I had posted my thoughts on the difference between a brand and franchise. Initially my understanding was that they are the same and a strong brand equates to a good franchise (franchise can be defined as a business which earns more than its cost of capital and has a sustainable competitive advantage).

However I have seen cases where the two are not the same ( ex : titan, Mercedes etc, general motor brands etc).

I put out a question asking for comments and got replies from bruce (see below) and from george who has put his thoughts on his website Fat Pitch Financials.

I am listing a few criteria which came to my mind after I got the comments from bruce and george

So here goes
A strong brand would equate to profitable franchise if price is not the key differentiator or is not key factor in the purchase decision. I can think of the following cases

• Low value purchase v/s high value purchase (borrowed from george’s post on his website). I cannot think of anyone putting as much effort in buying a cola v/s buying a car. As a result a strong brand can charge more for a product
• A complex purchase decision requiring substantial information to asess the true price of a product. For ex: high end electronic products – A bose system ?
• Emotional association with the product – Disney products / Barbie dolls – try giving a child a regular lower price but equally good doll and you will understand what I mean
• Social proof / Association tendency – High prestige product which confer a social status on the owner . Ex : tiffany’s

Ofcourse the above are not sufficient for a strong brand to be a profitable franchise. Cost structures and other factors would also be important for the business to be a profitable franchise.

Now why go through all this in trying to distinguish between a franchise and good business (with or without a brand). If I remember correctly, warren buffett in his annual report has written about newspapers as very strong franchise with a kind of a toll bridge business model. Later with internet and other media, he commented that newspapers were still good businesses, but not bullet proof franchise. In the same section he also did a rough valuation exercise of a good franchise v/s good business and showed how strong franchises are worth more than good businesses.


Please share your thoughts on the above topic.

Comments :
Bruce said…
Here’s my abstract opinion (there are a LOT of ways of looking at this one question). A brand/franchise/whatever is something which signals a contract with the customer. It’s a popular solution to the prisoner’s dilemma problem that plagues all economic transactions to some extent. Game theory deals with this subject very well.A vendor spends a great deal of time and money developing an easily recognizable public image that is protected by law (from having other vendors use the same image). That image slowly becomes a reputation, but it also signals a commitment from the vendor not to cheat the customer quickly and then run away. The average consumer must keep track of a very large and growing number of brands and franchises. They don’t want to have to do the enormous work to validate a vendor every time they want to make an economic purchase. A brand/franchise allows them to make quick decisions, often in unknown places. So in a sense, a brand/franchise becomes a contract between the buyer and the vendor. The cost in establishing the brand (and also the value in not destroying it) is a fuzzy guarantee placed into the public by the vendor.When you have a comodity product or service, that brand becomes less important. Someone stands by the side of the road with a rock that you want to buy. They have no brand, but all you want is a rock which is easily verified during the purchase. Anyone spending lots of money to establish a brand is at a cost disadvantage to someone who just gathers rocks and stands at the side of the road. For that reason, comodity markets are won by whoever has the lowest cost. If the market demands 10,000 rocks, then you essentially line up the vendors from lowest cost to highest cost. You start with the lowest cost and work your way up until you buy 10,000 rocks (well, it’s more complicated than that due to the supply/demand curve). The market price essentially becomes the highest cost rock among the 10,000.So call it a brand or franchise or whatever, it’s really a sort of contract. It’s very important that the law upholds the property rights of the brand or everything breaks down. In fact, it’s always important for property rights to be upheld for economic activity to be efficient and effective. India has come a long way over the years and I suspect it will become a very major economic superpower so long as it continues on the path of free markets and property rights.
7:02 PM
Bruce said…
What makes a strong brand? Well, one view is covered very well in The 22 Immutable Laws of Marketing. But a better answer is to look at your own behavior and where you rely on brand. Buffett made some comments about Coca Cola that make a lot of sense. One type of very good brand is small, repeat purchases that are almost habit.When you look at what a brand is all about (a contract), then you can ask yourself when is that contract valuable from the vendor’s perspective. One good thing is lots of confusion and doubt in the minds of customers. Another is a long delay before the customer finds out whether what they bought was good quality vs poor quality.
9:47 AM
George said…
This is a very interesting topic. I posted my comments about it over at my blog, Fat Pitch Financials. It would be nice to put together a set of criteria by which to gage how likely a brand will lead to a franchise.
8:04 PM

I have put this question to myself and have come up with two main reasons

1. My blog is more like an online dairy. I try to put my thoughts on a regular basis. I try to read what I have posted in the past and try to see what I was thinking then and how has my thinking changed. Typically if something works out, I tend to think that it was my foresight (given time I will be become the new warren buffett !!) and luck had nothing to do with it. My blog ensures that when I look at my posts, I would be able to ‘recall’ what I was thinking and see if I can improve/ change it. At the same time if something does not work out, my earlier posts may prevent me from attributing my failure to bad luck.
2. The second reason is to learn from others. Bruce, value architects and a few other visitors have commented or written personally to me in the past. It is good to have a different opinion or to get some inputs from others as it makes me rethink my assumptions or helps me in resolving some of my doubts.

I don’t think this blog is going to make me money directly (although it would not hurt), but hopefully would make me a better investor.

And what the heck ! , I am having fun putting my thoughts out and getting feedback/ suggestions/ clarifications from other. For me that is good enough.