OF BRANDS AND GROWTH
Interpreting the PIMS evidence on the contribution of branded consumer
businesses to economic growth – policy implications
Professor David Stout, Special Adviser
N/e/r/a
This report was commissioned by AIM.
September 1998
Executive summary
Particularly during the last decade it has become clear that non-price
competition - the fight to win market share by establishing a quality edge, by
product differentiation in established markets, and by innovation in new
markets - has become the most important driver of value added and
competitive success within the Single Market. The consequence is that
competitive advantage - whether at the level of the firm, the Member State or
the European Union as a whole - is not rigidly set by initial factor
endowments, but is created by R&D, learning and strategic investments,
supported by brand reputation in increasingly differentiated markets and
selling to ever more demanding and knowledgeable distributors and final
consumers. In this setting, horizontal product differentiation itself - that is to
say greater product variety - is a competitive weapon, to be deployed
alongside product quality in its several dimensions.
Competitive actions are most effective when they are most difficult to copy
quickly - as is the case with innovation. The incentive to innovate is further
increased by the successful entry of outside producers into the Single Market,
often with sophisticated versions of products already developed and sold in
their own domestic markets.
The distinction between the manufacturing function and the various
simultaneous and downstream service functions involved in supply is
nowadays fading. The service elements in the value chain - including the
promotion of brands, the communication of product benefits and the provision
of benefits to the distributor - have become at least as important in fast
moving consumer goods (FMCG) markets as the production process itself.
Furthermore, in the widened Single Market, scale economies persist in the
“service” elements, after production scale economies in manufacturing have
been largely exploited.
Brand reputation is a necessary enabling condition of non-price competitive
success, whether by innovation, product improvement or line extension. It is
one of the main functions of advertising and promotion to reach - on the
strength of pre-existing brand reputation - the early “critical mass” of demand
that facilitates profitable volume and share growth, which in turn justifies the
costs sunk during the development stages.
The wave of inward investment by global competitors, the avalanche of
information recently available to consumers and the further evolution of the
relation between distributor and manufacturer have all increased the
significance of brands, and the importance of reputation and intellectual
property.
Results set out in the PIMS Report, Of Brands and Growth, support these
observations. It appears there that the competitive process flows from R&D,
service investments, process and product innovation, promotion and
advertising to higher perceived relative value expressed by means of the
three main weapons - price competition, quality competition and new product
offers. All three are mediated, and enabled, by high reputation - but
particularly the last two. The dynamic system is continued, and the circle
completed, by way of consequent market share gains by the winners, scale
economies, value added increases augmented by the growth of the market,
and the resulting profit gain for plough-back into renewed R&D, innovation
and quality competition.
Quality competition and innovation do not simply redistribute value added
among competing firms: they raise it overall by raising domestic consumption
standards. They also benefit overall wealth creation by their impact on
industrial development. At a time when relatively low-value, labour-intensive
tasks are increasingly being transferred to low-wage economies outside the
EU, the development of higher value-added activities through innovation and
branding helps the EU economies to concentrate on economic activities in
which they retain a competitive advantage. The preservation of employment
levels by creating such high value activity provides the most robust basis for
sustainable employment policies and wealth creation.
Several fields of European policy competence can enhance these processes:
measures that help to free up commercial communications of all kinds; that
protect intellectual property; that continue the support of collaborative precompetitive R&D; that simplify and unify product description rules and develop
recognised quality standards that can be adopted by producers, without
limiting product diversification; that facilitate start-ups by small enterprises;
that encourage inward foreign direct investment, locating high value-added
stages of the supply chain within Europe; and that put in place environment
policies, industrial infrastructure policies and competition policies to stimulate
new entry, and innovation and to allow for the increased importance of both
knowledge and service in FMCG markets.
1. The importance of non-price competition
1.1 The Role of Non-Price Competition in the Single Market
Ten years ago, in The European Challenge 19921 Paolo Cecchini and his
team predicted that an increase in European economic welfare equal to 4.8%
of GDP would result simply from the reductions in the price of given levels of
output as a consequence of the Single European Act. This looked-for cost
saving from cross-border scale economies and more intense competitive
pressures driving out less efficient firms is what is chiefly remembered of the
Cecchini Report - peak prices brought down to average in industries like dairy
products, where competitive barriers were already low; and to the level of the
two lowest price producers in such industries as railway rolling stock where
cross-border entry barriers were high.
For several reasons, nothing like this degree of price uniformity has yet
occurred, but another set of welfare gains has been appearing in a way that
was envisioned elsewhere in the Cecchini Report. In a short section near the
end of the report, called “Market Dynamics and Technical Progress”,
Cecchini wrote:
“For companies, costs and prices are increasingly just two of
the components of their competitive strategy for the 1990s indeed as of now. Today, more than ever before, is witness
to the emergence of more telling competitive weaponry.
Business’ capacity to develop new forms of organisation, to
penetrate new geographical markets, to invent new products
and processes - these are the stuff of which competitive
edge is made. Comparative advantage is no longer seen as
divine inheritance, nor are market structures set in tablets of
stone.
These ‘non-price’ factors, central to competitive
business strategies, are dynamic and subject to continual
change. And among these factors, the role of innovation is
crucial.”
Today, as a generalisation, this has become received wisdom.
It is the
purpose of the PIMS study to investigate the processes on the ground, at the
level of the individual business. The study investigates the drivers of
innovation and quality competition, and what kinds of business conduct wins
and loses. By 1997, in the Commission’s Single Market Review, London
Economics and the other researchers involved found the principal gains from
the Single European Act to have appeared not from falls in cross-country
disparities in price-cost margins, which had not yet appeared in many sectors,
but from the consequences of company strategies in “product design”.
“Product design” was used as a collective term to include product variety,
R&D, innovations, advertising and promotion. Pro-competitive actions were
1
Cecchini, P., The European Challenge 1992 - the Benefits of a Single Market, Wildwood House, CEE, 1988.
found to include a large measure of competition by service provision. The
challenge of more intense competition and the opportunity of a larger and
more open European market encourages and enables a faster pace of
product innovation. It also increases quality and variety within established
product markets.
This 1997 finding corroborated an earlier observation by a European
Commission working paper on industry policy, that:
“at a time of rapid technological change associated with
substantial economies of scale, differentiated products, more
flexibility and globally operating firms, most sources of
competitive advantage are created rather than endowed....
Producers must meet the competition first of all in terms of
quality.... The ability to command a premium price constitutes
the best indication of superior competitive performance”.2
1.2 How Quality Competition Operates
The emphasis here is very different from the static welfare gains associated
with the homogeneous product markets, negligible transport costs, perfect
information and uniform tastes of old text-book models of competition. In
place of that model, we have here a turbulent disequilibrium process of
market evolution in the Schumpeterian tradition, in which bridgeheads are
established by innovation, undermined by imitation and counter-innovation,
and re-established. The process involves typically oligopolistic fights for
market share, combining every dimension of the product that affects
consumer choice.
Among these non-price factors - collectively called quality - are appearance,
appeal to other senses, image promoted by marketing effort, convenience,
speed of action, running cost, reliability, servicing, consumer friendliness,
environmental soundness, and how well the product performs the functions
for which it is selected. Because consumers are different, diverse products
co-exist. The theoretical difference between horizontal differentiation (variety)
and vertical differentiation (superiority) is blurred by the variety of tastes. In
customisation - the tailoring of a Dell computer or a cosmetics pack to the
precise requirements of the consumer - horizontal differentiation in fact
becomes a powerful quality discriminator (Stout & Swann, 1993)3.
The key dynamic consideration is the difference in the response lags to
different means of competing. In the very short run, with a fixed array of
product offers in the market, there are no effective means to try to raise
market share other than to lower price or to launch a sales promotion. With
excess capacity, or at least important unachieved economies of scale, such
actions will be undertaken, provided that they are not expected to be matched
European Commission DG III Working Paper, “Industrial Policy in an Open and Competitive Environment: Guidelines for
a Community Approach”, Brussels, 14 September 1990.
3
“Non-Price Competitiveness of British Firms”, in Hughes (ed) Future of UK Competitiveness and the Role of Industrial
Policy, PSI, 1993).
2
by rivals before they have had the intended effect on sales and unit costs of
players. However, since simple price competition is transparent and can be
simply copied by equally efficient rivals, it will seldom generate the kind of
breathing space that is necessary in order to win share and volume from
rivals. In contrast, competing on difference based upon an aspect of added
value that cannot be quickly copied is often the only reliable way to grow,
faster than the market as a whole is growing.
Response times to price
changes are measured in days. First mover advantages to major innovators
are measured in years.4
Several recent studies have supported this account of a more dynamic Single
European Market economy, impelled by cross-border competition and
enabled by information flows, a faster pace of technical change, inward
investment, alliances and mergers.
A notable feature has been powerful entry from firms based in other
economies, introducing a strong dose of global oligopoly rivalry. European
companies have lost ground, with a fall in the EU share of global exports by 7
percentage points since the early 1970s. This is largely due to the Tiger
economies of South East Asia, rather than to the success of US and
Japanese firms.5
1.3 The Weakened Distinction Between Manufacturing and Services
Products are best seen today as “bundles of utilities”, and the distinction
between manufacturing and services is becoming ill-defined. The “service”
elements in product provision by the producer include customisation, product
information, the many dimensions of product quality, design and packaging,
and the confidence the consumer has in the brand. We can expect to see a
continuation in the shift of added value downstream from raw material and
manufacturing, towards the services of convenience, product trust, variety and
shopping pleasure. This implies, for the manufacturer, a new and more
collaborative relationship with the increasingly powerful and concentrated
retail sector. The role of the manufacturer is to provide those contributions to
value added which lie outside the retailer’s province - the strength of
established brands and a stream of product improvements and innovations.6
1.4 Recent Developments in European Markets
The relationship between manufacturers and retailers has changed radically
in Europe, with the restructuring of distribution. The position has changed
from a situation in which retailers were seen as simply a passive conduit
through which goods had to flow to reach the consumer, to one in which
retailers have become vital partners with manufacturers in the successful
distribution of branded FMCGs. This has transformed the manufacturerretailer relationship from a zero-sum to a positive-sum game. It has also
4
See, for example, Panorama of European Industry 1997, Vol. 1 p. 93
UNICE, Benchmarking Europe’s Competitiveness from Analysis to Action, UNICE, 1997
See Hamel and Prahalad, Competing for the Future, HBS, Cambridge, Mass., Ch. 2, 1996, on the consequences of
“disintermediation” for the manufacturing-services distinction
5
6
endowed retailers with substantial “gatekeeper” power. Increasingly, scale
economies are realised more through the services associated with the product
offer than at plant level, and those services are generated both by the
manufacturer and by the retailer. Direct consumer advertising to the end
consumer and in-store promotions and related services are both critical to
success.
On the supply side, the most obvious benefits of the Single European Market
are the “lowered costs of space”, allowing scale economies and scope
economies to be generated across national boundaries. Associated with this
is a combination of production focus and wider consumer choice, which has
changed FMCG markets dramatically over the past decade.
Concentration in FMCG markets has generally been increasing. In their
1997 study for the Commission, the Economist Advisory Group found that at
the pan-European level the 4-firm concentration ratio rose between 1983 and
1993 from 21.1% to 23.5% for highly advertised product markets and from
34.8% to 37.2% for highly advertised, high R&D markets. Since most
available economies of scale in production are achieved at a plant size
equivalent to less than ten per cent of the total European market, it might be
supposed that concentration has gone further than is necessary to minimise
costs. However in branded goods markets, this is not the case, for
economies of scale in selling continue indefinitely for a global brand.
Reputation is not reduced when it is spread over more consumers. On the
contrary, it is increased. It is therefore not surprising to find that, over
recent years, pan-European firms have, in general, sustained their profits,
while businesses that have stayed regional have lost out. As the Economist
Advisory Group concluded, in that review, “Fewer firms in larger markets may
well start to compete more vigorously with each other”.7
High brand reputation is a consequence of success as well as a necessary
condition of successful non-price competition. For innovation to be worth the
investment cost and the risks, the product must be tried by a critical mass of
consumers early enough for demand for the new product to take off before it
can be imitated. Product differentiation, far from being a barrier to entry,
opens up niche opportunities which would be absent or disregarded in a more
homogeneous market (Caves, 1983).8 Consumer goods manufacturers
typically employ advertising to enable product differentiation, often relying
upon the accumulated reputation of an over-arching brand.9
Inter-firm rivalry is found to be at least as strong in advertising-intensive
industries as elsewhere. Industry concentration tends to be higher, but the
share of the leading firms is less stable.10 It is only when combined with high
rates of innovation that high advertising protects rank.11
7
Single Market Review, Vol. 3, Sub-Series V, p. 61
Caves, R;, “Information Structures of Product Markets”, Harvard IER Paper 1002, 1983
9
Mueller, WF & Rogers RT, “Role of Advertising in Changing the Concentration of Manufacturing Industries”, Re of Ecs and
Stats, Feb. 1980.
10
Eckard, “Advertising, Competition and Market Share Instability”, Journal of Business, 1987
11
Geroski & Toker, “Turnover of Market Leaders”, CBS Working Paper, LBS 1993.
8
New products, under an established brand, share the benefits of past
reputation. Brands can last indefinitely, while individual products ride a life
cycle up and then down. The investment in goodwill is vast and largely
unaccounted for in corporate and national statistics. In competitive markets it
is sustained by process and product innovation. Both advertising and
intellectual property protection are involved. Many young, fast-growing
markets (such as savoury snacks and yoghurt) exhibit high concentration
together with high new entry. These sections are strongly contested and the
leaders’ shares are constantly vulnerable to attack.
Both brand support and intellectual property rights have become more
important than ever as a result of the three major developments in European
FMCG markets:

the pace of inward investment;

technical change and a tidal wave of accessible information to
consumers and suppliers; and

the restructuring and concentration of distribution.
In short, the nature of FMCG industries is changing rapidly, and the way in
which competition works has undergone a transformation. It is important that
policy responses keep up with these changes.
1.5
Market Dynamics and the PIMS Report
The PIMS Report, Of Brands and Growth, presents a wealth of statistical
evidence on the contribution of branded consumer businesses to competitive
growth. Many of the main connections between cause and effect, as FMCG
markets change and grow, are highlighted in the Report. For the particular
firm, growth depends upon the growth of the market as a whole and upon the
strength of the particular drivers of competitive advantage, relative to its
competitors both inside and outside the European market. As increases in
the variables in this system work their way through, and feed back into profits
ploughed into new investment in knowledge, R & D and brand reputation, so
the firm prospers and grows. Conversely, if links are weakened or broken, the
firm declines, as does its contribution to market growth and overall
employment.
For the European economy as a whole, an increase in perceived relative
value enhances growth by two routes: first, by way of an increase in the
average quality and unit value of domestically consumed products; and
second, by way of the trade balance, as domestic value added is increasingly
exported and substituted for imports.
1.6
PIMS Evidence on Competition by Raising Value
The PIMS report has provided evidence that investment in knowledge and in
brands is just as important to the sustaining and strengthening of market
position as physical investment in plant, equipment and stocks. Without that
market building, capacity expansion would be wasted. There is a link from R
& D and marketing effort to the three main motors of competition - price,
quality and new product launches An essential enabling condition is
consumer interest and confidence, which can be summarised as reputation ,
raising consumers’ perception of increased relative value. This in turn
benefits market share, value added, and the means and motive to complete a
circle back to renewed physical, marketing, and R&D investment.
For the purposes of this discussion, the three key results of the PIMS study
are:

the drivers of FMCG growth and performance are price, quality and
innovation;

relative value for money is a combination of quality and price. Quality
change, which is harder to achieve, and takes longer to emulate, has more
weight
than
price
change;

relative quality change is best reflected in perceived value change when
the brand is highly regarded.
If price competitiveness is increased, there need be no conflict between price
and non-price competition. Successful innovation leads to gains in share,
volume increases and the facilitation of efficiencies that pave the way for cost
and price reductions. The case is different if price competition takes the form
of a simple squeeze on manufacturers’ margins, for that threatens the link to
value added, profits and the means to invest in R & D, know-how and
innovation.
2. European Policy Implications
The PIMS study has tested the dynamics of FMCG markets, particularly the
nexus of branding, innovation and growth. Almost every aspect of European
economic and social policy has some influence upon the competitive process
in consumer markets. The five policy areas that the PIMS results have a
direct bearing upon are innovation, intellectual property, consumer choice and
standardisation, commercial communication and competition.
2.1 Innovation: PIMS result - innovation drives growth
Critical mass is easier to reach, the larger is the total market open to the
innovator wherever he is located within the EU. The larger is the total market,
the greater the opportunity to specialise, customise and diversify, without
forfeiting economies of scale. Furthermore, scale economies in the application
of new knowledge and in the spreading of brand reputation are never
exhausted, as are scale economies in production. Both the completion of the
Single Market and the enlargement of the EU will tend to raise the rate of
innovation and hence the rate of growth of domestic value added.
2.2 Intellectual Property: PIMS result - IP provides the means to gain by
innovating
The links through R&D, know-how and product innovation to competitive
advantage are vulnerable to attack from “look-alike” products which free-ride
on established brand reputations. The copying of a good new idea and the
emulation of a process innovation is the means by which technology is
transferred through and across industries. But there is a trade-off between
making something easy to imitate and providing an incentive to invest in
research and development in the first place, which depends on the
appropriation of a temporary leadership advantage by the innovator. A
balance has always to be struck by the policy-maker between ensuring rapid
technology transfer and protecting intellectual property rights. Policies that
open markets will always need to contain safeguards to prevent the possibility
that incentives to innovate are undermined. It is important that intellectual
property rights are enforced and “look-alikes” discouraged in developing
markets.
2.3 Consumer Choice and Standardisation: PIMS result - brands give
choice
There are links - both ways - between value added growth and total European
market growth. Quality competition and innovation do not simply redistribute
value added among competing firms: they raise it overall by raising domestic
consumption standards. They also benefit overall wealth creation by their
impact on industrial development. At a time when relatively low-value, labourintensive tasks are increasingly being transferred to low-wage economies
outside the EU, the development of higher value-added activities through
innovation and branding helps the EU economies to concentrate on economic
activities in which they retain a competitive advantage. The preservation of
employment levels by creating such high value activity provides the most
robust basis for sustainable employment policies and wealth creation.
In other work12, quality standards, voluntarily adopted, have been found to be
strongly associated both with domestic competitive advantage and with trade
performance. The adoption of quality standards by a brand is part of its nonprice competitiveness.
Horizontal product differentiation, by increasing
“customisation”, is ipso facto an ingredient of quality. Quality standard setting,
with European rather than American or Japanese leadership in the process,
raise the competitive advantage of European nations, particularly in new and
hi-tech product and service markets. The distinction is important between
such open and voluntary adoption of standards on the one hand, and the
imposition of rules and measures that enforce homogeneity by standardising
output and thus diminishing the range of consumer choice.
The EU has recognised that all regulations have a cost particularly for small
new entrant firms who make an important contribution to the innovative
performance of markets. These firms do not generally have the advantage of
established brand reputation and it is usually harder for them to obtain
finance. It is therefore important that other impediments to their entry like the
task of understanding and responding to complex regulations are kept low.
Policies, like SLIM - to simplify internal market legislation - and BEST - to
lower entry barriers for small firms - are now appropriately being developed as
European initiatives.
The message to policy makers is not to insist upon narrow specifications of
products, imposed from outside the market, or homogeneity simply for the
sake of supposed economies of scale from uniformity. One of the main
developments in manufacturing processes in recent years has been mass
customisation - the ability to combine economies of scale with flexibility and
product variety. This has increased the advantages of product differentiation
as an expression of non-price competition. The reputation of a brand enables
a variety of products that carry that brand name to share in the consumers’
confidence of its technical and safety standards. The brand acts as a flag
under which a diversity of products can be sold without the consumer losing
confidence in the safety specifications of any of them. This is a credible
communication method because brand equity, and the reputation of all the
products with that brand name, suffer from a lapse in the standards of any
one of them.
2.4 Commercial Communication:
communication is part of competition
PIMS
result
-
commercial
Price cuts are apparent to the consumer of established products
independently of actual purchase. By contrast, quality competition and the
benefits afforded by a brand new product require that the product be tried.
For this to happen, buyer inertia must be overcome. Every form of
12
Shurmer, Swann, Temple, Standards, Non-price Competition and Trade Performance, CBS Working Paper 1994, LBS.
commercial communication is employed to encourage that trial. Media
advertising, the Internet, package design, labelling, samples and retailer
services are all involved. They support the reputation of the brand name
carried by the innovation or by the product difference.
A critical mass of consumers has to be won before demand for a new product
can take off, justifying the investment in it. Brand reputation encourages that
initial trial. The high importance of non-price competition has dissolved the
old distinction between the physical function of manufacture and the provision
of the range of services that inhere in the product, as described in the first part
of this paper. Product design, packaging, advertisement and product
information and convenient availability are all as much part of the bundle of
utilities that makes up a product as the physical product itself. An increasing
proportion of value added and employment is due to these service elements.
Retailers have a natural immediate access to the consumer and therefore an
important role in communication. But that is largely exercised to influence the
location of the purchase, both by the provision of physical amenities and by
psychological appeals - including smell and sound - that do not, for the most
part, distinguish between particular products. As retailers become larger and
more sophisticated, their ability to deliver on marketing and promotional plans
developed in partnership with manufacturers increases. At the same time,
however, the tendency for a few large retailers to act in effect as gatekeepers
between the manufacturer and the consumer can become a threat to access
to the market from the manufacturer’s perspective. It is important that the
manufacturer continues to have a prominent role in the direct communication
of product claims, through media advertising, the design of packaging, and
the communication of product information; and that new products can gain
access to the consumer.
2.5 Competition Policy:
PIMS results - leadership is not anticompetitive; advertising is not a barrier to entry
The PIMS study also indicates that a leading share position without
exceptional brand reputation is easily eroded if it is not well defended.
Conversely, the percentage point increase in share taken by a low share
business with high reputation is strikingly large. This points to the importance
- to the growth of these markets - of advertising and services to the retailer,
which both support the image of the brand. Examples are the building of the
close and automatic communication links between retailer and manufacturer
that make possible effective in-store promotions to their mutual advantage;
the provision of cast-iron guarantees of product safety; and, most importantly,
a continuous stream of product improvements that justify the outlets’ support
of the brand. A consideration for the framers of European competition policy
is to allow such drivers of reputation to continue to work. A competition policy
that placed price as the sole criterion would be missing out on crucial
elements of the drivers of consumer welfare, and could mistakenly undermine
beneficial partnerships between manufacturers and retailers.
It is important that policy does not discourage collaboration among
manufacturers and distributors to increase added value, as distinct from
fighting over shares of a fixed added value. There are big potential welfare
gains, both in efficiency terms and in consumer satisfaction, from
manufacturer-retailer collaborations. Provided that there is competition
between manufacturers, such collaborations are unlikely to imperil price
competition. A manufacturer seeking to win share from a rival manufacturer
will not overlook the importance of price competitiveness. Keeping the final
consumers’ preferences in mind, he will seek to equate, at the margin, the
market advantage of keener price with that of improved quality.
This is an area in which the development of increasingly powerful retail
groups can have ambiguous effects on welfare. Given their importance as
controllers of access to the consumer, large retailers are well placed to use
their leverage in negotiations with suppliers. This leverage is increased by
the fact that, through their extensive involvement in private label sales, large
retailers are at once the manufacturers’ most important customers and
amongst their biggest competitors. One way in which retailers exert
bargaining leverage is to lead branded goods manufacturers to supply private
label products that incorporate the most recent innovations. This activity has
become an established part of the competitive environment but one that
carries with it the risk that returns to manufacturer innovation are diluted and
innovation discouraged.
The PIMS study has general implications for the conduct of competition policy
in markets supplied by branded FMCG manufacturers. Two important
lessons to be drawn from the PIMS study are these: first, leadership - in the
sense of a preponderant share of a product market - is not per se anticompetitive. In the context of markets where innovation and branding are
prominent, positions that might be thought “dominant” under a static share-ofmarket test, turn out to be very vulnerable to competitive erosion, particularly
by new products. Leading firms have to run hard in order to stand still.
Second, advertising and product differentiation - far from being barriers to
entry - can make entry easier, by opening up opportunities to get close to
more specific segments of the market and more distinctive sets of consumers.