Wall Street analysts often focus on the short term – how a company will perform over the next quarter or two. Yet I am always thinking about the much longer term – 5, 10, or as long as 20 years down the road…
There are companies that speak “hopefully” that their businesses will perform better in future years. Contrast that to those companies who speak confidently and with assurance about their long term goals.
What confident companies have that hopeful companies don’t is a “sticky” customer base.
For example, Automated Data Processing (NASDAQ: ADP) made its name largely by providing automated payroll management services to businesses. They also accept the outsourcing of many human relations department functions. The company clearly demonstrates value with the services it offers, but also has a phenomenal 91 percent annual retention rate of its clients. The reason for this: switching costs.
One reason switching costs play such an important role in ADP’s success is that once a business agrees to a service contract with them, the client finds it very difficult to take their business back and switch to another company. For the stock, this means that whether the market is a bull or a bear, the company will see its profit.
To demonstrate this, we can look at how the stock fared during the latest market downturn. In 2008, 2009, and 2010, ADP’s sales actually grew where many other companies were reporting declines in revenue.
Why Brand Power is the Key to Profits
Another way of creating sticky customers is to create a product that changes the culture in new ways. Looking at Apple (NASDAQ: AAPL) it’s obvious that creating a great product that’s also innovative will have people lining up for hours to be one of the first to buy the product. Their smartphone and tablet lines have been consistent revenue producers for years.
Apple is an example of where brand loyalty translates into investor loyalty. Its stock became increasingly popular as its products became more embedded into the consumer culture. Whenever Apple came up with a new product model, people followed it with their money.
Experienced investors know how to follow a trail of breadcrumbs. A strong and proven track record of brand loyalty by consumers means a long period of extended growth can be expected. This requires management skills that continue to become even sharper. The result is the company moves in a direction with new products or in new markets with confidence and a plan of success.
An example of this is Chipotle Mexican Grill (NYSE: CMG) who has combined a fair consumer price, excellent dining experience, and a cultivated reputation for offering food that is both healthy and tasty, into a hugely successful hybrid of the fast-casual food business. Their next project is duplicating this model into another chain called “ShopHouse”, an Asian version of Chipotle. It makes sense that the combination of quality food, clean dining environment, and fair prices will likely duplicate the success of the original Chipotle model.
While creating brand loyalty can result in impressive yields, companies need to carefully handle their success, as customer loyalty can fade unless they continue to be innovative.
Consider McDonald’s (NYSE: MCD) “Home of the Golden Arches.” They’re established and recognized in more than 119 countries around the world. Yet same-store sales showed the steepest decline in sales in more than a decade. Customers began losing their taste for the company’s BigMac and fries cash cow.
McDonald’s isn’t the only company to suffer from tiring consumer palates. Budweiser, “The King of Beers”. saw it annual shipments of brews drop by 6 million barrels per year over the last five years. The reason is beer drinkers changed their tastes to the higher premium craft beers.
Obviously these popular brands are not going to fade away anytime soon, yet it’s important to note that no matter how string the brand loyalty, a stagnant company will lose ground to the competition.
However, there are other methods that can keep customers from wandering away. One way is to lock the customer into your eco-system.
AmeriGas Partners (NYSE: APU) installs storage tanks with a capacity as high as 1200 gallons directly into a wholesale customer’s backyard. These are stationary storage tanks that are leased, usually with a long-term contract. The stationary, high capacity tanks would require replacing the equipment, causing owners to be very hesitant when considering moving on to another vendor.
Getting back to Automated Data Processing, APU has seen its dividend distributions increase consistently over the last 11 years thanks in large part to a “sticky” customer base. And with a yield currently over 7 percent, I see it as a strong candidate for any portfolio.
Yours in profits,