Motley Fool: Emotions count for consumers

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Since we've been running our real money Rule Shaker portfolio at the Motley Fool we've been looking for Rule Breaker companies. These are companies that are throwing away the old rules that their industries used to play by and are inventing new rules. Perhaps unsurprisingly, Rule Breaking usually concerns a new technology of some sort, and we all know that hi-tech share prices are going up through the atmosphere faster than the space shuttle.

That makes separating the wheat from the chaff rather difficult, and it is why we are trying to stick firmly to our Rule Breaker criteria, which are designed to find the companies with the genuine means to be the leaders in their industry in 10 or 15 years' time.

It is also why we haven't found any Rule Breakers to buy yet. (In fact, the portfolio only contains one company at the moment - British Telecom - and that was bought according to our Rule Maker rules.)

But no matter: buying Rule Breakers is a relatively risky business and we don't mind waiting until we are convinced that we have found the sort of company we are looking for.

One of the criteria that companies sometimes fall down on is our rule that says they must have "strong consumer appeal". Just what "consumer appeal" is has been debated regularly on the Motley Fool message boards, and opinion is still pretty much split. The question we cannot firmly answer is what, exactly, defines a "consumer".

If we stick to the generally accepted idea that consumers are those people walking along the high street looking for bargains then we will be restricting the search for Rule Breakers to companies that have a retail consumer presence. And then we will be ruling out companies like Affymetrix, which we looked at last week. In fact, we'd be ruling out pretty much the whole of the biotechnology industry.

On the other hand, we could interpret the word "consumer" to mean a company's first-line customers. So, for a biotechnology or pharmaceuticals company, it is the National Health Service, the health insurance companies and the doctors to whom we would look for consumer appeal. And for a designer or fabricator of computer processors, we would look to the makers of computing devices to find it.

Does that make sense? One of our readers cautioned us recently against confusing a company's customers with its customers' customers. One company we have examined, Solectron, sub-contracts the manufacture of electronics sub-assemblies for big-name electronics companies, and its products end up in all sorts of devices. But what consumer appeal does it have?

When we think about companies in emerging industries, the very best are indeed those that have created a genuine consumer appeal, in the traditional "end user" sense.

A great example is Intel. If you sat anyone from Fool headquarters in front of half a dozen of today's best Windows PCs, there'd be no way we could tell what make of processor is in each one without checking the technical specification. But the "Intel Inside" advertising campaign works brilliantly, doesn't it? It keeps Intel's sales and profitability going and, perhaps more important, allows Intel to keep its prices and margins above the competition.

So the real reason that consumer appeal is so important is an emotional one. We need to look for a product or service to which our "consumers" are likely to build an emotional attachment of some sort.

Computer manufacturers won't build up an emotional attachment to chip makers, but they will buy their chips if they know it will make a difference to their end users and help keep their profits up.

By the same reasoning, is anyone going to be swayed to buy a TV because it has "Solectron Inside". Or will patients demand treatments from their doctors because they have "Affymetrix Inside"? It's unlikely. In that case we should toss the whole biotechnology industry into the Rule Shaker dustbin. But we don't want to do that just yet.

So what is the answer? What consumer appeal really does is to allow a company to capture the lion's share of the market and to command premium prices for its products. So it is really a means to an end rather than an end in itself. That makes us wonder if we should look deeper than "consumer appeal" and include some aspect of "market power" or "pricing power" in our future analyses.

We're not sure yet, and any opinions from readers are most welcome on the Motley Fool message boards.