The game of investing is largely a game of developing insights. The same goes for entrepreneurship. Peter Thiel’s favorite question to entrepreneurs and job candidates is: tell me something that is true that nobody agrees with? This really gets one thinking – this is an extremely difficult exercise. In the markets, even if you thoroughly understand the business, have a good idea of true long term earnings power, and admire management, you won’t achieve a greater than mediocre outcome if your views are undifferentiated. The market is akin to a pari-mutuel betting system in that the best businesses, recognized as such by a swathe of market participants, will command the highest valuations. This is why business (and investing) are extremely difficult activities. In the absence of idiosyncratic events which might create investment opportunities in our favorite businesses, we need to develop other tools to uncover opportunities.
One model I’ve recently been thinking about is the power of influencers. Influencers are people who command authority, are respected and admired by a great many, and others want to connect to and through. This is why the endorsement business is as big as it is and getting larger and seemingly more ludicrous every year. Nike’s recent decision to top Under Armour’s $275 million shoe deal offer to Kevin Durant with a $300 million offer of their own sounds extreme, but is it? Looking back, Nike’s $90 million deal with LeBron James in 2003, before he had played a single game of professional basketball, also appeared to be egregious, but turned out to be an extremely shrewd maneuver. The truth is, people are heavily influenced by authority figures and by their peers. These marketing tactics work by capitalizing on a number of psychological tendencies humans are susceptible to, including authority bias, mere association effects, and social proof tendency. Kevin Durant’s face in Nike commercials and extensive marketing campaigns in China, a burgeoning basketball market, will likely generate a lot more than $300 million in profits for Nike over the next ten years. Moreover, Nike will continue to build brand strength and thwart a very able and potentially dangerous competitor (Under Armour) from breaking into the basketball shoe market, where Nike has a whopping 93% market share. It was a necessary defensive play.
In the linkfest I recently put up, I referred to this PandoDaily article, which I found to be particularly insightful. The first delusion Rick Lewis discusses, “I wouldn’t use it,” is a filter many investors use to dismiss an opportunity. I think the same delusion applies to people’s view on the effectiveness of advertising. Most people will tell you that TV commercials, Google text ads, magazine print ads, and billboards have no impact on their purchasing decisions. Consequently, many people dismiss the powerful benefits of advertising. If that’s the case, however, why is it that the advertising industry has existed in various forms since ancient times? Why is it a $650 billion+ market worldwide? Why have many small businesses around the world doubled or tripled revenues by advertising on Google? Advertising works, that’s why. Buffett recognized the power of advertising early in his career when he got into the newspaper business. On one hand, the Buffalo News and Washington Post printed money selling ads, supporting many local businesses in their metropolitan areas. On the other hand, the Nebraska Furniture Mart and GEICO spent millions on advertising to increase business and build their brand. Today, GEICO spends greater than $1 billion annually on advertising. How many people do you know who (i) don’t recognize the GEICO brand, and (ii) don’t associate GEICO with low cost? The image that GEICO has imbued in consumers’ minds is a powerful competitive advantage. We certainly don’t think of Progressive the same way we think of GEICO, even though both companies have very similar product offerings. In many industries, advertising is a weapon businesses can utilize to break out of a competitive pack or expand a lead.
A recent deal which I found intriguing was Apple’s $3.2 billion purchase of Beats Audio. How could a company selling a purely commodity product in a viciously competitive market achieve such a singular outcome? Technology reviewer, Marques Brownlee, who I think is the best technology product reviewer in the world (and is a 20 year old college student to boot), laid out the truth behind Beats Audio in this video. Beats has an astounding 64% market share in the premium headphones ($100+) segment. What’s more interesting is that they obtained market dominance despite having a vastly inferior product to competing solutions. It brings to light the power of influencers and saavy marketing. Dr. Dre, a leading authority in the music business, is the face of the brand. In addition, the company gets many musicians (and athletes, actors, etc.) to promote Beats’ products in music videos, during live performances, at sporting events, during press conferences, and in public venues. Beats pays some of these celebrities to endorse their product, but also gives thousands of free products to key influencers. When people see not only an authority figure like Dr. Dre, but all their favorite musicians wearing a specific brand of headphones, it gives instant credibility and brand recognition to the product. Beats also does an excellent job with the design aesthetic of its headphones and unequivocally has the best product packaging in the industry, a la Apple. Beats products have a ton of sex appeal and trigger lust in the same way Apple products do. Beats is not an engineering company, it’s a marketing company. It’s fascinating that a marketing focused company has been able to crush all the sophisticated engineering companies in the space. The best product does not always win.
If I had an opportunity to invest in Beats Audio five years ago, I could provide 20 logical reasons for why it would be a horrible investment. But, it wasn’t. It’s the same reason that Jessica Alba’s company, The Honest Company, recently raised a round of funding at a $1 billion valuation. The company has strong brand recognition, particularly among affluent, health conscious mothers, because of Mrs. Alba.
Think of what makes Twitter such a valuable property. It’s a business which takes extreme advantage of authority bias. We humans are very interested in (i) what our peers are doing / saying (Facebook), and (ii) what the people we respect, admire, and are intrigued by are doing / saying (Twitter). Twitter is the only platform in the world where we can get inside the minds of the people who we are innately curious about, but otherwise have no access to. And it’s a platform where influencers can build their brand and communicate with the people who are interested in what they have to say. Once we are exposed to these platforms, it’s very difficult to break away because of our natural psychological tendencies. They are extremely habit forming.
Final thought: one of my favorite case studies is Prof. Bakshi’s lecture on Relaxo Footwear. It’s another example of how a commodity business operating in an industry with historically horrible economics has built a durable competitive advantage and provided outsized returns for shareholders. The lecture can be viewed here.
We should be cognizant of the powerful psychological effects caused by authority and social proof bias. One thing I’m currently trying to better understand is why Bajaj Almond Oil hair drops has a 60%+ market share in India. I suspect that some of these psychological factors could be at play in this case.