Marketing Science Institute Working Paper Series 2011 Report No. 11-112

How Do Brand Portfolio Strategies Affect Firm Value?

Liwu Hsu, Susan Fournier, and Shuba Srinivasan

“How Do Brand Portfolio Strategies Affect Firm Value?” © 2011 Liwu Hsu, Susan Fournier, and Shuba Srinivasan; Report Summary © 2011 Marketing Science Institute

MSI working papers are distributed for the benefit of MSI corporate and academic members and the general public. Reports are not to be reproduced or published, in any form or by any means, electronic or mechanical, without written permission. Report Summary

In this report, Liwu Hsu, Susan Fournier, and Shuba Srinivasan conduct an empirical investigation on the effects of brand portfolio strategy on shareholder value. Although previous research has shown that the branded house, in which all firm offerings are presented using the corporate umbrella brand, generate higher values of Tobin’s q than the house of brands, in which separate brands are cultivated, the risk profiles of these portfolio approaches have not been considered. Additionally, previous research ignores important nuances in brand portfolio strategy that are made salient when considering strategic variations on pure branded house and house of brands strategies: namely, sub-branding and endorsed branding.

The authors address these gaps by using a sample of 306 publicly traded firms from 1996 to 2006 and estimating the Carhart four-factor financial model to assess three components of shareholder value (levels of returns, idiosyncratic risk, and systematic risk). They relate these components to five strategies along the brand portfolio continuum: branded house, sub-branding, endorsed branding, house of brands, and hybrid.

Results suggest that firms should be cautious in the pursuit of risk-laden branded house strategy and offer evidence that the financial markets do appropriately value the house of brands strategy. Surprisingly, the results disconfirm conventional wisdom regarding the risk/return advantages of portfolio strategies that deviate from these extremes. The authors find that sub-branding, a variant on the branded house strategy wherein the corporate umbrella brand retains or shares the purchase driver role but is linked prominently to a different branded offering (e.g., Apple iPod), outperforms all other strategic options in returns, but at high level of risk.

In terms of improving the firm’s risk profile, the authors find outperformance for strategies that create separation (house of brands) or distance (endorsed branding) from the corporate brand. Endorsed branding reduces risk versus sub-branding and provides risk control benefits similar in magnitude to the house of brands. However, this managerially assumed “best of all worlds” strategy comes with a hit to returns that managers do not anticipate, placing it squarely in the lowest rung in terms of returns. Hybrid, the most common portfolio approach, proves a poor scenario, with moderate risk and no returns improvements over the house of brands.

These results suggest that the financial community appropriately values and recognizes the risk/return profiles of different brand portfolio options. However, the results also caution against ad-hoc choices in designing brand portfolios and offer practical guidance to managers about the value profiles of strategies that connect and leverage both separate and corporate brands.

Liwu Hsu is a doctoral student, Susan Fournier is Associate Professor and Dean’s Research Fellow, and Shuba Srinivasan is Associate Professor and Dean’s Research Fellow, all at the School of Management, Boston University.

Acknowledgements

The authors thank Vivek Goyal, Suryabir Dodd, Julie McCluney, Claudio Alvarez, and Anna Eng for help with the data and coding; Dominique Hanssens for his insights; participants at the

Marketing Science Institute Working Paper Series 1 2009 and 2010 Marketing Dynamics Conferences and the 2011 Marketing Strategy Meets Wall Street II Conference for their valuable suggestions; and, particularly, Thomas Madden for inspiring this research idea. Boston University School of Management is also acknowledged for its Faculty and Ph.D. research support.

Marketing Science Institute Working Paper Series 2 Introduction

Academics and practitioners have expressed growing interest in connecting marketing initiatives to financial performance and firm value (Srinivasan and Hanssens 2009). Research has explored the value impact of market-based assets (Srivastava, Shervani, and Fahey 1998), product innovations (Srinivasan et al. 2009), marketing initiatives (McAlister, Srinivasan, and

Kim 2007), and advertising spend (Joshi and Hanssens 2010). A key interest identified by both managers and researchers is the impact of branding on stock price and the riskiness of cash flows

(Srinivasan, Hsu, and Fournier 2011). Marketing Science Institute priorities for 2010-2012 reinforce the importance of research that bridges the marketing-finance divide.

Brand portfolio strategies—the structures that organize a firm’s branded offerings— are important marketing decisions that help firms allocate resources, target customers, position brands in the market, and communicate with investors. This paper provides an empirical investigation of the effects of different brand portfolio strategies on shareholder returns and risks.

Our study builds from Rao, Agarwal, and Dahlhoff (2004) who find that branded house (BH) strategies in which a unifying corporate brand extends across all branded entities in the company’s portfolio (e.g., FedEx) generate higher values of Tobin’s q than house of brands

(HOB) strategies wherein distinct brands not linked with the corporation are cultivated for specific market segments (e.g., Procter & Gamble), leading them to conjecture that financial markets do not appropriately value the HOB strategy. Our research informs the implicit recommendation of Rao et al. (2004) in favor of BH versus HOB architectures by reconciling this with managerial wisdom and experimental research that cautions against risk-laden strategies that connect all offerings to a unifying corporate brand (Aaker 2004a; Lei, Dawar, and

Lemmink 2008). Risk is a key metric for publicly-traded companies (Rappaport 1997); investors are sensitive to the unpredictable events that threaten corporations, and react violently to exposures of brand risks (Govindaraj, Jaggi, and Lin 2004). Given that managers and investors are inherently risk-averse (Swedroe and Grogan 2009) and seek to maximize returns while

Marketing Science Institute Working Paper Series 3 minimizing risk exposure, it is crucial to that our analyses of brand strategy effects consider risk.

Still, as Srivastava, Shervani, and Fahey (1997, p. 61) note: “marketing activities can be structured to reduce the volatility and vulnerability of cash flows but such assessments of marketing strategy are rare.” With few exceptions (Luo and Bhattacharya 2009; Madden, Fehle, and Fournier 2006; Rego, Billett, and Morgan 2009), research has yet to examine brand strategy effects on firm risk. Our first contribution is to address this gap by examining applying the well- established Carhart four-factor model from finance (Carhart 1997) to estimate the impact of a company’s brand portfolio strategy on its stock risk.

As a second contribution, we empirically consider popular strategic variants on pure BH and

HOB strategies that are intended to control the firm’s risk. Brand portfolio strategy offers a range of five options that vary in managerial leverage of the corporate brand connection and hence risk exposure (Franzen 2009). Through sub-branding (SB), wherein the corporate brand is dominant but linked prominently to a secondary brand (e.g., Apple IPod), managers expect to retain most of the benefits of the BH—namely, improved bottom-line performance due to lower costs associated with a shared-brand strategy—while controlling the risks associated with exclusive and prominent linkage to the parent brand. Endorsed branding (EB) is expected to yield even greater risk control through use of a prominent second brand that maintains but a distant connection to the corporate umbrella (e.g., Post-it by 3M). Managers generally consider EB a

“Best of All Worlds” portfolio option that grants some of the risk control of a HOB and many of its demand-side advantages from improved top-line performance due to higher revenues while also offering certain supply-side advantages of the BH. With a hybrid strategy, management maintains a mix of options along the continuum, expecting return and risk benefits through the diversification this allows. Ours is the first study to test hypotheses on the risk/return profiles associated with the five-part brand portfolio scheme. As our results demonstrate, the actual risk/return profiles of these strategies contrast sharply with what managers expect.

Marketing Science Institute Working Paper Series 4 The expanded brand portfolio strategy scheme is also important as it clarifies distinctions obscured in previous research emphasizing the simplified BH-HOB dichotomy. Most notably,

Rao et al.’s (2004) outperforming BH strategy includes the pure branded house strategy as well as sub-branding and endorsed branding, which also leverage corporate brand connections: “With the corporate branding strategy, the corporate name is dominant in endorsing all or part of the firm’s product and service brands. At the least, the corporate name is an element of the product brand names.” (p.127, emphasis added). As our results make evident, the pure versus superordinate versus subordinate use of a corporate brand linkage, as in BH, EB, and SB strategies, respectively, differentially affect returns and risks.

The five-part categorization also allows consideration of the implicit assumption that the portfolio options constitute a continuum that can be ordered from high-to-low in terms of risks and returns. Prior research demonstrates that BH has higher returns than the HOB (Rao et al.

2004) and conventional wisdom places SB and EB sequentially between these two extremes

(Aaker and Joachimsthaler 2000b; Franzen 2009). Finance theory leads management to expect a similar linear ranking for risk. Whether the implicit linearity of returns is an empirical reality, whether patterns of risk parallel patterns for returns, and where exactly the SB, EB and Hybrid place in this linear ordering, stand as unresolved questions at this time.

Finally, we offer a theoretical contribution in the provision of a brand-relevant conceptualization of idiosyncratic risk that goes beyond traditional concepts of consolidation and diversification to consider consumer and marketing research concerning the mechanisms whereby marketing strategies influence the equity of brands. We delineate four types of brand- relevant idiosyncratic risk that may be exacerbated or controlled through brand portfolio strategy: brand reputation risk, brand dilution risk, brand cannibalization risk, and brand stretch risk. We use this taxonomy to build hypotheses regarding the differential effects of brand portfolio strategies on firm-specific risks. Our hypotheses allow diagnostic insights that inform theories- in-use concerning the relative riskiness of popular brand portfolio structures. More generally, our

Marketing Science Institute Working Paper Series 5 idiosyncratic risk conceptualization helps frame branding decisions more formally in risk management terms.

The rest of the article is organized as follows. First, we review relevant literature on firm value and brand portfolio strategy to develop our conceptual model and hypotheses. Risk is central to our model, and we incorporate literature from finance and branding to decompose the construct of idiosyncratic risk. We then discuss our measurement and analytic approach and close with a presentation of our findings and implications that emanate from our work. As an aid to the reader, we also provide a two-part Glossary at the end of this paper to clarify and define the technical, finance-related, and brand strategy terms and concepts considered in this paper, including, for example, notions of endorsed branding, endogeneity bias, and idiosyncratic risk.

Conceptual Framework

We rely on theories of market-based assets and the risks to cash flows (Srivastava et al. 1998) to understand the possible relationships between brand portfolio strategy and firm value. The general conceptual model organizing our research accommodates two mechanisms through which marketing strategy drives firm value (Joshi and Hanssens 2010; Srinivasan, Hsu, and

Fournier 2011). First is a direct route wherein market-based assets enhance firm value directly through effects on cash flows. The enhanced cash flows valued by investors derive from demand-side advantages such as greater customer loyalty, increased marketing communication effectiveness, and elevated perceptions of product-market performance and supply-side advantages of economies of scale in marketing and lower costs of promotion (Lubatkin and

Chatterjee 1994). Demand- and supply-side advantages manifest directly through the brand-as- asset route.

The second mechanism whereby brand strategy affects firm value involves an indirect route wherein the brand serves not as an asset but as information that signals the financial well-being of the firm. Stock markets comprise an environment of information asymmetry (Myers and

Marketing Science Institute Working Paper Series 6 Majluf 1984), and the signaling framework (Spence 1973) holds that management information is conveyed to shareholders through various signals, one of which is the brand (Maheswaran,

Mackie and Chaiken 1992). Consistent with the view of brands-as-information, this framework explains stock market reactions to such events as reputation crises signaling weakened brand equity (e.g., Toyota’s acceleration problem) or news suggesting a strengthening global brand

(e.g., Starbucks in China).

We use the logic of these two complementary mechanisms to derive hypotheses concerning the effects of portfolio strategy on firm value. Figure 1, following References, provides the conceptual framework that organizes our research.

Components of firm value

According to the shareholder value perspective, the main objective of companies is to maximize shareholder’s return on their equity (Rappaport 1997). Shareholder value is determined by two fundamental metrics in finance: levels of stock returns and the volatility or risk associated with those returns (Srinivasan and Hanssens 2009). Stock returns are the percentage change in a firm’s stock price. Greater risk, as reflected in higher stock-price volatility, suggests vulnerable and uncertain future cash flows, which induce higher costs of capital financing, thus damaging firm valuation. Without considering stock price volatility, managers cannot assess “whether expected returns offer adequate compensation for the inherent level of risk” (Anderson 2006, p. 587).

Stock returns. Stock returns reflect investors’ expectations of cash flows. Positive stock returns result from both supply-side and demand-side advantages. Supply-side advantages improve bottom-line performance due to lower costs while demand-side advantages drive top- line performance through higher revenues, thereby enhancing cash flows. In turn, supply-side disadvantages and demand-side disadvantages reduce cash flows and thus negatively affect stock returns. To inform our hypotheses, we leverage known diagnostic frameworks (cf., Rao et al.

Marketing Science Institute Working Paper Series 7 2004; Srivastava et al. 1998) whereby the demand- and supply-side effects of the different brand portfolio strategies can be systematically considered. From the supply-side, we consider three factors significantly related to cost reduction: economies of scale in marketing, administrative and operating cost efficiencies, and lower costs of new brand introductions. From the demand- side, we consider three factors significantly related to revenue enhancement: ability to target niche market segments, success likelihood for brand extensions driven through awareness and trial advantages, and opportunity to distinctly customize brands. We expect the different brand portfolio strategies to deliver stock returns in line with their supply- and demand-side cash flow effects.

Stock risks. There are two types of risk: systematic and idiosyncratic. Systematic risk stems from economy-wide sources that affect the overall stock market and all firms in it. A key determinant of systematic risk is macro-economic or market risk stemming from exchange and interest rates, inflation, growth, recessions, news about the economy, and political events

(Campbell and Mei 1993). Industry risks concern macro-economic factors that systematically affect the earnings and cash flows of a specific sector, as due to factors such as seasonality, cyclicality, changing laws and regulations, technology advances, and price changes on specific commodities (Semaan and Drake 2011). Idiosyncratic risk is the risk associated with firm- specific circumstances and characteristics (e.g., R&D spending, company leadership, levels of advertising spend), after market variation is accounted for. Although there is robust evidence supporting the importance of examining both systematic and idiosyncratic risk for managers as well as investors (Ferreira and Laux 2007), idiosyncratic risk constitutes about 80% of the average stock variance measure (Goyal and Santa-Clara 2003) and has significant relevance in firm-value determination as a result (Brown and Kapadia 2007). In addition, the effects of brand strategy, as a firm-specific decision, will manifest primarily in terms of idiosyncratic risk. In light of these factors, our conceptual development and analysis focus on the impact of brand portfolio strategy on idiosyncratic risk.

Marketing Science Institute Working Paper Series 8 A critical step in tackling our marketing-valuation question involves the development of a brand-sensitive delineation of the determinants or sources of idiosyncratic risk. Such a typology can provide diagnostic value and help qualify exactly how specific brand strategies protect a firm from, or increase their exposures to, idiosyncratic risk. We build from consumer and marketing research on brand equity effects, threats, and management and identify four brand-relevant sources of idiosyncratic risk that can help us understand brand portfolio strategy effects.

Brand reputation risk concerns the deterioration of overall brand quality and esteem value that derives from negative information regarding a firm’s business practices or its leadership team. This risk derives from the reality that negative publicity, whether fact-based or not, can cause a decline in the customer base, costly litigation, or financial loss and revenue reductions

(Argenti and Druckenmiller 2004). Brand reputation risk is a type of spillover risk arising from exposure to “unintended risks from related brands in a portfolio when negative incidents occur"

(Lei et al. 2008, p. 111). Through selection of different strategies, firms are more or less at risk of exposure to sources of reputation risk. For example, reputation risk is exacerbated through use of a spokesperson (e.g., Martha Stewart) that also serves as the namesake for the firm (Fournier and Herman 2011). Strong linkages between brands in the form of shared attribute, feature, or benefit associations stand as good predictors of the incidence and magnitude of reputation spillovers (Erdem and Sun 2002). Perceived connectedness between brands through use of shared fonts, logos, trade dress, designs, or even proximate shelf locations also makes them vulnerable to this type of spillover risk (Lei, Dawar, and Lemmink 2008; Sullivan 1990).

Brand dilution risk concerns the loss of meanings that differentiate a brand from its competition. The loss of unique and favorable brand meanings affects cash flows through reductions in the customer base due to brand switching as well as declines in the price premiums commanded by relevant and differentiated brands (Mizik and Jacobson 2008). Certain factors such as the depth, frequency and range of brand extensions and product variations can increase a firm’s sensitivity to dilution risks. As a given brand is stretched through repeated extensions, it

Marketing Science Institute Working Paper Series 9 can become distanced from what is true and unique about the brand in consumers’ minds (Loken and Roedder-John 1993) and cause interference with memory and retrieval processes (Morrin

1999). The focal meanings associated with a brand that has been highly leveraged also become diluted as each new offering adds unique meanings that must be accommodated in the meaning mix (Roedder-John, Loken, and Joiner 1998). Companies with more brands in a category also risk brand dilution simply because such brands are more likely to overlap and thus lose distinctiveness in consumers’ minds (Park, Jaworski, and Maclnnis 1986). Lastly, as offerings accumulate under a brand umbrella, meanings can become more abstract as reconciliation at higher levels of abstraction is forced (e.g., high quality brand; good company to do business with). Generalized meanings are more readily replicated by competitors, causing differentiation declines (Aaker 2004a).

Brand cannibalization risk manifests in the loss of sales volume, sales revenue, margins, or market share of one branded product due to the introduction of a new branded product by the same firm. Mason and Milne (1994, p. 163) define cannibalization as “the extent to which one product’s customers are at the expense of other products offered by the same firm.” Through the selection of different strategies, firms may be more or less at risk of exposure to cannibalization risk. Firms with multiple brands in the same category risk overlap in their value propositions, cannibalizing sales (Park et al. 1986). Brands with value-based offerings (e.g., Coach and its new

Poppy line) can also exacerbate cannibalization: value offerings become counter-productive from a returns standpoint when customers who would otherwise purchase the costlier version trade- down to the cheaper brand in the line (Meredith and Maki 2001).

Brand stretch risk manifests in the lack of flexibility and ability to take advantage of new market opportunities, capitalize on new technologies, or adapt to changing consumer tastes through the introduction of new, tailored brand offerings. Brand leverage is a core motivation for building brand assets, and restrictions on this activity detract from the ability to capture value from a brand (Aaker 2004b). Certain brand qualities can increase a firm’s exposure to brand

Marketing Science Institute Working Paper Series 10 stretch risk. A brand with more concrete meanings has less room to grow and hence greater stretch risk (Aaker 1990). A brand with salient meanings tied to a specific category—such as with Kleenex and tissues or Levi’s and jeans—has less ability to respond to opportunities and hence greater stretch risk (Herr, Farquhar and Fazio 1996). A brand can also face growth restrictions through dominant meanings it has come to own which somehow strain the credibility of new offerings (Farquhar et al. 1992). For example, associations with photocopying were so strong for Xerox that a strategic move into the computer market was constrained (Dominique

2005).

Brand portfolio strategy

CEOs acknowledge brand portfolio strategy as a powerful driver of shareholder value and a crucial boardroom decision (Court, Leiter, and Loch 1999). Brand portfolio strategy provides the structure and discipline needed to support and enable a successful business strategy (Aaker

2004a) and becomes particularly salient when a company confronts pressing growth goals or pending mergers, acquisitions, and alliances. Five alternatives, discussed below, help firms organize their branded offerings in a way that best meets market conditions and company goals

(Franzen 2009). These strategic options differ in their leverage of, and accordingly, the prominence or visibility of (Keller 1999), corporate brand equity (i.e., the corporate brand connection), which, as detailed in a subsequent section, should legitimately drive differential patterns of return and risk.

Branded house (BH). Under the BH strategy, the corporate master brand acts as the single unifying banner, source of reputation, and federating force for all product and service offerings in the portfolio (Aaker and Joachimsthaler 2000b). In a pure branded house, all offerings carry only the corporate umbrella brand, though more common is a naming convention in which the corporate brand is qualified through a simple descriptor that serves merely to identify different product categories or business sectors in which the corporate brand participates. Tiffany & Co.,

Marketing Science Institute Working Paper Series 11 an organization with a powerful brand identity and ranked as Top 100 global brands by

Interbrand, makes prominent and exclusive use of the parent brand “Tiffany & Co.” on an extensive selection of jewelry at a wide range of prices and in different categories (e.g., engagement jewelry, silver jewelry, and designer jewelry). Dole Food Company offers a second example wherein consumers around the world identify a wide variety of high-quality fresh fruits and vegetables through a distinctive red oval bearing the “Dole” name and sunburst icon. IBM provides a variant on this strategy wherein the corporate umbrella unifies branded offerings that are further clarified using different business sector descriptors: e.g., IBM IT Services and IBM

Business Consulting. FedEx branding similarly clarifies offerings in different product categories, as with FedEx Ground and FedEx Express. Boeing and BMW provide a further variation on the branded house wherein the corporate brand is qualified not by sector descriptors but rather by model numbers addressing different segments and product varieties (e.g., Boeing 737, BMW 7- series). Aaker and Joachimsthaler (2000a, p. 118) illuminate these variants of the branded house concept in consumer decision-making terms: “In a branded house strategy, the master brand moves from being a primary driver (of consumer decisions) to the dominant one, while any descriptive sub-brand goes from having a minority role to having little no role at all.”

Sub-branding (SB). Sub-branding engages two brand entities, a corporate brand (e.g., Intel) and a linked and connected second brand (e.g., Celeron), each of which has meanings and associations that influence consumer decision making, and therefore operate as brands in their own right. Sub-brands are linked to the parent brand and thus contribute important meanings to master brand perceptions: “Sub-brands are brands connected to a master or parent brand that augment or modify the associations of that master brand” (Aaker and Joachimsthaler 2000b, p.

14). With sub-branding, the linked second brand can modify the corporate master brand by adding attributes and benefits (e.g., Martha Stewart Everyday; , Bausch & Lomb RENU and

Bausch & Lomb PureVision) or signaling a different category, market segment, or business (e.g.,

Microsoft Word and Microsoft PowerPoint). According to Aaker (2004a), while the linked brand

Marketing Science Institute Working Paper Series 12 is typically sub-ordinate to the corporate master brand in its influence on consumer experiences and decisions (e.g., Intel Core), the corporate master brand and linked brand can play equally prominent roles (e.g., Apple IPod). In either case, with sub-branding, the corporate brand remains highly visible and is clearly linked to the sub-brand using communication and design cues such as font styles and sizes, graphics, and physical placement on product packaging and advertising.

Endorsed branding (EB). Endorsed branding also involves two brands—the corporate master or parent brand and a linked second brand—but in this case, the second brand is clearly super-ordinate, more prominent and more visible than the corporate brand, which plays but a supportive, endorsement role. Endorsed branding can be cued visually using graphic cues that render the second brand more prominent vis-à-vis the parent brand, as, for example with larger font sizes, bold lettering, or other packaging placement cues. In addition, semantic conventions such as the use of the word “by” typically specify the sub-ordinate connection with the corporate brand. Consider as an example of this later executional strategy Post-it Notes by 3M, DeWalt by

Black & Decker and Fairfield by Marriott. In all of these cases, consumers likely search for, recognize, purchase, and use what they would colloquially refer to as a Post-it notes or DeWalt power tools or Fairfield branded products, though the parent brand connection is known and plays a reassurance role: for example, the 3M brand on the package assures the consumer that

Post-it products will live up to the creative vision and high quality performance of all 3M products.

Figure 2 and Figure 3 serve to clarify the differences in the above strategies, all of which include a parent brand connection, by providing visual examples of BH as compared to EB and

SB to highlight the brand signaling cues that distinguish these different strategic routes.

House of brands (HOB). The HOB stands in stark contrast to the BH at the opposite end of the strategy continuum. Here, a company operates entirely through an independent set of stand- alone brands while keeping the corporate brand itself discreet (Aaker and Joachimsthaler 2000a).

Marketing Science Institute Working Paper Series 13 In a house of brands, all brand equity resides expressly and exclusively at the individual brand level: each individual brand stands as a central and sole source of reputation, attention, and investment in and of itself. Noted examples of companies adopting the HOB strategy include:

Procter & Gamble with 80-plus major brands (e.g., Pampers, Tide, Max Factor, Duracell, Bounty,

Crest); Yum! Brands with restaurant chains including KFC, Pizza Hut and Taco Bell; and

Fortune Brands with Jim Beam, Titleist, Moen and Master Lock. It is common that the corporate brand connection in a house of brands remains unknown to consumers; the company does not advertise the branded products as being under the corporate umbrella and keeps the corporate name connection discreet.

Hybrid. A result of growth imperatives and stock market demands, it is quite common to find corporate entities whose brand portfolio strategies do not cleanly and expressly fall into one of the strategic categories above. Companies using the so-called hybrid portfolio strategy combine at least two of the four portfolio options discussed above. Per Franzen (2009), the most common hybrid strategy involves a combination wherein some products/services carry only the corporate brand name (BH) while others use a stand-alone, individual brand name (HOB). As examples of the BH-HOB combination, Colgate-Palmolive Company uses not only Colgate and

Palmolive as customer-facing brands but also goes to market with individual brands such as

Softsoap and Speed Stick, none of which bear the corporate brand connection; Heinz offers

Heinz ketchup and pickles but also Classico, Ore-Ida and T.G.I. Friday’s brands.

Some may question whether the hybrid is indeed a portfolio strategy in itself or just an unintended consequence of other strategic decisions. Clearly, the hybrid most often results from mergers and acquisitions (M&A) that have as one strategic consequence the expansion of branded offerings of the firm (Ettenson and Knowles 2006). While the management of risks and returns via brand portfolio strategy may not always be the primary consideration in these circumstances, it is sometimes the case that such deals are executed expressly to gain new branded offerings that can expand the branded house firm. An example of a BH firm that, via

Marketing Science Institute Working Paper Series 14 merger and acquisition, shifted purposively to a BH-HOB hybrid is the beverage giant Coca-

Cola Corporation. This company purposively acquired such brands as Honest Tea, Minute Maid, and Odwalla in order to tap attractive market segments that the Coca-Cola brand could not effectively reach. In addition, a merging firm that decides to apply different branding strategies in different contexts when considering how to leverage the brands of the acquiring company and the target firm suggests strategic intent behind the hybrid strategy (Basu 2006). An example is provided in the banking entity, HSBC. HSBC exercised discriminating judgment in its decisions regarding when and where to bring its acquisitions under the corporate umbrella brand, thereby supporting an inference of strategic intent. Specifically, when HSBC acquired Credit

Commercial de France it changed the name of this brand to HSBC France whereas when HSBC acquired Household Finance Corporation in the U.S. it kept the Household Finance brand name.

Thus, while the hybrid may indeed manifest as an ad-hoc consequence of growth decisions, it may also serve as a portfolio strategy in its own right.

How Brand Portfolio Strategies Affect Firm Value

Below, we develop hypotheses concerning risk/reward profiles for the different portfolio strategies. Our hypotheses build from our subjective ratings of the five strategies in terms of their benefits and shortcomings arising from the supply- and demand-side returns factors listed above

(see Table 1) and their exposures to different sources and levels of idiosyncratic risk, as developed previously (see Table 2). We present our hypotheses by drawing upon those paired contrasts that best highlight the comparative advantages and disadvantages of the different strategic approaches and the managerial intentions behind the choice of a particular strategy. For example, we compare sub-branding to branded house for the risk-control benefits this strategy shift is expected to obtain, and endorsed branding to sub-branding for the risk reductions anticipated through distance from the corporate brand. In this sense our hypotheses build upon

Marketing Science Institute Working Paper Series 15 accepted managerial wisdom and operative theories-in-use (Aaker 2004a; Rajagopal and

Sanchez 2004).

Branded house versus house of brands: trading off risk and returns

The branded house (BH) strategy offers major advantages in terms of economies of scale and scope, particularly for advertising and communications (Barwise and Robertson 1992). The

BH also provides some demand-side advantages that should manifest favorably on returns though these are more limited. Higher levels of brand awareness and perceived credibility for an established corporate umbrella can be leveraged to new branded offerings, thus sparking interest and trial (Morrin 1999). Companies that organize their offerings as independent, stand-alone brands gain significant demand-side advantages. Brands in a house of brands portfolio benefit from being optimized in design, brand name, brand identity, brand personality, brand values, brand positioning, and communication for specific niche market segments, and thus develop an intimate connection with targeted customers that other strategies cannot provide. In addition, multiple brands provide opportunities to manage conflicting categories and channels and allow the opportunity to provide distinctly customized brands (Keller and Lehmann 2006). These demand-side advantages would manifest favorably on returns by enhancing the level of cash flows.

On the flip side, this independent brand structure creates dramatic supply-side inefficiencies that require significant investments in marketing, operations, and communications for all brands.

It is often the case that the separate brands cannot themselves support investment, leading to a slowdown of revenues because of stagnation in small or struggling brands and overall deterioration of cash flows (Aaker 2004b). In the worst case wherein a brand needs to be cancelled, brand building efforts and investments are lost.

A summary comparison of these two strategies across the six returns factors (see Table 1) leads us to hypothesize, as did Rao et al. (2004), significant supply-side-driven returns

Marketing Science Institute Working Paper Series 16 performance advantages for the BH versus the HOB. This conjecture is consistent with investors valuing bottom-line over top-line performance through the brand-as-asset route (Pauwels et al.

2004).

H1: The branded house is associated with higher abnormal returns than the house of brands.

Rao et al.’s (2004) finding regarding outperformance for BH versus HOB strategies led them to question whether the market appropriately values the HOB. This question can be answered by considering the risk profiles for the competing strategies. According to conventional marketing wisdom (Aaker 2004a), the returns advantages of the BH strategy should come at a cost in the form of increased risks. Reputation risk is particularly exacerbated in the BH, where by virtue of linking one brand to multiple offerings, a quality failure or reputation crisis affecting an entity anywhere in the brand family will spill over and tarnish the remaining products and brands

(Erdem and Sun 2002). These spillover risks are bi-directional: when one product under the corporate umbrella fails or suffers from lower quality evaluations, or when the corporate umbrella is negatively affected, both the corporate brand and other portfolio brands can weaken from the addition of negative associations (Roedder-John et al. 1998). Dilution risks in the BH are also heightened since the meanings of all new offerings must be accommodated under the umbrella brand (Keller and Sood 2003). The BH also has higher brand stretch risk in light of brand meaning constraints on market opportunities imposed by the parent brand (Aaker 2004b).

Cannibalization risk, on the other hand, is alleviated as there exists but one operative brand.

The independent, multi-brand structure of the HOB, in contrast to a BH, offers great risk protection. The HOB offers tactical flexibility and increased market coverage, thus yielding lower vulnerability and volatility in expected cash flows overall. Without the constraints on positioning that are imposed by the corporate brand in the branded house strategy, the house of brands can readily take advantage of emergent market opportunities, and respond with new offerings to market evolution and change. More specifically, this strategy minimizes the risk of brand dilution since each offering is separate and unique in terms of market segmentation,

Marketing Science Institute Working Paper Series 17 targeting and positioning. Reputation risk is lower since spillover is controlled through the use of isolated, stand-alone brands. The HOB minimizes stretch risk since additional offerings can be created to respond to changes in markets and consumer tastes. Because of the possibility of micro-targeting within a given product category (e.g., P&G’s Tide, Cheer, Gain, and Era laundry detergents), the HOB does expose the firm to higher levels of brand cannibalization risk arising from switching among the company’s brands (Van Heerde, Srinivasan, and Dekimpe 2010).

Our summary logic (see Table 2) suggests that markets do appropriately value the HOB strategy and leads us to clearly favor the HOB over the BH in terms of idiosyncratic risk control:

H2: The house of brands is associated with lower idiosyncratic risk than the branded house.

Sub-branding: some returns advantages with a little risk control

Sub-branding (SB) is a strategy that attempts to draw benefits from the BH philosophy while gaining leverage offered in secondary brands. A key motivation for SB is to gain some supply- side economies in marketing, communication, operations and distribution through associations with the corporate brand while also benefiting from demand-side advantages associated with targeting segments with optimized and distinctive brands (Aaker 2004a). Since two brands are developed and maintained in a SB strategy, supply-side advantages are clearly inferior to those of the BH. Demand-side advantages, however, are much greater: SB allows the opportunity to customize brand meanings and offerings and target niche segments, albeit with less precision than a pure HOB. Through the opportunity for both demand- and supply-side economies, cash flow advantages accrue from SB that are not delivered through a pure BH. Our summary logic comparing these two strategies across the six returns factors (see Table 1) leads us to hypothesize:

H3: Sub-branding is associated with higher abnormal returns than the branded house.

Perhaps more salient to managers who opt for a SB strategy is the promise of the risk control afforded over the BH. Because all sub-brands maintain a strong connection to the corporate brand, SB still exposes the firm to the reputation risks that plague the BH. But the secondary

Marketing Science Institute Working Paper Series 18 brand under the umbrella offers a buffer and some risk protection, diverting attention in a crisis or quality failure situation away from the corporate brand. The number, salience and strength of associations between the corporate and sub-brand can control the directionality of spillovers such that damage to the corporate brand is limited when a sub-brand fails (Lei et al. 2008). Dilution risks are similarly buffered through SB, wherein meaning associations for the secondary brand offering remain somewhat isolated from the corporate brand (Milberg, Park, and McCarthy

1997). SB also controls brand stretch risk relative to a BH due to flexibility in modifying the corporate master brand through offerings with new attribute and benefit associations (e.g.,

Timberland Mountain Athletics, Timberland Earthkeepers) or that signal a different category, market segment, or business unit (e.g., Microsoft PowerPoint and Word). Brand cannibalization risks, in contrast, are greater with SB than BH because the sub-brands (e.g., Apple IPod Nano and IPod Shuffle) compete for consumer’s attention and purchase dollars when the corporate master brand plays the purchase driver role (Aaker 1997). Sub-brands also often include value- based offerings, which tempt cannibalization of higher-margin items (Dolan 1995). Summarizing across these risk factors (see Table 2), we expect:

H4: Sub-branding is associated with lower idiosyncratic risk than the branded house.

Endorsed branding: the best of all worlds

Managers consider endorsed branding (EB) a “Best of All Worlds” portfolio option that, like

SB, grants benefits derived from both the BH and HOB philosophies, but with an even greater cushion against risk. More specifically, EB offers: (1) demand-side returns advantages that come from the ability to address different segments through unique brands; (2) demand-side returns advantages from increased awareness and trial of new products generated through association with the corporate brand; (3) supply-side returns advantages that accrue from efficiencies in marketing spend on the corporate brand; and (4) strong risk control benefits from a strategy that maintains but a distanced association with the corporate brand. Consequently, the EB is expected

Marketing Science Institute Working Paper Series 19 not only to outperform the other two-brand alternative—SB—in its risk profile, but also to improve upon the HOB option by delivering more favorable returns.

EB seeks the advantages of having a known organization back the brand but unlike SB, tries to minimize any association contamination and hence mitigate risk (Rajagopal and Sanchez

2004). Endorsed brands, by squarely shifting focus away from the corporate brand to a second, super-ordinate brand, are intended to lessen brand dilution and brand reputation risks while preserving the desired effects of corporate brand association (Park, McCarthy, and Milberg

1993). Vis-à-vis SB, EB also offers a greater chance for each brand to build its own identity

(Dooley and Bowie 2005), resulting in lower brand stretch risk. Our summary logic (see Table 2) leads us to favor EB over SB in terms of idiosyncratic risk control:

H5: Endorsed branding is associated with lower idiosyncratic risk than sub-branding.

Per our prior discussion, the HOB also stands as an effective risk control strategy, but this benefit comes with a significant hit to returns. EB seeks improvements in returns performance versus the HOB through the use of both umbrella and prominent secondary brands (see Table 1).

Emphasis on secondary brands that can capitalize on market segmentation opportunities and optimize offerings for specific targets grants demand-side advantages, albeit at lower levels than the HOB strategy that brings to market only stand-alone brand offerings. Distanced association with the corporate brand permits additional returns benefits versus HOB, however, granting limited supply-side advantages in marketing and operations spend. Still, EB bears significant bottom-line costs and inefficiencies as companies struggle to support adequate investments in and operations for their portfolio of secondary brands (Dooley and Bowie 2005). These supply- side diseconomies of scale in marketing, administrative, and operations are not as high as under a

HOB wherein every offering must stand on its own with sufficient investment, but they are significant. Noting that investors value supply-side efficiencies over demand-side advantages

(Srinivasan et al. 2009) and summarizing across these supply- and demand-side factors (see

Table 1), we hypothesize:

Marketing Science Institute Working Paper Series 20 H6: Endorsed branding is associated with higher abnormal returns than the house of brands.

Hybrid: improved performance through complementarity

The hybrid strategy provides the most flexibility of all portfolio structures, and allows the firm to selectively leverage particular brand entities to address emergent and conflicting strategy needs (Rajagopal and Sanchez 2004). The financial performance of a hybrid portfolio will vary according to its composition since each strategy possesses a unique profile of demand- and supply-side costs and advantages, and exposes the firm to different sources and levels of risks.

As mentioned earlier, Franzen (2009) defines the hybrid using the most common BH-HOB strategy combination. We accordingly focus our hypotheses on this particular hybrid form.

The BH-HOB hybrid typically manifests due to conflicts between a stock market that commands growth through refined brand positionings against incremental targets and a company that recognizes the need to protect a central asset, the corporate brand. The Coca-Cola Company provides one such exemplar, wherein the flagship corporate brand, Coke, was fiercely protected while a HOB arsenal (e.g., Tab, Sprite, Fanta) was cultivated to take advantage of new tastes.

Mergers and acquisitions, again serving growth goals, exacerbate the BH-HOB combination as new products are continually added to the HOB list (e.g., Glaceau VitaminWater, Odwalla,

Schweppes).

As a combination of strategies at the extremes of the portfolio continuum, the BH-HOB hybrid can be expected to deliver performance improvements over its two ingredient strategies: one of which (BH) is disadvantaged in terms of higher risks and the other (HOB) that is burdened through lower returns. As Tables 1 and 2 illustrate, we expect a combination of these two strategies to reduce the risk exposure of the BH strategy through stand-alone brands that mitigate dilution, reputation, and brand stretch risk while also improving the returns profile of the HOB through the addition of marketing efficiencies on the supply-side.

H7: The hybrid is associated with higher abnormal returns than the house of brands.

Marketing Science Institute Working Paper Series 21 H8: The hybrid is associated with lower idiosyncratic risk than the branded house.

Data and Operationalization of Variables

Sample

Our initial sample consists of 400 firms using data obtained from multiple sources. The

CRSP financial dataset provides monthly stock returns (January 1996 - December 2006) for all companies. We obtain monthly data for the Fama-French/Carhart factors from French’s website.i

Accounting and financial data are obtained from COMPUSTAT. We conducted an extensive coding of the brand portfolio strategy of each firm, described in detail below, using various primary and secondary data sources.

From our initial sample of 400 firms, we excluded 94 companies for reasons that precluded clean classification of the firm’s brand portfolio strategy in the timeframe under consideration: insufficient or missing data, intractable corporate structures (e.g., predominance of partially- owned subsidiaries), illegal accounting activity (e.g., Enron), and or, in the case of mergers and acquisitions or new product introductions that precipitated a shift in brand portfolio strategy and were consequential, i.e. such activity contributed more than 1% of total firm revenues over the duration of the data. Our usable sample consists of 306 firms representing the following industry sectors: Manufacturing (50%), Retail Trade (14%), Information (8%), and Finance & Insurance

(8%) and other (20%). Our sample compares favorably with S&P 500 firms in terms of two critical performance variables, stock returns and operating margins: the multivariate T-test results in a Hotelling’s T2 value of 2.379, which is not significant.

Operationalization of brand portfolio strategy

We considered leverage of the corporate brand name in qualifying options along the brand portfolio spectrum. Corporate brand leverage was operationalized using two indicators: (1) the percent of revenues attributed to products and services bearing the corporate brand name, and (2)

Marketing Science Institute Working Paper Series 22 the visibility, emphasis, and prominence of the corporate brand name on branded products and services, packaging, and marketing communications. Our portfolio strategy classification exercise included a strict company-by-company analysis using databases including Datamonitor,

Nielsen, LexisNexis, Wikiinvest, United States Securities and Exchange Commission (SEC),

Mergent Online, Hoover’s Online, and Mintel as well as company websites, news articles, product brochures, and annual reports. Four MBA students coded firms independently using a sequential process to classify a firm’s brand portfolio strategy in terms of the above variables.

The coders, plus a team of three academic researchers, met as a panel to review data and recommended classifications for each firm and to negotiate final portfolio strategy codes. Final coder agreement was 98%.

Classification decisions proceeded as follows. First, coders examined every resource listed above to determine the different branded product and service offerings marketed by the firm during the research time period. This task was complex as many firms participated in both business-to-business and business-to-consumer markets using as many as hundreds of customer- facing brands. As a second step, we calculated the percentage of revenue derived from products and services bearing the corporate brand name. Revenue from corporate branded products and services was defined as any revenue generated by a product/service which displayed a corporate name or symbol on the product/service or its packaging, irrespective of the dominance or prominence of the corporate brand name or the presence/absence of any other brand. If 0% of firm revenues derived from products/services bearing the corporate name in any capacity, the firm was coded as adopting a HOB strategy (e.g., Yum! Brands).

If 100% of the firm’s revenues derived from products/services bearing the corporate brand name, the branded offerings were then closely examined to determine if the strategy was more appropriately considered a BH, SB, or EB. Firms with branded offerings identified only by the corporate brand or by the corporate brand plus product or model descriptors (e.g., Adobe

Systems, Boeing Company), were classified as adopting a BH strategy. If two brands were used

Marketing Science Institute Working Paper Series 23 as part of the naming convention—the corporate brand plus some other second brand—we considered the visibility, emphasis, and prominence of the corporate brand as indicated by various factors including font styles, the relative size of fonts, and the order or placement of brand names on the package as foreground versus background (Keller 1999). Strategies in which the corporate brand was dominant and prominent on all offerings (e.g., Intel), or received equal visibility to the second brand (e.g., Apple IPod), were coded as adopting SB. Strategies in which the corporate brand was always sub-ordinate to a more prominent and dominant second brand

(e.g., Post-It and 3M Corporation) were coded as adopting EB.

The hybrid strategy included firms which derived 1%-99% of revenues from products bearing the corporate brand name and could not be classified using the above coding rules.ii In line with Franzen’s (2009) definition of hybrid as including some combination of brand portfolio strategies, data for these firms was scrutinized to confirm that the companies went to market using two or more portfolio strategies.

The brand portfolio strategies in the final sample of 306 firms are: 86 firms (28%) BH, 30 firms (10%) SB, 18 firms (6%) EB, 38 firms (12%) HOB, and 134 firms (44%) with the hybrid strategy. Within hybrid, the breakdown is as follows: 91 firms (68%) with a combination of BH-

HOB; 12 firms (9%) with BH-EB-HOB; 11 firms (8%) with BH-SB-HOB; 11 firms (8%) with

SB-HOB; and 9 firms (7%) across all remaining strategy combinations. To test hypotheses about the hybrid strategy while controlling for differences that manifest among variants of the strategy and providing expositional clarity, we focus on the most common manifestation and consider only the 91 firms (68%) that adopt a combination BH-HOB strategy approach. Firms with other hybrid combinations serve as the baseline in our model. Our final sample composition across strategies compares favorably with Rao et al. (2004) and is in line with industry reports on brand portfolio strategies among contemporary firms (Franzen 2009; Laforet and Saunders 1994).

Marketing Science Institute Working Paper Series 24 Marketing, accounting, and firm control variables

We include marketing, accounting and firm drivers as control variables, following previous research. We control for a firm’s advertising expenditures since research has shown that advertising increases stock returns (Joshi and Hanssens 2010), increases idiosyncratic risk

(Osinga et al. 2011) and lowers systematic risk (McAlister et al. 2007). We control for the number of brands in the portfolio because investors value the marketing synergies afforded to firms with a larger number of brands (Morgan and Rego 2009). We consider brand equity because strong brands have been shown to generate higher abnormal returns with less risk

(Madden et al. 2006).

Accounting drivers include operating margins, sales growth rate, profit volatility, leverage, and dividend payouts. Previous research has demonstrated the link from operating margins to stock returns (Pauwels et al. 2004). Both sales growth rate and dividend payouts are valued by shareholders and influence the stock returns and risks (Luo and Bhattacharya 2009). Profit volatility reflects the uncertainty of future cash flow and is related to both returns and risk

(Morgan and Rego 2009). Leverage is also included following previous research in finance and marketing connecting leverage to risk (Rego et al. 2009). Firm drivers include firm diversification, business type (B2B versus B2C), and industry sector. We control for firm diversification as measured by the number of segments in which a firm operates since investors appreciate the economies-of-scale and scope afforded to diversified firms operating across sectors (Morgan and Rego 2009). We examine whether there is a difference in abnormal returns and risk for B2B versus B2C firms building on an implication from Rao et al. (2004). Finally, to control for industry-specific effects, we include sector dummy variables shown to explain variations in shareholder value and risk (Short et al. 2007). The measurements, data sources, and literature sources for control variables in our research are provided in Appendix.

Marketing Science Institute Working Paper Series 25 Research Methodology

Assessing the impact of brand portfolio strategy on stock returns and risks

Our methodology proceeds in two steps. First, we estimate the well-established benchmark in finance, the four-factor explanatory model, to obtain three components of shareholder value: levels of abnormal returns, systematic risk, and idiosyncratic risk. Next, we assess the impact of brand portfolio strategy on each of these components estimated in the first stage.

Step 1: Assessing stock returns and risks. The starting point for obtaining return and risk components is the Carhart four-factor explanatory model (Carhart 1997) estimated as follows:

R  R    (R  R )  s SMB  h HML u UMD  it rf ,t i i mt rf ,t i t i t i t it (1)

where Rit is the stock return for firm i at time t, Rrf, t is the risk-free rate of return in period t, Rmt is the average market rate of return in period t, SMBt is the return on a value-weighted portfolio of small stocks minus the return of big stocks, HMLt is the return on a value-weighted portfolio of high book-to-market stocks minus the return on a value-weighted portfolio of low book-to- market stocks, and UMDt is the average return on two high prior-return portfolios minus the

iii average return on two low prior-return portfolios. The parameter i captures abnormal stock returns that should not be present in the case of an efficient market. The parameter i measures

2 the impact of the systematic risk on the firm. Finally, the variance of the residuals ( it ) is a measure of idiosyncratic risk. Marketing acts on the unanticipated components of levels and volatility of stock returns. From a finance perspective, such efforts complement the Carhart four- factor financial model because they demonstrate how firm-specific managerial actions (e.g., brand portfolio strategy) can either add or subtract shareholder value.

The dependent variables of interest—stock returns, idiosyncratic risk and systematic risk

—are inherently long-term constructs whose changes manifest slowly over time (Braun, Nelson and Sunier 1995). Ghysels (1998) argues that since systematic risk changes slowly over time, an overly volatile measure might lead to worse predictions than a model with a static effect. The

Marketing Science Institute Working Paper Series 26 risk parameters in both the CAPM and four-factor model have been frequently estimated over long data windows. For example, Carhart (1997) uses 30 years of data with differing portfolios while McAlister et al. (2007) use 5-year moving windows of firm-level data to estimate CAPM.

We base our specifications for returns and risks on the moving-window methodology to capture the dynamic patterns in these measures over time. Specifically, we use monthly stock returns of each company and three-year moving windows to estimate the dependent variables, resulting in up to nine observations per firm. For the first window, we use the data from 1996-1998, for the second window we use data from 1997-1999, and so on. For the final window, we use data from

2004-2006. This allows us to obtain time-varying estimates of stock returns and risk which we relate to brand portfolio strategies while controlling for the dynamic changes in drivers such as advertising, operating margins, and other firm and industry controls.

Step 2: Assessing the impact of brand portfolio strategy on stock returns and risks. We assess the impact of brand portfolio strategy on components of shareholder value obtained from the first stage. We consider five brand portfolios (BH, SB, EB, HOB, Hybrid) and eleven control variables from marketing, accounting, and firm drivers, as mentioned above. This results in the following system of equations:

Marketing Science Institute Working Paper Series 27

where iw is abnormal returns for firm i at window w, iw is systematic risk for firm i at

2 window w, iw is idiosyncratic risk for firm i at window w, j denotes the industry sector, and BH,

SB, Hybrid, EB, and HOB are the dummy variables for the various portfolio strategies.iv In order to account for uncertainty in parameter estimates of dependent variables, we use weighted least squares estimation for the three second-stage equations (Srinivasan et al. 2004) with weights as the inverse of the standard errors of the dependent variable. We use the bootstrap method

(repeating 1000 times) to obtain corrected standard errors (see Appendix A.2 in Nijs et al. 2007 for details).

Table 3 summarizes our contributions to theory and method in the marketing-finance literature using relevant published benchmarks.

Empirical Results

Table 4 provides descriptive statistics and correlations among the variables in the data set.

The variance inflation factors (VIF) range from 1.10 to 3.26, which indicates that

Marketing Science Institute Working Paper Series 28 multicollinearity among the variables is not an issue in the model. We present the performance results of the brand portfolio strategy models in Table 5.v In testing hypotheses regarding the effects of brand portfolio strategies on returns and firm-specific risk, we perform t-tests to compare regression coefficients as shown in Table 6. We also share results for systematic risk in an exploratory spirit to illuminate this first-ever investigation of brand portfolio strategy effects on firm risk.

Tests of hypotheses

Our results as shown in Table 6 show that BH has marginally-higher abnormal returns relative to HOB (BH: 0.558 vs. HOB: 0.312, p < .10), lending only directional support to H1.

Thus we cannot support Rao et al.’s (2004) finding concerning BH out-performance on Tobin’s q and their contention that expected supply-side advantages outweigh any demand-side disadvantages the BH strategy creates. More importantly, the HOB strategy delivers lower idiosyncratic risk as compared to the BH strategy (HOB: 0.385 vs. BH: 1.823, p < .01), supporting H2. This result suggests that the cannibalization consequences of the HOB are overcome through the minimization of brand dilution risk, brand reputation risk, and brand stretch risk, yielding lower levels of idiosyncratic risk overall. Thus, counter to the contention of

Rao et al. (2004), the financial markets do appropriately value the HOB in terms of risk control.

Interesting results are obtained for the SB strategy. SB is associated with significantly higher abnormal returns than a BH strategy, lending support to H3 (SB: 0.993 vs. BH: 0.558, p < .05).

This implies that investors likely appreciate that SB synergistically enhances demand-side benefits afforded by the ability to partially customize brand offerings and target niche market segments while maintaining some of the supply-side scale and scope economies afforded by use of a unified corporate brand. However, H4 is not supported. Adding a sub-brand does not reduce risk exposure to the parent brand as would be expected: SB is associated with higher, not lower, idiosyncratic risk relative to a BH (SB: 4.296 vs. BH: 1.823, p < .01). This finding also

Marketing Science Institute Working Paper Series 29 challenges the implicit assumption that there exists a linear ordering of risks from highest to lowest along the BHHOB continuum with SB being placed sequentially after BH in this list.

Results also suggest the EB may not be perceived in the financial community as the “Best of all Worlds” strategy that managers intend. In line with H5, EB does lower idiosyncratic risk relative to SB (EB: -0.004 vs. SB: 4.296, p < .01). This finding suggests that investors recognize that in shifting focus away from the corporate brand to a super-ordinate endorsed brand, reputation risk, dilution risk and brand stretch risk are mitigated. In fact, EB provides risk control benefits similar in magnitude to the independent HOB (EB: -0.004 vs. HOB: 0.385, p > .10).

However, this risk control comes with a significant hit to returns. As shown in Table 6, we find that the EB strategy is not associated with significantly higher levels of returns relative to the

HOB strategy (EB: 0.162 vs. HOB: 0.312, p > .10); H6 is not supported. Thus, the supply-side benefits that derive from leverage of a shared corporate brand are smaller with EB than anticipated, a likely result of the fact that the corporate brand connection is distanced, weak, and in a sense opportunistic, which, when combined with the requirement for significant incremental investment to sustain a stable of secondary brands, results in lower returns. This finding also challenges popular wisdom that there exists a linear ordering of returns from BHHOB with EB being placed sequentially along the continuum.

Finally, we find that the hybrid strategy does not offer consistent performance improvements over the component strategies of which it is comprised. The BH-HOB hybrid does not offer returns advantages versus the HOB (Hybrid: 0.097 vs. HOB: 0.312, p > .10; H7 is not supported) but it does improve the firm’s idiosyncratic risk profile versus the pure BH strategy (Hybrid:

0.522 vs. BH: 1.823, p < .01; H8 is supported). In fact, hybrid is tied with EB and HOB for the lowest levels of returns among the five branding strategies (Hybrid: 0.097 vs. EB: 0.162 and

HOB: 0.312, p > .10). Per this finding, the corporate brand component of the hybrid portfolio is likely overwhelmed by the independent brand elements in sheer numbers, canceling out any

Marketing Science Institute Working Paper Series 30 possible supply-side benefits to returns. The last two columns in Table 6 provide a summary of our results and a comparison with published findings in the extant literature.

Systematic risk results

Patterns for systematic risk mirror those for idiosyncratic risk with one exception pertaining to the performance of the hybrid. We find that SB is associated with the highest systematic risk, hybrid and BH are associated with intermediate levels of systematic risk, and the HOB and EB have the lowest systematic risk compared to other strategies (see Table 5).

The SB strategy generates significantly higher systematic risk than the house of brands, offering additional empirical support for managerial “gut level” theories that caution against unifying branded offerings under one corporate umbrella (Aaker 2004a, b). This finding is also in line with financial research supporting higher risks in conjunction with greater returns

(Ghysels, Santa-Clara, and Valkanov 2005). Interestingly, the BH-HOB hybrid exposes the firm to as much systematic risk as does the “all eggs in one basket” BH approach.

Overall, the findings on systematic risk suggest that it is only via portfolio strategies that decidedly and forcefully pursue new segments, industries, and targets through prominent secondary or fully-independent brands (i.e., EB and HOB) that the firm grants protection from market and industry risk sources, possibly through the logic of diversification of risks.

Results for control variables

With respect to the marketing control variables (see Table 5), results suggest that increasing advertising expenditure enhances stock returns (1.964, p < .05), lowers systematic risk (-1.185, p

< .01) and increases idiosyncratic risk (3.966, p < .05). Our finding on advertising generalizes

Osinga et al.’s (2011) findings by expanding the result to industry settings beyond the pharmaceutical sector. Findings also suggest that an increase in the number of brands that a firm maintains in its portfolio is associated with lower levels of systematic risk, with significant but

Marketing Science Institute Working Paper Series 31 small effect sizes (-0.0004 and p < .10). We support Morgan and Rego’s (2009) conclusion that the number of brands in a portfolio matters. In addition, strong brands have lower systematic (-

0.139, p < .01) and idiosyncratic risks (-0.463, p < .05) as compared to weak brands in line with

Madden et al. (2006). Importantly, we show that brand portfolio strategy affects risk/return profiles over and above the effects of marketing control variables.

For the accounting control variables (see Table 5), we find that higher operating margins are associated with higher returns (2.082, p < .01) consistent with Srinivasan et al. (2009) and lower levels of both systematic (-0.575, p < .01) and idiosyncratic risk (-2.502, p < .01). Sales growth rate is positively associated with stock returns (4.103, p < .01) suggesting that investors reward growth in sales because returns are expected to grow as well. As expected, profit volatility is positively associated with both systematic (2.375, p < .01) and idiosyncratic risk (29.57, p < .01), and leverage is positively associated with idiosyncratic risk (1.254, p < .01). Finally, dividend payouts are negatively associated with returns and idiosyncratic risk with small but significant effect sizes (-0.0001, p < .01 and -0.0004, p < .01, respectively).

With respect to the firm controls (see Table 5), our results on firm diversification support the logic of finance and indicate that firms operating in a large number of segments have higher abnormal returns (0.013, p < .10), lower systematic risk (-0.007, p < .05), and lower idiosyncratic risk (-0.084, p < .01). These findings suggest that investors also appreciate the ability of the firms to diversify by spreading risks across customer groups in multiple segments. Such realized benefits of diversification from segment effects validate the findings of Baca, Garbe, and Weiss

(2000) in major equity markets. Our findings suggest that pure B2C firms have higher idiosyncratic risk (0.581, p < .05) relative to other firms. B2C firms are more likely to rely on a larger number of customers for their revenues, exposing them to higher levels of risk. In general, we find that our main results hold above and beyond the effects of B2B vs. B2C firms.vi Finally, the industry-specific effects captured via the sector dummy variables also explain variations in risk consistent with previous literature (Steliaros and Thomas 2006). However, our findings

Marketing Science Institute Working Paper Series 32 encourage reconsideration of the assumed dominance of sector effects in driving risk results: we find risk differences for brand portfolio strategies after controlling for sectors.

Test of endogeneity

The paper’s central hypothesis is that the firm’s brand portfolio strategy influences the components of firm value, above and beyond the known impact of other important variables such as the firm’s net operating income. However, one could also construct an argument in favor of the reverse causal effect: for example, a firms’ brand portfolio strategy is based in part, on that firm’s value. Specifically, marketers may want to incorporate investor behavior in their actions, realizing that there may be a “reverse causality” between marketing and firm performance

(Markovitch, Steckel and Yeung 2005). Under the reverse-causation scenario, brand portfolio strategy is endogenously determined; that is, the company applies the specific brand portfolio strategy in response to investors’ action as opposed to investors reacting to brand portfolio strategy information in their stock evaluations.

We tested for the presence of endogeneity using the Hausman-Wu test and Durbin-Wu-

Hausman test (Davidson and MacKinnon 1993; Gielens and Dekimpe 2001; Rinallo and Basuroy

2009). Drawing upon empirical research in this area, we use five instruments to assess endogeneity. The approach builds from the observation that a firm’s level of marketing spending is related to its branding strategy (Bahadir, Bharadwaj, and Srivastava 2008; Krasnikov, Mishra, and Orozco 2009). We use revenues, total assets, selling and administrative expenses, market-to- book ratio, and acquisition expense as instruments and include all the other variables in the test equation.vii For equation (2a), the Wu-Hausman test and Durbin-Wu-Hausman tests both fail to reject the null hypothesis of no statistical difference between estimators of exogenous model and

2 estimators of endogenous model (F(5, 1059) = 1.701 and χ df=5 = 8.645, respectively). For equation (2b), both tests again fail to reject the null hypothesis that parameters of endogenous

2 and exogenous models are statistical the same (F(5, 1059) = 1.233 and χ df=5 = 6.278,

Marketing Science Institute Working Paper Series 33 respectively). For equation (2c), the Wu-Hausman test (F(5, 1059) = 1.932) and Durbin-Wu-

2 Hausman test (χ df=5 = 9.807) once again fail to reject the null hypothesis. We conclude that endogeneity does not present a serious problem, indicating that our findings are robust to this issue.

Robustness checks

We assess the robustness of our findings to various issues: (i) the size of the moving window

(2-year and 5-year versus the reported 3-year window), (ii) inclusion of R&D expenditure as a proxy for new product activity (Kelm et al. 1995),viii and (iii) potential autocorrelation arising from the moving-window estimation.ix Per validation exercises reported in the web-based

Technical Appendix, in all instances, our substantive findings are found to be robust.

Conclusions and Implications

In response to recent calls for studies exploring the linkage between marketing strategy and firm value (Hanssens et al. 2009), this paper leveraged a sample of 306 firms and eleven years of data to gauge the impact of brand portfolio strategy on abnormal returns and risk. As a primary contribution, we add critical yet ignored risk components to our models, thereby framing brand strategy decisions more formally in risk management terms (cf. Madden et al. 2006). By considering risk as well as returns, we are able to offer more valid findings concerning the financial performance of the different brand portfolio strategies that managers use to organize and structure their companies’ brands.

Our study supports that risk/return profiles differ significantly and substantively across alternate brand portfolio strategies. To gauge the economic significance of our findings, consider the following application. Let us assume that in January 1996 a person invested $1,000 in five portfolios of firms with the different brand portfolio strategies. By December 2006, an investment in SB companies would have more than tripled to $3,690 (see Panel A in Figure 4).

Marketing Science Institute Working Paper Series 34 This same $1,000 investment in BH companies would have approximately doubled to yield

$2,080 by year-end 2006. In contrast, with the HOB, the $1000 investment would have increased by only 50% to $1,510. Finally, for the EB and hybrid portfolios, the $1000 investment would have resulted in only insignificant increases to $1,240 and $1,140, respectively. This application provides a clear and tangible demonstration of the shareholder value created through the discipline of branding.

A second contribution of our research is the development of an integrative conceptual framework that links brand portfolio strategies to firm value. This framework identifies two mechanisms by which brands drive the components of shareholder value: the cash flow perspective, which views brand as an asset enhancing firm value directly through its effects on cash flows, and the signaling perspective which views brands as visible signals of financial well- being of a firm. Our most significant conceptual contribution is the delineation of four types of brand-relevant idiosyncratic risk that may be exacerbated or controlled through brand portfolio strategy: brand reputation risk, brand dilution risk, brand cannibalization risk, and brand stretch risk. This taxonomy is critical for building hypotheses regarding the differential effects of brand strategies on firm-specific risks. Very few marketing papers have considered risk within the brand-shareholder value environment, and those that do view brands merely as wholesale insurance-like protection mechanisms that help firms weather difficult times and confront equity challenges. Our framework offers a more refined perspective on the brand-shareholder value link that provides diagnostic insight into the different ways in which brand strategies can both increase and decrease risk.

A third contribution is substantive and derives from our informed conceptual framework.

Our findings inform theories-in-use concerning the relative risk-reward profiles of popular brand portfolio structures, and in several cases, expose this logic as flawed. Most significantly, SB does not control risk versus the BH and in fact exacerbates it, generating the highest idiosyncratic and systematic risks of all portfolio strategies. Two different forms of sub-branding

Marketing Science Institute Working Paper Series 35 may be implicated in this result: value-based sub-branding intended to gain access to lower- priced markets, as with Mercedes C-Class or Kodak FunTime film, and up-market sub-branding which extends the reach of the corporate brand into higher-priced markets, as with the $75,000

Volkswagen Phaeton. The main empirical finding suggests that value-based sub-branding may be considered particularly risky by financial markets which view such offerings as exposing the firm to increased risks of brand cannibalization and brand dilution (Aaker 1997). In addition, upscale access may also be risky when it stretches the brand beyond its natural boundaries

(Fournier and Vogels 2007). The presence of sub-brands may thus offer managers a false sense of protection against cautions not to overextend the corporate brand. This can—ironically— encourage broader participation in markets with incompatible or conflicting brand associations, thus worsening brand dilution risk.

Another anomaly concerns the performance of the EB strategy. Results show that EB does reduce idiosyncratic risk versus SB, as intended, and provides risk control benefits similar in magnitude to the stand-alone HOB. But EB comes with a hit to returns that managers may not anticipate, all else being equal, generating performance in the lowest rung in terms of abnormal returns. This finding calls into question popular recommendations in favor of controlled but distanced corporate brand connections such as in “Dewalt by Black & Decker” (Dolan 1998) that are thought to facilitate new product launch and maximize sales (Keller 1999).

The hybrid also performs in ways counter to hypothesized effects. The BH-HOB hybrid strategy, the most common portfolio approach in our database, proves a poor scenario in terms of financial performance, with returns in the lowest performance tier at moderate levels of risk.

Underperformance may reflect that the hybrid manifests as an ad-hoc manifestation through mergers and acquisitions rather than as a strategic decision to optimize brand performance results.

It is also interesting to consider that the hybrid, which consists of a mix of different portfolio strategies, does not behave as one would expect a diversified financial portfolio to behave

(Rubinstein 2002). That the stock portfolio analog is not operative in the marketing context

Marketing Science Institute Working Paper Series 36 suggests that mixing branding strategies is inherently more complicated than mixing financial assets to balance returns and risks.

Fourth, our research contributes to branding theory more generally by refining the conceptualization and operationalization of portfolio options along the BH-HOB continuum to consider an expanded five-category model of effects. As our results make evident, the pure (BH) versus superordinate (SB) versus subordinate (EB) use of a corporate brand linkage has important, differential effects on returns and risks. Further, our finding that SB outperforms the pure BH strategy suggests that Rao et al.’s (2004) result concerning the outperformance of the

BH strategy was likely driven by the SB variant within strategies that leverage a corporate brand connection, rather than by the pure BH itself. Our results involving the five-part scheme also reveal that risk-return profiles do not proceed as expected along the continuum in an ordered, linear manner. Our empirical results show that strategy effects are non-linear (see panels B and C in Figure 4), shedding new insights on branding risks and rewards.

Lastly, our research informs the general question of whether the financial markets appropriately value brand portfolio strategies and recognize the advantages and disadvantages the various options entail. Counter to Rao et al. (2004), who concluded that “the investor community might underappreciate that a multitude of brands (i.e., a house-of-brands strategy) distributes risks” (p. 139), our findings suggest that the reduced branding-related risks associated with the HOB strategy are communicated to investors via the brand-as-information route.

Generally, our results support sophistication within the financial community concerning the risk/return profiles of different brand portfolio options and inform theories-in-use about the value profiles of strategies that connect and leverage both separate and corporate brands.

Limitations and Future Research

Our research has limitations that warrant consideration in future research. We study manifest branding strategies as revealed through customer-facing product identification cues and brand

Marketing Science Institute Working Paper Series 37 presentations on packages, store shelves, company communications, and corporate websites.

However, brand strategies as received by consumers may differ from revealed managerial intent.

Future research that clarifies manifest versus received portfolio strategies would be useful in understanding brand portfolio effects. Also useful would be a customer-centric classification scheme for portfolio strategies that incorporates the brand driver role in addition to visual/verbal cues of brand dominance and prominence (Aaker 2004a).

Our research also highlights the difficulty of classifying a company’s brand portfolio strategy based on marketplace data and perceptual clues. Our coding exercise was protracted, time intensive, and complicated. An investor or analyst seeking to qualify the risks associated with a firm’s portfolio strategy may not readily conduct such analyses in the normal course of daily operations, yet such information is critical when evaluating firm risk. We came across only two company examples that provided clear and unambiguous information about the firm’s portfolio strategy in their company annual reports: The Gap and The Coca-Cola Company. Our research sounds a call for transparency in reporting the brand portfolio strategies pursued by firms.

In addition, our coding exercise and post-hoc examinations leads us to question the degree to which brand portfolio strategies are planned, suggesting the need for focused research. This issue is particularly manifest in the hybrid strategy. Oftentimes companies shifted from a BH strategy to complex hybrids upon acquiring new brands and corporate entities, with no evidence of a deliberate or conscious strategic shift. This calls into question whether the hybrid is best considered a valid portfolio alternative or, more appropriately, a simple unintended consequence of other strategic decisions. More generally, survey research can investigate whether companies pro-actively manage their brand portfolio strategies as risk control mechanisms versus treating them as simple consequences of other choices driving corporate growth. If brand portfolio strategy is purely reactive to higher-level corporate growth goals, marketing managers lose a powerful lever for the management of risks through branding. Aaker (2004a) claimed that for

Marketing Science Institute Working Paper Series 38 most firms, the strategic management of the brand portfolio is deficient or non-existent compared to the more operational management of individual brands. Brand strategy may be strategically used to signal organizational change in post-mergers (Dinner et al. 2010). Still, this issue needs clarification if marketing is to reach its potential in the firm.

Opportunities to enhance our conceptual framework are many and also provide directions for future research. All of the factors used in evaluating the brand portfolio strategies on returns and risks were given equal weights in developing our hypotheses. Future experimental and/or survey-based research could evaluate the relative importance of each of these factors, fine-tuning the logic whereby brand portfolio strategies exert their effects. Research could also consider a multiple stakeholder perspective, incorporating the role of customer-based assets in addition to brand-based assets, for example. A relevant question might include the role of EB strategies in building customer mindset metrics such as brand familiarity and liking, and whether EB benefits are of similar magnitude to SB strategies that showcase the corporate brand. Product recalls or other shocks such as reputational crises or changes in C-level management may also influence firm performance and the interplay of these events with the different brand portfolio strategies also provides fertile ground for future research.

This research responds to increasing pressures on marketing executives to demonstrate the financial accountability of their branding initiatives. We hope this research contributes to ongoing efforts of practitioners and academics alike by underscoring the importance of assessing the contribution of brand strategy decisions in light of their impact on the firm’s ultimate goal of maximizing shareholder wealth while mitigating firm risk.

Marketing Science Institute Working Paper Series 39 APPENDIX Definitions, Measures, and Literature Sources for Dependent and Control Variables

Variable Definition Source Prior Literature Support

Abnormal returns ( ) CRSP; Kenneth Carhart i French’s website (1997); Fama

and French

Systematic risk ( i ) (1993)

Idiosyncratic risk ( it )

Advertising Measured as the ratio of advertising expenditures COMPUSTAT Srinivasan et (Ads) to total assets (AT) al. (2009); Osinga et al. (2011)

Number of brands Measured as the number of brands owned by each Hoover’s; Mergent Morgan and company Rego (2009) Brand equity Identify the brands that appeared on the Interbrand Madden et al. Interbrand Top 100 list at least once from 1996 (2006) to 2006 as strong brand Operating margin Measured as the ratio of net income before COMPUSTAT Ferreria and depreciation (NI) to sales (Sales) Laux (2007)

Sales growth rate Measured as the compound sales growth rate COMPUSTAT Barth et al. (1998); Rao et

al. (2004) Profit volatility Measured as the standard deviation of return on COMPUSTAT Luo and assets which is the ratio of net income before Bhattacharya extraordinary items (IB) to total assets(AT) (2009); Rego et al. (2009)

Leverage Measured as the ratio of total liabilities (LT) to COMPUSTAT Dewenter and total assets (AT) Malatesta (2001)

Dividend payouts Measured as the total amount of cash dividends COMPUSTAT Luo and paid (DIV) Bhattacharya (2009)

Firm diversification Measured as the number of segments in which a NAICS Morgan and firm markets its brands Rego (2009) Business type Two dummy variables indicate that the company Company website Kumar and is in business-to-business market (1,0), mixed Shah (2009) (0,0), or business-to-consumer market (0,1). Industry sector Four dummy variables indicate that the company NAICS Nijssen et al. is in manufacturing (1,0,0,0), retail trade (2003) (0,1,0,0), information (0,0,1,0) or finance & insurance (0,0,0,1).

Marketing Science Institute Working Paper Series 40 Glossary A: Brand Portfolio Strategy

Brand Portfolio Definition Example Strategy Branded House The corporate master brand acts as the single Tiffany, IBM, FedEx, (BH) unifying banner, source of reputation, and Boeing federating force for all product and service offerings in the portfolio.

Sub-branding Sub-branding engages two brand entities, a Microsoft, Bausch & (SB) corporate brand and a linked second brand. The Lomb, Intel, Apple corporate master brand and linked brand can play equally prominent roles to influence the decisions that consumers make.

Endorsed Endorsed branding involves two brands—the 3M, Intuit, Genzyme, Branding (EB) corporate master brand and a linked second brand. Bristol-Myers Squibb The second brand is clearly super-ordinate, more prominent and more visible than the corporate brand, which plays but a supportive, endorsement role.

House of A company operates entirely through an Procter & Gamble, Brands (HOB) independent set of stand-alone brands while YUM! Brands, keeping the corporate brand itself discreet. All Fortune Brands, brand equity resides expressly at the individual Darden Restaurants brand level: each individual brand stands as a central source of reputation, attention, and investment in and of itself.

Hybrid Companies using a hybrid strategy combine at least Colgate-Palmolive, two of the four portfolio options to the Black & Decker, products/services. Heinz, Hershey Food Corporation Value-based A company uses a linked second brand to gain Mercedes-Benz C- sub-branding access to lower-priced and lower-quality markets. class, Eastman Kodak FunTime film Up-market sub- A company uses a linked second brand to a new Volkswagen Phaeton, branding product line with higher price and higher quality. Dell Inspiron

Marketing Science Institute Working Paper Series 41 Glossary B: Definitions of Technical Terms

Terms Definition Example Sources of abnormal returns for the different brand portfolio strategies

Supply-side Factors Factors are related to cost reduction Economies of scale in marketing, Administrative and operating cost efficiencies, Lower costs of new brand introductions

Demand-side Factors Factors are related to revenue enhancement Ability to target niche market segments, Success likelihood for brand extensions driven through awareness and trial advantages, Opportunity to distinctly customize brands

Sources of idiosyncratic risk for the different brand portfolio strategies

Brand Reputation Risk The deterioration of overall brand quality and esteem Martha Stewart’s insider trading crisis value that derives from negative information regarding a firm’s business practices or its leadership team.

Brand Dilution Risk The loss of meanings that differentiate a brand from its Harley-Davidson aftershave and perfume competition.

Brand Cannibalization Risk The loss of sales volume, sales revenue, margins, or Coach and its new Poppy line market share of one branded product due to the introduction of a new branded product by the same firm.

Brand Stretch Risk The lack of flexibility and ability to take advantage of Xerox’s move into the computer market new market opportunities, capitalize on new technologies, or adapt to changing consumer tastes through the introduction of new, tailored brand offerings.

Marketing Science Institute Working Paper Series 42 Terms Definition Financial Terms

Capital asset pricing model CAPM takes into account a given stock’s sensitivity to systematic risk in order to describe and (CAPM) estimate stock returns. Carhart four-factor model The Carhart model is an extension of CAPM that provides estimates of four value-relevant factors in order to determine stock returns: systematic risk factor, market size factor, book-to-market factor, and momentum factor. Abnormal returns Abnormal stock return components that are the result of actions or signals include changes in marketing strategy, partnership announcements, top-management changes, advertising campaigns, new product introductions, and the like. Systematic risk Systematic risk affects a large number of assets in the economy and is generally market wide such as exchange and interest rates change, inflation, recession, and news about political events. Idiosyncratic risk Idiosyncratic risk is the part of the risk which cannot be explained by changes in average market portfolio returns but instead by firm-specific events. Macro-environmental risk Macro-environmental risk results from several types of external macro environment factors including political, economic, social, technological, environmental, and legal concerns and changes. Industry risk Industry risk results from multiple competitive forces beyond the control of the firm including raw material providers, suppliers, current and new competitors, and distribution channels. Volatility of cash flow Volatility is defined as any occurrence that creates fluctuations in cash flow. Vulnerability of cash flow Vulnerability is defined as any occurrence that negatively affects cash flow. Empirical Modeling Concepts

Endogeneity bias Endogeneity bias can pose a problem with drawing causal inferences through modeling exercises. It arises because the independent variable may be correlated with the error term in a regression model, thereby precluding definitive conclusions regarding the effect of the independent variable on the dependent variable of interest. The presence or absence of endogeneity is assessed using the Hausman- Wu test and Durbin-Wu-Hausman test (Davidson and MacKinnon 1993). Robustness check A robustness check is a common exercise in empirical modeling research, involving an examination of how the model coefficient estimates behave when the empirical model specification is modified by adding or removing regressors. If the coefficients remain plausible and robust, this is commonly interpreted as evidence of validity and robustness of the specified empirical model.

Marketing Science Institute Working Paper Series 43 Notes i http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html. ii It is important to note four exceptions (FedEx, Starbucks, 3COM, and Aflac). These firms are coded as BH versus hybrid strategies even though there are stand-alone independent brands in the portfolio that do not bear the corporate brand name. In these cases, we examine whether the contribution of standalone brands to revenues is minimal (i.e. less than 1%) over the duration of the data. As illustrations, FedEx Kinko’s generated less than 1% of the total revenue of FedEx when averaged from 1996-2006 and Seattle’s Best Coffee and Via account for less than 1% of total net revenue of Starbucks over same time period, thus justifying classification as BH. iii The parameter si indicates the extent to which the firm’s stock returns move with those from a portfolio of small stocks (higher value for si) or those from large stocks (lower value for si); similarly, hi takes on a higher value when the stock returns show more correspondence with those from high book-to-market equity firms and lower values when they are closer to the returns from low book-to-market equity firms. The parameter ui indicates the extent to which the stock returns relate to those from firms that performed well in the previous period; therefore, when a firm’s stock has momentum, we expect a positive significant estimate for ui. Short-term excess returns appear in the form of εit. iv As there are two sets of dummies in the model (i.e., brand portfolio strategy and business type), we will add interaction terms in the regression to relieve the assumption of independence of these qualitative effects (Baum 2006), and test for robustness of the overall findings (details are in web-based Technical Appendix). v We use the list-wise deletion of missing values in the empirical analysis following standard practice (Little and Rubin 2002). Since COMPUSTAT does not report advertising or accounting variables for all years for all firms, this approach leads to 1115 observations for the analysis. vi Rao et al. (2004) suggest a confound between brand portfolio strategy and the firm’s status as a B2B or B2C player. Though our sample suggests, as does that of Rao et al. (2004), that B2B firms are more likely to pursue branded house strategies, our sample diversity allows a significant number of B2C firms in the branded house strategy such that we can tease out these two effects. We find that the results of the BH strategy are not constrained to B2B firms only; the BH risk/return profile holds when controlling for B2B vs. B2C firms. vii We perform endogeneity test using the “IVREG2” and “IVENDOG” procedure in STATA 10.1. viii We use R&D to measure innovation as in Kelm, Narayanan, and Pinches (2005) paper. Since the R&D expenditures are reported in COMPUSTAT only for a subset of 197 firms, we report these results as a part of the validation exercise. x We thank an anonymous reviewer for pointing this out. As per Hanssens, Parsons and Schultz (2001), the least square regression method due to Liu and Hanssens (1982) offers the robustness and ease of use of multiple regression while avoiding the pitfalls of making inferences with autocorrelated data. Following Liu and Hanssens (1982), we proceed in two steps: (1) we find the ARMA process underlying the residuals from OLS estimation, and (2) we transform the data by these ARMA filters and re-estimated the model. Our results remain robust confirming the conclusion of Hanssens et al. (2001, p. 293) that “it is seldom necessary to engage in such an iterative procedure, though, as the OLS identification results alone are typically satisfactory.” We perform ARMA(1,0) model using the “XTREGAR” procedure in STATA 10.1 (see web-based Technical Appendix for details).

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Marketing Science Institute Working Paper Series 51 Table 1: The Impact of Brand Portfolio Strategy on Stock Returns1

Portfolio Strategy Supply-Side Demand-Side

Economies of Administrative Lower costs of Ability to target Probability of Opportunity for scale in and operating cost new brand niche market success for new distinctly marketing efficiencies introductions segments introductions customized (trial/awareness) brands

Branded house +++ ++ +++ - ++ - (BH)

Sub-branding (SB) ++ + ++ ++ ++ +

Endorsed branding + - + ++ + ++ (EB)

House of brands ------+++ - +++ (HOB)

Hybrid - - + ++ + ++

1 NOTE: (+) and (-) denote advantages and disadvantages, respectively, of the different brand portfolio strategies in terms of specific demand- and supply-side effects. The number of (+) or (-) signs denotes the extent or degree to which the advantages and disadvantages are manifest. For example, a strategy with three positives (+++) versus another with one positive (+) indicates a sizeable comparative advantage for the first strategy on a particular factor. Ratings are subjective and assigned by a panel of four judges who provided relative ratings for the strategies using a 6-point scale ranging from significant advantages (three +) to significant disadvantages (three -). To formulate the hypotheses, net effects for each strategy sum across the ratings for the six factors to obtain an overall judgment of the relative advantage or disadvantage of the strategy in terms of its effect on abnormal returns.

Marketing Science Institute Working Paper Series 52 Table 2: The Impact of Brand Portfolio Strategy on Idiosyncratic Risk2

Portfolio Brand Reputation Brand Dilution Risk Brand Brand Stretch Risk Strategy Risk Cannibalization Risk

Branded house ↑↑↑ ↑↑↑ ↓ ↑ (BH)

Sub-branding (SB) ↑↑ ↑↑ ↑ ↓

Endorsed branding ↑ ↑ ↑ ↓↓ (EB)

House of brands ↓↓ ↓↓ ↑↑ ↓↓↓ (HOB)

Hybrid ↑ ↑ ↑ ↓↓

2 NOTE: (↑) and (↓) denote the exacerbation or reduction/control, respectively, of exposure to specific sources of idiosyncratic risk for the different brand portfolio strategies. The number of (↑) or (↓) symbols denotes the degree of exposure to each firm-specific risk factor. For example, a strategy with three up arrows (↑↑↑) versus another with one (↑) indicates a sizeable comparative disadvantage in exposure to a specific risk. Ratings are subjective and assigned using a panel of four judges who rated the strategies on a 6-point scale from significant exacerbation of risks (↑↑↑) to significant reduction or control of risks (↓↓↓).To formulate the hypotheses, net effects for each strategy sum across the ratings for the four factors to obtain a summary judgment of the relative performance of the strategy in terms of its effects on idiosyncratic risks.

Marketing Science Institute Working Paper Series 53 Table 3: Comparison of Present Study with Previous Studies

Rego et Luo and Rao et al. Present al.2009 Bhattacharya 2004 Study 2009 1. Drivers of firm performance Focal driver of firm performance Customer- CSR Portfolio Portfolio brand equity strategy strategy Brand portfolio (five-category) ------ Brand-as-asset vs. Brand-as-information routes ------ Marketing components of brand risk ------ 2. Financial Performance Metrics Carhart four-factor modeling approach --  --  Abnormal returns -- --   Systematic risk/Idiosyncratic risk   --  3. Marketing Drivers Advertising --    Number of brands ------ Brand equity ------ 4. Accounting Drivers Profitability/Operating margin/Cash flow     Sales growth rate -- --   Profit volatility/Cash flow variability   --  Leverage     Dividend payouts --  --  Selling, general, and administrative spending * Market-to-book ratio/Market cap/Tobin’s q   -- * Acquisitions -- --  * 5. Firm Drivers Firm diversification     B2B vs. B2C business -- --   Industry sector  -- --  R&D --   + Firm size  -- -- * 6. Empirical Setting Number of firms 252 541 113 306 Time period 7 years 2 years 5 years 11 years +-used as part of validation checks; *- used as instruments in endogeneity tests

Marketing Science Institute Working Paper Series 54 Table 4: Correlation Matrix

Variable Mean 1 2 3 4 5 6 7 8 9 10 11 1.Abnormal returns .52 1.00 2.Systematic risk 1.02 -.09** 1.00 3.Idiosyncratic risk 9.07 .19** .39** 1.00 4.Advertising .05 -.01 -.18** -.01 1.00 5.Number of brands 30.43 .01 -.09** -.11** .03 1.00 6.Operating margin .06 .14** -.21** -.28** -.03 .12** 1.00 7.Sales growth rate .06 .32** -.03** .03 -.10 -.01 -.03** 1.00 8.Profit volatility .03 .04 .19** .48** .07** -.05 -.29** -.05* 1.00 9.Leverage .67 -.13** .08 .17 .19** -.03 -.26** -.15 .29** 1.00 10.Dividend payouts 334.6 -.06** -.13** -.22** -.07* .13** .17** -.01 -.08** .02 1.00 11.Firm diversification 7.62 -.02* -.11** -.19** .04 .01* -.05** .01 -.08** .07** .13** 1.00 *p < .05 **p < .01

Marketing Science Institute Working Paper Series 55 Table 5: Three-year Moving Window Estimation Results for Brand Portfolio Strategies Alpha (Returns) Beta (Systematic Risk) Sigma (Idiosyncratic) Branded house .558*** .195*** 1.823*** (3.66) (3.21) (6.23)

Sub-branding .993*** .338*** 4.296*** (4.79) (4.03) (10.64)

Hybrid .097 .124** .522** (.73) (2.34) (2.04)

Endorsed branding .162 -.044 -.004 (.70) (-.47) (-.01)

House of brands .312** -.083 .385 (2.13) (-1.43) (1.36)

Brand equity .048 -.139*** -.463** (.44) (-3.11) (-2.18)

Advertising 1.964** -1.185*** 3.966** (2.25) (-3.53) (2.34)

Number of brands .0003 -.0004* .0002 (.60) (-1.72) (.23)

Operating margin 2.082*** -.575*** -2.502*** (4.94) (-3.76) (-3.05)

Sales growth rate 4.103*** -.159 .948 (8.55) (-.86) (1.00)

Profit volatility 2.066 2.375*** 29.57*** (1.62) (4.73) (11.50)

Leverage -.316 -.036 1.254*** (-1.40) (-.41) (2.82)

Dividend payouts -.0001*** -.00004* -.0004*** (-3.24) (-1.85) (-5.34)

Firm diversification .013* -.007** -.084*** (1.66) (-2.03) (-5.39)

B-to-B .137 .041 .503 (.83) (.61) (1.59)

B-to-C -.155 -.005 .581** (-1.28) (-.11) (2.50)

Manufacturing .188 -.059 .083 (1.23) (-.94) (.28)

Retail Trade .319* -.127* .972*** (1.91) (-1.88) (3.04)

Information .395* -.064 .074 (1.86) (-.74) (.18)

Finance & Insurance .426* -.197* -1.571*** (1.65) (-1.88) (-3.23)

Intercept -.423* 1.165*** 5.439*** (-1.66) (11.39) (10.96) N 1115 1115 1115 R2 .143 .151 .339 F 9.906 10.590 30.580 t statistics in parentheses; * p < .10, ** p < .05, *** p < .01

Marketing Science Institute Working Paper Series 56 Table 6: Hypotheses Testing on Brand Portfolio Strategies and Comparison of Findings

Hypotheses Focal Comparison Estimates (from Test of Extant literature Table 5) significance (t statistics)

H1: The BH is associated with higher abnormal returns than Branded house vs. House of brands .558 .312 1.65* Rao et al. (2004) the HOB.

H2: The HOB is associated with lower idiosyncratic risk than House of brands vs. Branded house .385 1.823 -5.04*** NA the BH.

H3: SB is associated with higher abnormal returns than the BH. Sub-branding vs. Branded house .993 .558 2.15** NA

H4: SB is associated with lower idiosyncratic risk than the BH. Sub-branding vs. Branded house 4.296 1.823 6.31*** NA

H5: EB is associated with lower idiosyncratic risk than SB. Endorsed branding vs. Sub-branding -.004 4.296 -8.51*** NA

H6: EB is associated with higher abnormal returns than the Endorsed branding vs. House of brands .162 .312 -.62 NA HOB.

H7: The hybrid is associated with higher abnormal returns than Hybrid vs. House of brands .097 .312 -1.61 NA the HOB.

H8: The hybrid is associated with lower idiosyncratic risk than Hybrid vs. Branded house .522 1.823 -5.32*** NA the BH. * p < .10, ** p < .05, *** p < .01

Marketing Science Institute Working Paper Series 57 Figure 1: Conceptual Framework for the Effects of Brand Portfolio Strategy on Firm Value3

3 We draw upon Srivastava et al. (1998)’s framework which proposes that the value of a marketing strategy is inherently driven by (a) a reduction in RISK associated with cash flows as driven by reductions in both the volatility and vulnerability of future cash flow and (b) increases in the absolute LEVEL OF CASH FLOW through higher revenues and/or lower costs, working capital, and fixed investments. 4 The Brand as Asset route considers brands as intangible assets that increase the level of cash flows and reduce the volatility and vulnerability of cash flows to create firm value indirectly. 5 The Brand as Signal route refers to a brand’s direct influence on firm value through the signaling and communication of brand equity information to investors of the firm.

Marketing Science Institute Working Paper Series 58 Figure 2: Examples of Branded House Portfolio Strategy

Branded House Tiffany & Co. BMW FedEx

Dole Food Company Boeing IBM

Marketing Science Institute Working Paper Series 59 Figure 3: Examples of Sub-branding and Endorsed Branding Portfolio Strategies

Sub-branding Endorsed Branding Apple 3M

Intel Intuit

Marketing Science Institute Working Paper Series 60 Figure 4: Impact of Brand Portfolio Strategy on Components of Shareholder Value

Panel A: Returns on $1000 investment in each brand portfolio (1996-2006)

$4,000 $3,690

$3,500 $3,000 $2,500 $2,080 $2,000 $1,510 $1,500 $1,140 $1,240 $1,000 $500 $- Branded Sub-brand Hybrid Endorsed House of House Brands

Panel B: Idiosyncratic risk associated with each brand portfolio

4.9

3.9

2.9

1.9

0.9

-0.1 Branded Sub-brand Hybrid Endorsed House of House Brands

Panel C: Systematic risk associated with each brand portfolio 0.4

0.3

0.2

0.1

0 Branded Sub-brand Hybrid Endorsed House of -0.1 House Brands

Marketing Science Institute Working Paper Series 61