Economic Moats in Consumer Goods

Despite the risks, one very attractive feature of this competitive sector is that consumer goods companies often have wide economic moats or at least a narrow moat—and this helps preserve pricing power.

The handful of giant firms that dominate each consumer goods industry enjoy such massive economies of scale that it "would be virtually impossible for a small new entrant to catch up. Anheuser-Busch, the largest brewer in the "world with 12 breweries in the United States , consistently invests in upgrading its plants with new technology that makes it possible to brew and package vast quantities of beer at lower costs.

The Win. Wrigley Jr. Company is a good example of a strong and steady consumer goods company that has built up a wide economic moat over many years. Its Juicy Fruit and Spearmint brands have been around since the early 1890s, and it's been the world's leading gum maker for most of the past century. It has a nearly 60 percent share of the U.S. gum market, more than twice as much as second-place Cadbury Schweppes. Its products are sold in 140 countries, making it number one in world gum market share as well. This dominance has helped Wrigley to become very profitable, with net margins around 15 percent and returns on equity consistently in the 25 percent to 30 percent range.

Wrigley has traditionally been a very conservative company, but it has also done a good job of innovating to stay ahead of the competition. When Bill Wrigley Jr. took over the company in 1999, increased competition from breath mints such as Altoids had threatened Wrigley's market dominance and caused its growth to slow. The youthful CEO stepped up the pace of innovation in response to these threats, and Wrigley has come out with a plethora of new products focused on breath freshening, including Orbit gum and Eclipse Flash Strips. Sales grew at a strong double-digit rate in 2001 and 2002, and the company is looking more energized than it has been in years.

Consumer product companies often invest a great deal of time and money in building up strong relationships "with end users in the form of brands. Brands were born in the late nineteenth century when these consumer goods firms sought to provide consumers with assurance of consistent quality—so you'd know what you were getting for your money. Since then, brands have evolved into a host of meanings, including expressions of aspiration and affirmation of self-image. By imbuing a product "with a meaning that extends beyond functionality, companies create a higher level of perceived value.

For instance, for years, Heinz Ketchup built up a reputation for top quality—the thickest, richest ketchup that premier food establishments preferred. By the time Hunt's Ketchup finally matched the Heinz product with comparable thickness, it was too late. Hunt's didn't gain much share, and Heinz continued to command a premium price over its competition.

Not all brands are created equal, however. Simply putting a trade- marked name or logo on the product does not turn it into a brand that can command higher prices or greater share. The most powerful brands have nurtured a connection with consumers that can last for years, creating a significant challenge to new entrants, but this takes time, money, and marketing savvy.

The networks that manufacturers use to get their products on to shelves in the stores can be another competitive advantage that is very difficult for competitors to replicate. For instance, beverage manufacturers rely on their wholesalers and bottlers, each of whom retains exclusive control over a certain geographic area, to cultivate close relationships with retail customers.

Large beverage firms can leverage extensive distribution networks that span the map. On the other hand, a small company often finds it prohibitively expensive to build a network from scratch and must rely on creating an alliance with a large firm to distribute its products, usually by demonstrating how its products can fill a niche in the bigger firm's product portfolio. For example, 7lJp did not have its own bottler network that provided full coverage of the entire United States and had agreed that some of PepsiCo's bottlers would distribute 7Up products. This approach, however, leaves the smaller firm at the mercy of the large one. Once PepsiCo formulated its own lemon-lime soft drink to compete with 7Up, PepsiCo applied pressure to make its bottlers drop 7Up and distribute Sierra Mist instead.

Exclusivity is another aspect of the distribution system that can enhance a company's economic moat. For instance, 60 percent of Anheuser-Busch's distributors sell only Anheuser-Busch products. This arrangement leads to "wholesalers with focus and incentive to sell harder. In contrast, the vast majority of Coors and Miller distributors are not exclusive and, thus, sell a variety of competitive brands. This means that a Miller wholesaler who tries to sell Miller products unsuccessfully can pull a competitive product out of his portfolio to sell instead. In the end, Miller's distribution system may not be as dedicated to Miller products as Anheuser-Busch's are to its products.