It’s not the stuff you sell. It’s the people you sell it to.
Brand might be the most under defined word in ecomm. Ask ten people and you will get ten definitions. For something so core to our strategy and day to day, this is dangerous. If we are building a company to generate wealth and we have decided that a core way we are going to do that is by building our brand, then we should be precise about the definition of brand to guide our strategy and actions.
Brand is more than marks
The logo and color scheme and typography I am going to call marks. I am not talking about that.
Is brand the delta between cost and price?
A common definition of brand is the value between the cost of the product and the selling price. This delta is then called the brand value. The logic here is tempting.
No one outside of Hermes really knows what it costs to produce a Birkin bag. But let’s guess it’s $1,000 of materials and $1,000 of direct labor for a cost of $2,000. When they sell it for $20,000 we can then say they have $18,000 in brand value.
Let’s say Coach went to France and convinced a Hermes artisan to make bags for them and they produce a bag that in every way is the equal of a Hermes bag in terms of craftsmanship and materials. This bag also costs $2,000 to produce. Can Coach then sell theirs for $20,000? Probably not. Maybe Coach can only sell theirs for $5,000. So according to this methodology, the Coach brand value on the bag is $3,000. A big difference from Hermes.
So far, this methodology seems to conform to what we experience and know day to day. Hermes is a more valuable brand with higher ‘brand value’ in each product. So the value of ‘the brand’ confers a delta between price and cost on a per product level.
But does the equation work the other way? Is the value of a company’s brand the sum of all those per product deltas? Does brand value in each product translate into overall brand value measured at the company level?
In other words, if we want to increase our company’s brand value and ultimately our valuation in our goal to generate wealth, do we simply make more products?
Let’s do a simple thought experiment. No one outside of Hermes knows for sure, but credible estimates are that 12,000 Birkin bags are made each year. Now let’s say Hermes figures out a way to 10X that volume at the same quality. They need to push volume so they start selling them online and they are stacked in the window of every store. Instead of waiting patiently for an appointment, you can stroll into any store and grab one off the shelf. The bags start showing up in department stores and we start seeing them on the arms of women (and men) all around us. Does the price they can achieve remain the same? Maybe for awhile they can keep the price, but we all know where this goes. Prices will fall and we all intuitively know why. The cache of owning one would decline precipitously.
Being generous to Hermes, let’s assume the price falls to half. The product focused definition would imply that while Hermes lowered their per product brand value, as a company they dramatically increased the overall value of the brand.
Current value: 12,000 bags * $18,000 = $216 million
Increased volume at half the price: 120,000 bags * $8,000 = $960 million (4.4X increase)
In fact, the logic of the product based brand value would have us believe that if Hermes increased volume 10X and decreased prices to $3,800, their company brand value would remain the same.
But does anyone really believe this? We all know that Hermes would destroy its brand value by pursuing such a strategy. The luxury brands all understand this as evidenced by their annual destruction of billions in unsold inventory.
We are focused on the wrong part of the equation.
It’s essential to put the emphasis on people, not product when valuing a brand. Products don’t monetize themselves. They are bought by people. And focusing on the people who buy from us as opposed to the products will help us avoid disasters like the Birkin bag thought experiment above.
The customers are what count. Our products are simply the mechanism by which we convert that predisposition to buy into reality.
Predisposition to Buy = Potential Energy
Remember grade school science where you learned the concept of potential energy? The water in the reservoir behind the dam represents potential energy. When it is allowed to flow through the turbines, it is converted to kinetic energy and electricity.
/w=828,quality=90,fit=scale-down)
Your reservoir is your customer base and their collective predisposition to buy. And like the hydroelectric plant, our ability to convert that potential energy into electricity (or cash flow in our case) is imperfect and full of friction. But the bigger that reservoir, the bigger the potential cash flow. That much is obvious.
Unlike water, each person’s predisposition to buy is influenced by the others around them. As humans, we take comfort in the crowd. The more people we sense who share our predisposition and the stronger that predisposition is, the more comfort in our choice we have. The bigger the reservoir, the better we feel about our choice.
Balancing potential and kinetic
Brand have to find their balance between the predisposition to buy and actual buying. Luxury brands know that higher ratios matter. Ferrari sells about 13,000 cars per year, so they probably want somewhere between 10,000 and 100,000 people to covet a Ferrari for every person who actually buys one.
But drain the reservoir too fast, like in the Birkin thought experiment above, and the ratio is thrown off. We see with our eyes and sense that the ratio of predisposition to buying i.e. wanting to having, has been lowered and we react negatively. A dangerous downward spiral begins.
Of course the opposite can happen too. Make the reservoir too big, have the ratio too high and spread among too many people and certain highly influential customers will automatically turn away from the brand as being too popular and too mass appeal.
OK, I will stop torturing this analogy.
This isn’t just theory
Putting customers at the center of our definition of brand has important consequences for how we measure brand value and the actions we take to increase it. It impacts marketing, product planning and inventory buying. It changes how we think about finance and increasing our valuation.
I am going to explore these topics and how to make all this actionable in my next posts.
Valuing brand. Why customers are your greatest asset and the accounting treatment is misleading (and wrong).
How brand value translates into financial valuation
ROAS and MER are not your guiding metrics for brand building advertising.
Cohort analysis is a sub optimal tool. Focus on the brand pyramid.
The Paradox of Product Expansion.
How focusing on brand improves revenue predictions and capital efficiency.
Previous posts:
Making the Capital → Sales → Capital cycle efficient
https://elephantherdconsulting.com/blog/blog-database/capital-cash-and-growth-tuning-the-machine
Building compounding into your business by understanding not all customers are equal
https://elephantherdconsulting.com/blog/blog-database/compounding-drives-success
Defining the purpose of a company. Not all cashflows are equal.
https://elephantherdconsulting.com/blog/blog-database/goals-define-strategy-define-outcome