Review – Scientific Advertising

Scientific Advertising

by Claude C. Hopkins, published 1923

The “Benjamin Graham of advertising”?

Claude C. Hopkins was not only a contemporary of Benjamin Graham’s, but apparently a man after his own heart, for if the essence of “Scientific Advertising” were to be boiled down to one phrase it would be:

Advertising is most successful when it is most business-like

Anyone who follows the writings of Benjamin Graham should immediately understand what that means. For those who are unfamiliar with Graham, the idea is that advertising has its biggest impact when its goals and results are examined as to their practical effect– your advertising is a sales person for your organization and it should earn its keep; advertising is not about being witty, creative or memorable, it’s about buying customers at the lowest cost possible.

This has much in common with Graham’s concept of value investing, whereby the objective is to buy future investment returns potential at the lowest cost possible. Just as Graham would advise us not to overpay for anticipated business growth and the eagerness of the investment crowd, Hopkins advises us to study our costs and profits from our advertising campaigns scientifically, to ensure we’re getting the most bang for the buck without wasting money on entertaining and amusing those who never intended to buy from us in the first place.

Advertising as sales force multiplier

The role of advertising within a business organization is best thought of as a sales force multiplier. Accordingly, Hopkins stresses that,

The only purpose of advertising is to make sales… treat it as a salesman

This line of reasoning anticipates some self-check questions when considering an advertising campaign, namely:

  • Would this help a salesman sell the goods?
  • Would it help me sell them if I met the buyer in person?

When crafting an ad campaign, it’s important to think of an individual buyer of your product, what they look like, what they need and want, how they like to be communicated with, etc. You should consider how you would entice them if you were selling them face-to-face. Ultimately, it may be “the masses” who create volume markets for your products, but it is individual buyers who will read your ads and actually place orders.

The making of a great ad

The best ads:

  • based on the service rendered by the product in question
  • offer wanted information
  • cite advantages to users
  • often do not quote a price

They play to the ego of the individual buyer, because “whatever they do, they do to please themselves.”

Headlines are about grabbing the attention of people who are interested in your product. Not everyone is going to be a buyer of your product. You only have to get the attention of people who actually might buy.

The use of psychology is critical to ad programming. Human psychology is mostly constant and has been “since the time of Caeser”:

  • “Americans are extravagant. They want bargains, but not cheapness”
  • create a feeling of possession, ownership of property; when people feel something belongs to them, they’ll go out of their way to obtain it, even if it’s a trifle
  • limited offers applicable to restricted classes are more appealing than general offers available to anyone; “those seemingly entitled to an advantage will go a long way not to lose that advantage”
  • invite comparisons to your rivals, which demonstrates you do not fear them

Specificity is also another powerful tool in the advertiser’s arsenal– whereas an advertisement is a sales force multiplier, specificity is an authority multiplier for an individual ad.

Platitudes and generalities roll off the human understanding like water from a duck

Specific claims imply engagement with truth; something which is precise and “tested” demonstrates accuracy and experience which is usually accepted. To make a specific claim, one must have made tests and comparisons. This is why they have more force in the buyer’s mind. Further, standard, essential ingredients or functions of a product’s make or capabilities can be addressed in a specific way which creates a sense of differentiation (eg., two beer makers use the same pure, filtered water but one advertises that he “drilled 4,000 feet into the earth” to obtain the proper purity for his product).

Another principle of good advertising is “telling your full story”:

When you once get a person’s attention, then is the time to accomplish all you ever hope with him. Bring all your good arguments to bear

Think of the readers of your ad as new customers. Those who use your product don’t read your ads and you don’t care if they do anyway as they’re already happy customers.

The use of art in advertising should be made according to similar guidelines as those followed for writing headlines. Art, like headlines, use critical and costly advertisement real estate; they should be used in such a way, if at all, that they pay for their cost. Art should only be used to attract those who can profitably be sold to, and then only when the same message could not be conveyed as efficiently through a similar-sized amount of text.

Information, strategy, samples and more

It’s important to know your market, how big it is and what it’s worth. You never want to make the mistake of spending more than you could ever hope to earn because you were ignorant of the market you were advertising into.

You must also keep in mind your competitors: what do they have to offer? What kind of price, quality or claims can they weigh against your own? How can you win trade from them, and how can you hold it once you’ve got it?

We cannot go after thousands of men until we learn how to win one

Further, never forget that people don’t change their habits without a reason. And that it’s costly to create a non-specific market through your advertising that can be served by others than just yourself– then you make the mistake of advertising for your competition.

As far as samples are concerned, they are ineffective if wasted on people who have no intention or no ability to purchase your product. Give them only to those who show and interest, and then, make them exhibit that interest by exerting some effort.

Test campaigns can be used to establish the effectiveness of particular strategies on a small scale (say, thousands versus millions); then, using the law of averages, we can expect the results to hold at greater scale if the campaign is to be expanded or incorporated into the standard strategy set.

Whenever possible, introduce a personality into your ads and then, stick to it. If you change the personality, you’ll force people to continually refamiliarize themselves with your product and you’ll give up all past prestige you’ve managed to build up.

Negative advertising is not a good strategy:

  • never attack the competition
  • show the bright side, happy side, attractive side
  • beauty, not homeliness; health, not sickness; envied people, not the envious; tell people what to do, not what to avoid

Unless you have a catchy name that has become a household replacement word (like Kleenex, Vaseline, etc.), remember you’re advertising the service of the product, not the name.


When you think of your advertising efforts, imagine a rapid stream passing by in front of you. Without scientifically testing the results of your advertising efforts, the potential power of your advertising effort is wasted like the water rushing past. Scientific measurement and testing of your ad campaign is akin to placing a water wheel in the middle of the stream and channeling all that potential energy into actual energy which can be useful as a multiplier to the efforts of your sales force and your business organization as a whole.

Review – Oglivy On Advertising

Oglivy On Advertising

by David Oglivy, published 1985

How to produce advertising that sells

  • Advertising doesn’t need to be “creative”, it needs to be so interesting that a person is compelled to buy the product
  • When Aeschines spoke, they said, “How well he speaks.” But when Demosthenes spoke, they said, “Let us march against Philip.”
  • The wrong advertising can actually reduce the sales of a product
  • Study the product you are going to advertise and look for a “big idea” that can sell it (a big idea whose genesis is found in your research of the product itself)
  • Find out what kind of advertising your competitors have been doing for similar products, and with what success, to get your bearings
  • Consumer research: investigate how they think about your kind of product, what language they use when they discuss the subject, what attributes are important to them and what promises would be most likely to make them buy your brand
  • Product positioning: what the product does, and who it is for
  • Decide what image (personality) you want for your brand
  • Your advertising should consistently project the same image, year after year
  • People don’t pick products, they pick images; few customers try all products within a space and compare before picking one they like best
  • Unless your advertising contains a big idea, it will pass like a ship in the night
  • When researching: stuff your conscious mind with information and then unhook your rational thought process and see what creative ideas flow in
  • Questions to ask about a potential “big idea”: did it make me gasp when I first saw it? do I wish I had thought of it myself? is it unique? does it fit the strategy to perfection? could it be used for 30 years?
  • Make the product itself the hero of your advertising
  • Just say what’s good about your product, and do a clearer, more honest, more informative job of saying it
  • If you are lucky enough to write a good advertisement, repeat it until it stops selling
  • A good advertisement can be thought of as a radar sweep, constantly hunting new prospects as they enter the market
  • Lessons from direct response: use 2-minute commercials (not 30-seconds), there are more sales late at night (not during prime time), use long copy (not short copy)
  • Do your homework, avoid committees, learn from research, watch what the direct-response advertisers do

How to run an advertising agency

  • If each of us hires people who are smaller than us, we will become a company of dwarfs; but if each of us hires people who are taller than us, we will become a company of giants
  • Every time I give someone a title, I make a hundred people angry and one person ungrateful
  • Even a mature agency with a pool of potential leaders does well to refresh its blood occasionally by hiring partners from outside
  • Don’t hire: your friends, partners’ children, your own children, or clients’ children (ambitious people won’t stay in organizations following nepotism)
  • It is suicide to settle for second-rate performance
  • It is a good idea to start the year by writing down exactly what you want to accomplish, and end it by measuring how much you accomplished (you can pay people bonuses based on something like this)
  • Companies cannot grow without innovation
  • Be ruthless and let all the “chefs” feel that they work in the “best kitchen in the world”
  • The more centers of leadership you create, the stronger your agency will become
  • The final test of a leader is the feeling you have after you leave his presence after a conference; have you a feeling of uplift and confidence?
  • Every company should have a written list of principles and purpose
  • Agencies are seldom for sale unless they’re in some kind of trouble
  • Retirement planning: buy the building that houses your office with your excess capital
  • Never allow two people to do a job that could be handled by one
  • Never summon people to your office, go to see them in their offices, unannounced
  • If you want to get action, communicate verbally

How to get clients/how to find an agency

  • Only first-class business, and that in a first-class kind of way
  • What you should worry about is not the price of your agency, but the selling power of its advertisements
  • Tear out the advertisements you envy, and find out which agency did them
  • Pick the agency whose campaign interests you the most
  • Don’t haggle over price and if anything, offer to pay more to ensure extra attention and service
  • Don’t keep a dog and then bark yourself

Print advertising

  • Five times as many people read the headlines as read the body copy
  • Unless your headline sells your product, you have wasted 90% of your money
  • Promise the reader a benefit
  • Headlines which contain news are sure-fire
  • Headlines that offer the reader helpful information attract above-average readership
  • Include the brand name in your headline
  • In local advertising, including the name of the city in the headline attracts better readership
  • The silliest thing of all is to run an ad without a headline
  • On illustrations: have a remarkable idea; the reader should ask, “What goes on here?” at a glance; illustrate the end-result of using your product; crowd scenes don’t pull; don’t show the human face scaled larger-than-life; babies, animals and sex catch the most attention; when you use photographs of a woman, men ignore the advertisement and vice versa
  • Remember: when people read your copy, they are alone
  • Copy should be written in a language people use everyday
  • Avoid analogies, stay away from superlatives, include a testimonial
  • An ad’s chance of success is directly proportional to the number of pertinent merchandise facts included in the copy
  • Until you have a better answer, copy others
  • Illustration at the top, headline underneath illustration, copy under headline
  • Capitals retard easy reading; don’t place periods at the end of headlines; use serifed fonts as they aid easy reading

How to make TV commercials that sell

  • The more amateurish the performance, the more credible
  • Commercials which name competing brands are less believable and more confusing
  • Provided they are relevant to your product, characters are above average in their ability to change brand-preference
  • Cartoons can sell things to children but they are below average in selling to adults
  • Use the name within the first ten seconds
  • Play games with the name
  • Open with the fire, you only have 30 seconds
  • Sound effects can make a positive difference
  • It is better to have the actors talk on camera
  • Show the viewer something she has never seen before
  • The only limit is your imagination
  • Make your commercials crystal clear
  • Because radio is a high-frequency medium, people get tired quickly of the same commercial so make several

Competing with Procter & Gamble

  • They use research to determine the most effective strategy, and they never change a successful strategy
  • They always promise the customer one important benefit
  • They believe that the first duty of advertising is to communicate effectively
  • All their commercials include a ‘moment of confirmation’
  • In 60% of commercials, they use demonstrations
  • Their commercials talk directly to the consumer, using language and situations which are familiar to her
  • They communicate the brand name, always within the first 10 seconds and an average of 3 times in addition thereafter
  • Their commercials deliver the promise verbally and reinforce it with supers
  • They show consumers what the product will do for them
  • They show the users of their products deriving some emotional benefit
  • They use slices of life, user testimonials and talking heads, all proven ad techniques
  • They do not spend their money naming competing brands
  • Continually test new executions of ongoing strategies
  • Continually test higher levels of expenditure
  • Almost all brands are advertised throughout the year

Miracles of research

  • Research lets you measure the reputation of your company
  • Research can estimate the sales of new products and the advertising expenditures necessary to earn maximum profits
  • Research can help you determine optimum positioning of your product
  • Research can define your target audience
  • Research can find out what factors are most important in the purchase decision and what vocab consumers use when talking about your kind of product
  • Research can save you time and money by ‘reading’ your competitor’s test markets
  • Research can determine the most persuasive promise; advertising which promises no benefit to the consumer does not sell, yet the majority of campaigns contain no promise; the selection of the promise is the most valuable contribution that research can make to the advertising process; try to find a process that is not only persuasive, but unique
  • Research can tell you which of several premiums work best
  • Use research to measure a commercial’s ability to change brand preferences; recall testing is a waste of time

What little I know about marketing

  • You can judge the vitality of a company by the number of new products it brings to market
  • Concentrate your time, your brains and your advertising money on your successes
  • In the long run, the manufacturer who dedicates his advertising to building the most sharply defined image for his product gets the largest market share
  • Sales are a function of product-value and advertising. Promotions can not produce more than a temporary kink in the sales curve
  • Regard advertising as part of the product, to be treated as a production cost, not a selling cost
  • The task of advertising is not primarily one of conversion but rather of reinforcement and assurance

Review – Hey Whipple, Squeeze This!

Hey Whipple, Squeeze This!

by Luke Sullivan, published 1998, 2012 (4ed)

Sullivan’s appeal

Not just a thoughtful introduction to the basics of creating advertisement and marketing campaigns, Luke Sullivan’s “Hey Whipple!” is also an argument for aesthetic sense in advertising– in essence, you can sell a lot of things a lot of ways, but not all those ways are artful. Using the eponymous “Mr. Whipple” campaign for Charmin toilet paper in the 1970s as his example, Sullivan laments:

In 1975, a survey listed Whipple’s as the second-most-recognized face in America, right behind Richard Nixon… To those who defend the campaign based on sales, I ask, would you also spit on the table to get my attention? It would work, but would you?

His point is arbitrary, it is an opinion on the state of advertising, but it’s worth considering. If you could get sales by getting on people’s nerves, or by pleasing them, wouldn’t you have to be a lazy or annoying person to do it the first way instead of the second? If you’re passionate about life in all its forms, why not fill the world with advertising art?

Evolution in advertising

The era of modern advertising began in the 1950s, when a person could go on a major television variety show and count on everyone who was watching the show (which was nearly everyone in the country) seeing your product message. Soon, with multiple brands available for each product type, advertising men had to come up with a reason to convince people their product was the best in category.

This gave rise to the unique selling proposition: “Buy this product, and you will get this specific benefit.” This was quickly followed by the Creative Revolution, whose motto was, “It’s not just what you say that stirs people. It’s the way you say it.”

Then came the idea of product positioning: the notion that the consumers head had finite space for categorizing products; you must deposition a competitor for another product to take its place.

Learning the art of advertising

The author himself went on a journey as he learned the ins and outs of advertising. He read the One Show and Communication Arts award annuals as a “graduate education in advertising.” He also quickly learned that there were no points for originality, at least not until you knew how to properly execute on the basics. Essentially, “Until you’ve got a better answer, you copy.” Then, once you learn all the rules, you break them.

Copywriting basics

Developing good copy in an ad requires mindfulness about the value of brands:

  • brand equity: all the baggage, good and bad, that is associated with and comes with the brand
  • a brand is the sum total of all emotions, thoughts, images, history, possibilities and gossip that exist in the marketplace about a certain company
  • in categories where products are essentially all-alike (commodities), the best brand wins; example, most light beers are essentially identical, so people are drinking the advertising, the advertising is the brand
  • “if you systematically dismantled the entire operation of the Coca-Cola Company and left them with only their brand name, management could rebuild the company within five years. Remove the brand name and the company would die within five years”; some companies, like $KO, are nothing but a brand

Next, comes the creative process, which has an element of Underpants Gnomery to it:

  1. Gather info about the brand, company, campaign
  2. Do something else
  3. Generate an idea

The point is that you can’t force creativity, and often distracting yourself with unrelated activities during the process can allow the subconscious time to integrate various thoughts and ideas into a usable idea. In fact, sometimes a process can be deleterious to creativity, “If you want to be ordinary then, yes, use a process.”

Getting the reader’s attention is all about dramatization, finding a way to capture the value of your product in a unique, provocative, compelling and memorable way. More importantly, it must be clear to the reader what they get out of the deal:

How to write an interesting ad? Try this: “Hello. I want to tell you something important or interesting or useful or funny. It’s about you. I won’t take very long and there’s a prize if you stay till the very end.”

Find a “thing” that will keep the reader pondering long after they finish the ad. That thing usually comes from the problem (that the product solves) itself, out of the product or the realities of the buying situation.

Consider brands as verbs or adjectives:

  • Sony dreams
  • Nike exhorts
  • IBM solves
  • Coca-Cola refreshes; refresh
  • Gatorade quenches; quench

Keep in mind the theory of positioning; you’re not just competing with brands in your industry or category, you’re competing with the entire universe of brands for real estate in people’s minds. And it’s a cluttered, confusing world. So wouldn’t it make sense that the solution is– simplicity? Look at $AAPL’s ad campaign; they’ve built an entire brand around simplicity.

Never settle for second best; instead, try the polar opposite. Keep searching, the right adjective tends to come out of the product or your customers. Once you find an adjective, stick to it (continually changing means giving up the brand equity you build each time):

A brand is the most valuable piece of real estate in the world: a corner of someone’s mind

Guard it well. And before you begin your campaign, consider the current positioning of your product. It will inform your strategy and create a context for what’s appropriate as you go forward.

Then, try to get inside the target customer’s head.

How does it feel to be this person? Find the emotion

Know your audience. And know the history of your brand; what has been tried, what has worked, what has not. Eavesdrop on your customers. Learning what customers think can give you huge insight into your brand.

Study the award books. See what is already working. Examine the cliches that are already being used by others and avoid them. Even more importantly, perhaps, pay attention to what is not working and what not to do if you seek to be original.

Ultimately, good copywriting comes down to strategy (what your selling point is) and execution (the creativity you employ in communicating the point).

You’re looking for the central human truth of your product:

write down the truest thing you can say about the brand or the product

When you understand this, you can identify and leverage the central conflicts within your company or product category. You should always be looking for polarities. Additionally,

Underpromising and overdelivering is perhaps another way to disarm distrust. Even self-depreciation can help establish authenticity

You also want to examine the central truths of your competitor’s products. In the vein of Charlie Munger’s “invert, always invert”,

Find a weakness in the leader’s strength and attack at that point

Try to get behind the problem. Ask yourself, “What would make me want to buy this product?” Use sales techniques, “the benefit of the benefit”. Keep in mind that “People don’t buy quarter-inch drill bits. They buy quarter-inch holes.” Focus your efforts on speaking to basic needs that are part of human nature and are unchanging.

Remember that advertising is an argument on behalf of a brand so you want to bring an argument that’s good enough to end any further argument.

If you can think of a comeback [that would shut up the annoying guy in the bar], you should consider a campaign based on this argument.

If you’re stumped, try just writing out what you want to say in plain language, first. You can make it memorable, different or new later. Start with, “This is an ad about…” Ultimately, as you add creative elements, the interesting part of an ad should be the sales message itself, not a device pointing to the sales message. In advertising, form often rules over substance (how you say, not what you say).

emotion usually trumps rational thought when it comes to buying something

So, pick an emotion to characterize your campaign. What do you want your customers to feel when they come across your ad? It might help if you got yourself into the right emotional frame of mind.

Another technique to utilize is to create a list of categorical words related to your product. Try picking two at random and combining them to see what kind of images or ideas they cook up.

Don’t try to come up with a perfect idea right away. It’s okay to write down terrible ideas– you can always discard them or revise them later. Just try to get big ideas down, then go back later to work out the details. And when you’re on a roll, stay on it. Don’t take a break or allow yourself to be interrupted so long as you’re in that creative zone. Ask yourself, “What is good about this idea?” and keep coaxing it along and encouraging it.

It’s okay to be provocative, just be sure it stems from your product.

If you’re about to spend advertising dollars on a campaign and you can’t imagine that anybody is going to write about it or talk about it, you might want to rethink it. It means you probably missed injecting a truth or social tension into it.

Find creative ways to integrate the medium into the message. Also, avoid being an ad as much as possible.

Visuals work fast.

If you can reduce your idea to one simple thing that gets customers to lean in, your ad is a resounding success.

Learn what kind of visual cliches are common in your category and avoid them.

Show, don’t tell. Give your audience some credit, give them an opportunity to figure out how witty you are without you spelling it out for them. “It is far more impressive when others discover your good qualities without your help.”

Try on other people’s shoes, think about how different people will interpret or appreciate your ad.

Use metaphors– they’re conceptually efficient.

Focus your efforts by employing simplicity. Reduce to the essential. Simple is easier to remember.

Every item you subtract raises the visibility and importance of what’s left

Questions to ask to judge the “size of your idea”:

  1. What is the press release of my idea?
  2. Is my idea cool enough that people would seek it out and watch it on demand?

Creating an ad

Start by breaking down the product elements into idea categories and work them one at a time. Don’t be frustrated by dead-ends and don’t think you can get a winning idea after a few tries:

We cannot seriously believe we’ll have crafted a ticket-selling, brand-building, One Show-winning ad after 22 stinking tries… the wastepaper basket is the writer’s best friend

To create an authentic ad experience,

Avoid fake people. Avoid fake names.

Similarly, don’t treat the ad target like an idiot by being too obvious.

Never show what you’re saying and never say what you’re showing

Write like you talk.

And keep an actual individual in mind as you write ad copy… think about the qualities of the kind of person whose attention you’re trying to get.

Put your most interesting, surprising or persuasive point in the first line if you can.

When you’ve done it well, you shouldn’t be able to take out any sentence without disrupting the flow and structure of the entire piece. Test your piece for congruency by reading it aloud.

An ad needs a boss. There needs to be an overall visual hierarchy.

Own something visual.

Social media advertising

Keep the following guidelines in mind:

  • Inspire; give them something beautiful or emotive
  • Provoke; give them something that makes them think
  • Entertain; give them something that’s fun to do
  • Status; give them something that confers kudos among their community
  • Utility; give them something that makes their life easier
  • Access; give them something they couldn’t otherwise get

The human brain is wired to hunger for story. Discover the stories behind a brand and tell them in a way that will get people’s attention.

Social should run through all other formats and efforts like a thread.

“What does this brand stand for? What can we do for these people?”

Five types of social media users:

  1. joiners
  2. spectators
  3. creators
  4. critics
  5. collectors

Design content that’s appropriate for the type of people following you

The objective with your social media efforts is to create an “all-volunteer marketing department” that work for your brand without being paid. Brand ambassadors. However, these users must feel rewarded for participating in your community.

“Is it useful, beautiful, entertaining, incredible, participatory and interactive?”

Facebook-savvy brands:

  • Skittles
  • Starbucks
  • Target

Twitter tips:

  • listening tool
  • research platform
  • service center
  • lead generator
  • promotion device
  • community builder
  • use hastags to make tweets searchable and for making groups
  • frequent $100 prizes beat one big $500 prize
  • keep messages 20 chars short of 140 limit to allow for retweeting

Mobile is where everything is headed, so develop a mobile-ready ad and social media presence.

Useful phone apps: schedule a test drive, service appointment, meet w/ salesman

Putting it all together

Adjust advertising efforts to customer habits– how does a typical customer spend their day?

Don’t buy media without researching customer habits and don’t use the same media buy plan for every audience; you risk diluting efficacy, increasing media competition.

Think through how a customer decides to buy your product, visualize what happens as they move toward actually buying your product, think about “contact points” along the way.

Generate ideas worth advertising.

How would you tell your brand’s story around the campfire?

What works in outdoor may suck in print.

Pull stunts to multiply ad effectiveness and get news coverage which is free publicity.

“Create one world and then look at it through the eyes of another.”

Viral is a result, not a strategy.

Telling stories visually

“Don’t talk at customers. Tell them a story with pictures. Start with images. Stay with images.”

“The eye will remember what the ear forgets.”

Don’t worry too much about production values, worry about the idea.

The most important part of any television advertisement is its conclusion, the last five seconds.


Radio is “theater of the mind.”

Radio lets you do impossible things– things way too expensive to make into TV commercials.

Radio ad thought process:

  1. Figure out what you want your listeners to feel
  2. What do you want them to do?
  3. Base it partly on your product, partly on what the competition is doing and partly on what you know about the customer

You want your listener to immediately get what’s going on, within the first 5 seconds.

Overwriting is the most common mistake people make in radio. Be a genius. Underwrite.

Write exactly as people speak.

Let a straight voice-over do the heavy lifting.

Make sure it sounds like everyday speech. Read it aloud.

Avoid the formula of “schtick–serious sales part–schtick reprise.”

Avoid jingles as you would a poisonous toad.

Minute subtleties are going to be lost.

Cut into a scene as late as you possibly can, in media res, “in the middle of things.”

Let the sound effects tell your story for you.

Keep cacophony out.

A flat read is almost always best.

“You cannot logic your way to an audience’s heart.”

Notes – Competition Demystified: Chapter 5

Reading notes to Competition Demystified, by Bruce Greenwald and Judd Kahn

Looking for competitive advantages through industry analysis

One way to approach competitive analysis is by critically examining two key measures of performance:

  • operating margins; most useful when comparing firms within an industry
  • return on invested capital; useful for comparing between industries and within

These ratios are both driven by operating profit so they should track one another; when they do not, changes in how the business is financed may be the cause.

As the authors state,

Though the entries on the income statement are the consequences, not the cause, of the differences in operations, they tell us where to look for explanations of superior performance.

Learning by example: the Wal-Mart (WMT) case study

The explanations for Wal-Mart’s success have been numerous and diverse:

  1. WMT was tough on its vendors
  2. WMT monopolized business in small towns
  3. WMT had superior management and business systems
  4. WMT operated in “cheaper” territories in the Southern US
  5. WMT obtained advantages through regional dominance

Let’s examine these claims in order.

The first explanation fails the sniff test because WMT in fact had a higher Cost of Goods Sold (COGS) than it’s competitors. Additionally, its gross profit margins did not increase as it grew larger, implying it was not getting better and better economies of scale with suppliers by buying in bulk.

And while Wal-Mart did manage to generate additional income from higher prices charged in monopoly markets, this advantage was more than offset by its policy of “everyday low prices” in more diverse markets where WMT did higher volumes.

Technologically, WMT was a buyer of logistics and distribution technologies, not a developer of them. Anything it used, its competitors could use as well. Managerially, WMT appeared to have no advantage when it expanded its retailing into hardware, drug and arts and crafts stores. Why would WMT’s superior management be effective at discount general merchandise retailing but not add additional value in these markets?

The fourth explanation fails because Wal-Mart’s opportunities for expansion in the home markets of the South were not very large. Much of Wal-Mart’s growth and success took place in larger markets outside the South.

Wal-Mart’s secret sauce was regional dominance

Competitive advantages occur in numerous, often complementary ways. In the case of WMT, the initial competitive advantage was centered around a concentrated, regional dominance. Though smaller than its competitor Kmart, by focusing on one local region WMT was able to create a number of other competitive advantages for itself, including local economies of scale, that were not available to its competitor:

  • lower inbound logistics due to density of Wal-Mart stores, distribution facilities and vendor warehouses
  • lower advertising costs due to concentration of stores and customer base in target markets
  • concentrated territories which allowed managers to spend more time visiting stores rather than traveling to and from

Looking at Wal-Mart’s activities within the relevant boundaries in which it competed, it was far larger than its competition.

Eventually, economic law won out and growth took its toll on WMT’s great business,

it was unable to replicate the most significant competitive advantage it enjoyed in these early years: local economies of scale combined with enough customer loyalty to make it difficult for competitors to cut into this base.

WMT’s margins and return on capital both began to fall during the 1980s as it began its aggressive growth into the national market. Until then, WMT enjoyed the absence of established competitors.

What could WMT have done if it wanted to grow but maintain its competitive advantages?

If it had wanted to replicate its early experience, Wal-Mart might have targeted a foreign country that was in the process of economic development but that had not yet attracted much attention from established retailers.

Lessons learned from the WMT case study

The WMT case study leaves several general impressions:

  1. Efficiency always matters
  2. Competitive advantages matter more
  3. Competitive advantages can enhance good management
  4. Competitive advantages need to be defended
Learning by example: the Coors case study

From 1945 to 1985, the brewing industry experienced significant consolidation due to the following factors:

  • demographic trends, as home beer consumption rose at the expense of tavern consumption
  • technological disruption, as the size of an efficient plant grew from 100,000 bbl/y to 5M bbl/y, leaving many smaller brewers in a position where they could not afford to keep up
  • advertising trends, as the advent of television meant national brewers could spread fixed advertising costs over a larger revenue base
  • growth in brands, the market segmentation of which did not lead to growth in consumption but did result in larger advertising burdens for smaller brewers
The organization of Coors business

Coors’ business operations were characterized by a few fundamental structures:

  1. vertical integration, Coors produced its own strain of barley, designed its own cans, had its own bottle supplier and even had its own source of water, none of which produced a meaningful cost advantage
  2. operated a single brewery, which required it to transport all its product to national markets at great cost rather than producing within each market and shortening transportation routes
  3. non-pasteurization, which led to shorter shelf life than its rivals, adding to spoilage costs
  4. a celebrity aura, which, like most product differentiation strategies, did not result in a meaningful premium charged for a barrel of Coors compared to its rivals
For Coors, geographic expansion brought with it higher costs and reduced competitive advantage as these business organization decisions interacted with the wider distribution network in unforeseen ways:
  • longer shipping distances from the central plant in Golden, CO, resulted in higher costs that could not be passed on to consumers
  • the smaller share of new local markets it expanded to meant it had to work with weaker wholesalers
  • higher marketing expenses were incurred as Coors tried to establish itself in new markets and then keep up with the efforts of AB and Miller
The net result was that Coors was “spending more to accomplish less.”

Why Coors expansion was so costly

First, although Anheuscher-Busch, the dominant firm in the brewing industry, spent almost three times as much in total on advertising compared to Coors, it spent $4/bbl less due an economy of scale derived from larger total beer output.

Second, Coors experienced higher distribution costs because distribution has a fixed regional component which allows firms with a larger local share of the market to drive shorter truck routes and utilize warehouse space more intensively.

Third, advertising costs are fixed on a regional basis. Again, the larger your share of the market in a given region, the lower your advertising costs per unit. Coors never held substantial market share in any of the national markets it expanded into.

If Coors had “gone local” (or rather, stayed local), all of its competitive disadvantages could’ve been turned into competitive advantages. Advertising expenses would’ve been concentrated on dominant markets instead of being spread across the country. Freight costs would’ve been considerably lower as it would not have been transporting product so many thousands of miles away from its central plant. With a larger share of the market it could’ve used stronger wholesalers who might have been willing to carry Coors exclusively because it was so popular in local markets.

Additionally, Coors sold its beer for less in its home regions, allowing it to win customers from its competitors by lowering prices, offering promotions and advertising more heavily. Expansion, when and if it occurred, should’ve worked from the periphery outward.

The Internet and competitive advantages

Greenwald and Kahn are skeptical of the virtues of combining the Internet with traditional competitive advantages:

The main sources of competitive advantages are customer captivity, production advantages and economies of scale, especially on a local level. None of them is readily compatible with Internet commerce, except in special circumstances. [emphasis added]

With the Internet,

competition is a click away,

and furthermore,

economies of scale entail substantial fixed costs that can then be spread over a large customer base

a state of affairs which often doesn’t exist with virtual, e-businesses.

The Internet is great for customers, but its value to businesses as a promoter of profits is questionable. The Internet doesn’t provide a strong barrier to entry because it is relatively inexpensive to set up an e-commerce subsidiary. Additionally, there are no easily discernible local boundaries to limit the territory  in which a firm competes which is another essential element of the economies of scale advantage.

In other words,

the information superhighway provided myriad on-ramps for anyone who wanted access.

Questions from the reading

  1. Greenwald and Kahn argue that management time is the scarcest resource any company has. Is this true? Why can’t companies solve this simply by hiring more managers and increasing the manager-employee ratio?
  2. In the case study with WMT, why couldn’t Kmart at least match WMT’s efforts in establishing critical infrastructure organization and technology and compete on that basis?
  3. What were the sources of WMT’s customer loyalty?
  4. Which publicly-listed firms have regional dominance as a specific strategy they follow? Do these companies’ financial performance seem to suggest they derive a competitive advantage from this strategy?
  5. In the case study with Coors, what were the industry conditions in beer brewing that made national competition more efficient than local competition?
  6. Standard Oil, another producer and distributor of “valuable liquids” was vertically integrated. Why was vertical integration beneficial in the oil industry but not in the brewing industry for Coors?
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