May 2003

Building a brand and building a profitable brand are two different things.

Take Sony, for example. If you did a survey, you would probably find that Sony is the world’s most admired electronics brand. Way ahead of whoever might be in second place.

Terrific for owners of Sony products. But how about the owners of Sony stock? Does the company make any money? The sad fact is no. Net profits after taxes of Sony Corporation are small. Very small.

In the last ten years, Sony Corporation had revenues of $519.2 billion. But net profits after taxes were only $4.0 billion. That’s 8/10th of one percent of sales. It’s hard paying off your bank loans, not to mention paying dividends to investors, with that kind of return.

Of course, this is Japan, so who pays off its bank loans anyway? In 1999, the Bank of Japan cut its benchmark short-term rate effectively to zero.

Like most Japanese companies, Sony is heavily line extended. Sony puts its brand name on television sets, videocassette recorders, digital cameras, personal computers, cellphones, semiconductors, camcorders, DVD players, MP3 players, stereos, broadcast video equipment, batteries and a host of other products.

Yet Sony’s most profitable product is the PlayStation video game, a brand which makes only marginal use of the Sony name. (As powerful as the Sony brand might be, PlayStation is even a better brand name because it stands for something in the prospect’s mind.)

Compare Sony with Dell Computer. Sony makes personal computers and a lot of other products. Dell just makes personal computers (until recently when they added printers.) In the last ten years, Dell Computer had sales of $140.3 billion and net profits after taxes of $8.5 billion, or a net profit margin after taxes of 6.1 percent.

That’s not fair, you might be thinking. To compare with Sony, you picked  a company (Dell) that is exceptionally profitable.

Actually that’s not true. Dell is in a highly competitive business where profit margins are thin. (IBM has never made money in the personal computer business and Hewlett-Packard’s PC business is barely profitable.) As a result, Dell’s 6.1 percent profit margin is not spectacular.

In the last ten years, net profit margins at the average Fortune 500 company were 4.7 percent of sales. (If you leave out the last two years which were mostly disasters, the percentage jumps to 5.7 percent.)

I have preached against the perils of line extension ever since the publication of the Positioning book some two decades ago. And ever time I do, someone always says, “What about the Japanese, they do the exact opposite of what you are recommending and they are extremely successful.”

Are they? In the last ten years, Hitachi had revenues of $708 billion and managed to lose $722 million. NEC had revenues of $397 billion and lost $1.3 billion. Fujitsu had revenues of $382 billion and lost $1.6 billion. Toshiba had revenues of $463 billion and a net profit margin of just 0.15 percent.

Large unfocused companies make very little after-tax profits. And if you don’t make money, you can’t pay off your bank loans. And if you can’t pay off your bank loans, the banks are in trouble.

And if the banks are in trouble, a country’s economy is in trouble. And if a country’s economy is in trouble, the country’s political system is in trouble.

The top of the Japanese economic system is weak because the base is weak. Japanese companies, for the most part, make everything except money.

Why is it so difficult for large, unfocused Japanese companies to make money? It can’t be product quality. Most Japanese companies have a worldwide reputation for high quality. A reputation that, for the most part, they deserve.

Our conclusion is that line extension inhibits the branding process. When a company makes and markets a broad range of products under one name, it is extremely difficult to build that name into a powerful brand.

Don’t any Japanese companies make money? Companies whose brands are relatively focused do much better. Sharp (1.8 percent), Toyota (3.1 percent), Honda (3.3 percent) and Canon (3.8 percent.)

We have followed the financials of Japanese companies for many years. We find that the average large Japanese company has a net profit margin after taxes of about 1.0 percent compared with the average large American company at 5.0 percent.

But even that result is peanuts compared with companies whose brands are highly focused. As a general rule, the more focused the brand, the higher the profit margin. Some examples: Nokia (10.6 percent), Intel (21.6 percent) and Microsoft (31.8 percent).

Now tell us again why line extension is such a good thing.