On the Physical Effects Fallacy
This post was prompted by something I read over at Absolutely No DooDahs. As I’ve said before, most of the commentary on Bill’s blog is highly intelligent. So, I feel bad about singling out this most unintelligent (and most unrepresentative) post. However, this myth has been around for several centuries, and has enjoyed the support of some otherwise intelligent individuals; so, it is in desperate need of dispelling.
Regarding Anheuser-Busch (BUD) and Coca-Cola (KO), Bill wrote:
Colored, flavored corn – syrup water doesn’t generate brand loyalty, and neither does fermented hops and barley malt. The desired effects of either can be gotten with off-brand products and substitutes.
This statement is false. The desired effects can not be gotten with substitutes. The demand for a product is not determined by the physical effects of that product on the user.
Most misinterpretations of economic activity begin with a failure to properly define economics as the study of human choice. If the field is further limited in scope, it can no longer explain commerce. In other words, a unified theory of economics must explain all human actions, because humans do not have one “program” for making economic choices and another “program” for making non – economic choices.
The demand for a product is derived from that product’s (expected) ultimate impact. I’m using the word “impact” simply because I want to conjure up the image of the mind as something that is being stamped or imprinted. In ancient times, the idea of the physical world “stamping” the mind was popular, and I think it’s an apt metaphor in this case.
Humans act to effect changes in their mental states; humans do not act to effect changes in their physical state. Human actions that appear to be motivated by a desire to alter one’s physical state are actually motivated by a desire to alter one’s mental state. That’s where the “ultimate” half of “ultimate impact” comes from. Alterations to one’s physical state are merely desirable insofar as they lead to alterations in one’s mental state.
Let me use a few examples. You don’t eat to prevent starvation; you eat to eradicate the sensation of hunger. You don’t take your hand off a hot stove to prevent further burning of your flesh; you take your hand off a hot stove to prevent further pain.
I’m not just splitting hairs here.
Humans are rational in the sense that they act to maximize pleasurable mental sensations and minimize painful mental sensations. They are not rational in some greater sense. For instance, humans have no inherent desire to live, they merely tend to believe living is the more pleasurable state. Some humans weigh all the pleasure and all the pain and find they’d prefer a quick exit. Many rational people have committed suicide under extreme circumstances. The fact that under normal circumstances most rational people do not contemplate suicide doesn’t necessarily mean we are hard – wired to live, it could simply mean we are hard – wired to seek pleasure, and for most of us death is the greatest displeasure.
It’s important to dispel the myth of physical primacy to understand what products really are. They are far more than their physical properties. They are agents of change.
For whatever reason, many people have trouble recognizing the fact that the physical properties of a tangible good are only important insofar as they effect changes in the user’s mental state. I’m not sure why this is.
We all know that if you were eating something particularly delicious and I began to describe a festering, rotting, rancid, pus – filled something or other, you would no longer find your meal quite so tasty. I did not alter your physical state (directly). Rather, I effected physical changes by first altering your mental state. The gagging isn’t the important part. That came after your mental state was altered.
Obviously, we all know about the placebo effect as well. If you give someone a sugar pill and say “this is a sugar pill” and you give someone else a sugar pill and say “this is a drug” you get two very different results. In reality, you have two different products.
The fact that both pills are physically identical is immaterial. An identified sugar pill is different from an unidentified sugar pill as far as human minds are concerned. Human minds take human actions and human actions are all there is to the economy. Therefore, an investor needs to concern himself solely with how products are perceived by human minds. Products’ physical properties are unimportant except insofar as they affect those perceptions.
There can be no doubt that Coke and Bud both generate brand loyalty. They are highly differentiated products. As I’ve said before, most people view Coke and Pepsi as being very different products (they may place them in the same class of products, but they do not view them as true substitutes).
There are many other competing products that are less similar physically and yet also less differentiated in consumers’ minds. Drugs are an excellent example. Some competing drugs have very different physical properties, but they tend to be poorly differentiated. In fact, if the efficacy of prescription drugs wasn’t tested in any way, and doctors were willing to hawk sugar pills, people would buy them – and I’m sure a lot of people would swear by them. After all, a lot of people already swear by various herbal supplements that do absolutely nothing.
So, if you want to make the argument that there’s something unethical about selling Coke or Bud rather than a cheaper generic, you might have some standing. But, to argue that “the desired effects of either can be gotten with off-brand products and substitutes” is absurd.
By that logic, a Red Sox fan could get the desired effects of rooting for the Red Sox by switching over to rooting for the Yankees. Yet, somehow, I think the rights to broadcast Red Sox games in New England are a lot more valuable than the rights to broadcast Yankees games – and I don’t think that will be changing anytime soon.
By the way, I do agree with Bill’s assertion that Bud and Coke are not the best options for individual investors, because Buffett’s options are greatly limited by the amount of capital he has to deploy. Neither of these stocks is super cheap right now. But, they are great businesses and great franchises.
Comments
"The demand for a product is not determined by the physical effects of that product on the user."
Actually, here we'll probably have to agree to disagree. A great many people drink alcoholic beverages for one primary, overarching purpose: to get drunk. Many different brands can perform this function, as well as fermentations distilled from potatos, corn, etc. I know of which I speak (um, er, type) - re-read the part of my profile concerning my time at Tulane.
A similar phenomenon occurs with sodas. The impact is the rush of sugar and caffiene, or caffiene alone if drinking a diet soda, or merely the sweet taste if drinking caffiene-free diet sodas. The physical body is conditioned to crave the sweet taste - it's physiological.
A person desiring the "kick" of a soft drink, or the "buzz" of an alcoholic beverage, is not going to deny themselves that pleasure simply because their "brand" is unavailable ... they will substitute. There are a great many people who are predisposed to this type of addictive behavior. :-)
I don't disavow *all* power of brand loyalty, and perhaps there a few "social drinkers" that only drink a particular brand. I do think you and I have different estimations of the importance of brand in alcoholic beverages or in sodas. But from my own personal experience, even when I had a preference, if the choice was "go without" or "go with a different brand," I went with a different brand - and I know and converse regularly with a great number of similarly-minded individuals.
This may be a case of different life experience leading to different perspectives.
Posted by: nodoodahs | February 19, 2006 11:31 PM
You’re probably right. I can’t say anything about beer, because I don’t drink.
As for soda, I drink copious quantities of Pepsi – easily 2,500+ cans a year. In the U.S., I can drink Coke at restaurants, because I don’t mind it if it comes from a fountain. I’ve ordered it a couple places overseas where it comes in a bottle – can’t stand it. It tastes sweet, sticky, and has a very strong caramel flavor. But, that’s probably just my Pepsi addiction talking. Maybe I could have just as easily been conditioned to love Coke.
I do know that by this point in life, I'm alreay hooked on the Pepsi. For me, they're two very different products.
Posted by: Geoff Gannon | February 20, 2006 12:16 AM
About non-U.S. coca-cola: Overseas (and in Mexico) they use real sugar. Here they use corn syrup. This is because of protectionist policies that cause U.S. sugar to cost 2x the world price, and also about U.S. grain subsidies that make corn cheap. This might explain the overseas difference.
I've got some questions for you, please do answer them ...
About soda: Do you drink the regular or unleaded? Do you drink the corn-syrup or aspartame versions?
If you drink the version with caffiene and/or corn syrup, do you feel a decline in energy or feeling of hunger if you don't drink another, or eat, within a few hours?
If you drink the version with caffiene and/or aspartame, have you ever tapered off suddenly, e.g. went a day without drinking any? If so, did you feel irritable, or have headaches, or feel like you needed a nap?
If you were driving cross-country and ran out of Pepsi and were low on gasoline ... you're thirsty, and you've got that road sleepiness starting to kick in ... imagine the store where you stopped, the only one for miles, had no Pepsi. How would you combat your sleepiness and thirst? Would you buy some bottled water and No-Doze? Or coffee? Or another brand of soda? ... or would you do without?
About alcohol: It might be instructive to look at stats for who consumes the most alcohol. As a demographic, it's those under 25. College binge drinkers and alcoholics may have brand preferences, but they drink primarily for the effect produced by alcohol. The individuals who *don't* drink for effect, quite frankly don't drink as much as those who do. I would have considered your Pepsi habit to be a "tapering off" period when I was a wee bit younger.
About "conditioning": Part of the conditioning is the addictive qualities of aspartame and caffiene, and part is associating those with a particular brand or taste. Pavlov's dogs drooled for the bell because they associated it with feeding - I'm certain that many drinkers of soda or beer associate the sight of their favorite brand with the physical feeling they get after consuming it, and many of those would get that same feeling from a substitute if their brand were unavailable.
About brand: Brand is about customer IMO. Some people are inclined to be brand-sensitive and some aren't, and even that probably varies from product to product, i.e. she might only drink Pepsi but doesn't care where her lingerie comes from. IMO to the extent that brand influences decision purchases in soda and beer, it is at the margin for a subset of the customer base, and even then there is some substitution.
Summary of my position: Brand has some importance but in general is overemphasised. Disclosure, I am one of those non-brand-sensitive types.
Posted by: nodoodahs | February 20, 2006 09:31 AM
Bill, in response to your questions:
I do drink the regular (w/ caffeine) soda. It’s not unusual for me to run out of soda for a day or two. I probably go a total of two to four days a month where I don’t drink any soda, simply because I ran out and didn’t notice – this happens from time to time near the end of the week.
I would think that consuming as much caffeine as I do would cause problems for me whenever I stopped for a day or two, but I’ve never noticed any. Of course, I’ve never gone more than a few days (2-3) without soda. But, I think caffeine works pretty quickly; so, it shouldn’t take several days to notice any difference. I have noticed that I have a pretty high tolerance for caffeine compared to some people. That may be the result of having taken so much everyday for so long. For instance, I have no problem drinking a lot of caffeine at one or two in the morning and then immediately falling asleep.
Your question about whether I would do without is interesting. I hadn’t really thought about it before, but the sodas I tend to substitute for Pepsi are primarily non-caffeinated. Although I don’t really like them, I’ll drink Sprite, 7up, and Minute Maid Orange Soda in a pinch. I believe all of those have no caffeine whatsoever. I hate Sunkist Orange Soda which I believe has a very high caffeine count.
Keep in mind in all of this that I don’t drink coffee. I’ve never seen really good statistics on this stuff, but I believe I’ve read that regular coffee can have up to 2 – 4 times as much caffeine as Pepsi. Diet colas usually have more caffeine, up to 1.5x as much I think.
I agree completely about the conditioning. There’s this association between the image, product, brand, etc. and the positive experiences of the past (whether it’s the use of a drug like caffeine or childhood memories). That was the point I was trying to make by bringing up baseball teams. They’re brands too. It isn’t just a question of geographic franchises.
New Jersey has two football teams (both use the New York name but play in Jersey), but the Jets and Giants are not viewed as interchangeable. Some overwhelming number of sports fans root for the same team as their fathers. This seems to be true even when there are multiple teams within the same geographic areas, and to some extent, when teams move. I know a couple Dodgers fans in the NY / NJ area. Some aren’t really old enough to have seen the team in Brooklyn – it’s been almost fifty years now. Likewise, there are plenty of Rangers, Islanders, and Knicks fans in New Jersey despite the fact that the state has its own NHL and NBA franchises. So, I think the whole brand idea goes beyond the consumer products that first come to mind.
That is part of my concern about newspapers. People don’t switch papers very often. No one reads competing papers to try them out. So, really newspaper brands are stronger than car brands (which are pretty weak in my opinion) even though most people can name a lot car brands, but can only name a few papers other than the one they read everyday. The problem for papers is how much of the circulation is based on old habits that won't be present in the next generation.
Finally, I have to say that even though I think brands are important, I think they also tend to be misunderstood. A lot of people know luxury brands and fashion brands, but I’m not sure how important they are. They have to keep reinventing themselves, because their customers do look around for alternatives.
I can’t resist noting that Berkshire owns Fruit of the Loom, which is the ultimate boring brand. I’m not sure anyone really cares about the Fruit of the Loom brand, but underwear isn’t the kind of product people are likely to break old habits over. I mean, once you start buying a certain brand of underwear, are you really going to do a lot of comparison shopping?
Posted by: Geoff Gannon | February 20, 2006 12:18 PM
I think that alcohol has a great deal of brand loyalty as well. Some do drink to get drunk, but most people at a restaurant don't ask for the cheapest beer, they order a Guinness or Bass, etc. by name. (A good reason to add Diageo to your wide moat section) Furthermore, many cocktail menus don't even have prices on them. People order alcohol for the "Image" it gives- go to a bar after work and the preppy young guy will order a "Ketel One and tonic" rather than a vodka tonic, even though he probably couldn't tell the difference between Ketel One and Smirnoffs. Most people who frequent bars have a "signature drink" and brand (many use a Diageo product- another good reason to add them to the wide moat section)They do this to project an "image" to their fellow patrons as they order.
Posted by: Michael | February 20, 2006 05:58 PM
Diageo has gotten my attention through some FT articles, but I haven't done DD yet.
What matters is how much money is spent by people who do what they do, vs. how many people do something. For example, if 10,000 people did 1 each of X but 1,000 people did 14 each of Y, which has the most impact?
The "most people" who drink for "image" will probably not be drinking 5-10 drinks at a sitting, or having such binges on a regular basis (nightly, every weekend, etc.). They are also more likely to abstain if the location doesn't have their signature drink available.
The few dedicated power drinkers and the demographic that drinks the most beer by far, those of college age, are IMO both less likely to be brand sensitive, and more likely to drink large quantities (therefore spending more money and diluting the impact of brand).
I believe more money is spent on these purchases by those that are insensitive to brand, than is spent by those who are brand-sensitive, based on the fact that the "effect users" purchase MUCH higher amounts. This is not to say that brand loyalty doesn't exist - this is to say that brand loyalty has less impact than most people think, because of the quantities consumed.
Again, this may be a question of personal biases and preconceptions entering into the discussion. When I drank, I drank to get drunk. I hung around people who drank like I did, quite frankly because if I hung around the crowd that drank for image, I would stick out like a t**d in a punch bow.
When I go to the grocery or WMT, there are plenty of high-dollar brands for sale, like "you never forget your first girl" from St. Paulie, etc. They come in six-packs. They don't come in 30-packs. There's a reason for that. The folks that buy 30-packs don't select their choice for image ...
The natural tendency is towards "false consensus" - the thought that "I think this, therefore everyone thinks this." We all have to control that. While I have zero identification with the person who wants to project an image by buying a fancy-smancy drink at a trendy bar, I agree those people exist. I am merely trying to state my reasons for believing that the sum total of money those people spend on alcohol is smaller than most people think, when compared to the amount spent by "my people."
Posted by: nodoodahs | February 21, 2006 11:59 AM