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The best selling book by Charles Duhigg, The Power of Habit: Why We Do What We Do In Life and Business (2012) offers many lessons for investors. An in depth book review appeared in Bloomberg Businessweek.

Brushing up on Habits

In The Power of Habit, Duhigg examines habits at the individual, organizational, and societal level. Most of us already know habits impact our behavior. However, how habits work--with a cue signaling some routine and a resulting reward--is often subtle. And understanding this habit loop can be very lucrative for firms able to provide the products that become part of our daily lives.

For example, the book chronicles the rise of toothbrushing in America (and then the world). This only became a habit when marketing guru Claude C. Hopkins found the right cue (film on teeth) and was able to clarify the reward for consumers (a tingling, clean mouth). It quickly became a habit (with Pepsodent spreading across the globe).

Today, this daily ritual is the basis for a multi-billion dollar global market in oral care dominated by Colgate Palmolive's Colgate (CP), Proctor and Gamble's (PG) Crest and other players such as Glaxo SmithKline's (GSK) Aquafresh, and Church and Dwight's (CHD) cadre of AIM, Arm & Hammer, Close Up, and Pepsodent brands.

Today these firms compete to tap this lucrative habit-based market with a myriad of rinses, brushes, flosses and varieties of toothpastes. Leadership in this oral care market is especially advantageous in developing markets where the habit is still taking hold.

The Habitual Firm in Focus

Proctor and Gamble (PG) is the corporate star of Duhigg's habit treatise. Most of the firm's brands are based on daily human habits related to oral care (Crest, Scope, Oral B), hair care (Head and Shoulders, Pert) Fabric Care (Tide, Bounce, Bold, Cheer, Gain), and shaving (Gillette). But Proctor & Gamble's Febreze story really brings home the "power" of habit for investors.

Duhigg recounts how Proctor & Gamble chemists invented a substance [HPBCD] that eliminated odors. The company felt it had a potential blockbuster. However, nobody was really buying or using the product initially. Market researchers discovered that people who likely needed the product (smokers, pet owners, etc.) lacked a regular cue signaling them to spray the substance; the potential users had become accustomed to the odor; they did not smell it. Thus there was no cue (bad odor); no reward; no habit loop; and hence no sales. The Febreze team even felt their jobs were in jeopardy.

But, as Duhigg explains, Proctor and Gamble researchers found that a few consumers were actually using the product regularly. Further research found these particular consumers were using it as part of a routine, a finishing touch to cleaning, for instance. Once Proctor and Gamble was able to design and market the product around that routine--as the final step in the cleaning process (and by adding pleasing scents as a reward), the firm had created a product--Febreze- that is now listed as a billion dollar brand on its website. So understanding and exploiting habits can literally be a billion dollar business.

Starbucks (SBUX) also has a strong presence in the book, but interestingly, not for the habit of buying coffee (though that is also an ideal habit for investors to tap). Starbucks is cited for its human resources practices, for the company's role in instilling good work habits in its employees. Duhigg calls Starbucks one of the largest educational organizations in the US. The company has stringent professional development programs focused on improving employee work habits and company culture. The result is an improved customer experience and ultimately profits.

Alcoa (AA) is used in the book to highlight the role of organizational habits (called routines). This section of the book follows Paul O'Neil's laser focus on safety during his tenure at Alcoa. Safety related habits helped reform routines across the firm, improving efficiency, updating factories and increasing communication. Hence safety habits and routines were the levers that largely fueled the dramatic turnaround at Alcoa. The lesson here for investors: spot firms with strong leadership able to build organizational routines around unifying themes (e.g., quality, safety, customer satisfaction) and return a lagging company to profitability.

Even retailers were a topic in the book. Target (TGT), for example, was the company Duhigg chose to reveal how firms can use customer data to predict shopping habits. Perhaps most interesting was how Duhigg revealed that retailers can pin-point potential changes in consumer habits (e.g., when they may shift brands or retailers). The thesis in the book is that a major life change (like having a child) can position a consumer for a drastic change in consumer habits. Hence, Target tries to predict (and can with some accuracy) these life changes through shopping patterns. New parents, for example, may be poised (and tired enough) to forget their old habit of shopping at several stores and seek all their items in one place, and ideally that place is Target (especially if you are a shareholder).

Caution: These Companies Are Potentially Habit Forming

  • Proctor & Gamble : A high end habit play, the firm is currently under pressure to keep customers paying a premium for their habits. But the brands are strong for the long term. At least one analyst has cited current issues as management (not product) related and thus could improve.
  • Colgate Palmolive : The global strength of Colgate brands in oral care in tandem with their presence in soaps and deodorant makes this firm a strong global play on daily habits.
  • Church & Dwight : With brands in oral care, deodorizers, fabric care, condoms, soap, and even pet food, Church and Dwight covers many of the same areas as Proctor and Gamble but often at different price points and with an eagerness for increased market share.
  • Unilever: Here is a potential double habit firm with both foods and personal care brands, allowing investors to profit from habits related to Lipton tea as well as Dove soap or Axe body spray. With a variety of brands, the company's website notes that consumers reach for a Unilever product 160 million times a day, exemplifying the power of habit
  • Kraft (KFT): A global leader in the gum, cookies/crackers, chocolate and coffee categories, Kraft may be the ideal firm to tap the snack habit in both North America and across the globe with an upcoming split giving investors shares in two habit companies.
  • JM Smucker (SJM): Smucker now has a big chunk of the breakfast routine with Jams and Jellies, Folgers Coffee, and a chunk of the lunch routine and dessert as well with Jif, Pillsbury, and more brands.
  • Starbucks : We all know the stores and kiosks in high traffic areas feed our coffee habits, but CEO Howard Schultz has the on-the go and in-home coffee habit in sight with the VIA instant product line and more.
  • Costco (COST): This retailer has become a part of the weekend shopping routine for millions. And the free samples, affordable snack bar (hot dogs, drinks, and cold treats), the magazine, regular coupon pamphlets, and ever-changing inventory all load the entire Costco experience with cues and rewards making it potentially habit-forming for even more consumers.

Habit Companies of the Future

Another profound lesson from the Power of Habit is that habits are malleable. They can change. Duhigg explains how we can change our bad habits (like overeating or smoking) and how consumer habits can change or evolve over time. Hence the most profitable habit-based investments may be related to habits that are still forming. Some firms may be on the vanguard of tomorrow's habits.

Consider how we read. E-books may be our generation's tooth brushing, and Amazon (AMZN), Barnes & Noble (BKS), Apple, (AAPL) and others are all jockeying to profit from our future reading habits. Ironically, The Power of Habit was the first book I (a fan of paperbacks) read as an e-book. And, of course, the future habits of our social interactions are already being tapped by Facebook and other sites.

Profits from habits are not new. Investors may recall decades of Warren Buffett's folksy sayings--as a major Gillette shareholder--that he slept well each night comforted by millions of beards growing. Buffett is well known for his fondness of strong brands that people use regularly.

The Power of Habit offers investors an enhanced perspective on human habits and more detail about how you can use this power to profit.

Source: These Companies May Be Habit Forming