovation, regardless of company size o Damages companies that rely on brand and distribution rather than innovation and value for money

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Mistrust of the food system (and some parts of beverages), particularly in the US: o Favors organic/natural/local brands and retailers o Damaging for mainstream, undifferentiated food offering o Soda companies need sweetener innovation to come through strongly

Ultimately, many of the principles of stock-picking in this sector apply more than ever in this environment. In other words, looking for companies with a good understanding of their consumer, strong innovation and relevant marketing becomes all the more important. Not yet convinced? Consider this: marketing agency Havas Media asked 134,000 consumers in 23 countries what they thought of 700 brands. The answer? Most would not care if 73% vanished.

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Talking Point Is the power of brand in decline?

Important Information: The views and opinions contained herein are those of Charles Somers, Global Sector Specialist, Consumer and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This newsletter is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument mentioned in this commentary. The material is not intended to provide, and should not be relied on for accounting, legal or tax advice, or investment recommendations. Information herein has been obtained from sources we believe to be reliable but Schroder Investment Management North America Inc. (SIMNA) does not warrant its completeness or accuracy. No responsibility can be accepted for errors of facts obtained from third parties. Reliance should not be placed on the views and information in the document when taking individual investment and / or strategic decisions. Past performance is no guarantee of future results. Sectors/regions/companies mentioned are for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The information and opinions contained in this document have been obtained from sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties. Schroders has expressed its own views and opinions in this document and these may change. The opinions stated in this document include some forecasted views. We believe that we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee that any forecasts or opinions will be realized. Schroder Investment Management North America Inc. (“SIMNA Inc.”) is an investment advisor registered with the U.S. SEC. It provides asset management products and services to clients in the U.S. and Canada including Schroder Capital Funds (Delaware), Schroder Series Trust and Schroder Global Series Trust, investment companies registered with the SEC (the “Schroder Funds”.) Shares of the Schroder Funds are distributed by Schroder Fund Advisors LLC, a member of the FINRA. SIMNA Inc. and Schroder Fund Advisors LLC. are indirect, wholly-owned subsidiaries of Schroders plc, a UK public company with shares listed on the London Stock Exchange. Further information about Schroders can be found at www.schroders.com/us. Schroder Investment Management North America Inc. is an indirect wholly owned subsidiary of Schroders plc and is a SEC registered investment adviser and registered in Canada in the capacity of Portfolio Manager with the Securities Commission in Alberta, British Columbia, Manitoba, Nova Scotia, Ontario, Quebec, and Saskatchewan providing asset management products and services to clients in Canada. This document does not purport to provide investment advice and the information contained in this newsletter is for informational purposes and not to engage in a trading activities. It does not purport to describe the business or affairs of any issuer and is not being provided for delivery to or review by any prospective purchaser so as to assist the prospective purchaser to make an investment decision in respect of securities being sold in a distribution. Further information on FINRA can be found at www.finra.org Further information on SIPC can be found at www.sipc.org Schroder Fund Advisors LLC, Member FINRA, SIPC 875 Third Avenue, New York, NY 10022-622

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