How can potential investors tell if a product is more Atkins or organic, classic Oreo cookie or three-dollar cupcake? The investment can be profitable either way, but knowing the difference upfront will help determine the correct multiple and drive favorable post-deal economics.

In general, there are three key differentiating factors between a fad and a trend.

Fad vs. Trend Framework

Reason for rise. Trends generally have identifiable and explainable rises, driven by consumers’ functional needs and consis­tent with other consumer lifestyle trends. In contrast, fads are driven by an emotional need to purchase, based on hype and idealistic product perceptions. The benefits are ether-eal or ill-conceived and don’t turn out well for consumers.

Incubation period and life span. Trends rise slowly, whereas fads spike—and die out— quickly. For example, demand for multiple fashionable handbags and accessories for each occasion has grown slowly and steadily over the years, fueling Coach’s decade-long growth and healthy 11-year compound annual growth rate (CAGR) of 19%. Beanie Babies, on the other hand, went from $400 million in sales in 1997 to $1.3 billion in 1999, a CAGR of 77%, before dropping to $850 million the next year. (See Exhibit 1.)

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Scope. A trend usually encompasses sever­al brands or products that are applicable to many different consumer segments, while a fad typically includes only a single brand or product and has limited appeal outside of one narrow consumer segment. A trend possesses some agility and consumers have granted it permission to expand beyond its current platform while maintaining authenticity.

The Atkins Diet is the perfect illustration of the difference between fad and trend. Healthy eating has been important to a certain part of the population for a long time, but Atkins was a fad within that trend. Atkins’ emphasis on fat and protein went counter to the larger trends at the time—ones that mandated lean protein, whole grains, and plenty of fruits and vegetables. Millions of consumers tried the diet—15 million alone purchased Dr. Atkins’ books—but the fad soon burned out as those consumers realized that the diet was hard to sustain. In this way, a fad experiences rapid adoption among consumers with a weak level of commitment to the concept (or high dropout rate), as many consumers hop onto the bandwagon only to find the product or experience more difficult or less useful or beneficial than they thought it would be.

We used our fad-trend framework to evalu­ate two recent retail and consumer product opportunities—the handbags and accessories and gluten-free market segments.

Trend: Casual fashion handbags for multiple occasions

In 2006, we were asked to evaluate whether Vera Bradley, the maker of women’s handbags, purses and backpacks, often made out of col­orful, quilted fabric, would be a good invest­ment. Using our framework, we determined that Vera Bradley bags were a lasting trend, not a fad.

Why? First, Vera Bradley had a compelling reason for its rise. It was in line with the larger trend of women wanting different handbags for each occasion and it also filled a niche in the market among classic consumers at mid-range price points.

Secondly, Vera Bradley exhibited the attrac­tive, steady growth of a trend in the years leading up to 2006 and had a five-year CAGR of 27%. (See Exhibit 2.)

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Beyond that, Vera Bradley has grown its scope, expanding distribution channels to include 48 full-price and eight outlet stores, an international presence, and a growing e-commerce site. Vera Bradley’s wholesale future also looks bright, with distribution in 3,300 independent specialty retailers and a further penetration into department stores, like Dillard’s.

Vera Bradley is also expanding its reach, adding new products and lines to help it meet different price points and target more age groups—from teenagers to their grandparents (one recent addition is an all-black cross-body bag called “The Hipster”).

Because of these factors, Vera Bradley has continued its steady growth. Its sales were approximately $460 million in 2012, for a CAGR of 13% since 2006.

Trend: Gluten-free delivering benefits

Most gluten-free products were originally designed for sufferers of celiac disease, which afflicts about 1.8 million Americans. Even with such a small portion of the population diagnosed with the disease, the gluten-free business is booming. Sales have been rising steadily since 2006 and are expected to sur­pass $5 billion by 2015.

And gluten-free products are becoming more widely available. Mintel data shows that product launches with a gluten-free claim nearly tripled in 2011, to roughly 1,700 products. Walmart has dedicated gluten-free displays in approximately half of its U.S. stores, and gluten-free menu items have also increased 280% from Q3 2008 to Q3 2011.

This proliferation of products and channels is a good sign that the gluten-free trend has staying power. Gluten free is also consistent with the healthy eating trend mentioned previously, and many consumers purchase gluten-free products as healthier alternatives, not because of any medical condition. In fact, in a survey of consumers who regularly buy quinoa (a gluten-free pasta), more than half said they ate it for its nutritional benefits, not because of a medical condition. But it is important to note that any one gluten-free product could be vulnerable to fad-like run-ups. That the success of gluten-free products does not hinge on one small part of the population or a single product cements its trend classification.

Making the Most of a Fad

Of course, even if something is a fad, it can still be a good long-term investment if it has uses outside of its narrow original purpose. Take scrapbooking. Scrapbooking itself seems to have been a fad in retrospect. Sales peaked in 2004–2005 at $2.5 billion and have since declined to $1.4 billion. But scrapbooking companies and retailers can still be viable investments if they are able to position themselves to cater to the needs of new fads and trends—such as paper crafting and mixed media—as they arise. In these cases, the key to success is using the brand for the long-term consumer-serving capability it has created, not for one category-specific product.

Crocs is another interesting case study. For many, the iconic rubber clog was clearly a fad as consumers rushed to buy them and the market value of the company soared, peaking in late 2007 at nearly $70 a share. But once sales started to decline, the value of the company fell dramatically, plummeting to just over $1 a share by early 2009, when the company nearly went bankrupt. The fad was over and many assumed Crocs would continue to shrink.

But that has not happened. Instead, Crocs has successfully expanded beyond just clogs and kids’ shoes—clogs make up 40% of sales now, down from more than 75% in past years, and the proportion of adult sales has doubled. As a result, the brand has broadened its reach and made itself less susceptible to big swings in the popularity of one product. It now has a market capitalization of $1.37 billion, which speaks to the possibility of finding great value in transforming fad-like businesses.

But, in any case, it pays to understand whether a product is destined to be a steady, burning success or rise and fall quickly in a blaze of glory before you make any deal.

2013 promises to include many hot products and brands that could go either way. From Kombucha to juice cleanses, TOMS to J Brand, knowing what to look for can help private equity sponsors invest with confidence.

8 March 2013