Why Iconic Brands Struggle With Innovation

Emphasising a product’s heritage can be a powerful marketing tool. Think of brands like Coca-Cola or Converse’s Chuck Taylor All Star sneakers.

But the strategy could have a big drawback, according to research . When a brand emphasises its past, customers are less likely to buy its updates and innovations. A food company that heavily promotes its classic recipe, for instance, could have a tough time getting customers to buy a new variation on the product. The reluctance is particularly strong if people think the brand has stood the test of time and is authentic the way it is.

When you change an original product, it challenges why many people like the product in the first place, says Rosanna Smith, an associate professor at the University of Illinois Urbana-Champaign and one of the paper’s co-authors.

“We call it the curse of the original, and the question is how to update a product that is considered an icon without enraging your customers,” says Smith.

The shock of the new

In one part of the study, 418 participants read about a fictional hand-cream company and its top lotion. Participants were either told the company was established in 1917 with “deep roots in the old world French apothecary” or that it was established in 2017. Then the participants were either told the hand lotion was developed when the company was founded or was a new and improved version of the original.

All participants tried the same lotion and rated it on a nine-point scale, with nine being most favourable. When it came to the 1917 company, people rated the classic formula much higher than the new one: The original got a 6.68, while the new one averaged only 6.09. In other words, people didn’t like a venerable brand that tried to innovate as much as a brand that stuck to its roots.

Meanwhile, participants who were told the company started in 2017 rated the original and improved hand creams similarly.

“One big limitation of heritage branding is that it makes it harder to innovate,” says Smith. “But there are ways to lessen the effect.”

Back to basics

For instance, in another experiment, 602 participants read about Fratellino, a fictional Italian-food brand launched in 1911 when founder Martina Fratellino began selling tomato sauce from her front porch. The participants were told the brand would be improving its original tomato-sauce recipe.

The people were then divided into three groups. The control group was told the company was proud to introduce the new formula. The second group was told the new sauce was a bold departure from the original recipe, while the third was told the change was inspired by traditional techniques Martina used to create her tomato sauce in 1911 and that the change was a return to the company’s beginnings.

The authors found that participants in the control group rated the new tomato sauce less favourably than the original, giving it a score of 6.0, compared with 7.2 for the original. Simply doing something novel hurt the tradition-heavy company. The new product did even worse among people who heard that it was a bold departure: The new item got a 5.57, compared with 7.19 for the original.

But in the third group, where the change was framed as grounded in the product’s origins, the scores for the original and new tomato sauces didn’t significantly differ.

“Stressing the connection to the brand’s origins may have made the update seem more authentic,” says Smith.

Wall Street’s hottest trade has gone ice cold.

For years, it paid off to buy stocks that were rising in price—and bet against struggling shares. The momentum trade was especially profitable this year, as investors piled into hot stocks including Micron Technology, Nvidia, Advanced Micro Devices and other artificial-intelligence darlings while wagering against those likely to be hurt by the embrace of AI.

The S&P 500 Momentum Index soared 44% in the second quarter, its best quarterly performance on record, and it surged 133% over the past five years, nearly double the broad market’s performance.

Mega funds and rookie investors alike piled into the trade, some using leverage and options contracts in an effort to amplify their returns, propelling the underlying shares higher.

“It is a self-fulfilling prophecy,” said Matthew Tym, managing director at Cantor Fitzgerald, of the trade.

Suddenly, the trade is a loser. The momentum index has tumbled more than 9% since July 1, lagging behind the S&P 500’s 2.8% gain. The index—which tracks stocks in the S&P 500 based on a “momentum score”—is on track for the biggest quarterly underperformance in 25 years. July was the second-worst month for the momentum trade in around 40 years, according to Bank of America estimates; the only month worse was April 2009, in the teeth of the global financial crisis.

Hedge funds that bought momentum shares while shorting low-momentum stocks suffered even more. At the same time, a basket of the most popular stocks held by hedge funds tracked by Goldman Sachs recorded its biggest one-month underperformance in July relative to the S&P 500 in more than 20 years, according to the bank’s analysts.

Momentum trading is based on a rather simple observation: Investments that go up tend to keep outperforming; those that underperform often remain laggards. This kind of trading might seem too simple a stock-picking strategy to work. Yet it often has.

“For decades, it didn’t take a lot of sophistication to run a momentum strategy and make a decent living at it,” says Agustin Lebron, senior researcher at EquiLibre, a trading firm.

Part of the reason: It takes a while for corporate and other information to spread to various investors, so they slowly build positions, producing buying momentum.

“A huge pension fund can’t flip around its positions in a day,” says Lebron. “Behavioral biases also account for some of the effect, as well—people tend to sell their winners too early and hold losers too long.”

Fans of the strategy point to the human tendency to extrapolate from past results—and chase investment returns—noting that momentum patterns have been evident in markets for decades, even centuries. They also say that some of the worst months for momentum strategies are during longer periods of outperformance.

Some have been doing the trade by buying the strongest investments in a sector while shorting the weakest; others lean in to rising markets or asset classes. Still others use a quantitative approach or turn to banks or others who sell ways to make distinct wagers on momentum as a “tradable factor” or a “thematic basket.”

The fans remain believers. “Any strategy has disappointing periods,” says Antti Ilmanen, global co-head of the portfolio solutions group at AQR Capital Management.

The surge in Moderna and other biotech stocks helped crush the momentum trade. These shares were among the most heavily shorted in recent years, but positive news on a cancer vaccine from Moderna and Merck sent those stocks flying, crushing some quant and other hedge funds. Moderna is up around 150% so far this month.

These traders had an especially rough day on Aug. 19, which Goldman Sachs told its clients was the worst day for “systematic long-short managers” in more than two years. About half of the losses were because of momentum trades, the bank said.

Some traders have begun to short, or bet against, the very stocks that propelled the momentum trade earlier this year. Net short positions in futures tied to the Nasdaq-100 index among speculators recently climbed to some of the highest levels of the past two decades, according to data from the Commodity Futures Trading Commission.

The about-face is a sign of how markets have become more treacherous for investors, even as indexes keep climbing. Part of the issue: the recent meltdown of Situational Awareness, a hedge fund that had piled into some of the most popular momentum shares, including chip stocks. After a period of market tumult, Nvidia shares rocketed almost 9% after its earnings, showing how quickly sentiment can shift.

Some investors say the run-up in share prices driving tech stocks higher reminds them at times of the dot-com frenzy decades ago.

Mike Ogborne, the founder of San Francisco-based Ogborne Capital Management, said he has grown more cautious on technology stocks and is keeping more of his portfolio in cash than he typically does.

And he is nervous about the surge in spending by technology giants and quarterly capital expenditures that keep rising.

“It is a little bit like Cinderella and the clock striking midnight. You don’t know when midnight is going to come around,” Ogborne said. “They don’t send a memo around telling you when the capex cycle is over.”

Why Iconic Brands Struggle With Innovation

When a company markets its product’s long, iconic heritage, consumers are reluctant to buy a new variation

The shock of the new

Back to basics

Wall Street’s hottest momentum trade has reversed sharply, as former winners tumble and heavily shorted stocks surge.