The NEO Manifesto

Where to invest, when to invest, why to invest? These questions occupy us on a daily basis. And now investors have a new metric or tool to help them evaluate the potential value of consumer-focused public companies. This is of course, only one weapon in the investment armoury but it could change the way you think about your investment choices.

A powerhouse group of consumers is redefining the economic landscape of Australia and the impact on investments will be great. This new economic order (NEO) consumes more quality products and experiences, is less price-sensitive than the rest of society and provides a signpost to future value in a potential investment.

So, lesson number one: Look for companies that put quality, design and service ahead of the deal; everyone wants the best price, but high-spending NEOs are sceptical that a discount will automatically deliver the quality they demand.

Take David Jones and Myer as examples. Seventy percent of David Jones' customers belong to this new economic order and, comparing the growth of NEOs at each brand between 2001 and 2004, Myer has suffered a 7% decline in its share of high-margin NEOs while David Jones has increased its NEO market share by 50%.

It is unsurprising, therefore, that at the end of 2004, David Jones' retail margin, at 6.1%, was nearly double Myer's 3.6%. Additionally, although David Jones' EBIT (earnings before interest and tax) of $59.6 million was virtually the same as Myer’s $60.7 million, in the first half it grew 20% compared with Myer's 2%. The full-year results for David Jones, due to be released next week, are expected to show an even stronger result.

David Jones and Myer Share Price Performance Comparison (Common Base comparison)

Source: Bourse Data

This new economic order is so called because even though they are a significant minority, at 24% of the Australian population, this four million strong group account for the majority of discretionary spending in the economy.

And their confidence about the economy means they are more consistent in their consumption. They consume more of almost everything more frequently.

A brief look at consumer confidence over the past five years paints a graphic picture.

Significantly more NEOs are confident consumers when compared to the general population and fewer are unconfident. This group consumed its way through the last recession. Their confidence makes them more robust in times of economic uncertainty and their spending puts them at the epicentre of value in the economy.

Over the past five years there has been very little difference in the population between the Big Spenders (top third of spending) and Light Spenders (bottom third). When it comes to the spending of NEOs, however, the top third dominates all spending and the bottom third is almost non-existent.

And if you’re an investor AND you trade shares online, chances are you are a part of the new economic order. NEOs are 44% more likely than anyone else to own shares and 365% more likely to trade shares online.

NEOs prefer to invest in companies that operate at the quality or value-added end of the market rather than at the commodity end. For example, the five stocks most preferred by NEOs are: News Corporation, Qantas, David Jones, Lend Lease and Southcorp.

The five stocks least preferred by NEOs are: Bendigo Bank, AMP, Woolworths, Boral and BlueScope Steel. (There is less than a 44% uplift of NEO share ownership when compared to the general population at least 1% ownership by both Pop & NEOs.)

Next lesson: Beware of investments that do not have a sophisticated value-added component AND an attractive online offering and a website bursting with rich information; 98% of NEOs are online and 61% have made a purchase online compared to only 25% of the general population.

In 2004, NEO analysis was used to predict the shift in the business cycle and, around the same time, a leading broker commissioned a prognosis on the share performance of Miller’s Retail Limited. The analysis resulted in a negative report.

Miller’s brands including Katies, Miller’s Fashion Club, Crazy Clark’s and Go-Lo do not appeal to high-value NEOs, but neither do they appeal sufficiently to the majority of Australians, the price-sensitive Traditional Consumers. Traditionals love a bargain, but look for high-profile brands at a discount price. In the 1970s and 1980s Katies was a prominent brand that sold quality merchandise at a low price. By 2004-05, Katies had lost much of its brand equity as Traditionals consumers flocked to discount factory outlets (DFOs) to get great brands at great prices.

And last week, Miller’s Retail said it would sell or close 62 underperforming discount variety stores in the next 12 months after reporting a net loss of more than $100 million.

This kind of NEO analysis has some underpinning principles that can be adopted by any investor looking at consumer-centric businesses. Typically, customer value measurements or metrics used by most corporations are either quantitative or qualitative, but not both. This presents difficulties in practically applying either type of measurement.

For example, quantitative metrics include individual wealth, socio-economic profiling (income, occupation and education) and company-based transaction records. There is no doubt that income is important '” a consumer must have money to be able to spend it '” but the surprising news is that those with money don’t automatically have any desire to part with it. Look around at your friends: you’ll see this every day.

Two problems exist, therefore, with personal wealth and socio-economics as effective measures of potential profit. The first is that they rely on savings or income rather than spending; and the second is that they offer nothing on the personality or psychology of the consumer: Why they spend? What will motivate them to spend? Do they even want to spend?

Qualitative metrics, on the other hand, provide a much better picture of the attitudes and values of consumers, but provide no quantified data on spending '” either spending behaviour or spending capacity.

This NEO metric can be applied to many investment opportunities.

But who are these NEOs? What do they look like and how do they live their lives?

To qualify as a NEO-Consumer, or NEO, an individual must have: high levels (top 25%) of past, present and intended spending; and sustainable differences in the 182 underlying attitudes and values that motivate high spending.

Two distinct groups in society are revealed. Half exhibit low-spending, low-discretionary choice consumption behaviour and traditional social attitudes. Not surprisingly, they are known as Traditional consumers or Traditionals. They are price-sensitive and more interested in a deal than in quality. As a consequence, they account for only 23% of discretionary spending.

The other half include high-spending, high-margin, high-discretionary choice NEOs and another group known as Evolvers, so called because they exhibit a number of NEO characteristics and spend more than Traditionals and, as a consequence, are likely to evolve toward NEO behaviour over time. Between them, NEOs and Evolvers account for 77% of all discretionary spending in the Australian economy.

In addition to the four million NEOs in Australia, there are 12 million in Britain and 59 million in the United States. NEOs are largely metropolitan dwellers; more of them live in inner-Melbourne and Sydney than anywhere else in Australia. Almost half of all NEOs live in these urban locations, and when compared to their Traditional cousins, NEOs are more likely to live in inner Sydney and Melbourne. Forty-five percent of NEOs are women and 55% are men.

Although NEOs range over all age groups, they tend to be younger and, conversely, Traditionals tend to be older. NEOs exceed the national average in every profile between the ages of 20 and 50, while Traditionals exceed the national average in every profile above age 50. Specifically, NEOs are most highly represented in the 25–39 age segments.

Half of all Australians with a university degree are NEOs, and four times as many NEOs as Traditionals have degrees. They are most likely to be in professional or management occupations and earn significantly more than the rest of society. Specifically, they dominate every income category above $45,000 a year and are five times more likely than anyone else to earn in excess of $100,000 a year.

More importantly, they earn more because they’re NEOs; they are not NEOs because they earn more (income was not used in identifying who was or wasn’t a NEO).

And, as we have seen they do spend more '¦ and more frequently than anyone else. NEOs dominate by more than two to one the top third of discretionary spending in the Australian economy, while at the other end of the scale, Traditionals dominate by more than 10:1 the bottom third of spending.

So, investors now have a new lens through which to evaluate investments. The new economic order is changing our world and savvy investors will recognise not only where they consume but also where they invest.

ACTION PLAN

Investors now have a new metric or tool to help evaluate the potential value of a public company with consumers as their customers. This, of course, should be only one weapon in the armoury and while it is a significant breakthrough, other factors also impact the future value of a corporation.

1. Beware of companies that rely solely on price and the 'deal’ to attract and motivate customers; this attracts low-spending Traditionals, who tend to be more promiscuous as consumers and who spend even less in times of economic uncertainty.

2. Look for companies that put quality, design and service ahead of the deal; everyone wants the best price, but high-spending NEOs are sceptical that a discount will automatically deliver the quality they demand.
3. Beware of brands that do not have a sophisticated online offering and a website bursting with rich information; 97% of NEOs are online and 61% have made a purchase online compared to only 25% of Traditionals.
4. Look for brands that try to create long-term relationships with customers based on trust, truth, great information and a memorable experience; NEOs love fresh information and are more likely to spend if they have an ongoing relationship, rather than just a transactional relationship with a brand.
5. Beware of companies whose marketing focuses solely on the functional nature of what they sell rather than on how the product will make a consumer feel; NEOs, while entirely rational, are much more likely to purchase a product that makes them feel great (take a look at Apple’s advertising for its computers or its spectacularly successful iPod.)
6. Look for companies that offer customers a set of options rather than just a set of bundled items at a price; NEOs love to create their own solutions from a short-list of possibilities.
7. Finally, look for companies that are not afraid of using creativity and imagination to reach and motivate customers; NEOs prefer the path signposted by inventive milestones while Traditionals favour the tried and true journey travelled by other people just like them.

Ross Honeywill (ross@customerstrategy.com.au) is an internationally published author and a foundation director of consumer think-tank the Centre for Customer Strategy. Data used in this article is drawn from Roy Morgan Single Source and is subject to copyright.