Takeaways from China's 'Me Too' Habits
Tom is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Over the past year, well more than a handful of Chinese-manufactured “me-too” products have surfaced on the market. This week brings the news of Qiaodan Sports Co., a Chinese retailer with more than 5,700 outlets that has been profiting illegally on the name and likeness of Michael Jordan since the mid-1980s. The Jordan brand is among Nike’s (NYSE: NKE) most valuable, raking in more than $1 billion per year in recent years.
The problem is hardly isolated to this particular issue however, as the design copycat habit has led to the knock-off of thousands of individual products over the past several decades. Many prominent American corporations continue to deal with the ongoing problem, including Apple (NASDAQ: AAPL), which has had select products, full retail stores, and even former-CEOs (?!) mimicked by different Chinese retailers.
The continuous copycatting habits of many manufacturers in the nation resonates with Americans on many different levels – perhaps to some it is flattering (maybe the notion of American “exceptionalism” isn’t completely extinct), to others it is humorous (see photo above), yet to most it is worrisome. The support for innovation, the protection of patents and original ideas, and the preservation of ethical business practices are all taken extremely seriously in the American business culture.
However, despite the reactions that this non-stop problem elicits with individuals, there is definitely something to be learned from the copycatting trend. What general investing lessons can be extracted from the topic?
- Customer Captivity Runs Much Deeper than Simple Product Appeal
Claiming rights to the next “hot” product is the goal of every enterprise, yet some of the most important consumer brands are those that transcend the basic buy/sell transaction level.
Even the simplest products tend to hold a special place in consumers’ lives – Coca-Cola (NYSE: KO) sells syrup with a highly secret recipe, McDonald’s core product is fatty cheeseburgers, and Disney (NYSE: DIS) makes hundreds of millions every year from the production of animated feature films. All of these products are replicable, yet when presented to consumers from these particular corporations, they become much more than what they appear to be on the surface.
Consumers, whether or not they like to believe it, and whether or not they do so consciously, seek to form relationships with specific consumer brands. The characteristic that separates an overlooked brand from a brand that tends to captivate consumers stems from the experience that is wrapped around the product/service offering.
Many Chinese knock-off manufacturers are solely driven by risk/reward tradeoffs and return on investment-based decisions. This is important, no doubt, as investments that do not return above and beyond an enterprise’s cost of capital requirements is not value-generative. However, it is inherently more expensive, and much less sustainable, to operate along such lines.
Customer captivity generated through positive consumer experiences tends to generate recurring, or even better, annuity-like, revenue streams. Many consumers that have had a positive experience with Apple products, for example, claim to own nearly every product in the corporation’s portfolio (these days it is hardly considered excessive to own an iPod, iPad, iPhone, and a Mac). This is despite the fact that all of these products share many overlapping features, including music and game playing, video streaming, and web surfing. Apple’s ability to captivate consumers not only comes from its individual product offerings, but also through the experience it offers. This experience has generated recurring revenues from millions of individuals around the globe.
Annuity-like revenues can be equivalently valuable, as explained in a recent article regarding the marketing strategies of Weight Watchers.
- Return on Investment is Important, but Consistency is Key
Ignoring the obvious unethical (in America, anyway) decision to blatantly copy another corporation’s designs or strategies, following such a route is much more certain to generate profitability than assuming the risk of new product launch from the ground up. Sustainability, once again, is the recurring theme, and such a strategy that is followed by more than a handful of Chinese retailers is not sustainable.
As the country continues to open its borders, engage in relationships with foreign corporations, and get pressured into tightening its control on copyright laws, many Chinese corporations with a lack of innovation will be left with a very serious identity crisis.
Such an issue could not come at a less ideal time, as China is quickly becoming a less attractive place for overseas corporations to exploit the East’s most important asset – its manufacturing capacity.
As the recent news release from Apple supplier Foxconn Technology highlights, labor relations is a topic that is on the forefront of nearly everyone’s minds. The corporation’s announcement of a drastic pay raise, up to 25% for some employees, is closely following the national average wage trends, which have nearly doubled over the past four years. The copycat mentality becomes increasingly less attractive, and promotes less sustainability, as manufacturing slowly leaves and these corporations are up to their own devices to design, produce, and market their own products and services.
The example has an investing parallel – having the ability to produce one, or several, large hits in a row is extremely nice, but investment into a skill set or knowledge base that can be tapped into time and time again will lead to a much more sustainable operating future.
Is a Zynga–like corporation, which produces one or two big hits (and then starts getting accused of copying others) worthy of being priced similarly to a corporation like Dolby (NYSE: DLB), which has generated superior, and consistent, returns on investment over at least the past decade? The similar market caps, $4.6 billion for Zynga and $4.2 billion for Dolby, imply that the market thinks so.
- Reinvestment is Key
Having the ability (or the audacity) to blatantly copy from and capitalize on the work of others is extremely attractive from a financial standpoint, assuming legal implications are overlooked or nonexistent. The strategy requires considerably less in the way of research and development than does a do-it-yourself route, and because the product has already been tested and is known to be of high demand, swiftly growing sales swiftly fall to the bottom line.
Partly due to ever increasing consumer discretionary incomes, the insignificance of reinvestment mentality extends much further than the me-too product manufacturers. The average proportion of investments in R&D by China’s top 500 enterprises to their annual revenues is calculated to be slightly above 1.4%. Only 17% of these firms reinvest 3% of their annual revenues back into their technical know-how, and only 0.28% reinvest more than 5%. (Source: Beijing Review). This compares with the top ten Nasdaq firms, in terms of market cap, which averaged a 13.1% research and development reinvestment as a percentage of sales over the past three years.
A corporation is a living, breathing entity. As a bundle of depreciating assets, corporations require significant reinvestment in order to maintain efficiency and relevancy. Manufacturing equipment requires reinvestment, brands require reinvestment (advertising, for example), and personnel require reinvestment (product, sales, and safety training). Swiftly growing companies are naturally destined – in both theory and as shown in practice – to evolve from manufacturing-based economies to product sellers and service providers. The current neglecting of reinvestment back into such endeavors is not sustainable for such Chinese corporations.
The example, once again, has a parallel in our investment community. The recent Sears announcement of a strategic realignment and a heightened reinvestment back into its core brand highlights the long-term consequences of such a cost-saving strategy.
While the knock-off products may present a laugh every now and then (the picture above still makes me laugh), the issue undoubtedly has much more depressing undertones. What will the country’s corporations do when accountability begins to creep into the business culture? Many me-too manufacturing corporations will soon face a serious identity crisis, and the lack of independence (in the way of the ability to innovate) will lead to very serious issues.
In terms of the individual investor simply researching the topic, several key points do come from the ongoing copycat issue: first companies that can captivate customers beyond the basic product level, those that are shown to generate meaningful returns on investment in a consistent manner, and those that have continuously reinvested in the business to prevent serious asset (both tangible and intangible) depreciation, have inherently more sustainable operations and long-term shareholder value creating abilities.
gibbstom13 has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Walt Disney, Dolby Laboratories, The Coca-Cola Company, and Nike. Motley Fool newsletter services recommend Apple, Dolby Laboratories, Nike, The Coca-Cola Company, and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.