Every time we run to the grocery store or pharmacy for household staples like baking soda or ibuprofen, we’re faced with a choice – to buy the name brand or the store brand. On the one hand, there’s something reassuring about purchasing a nationally-recognized brand; after all, if they can afford to advertise during the Super Bowl, surely they must have a quality product! On the other hand, why should we pay three times the amount for cough syrup when the store brand has the exact same list of ingredients?
In truth, we often use brand recognition as a proxy for quality, whether or not that conclusion is valid. If we consumers had perfect information, we would only buy name brands if the cost premium were clearly justified by higher quality or value. This implies that subject-matter experts, such as pharmacists in the drugstore or chefs in the supermarket, should typically purchase fewer name brands in their domain of expertise, and their consumption of name brands would focus on products where meaningful differentiation exists. But do the statistics bear out this hypothesis?
In a recent working paper at the National Bureau of Economic Research, entitled “Do Pharmacists Buy Bayer? Informed Shoppers and the Brand Premium,” economists Bronnerberg, Dubé, Gentzkow, and Shapiro find a meaningful reduction in name brand purchases among subject-matter experts within their domain. Pharmacists buy nationally branded headache medicine only 9% of the time, while the average consumer does so 26% of the time. Chefs purchase nationally branded salt and sugar 12% less frequently than non-culinary experts, after controlling for demographic factors.
We find the specific product analysis even more fascinating. As a category, consumers overwhelmingly favor nationally branded ibuprofen gelcaps, buying them 71% of the time, while physicians and pharmacists do so less than half the time. By contrast, the medically informed are modestly more likely to buy well-known brands of contact lens solution, signaling that there may be a meaningful quality difference in this category. Over in the supermarket, chefs buy store-branded baking soda more than half the time, while all consumers do so only 1/3rd of the time. But when buying ice cream, the preferences invert: general consumers buy the store brand 60% of the time, but chefs despise it, selecting the national brands more than 80% of the time (way ahead of you there, culinary experts!).
We’re delighted to have seen this study – based on expert consumption choices, we know it’s fine to go cheap on headache medicine and baking staples, but best to keep paying the brand premium for contact lens solution and ice cream. The experts have shown us exactly where to prioritize our attention and expenditure. And while no one has ever accused us of being prominent physicians or iron chefs, we have spent two decades honing our risk management advisory expertise, learning where to focus for optimal results. Here are a few of our conclusions:
DO prioritize hedging-related terminology in loan documents and ISDAs Each year, Chatham negotiates 2,000 ISDAs on behalf of clients, and we review countless loan documents as well. Critical clauses and paragraphs within these documents can mean giving up significant economic value, constraining acceptable hedge providers, and pulling in other entities or financial contracts needlessly. Given our significant experience and market knowledge, we can negotiate these documents knowing exactly what’s at stake in each paragraph, what counterparty banks have been willing to concede in negotiations for other clients, and how to prioritize trade-offs.
DON’T prioritize trading at a specific FX fixing rate Many institutions have chosen to do all of their FX trades at a publicly known fixing rate for a certain day and time. Unfortunately, these rates have proven to be ripe for manipulation, trading up (or down) noticeably right before fixing times on days when a large trade’s rate-setting is known to be happening, and then trading back as soon as the fixing is set. Prioritizing trading at such fixing rates doesn’t protect value; it actually erodes it. To help ensure best execution, Chatham provides an FX transaction cost analysis, allowing direct comparison with actual market rates (rather than manipulated fixings) to benchmark trading quality.
DO prioritize regulatory compliance The regulatory landscape for derivatives is tremendously complex, with millions of lines of rules still being written. Further, since the US, Europe, and Asia all have different timelines for regulatory reform, compliance in cross-border transactions has to contemplate overlapping rules from multiple jurisdictions. For instance, there are more than 100 permutations of Dodd-Frank and EMIR requirements based on a party’s status! Understanding the implications of all the new rules, as well as adopting strategies that correctly implement them, requires expert attention, ideally well in advance of a contemplated transaction.
DON’T prioritize hedging 100% of all exposures In a large multinational corporation, it might seem intuitive to hedge all currency exposures, or all exposures above a certain notional threshold in the functional currency. However, such an approach will fail to take into account the considerable benefits of flattening the exposures across entities, and of cross-correlation of the currency exposures. In addition, hedging amounts should not be decided without considering the accounting capacity that exists within each entity for each currency. Failing to net exposures across the organization, or to maximize hedge accounting capacity for each currency, may lead to sub-optimal or even value-destroying hedge notional amounts.
In the supermarket, we should pay less for baking soda and more for ice cream, since the best-informed people (chefs) signal by their consumption patterns that this is optimal. In the same way, we should prioritize risk management actions that create the most value, rather than those that have little impact or even erode value. To discuss which of the risks you face should be at the top of your list, please give us a call at 610.925.3120 or email us.