Umbrella branding and reputation building

1. Umbrella branding and reputation building Jeanine Miklós-Thal University of Mannheim Martin Peitz University of Mannheim Prepared for: Workshop Economic Analysis of Trademarks and Brands Alicante, June 6, 2008

2. Seller reputation • Exchange of product or service between buyer and seller • Value of trade uncertain • unobserved skill (type) • unobserved actions • Information and beliefs that the buyer has about the seller´s skills and action are crucial = seller reputation • gives rise to intangible assets

3. Branding and trademarks • Trademarks are critical for the successful use of branding strategies by sellers • In particular, implementation of umbrella branding strategies is helped by trademark protection (McDonalds example)

4. Branding and reputation • Brands as carriers of information • Brands allow firms to maintain reputation over time and across consumers (e.g., word-of-mouth) • Supergame strategies in infinite horizon • Klein and Leffler (1981 JPE), Shapiro (1983 QJE) • Quality commitment in finite time • Type uncertainty combined with effort choice

5. Umbrella Branding: Practice • Richard Branson, founder of Virgin: “Consumers understand that all the values that apply to one product apply to others” Time Magazine, June 24, 1996 drinks music stores space travel balloon flights books clothing flights fitness clubs computer games

6. Umbrella Branding: Ideas • information transmission to consumers / incentives to provide quality • to link expected quality of one product to the customers’ experience with another product • include new products of similar quality under an existing umbrella • Economic mechanisms to support the role of umbrella branding: • Mechanism 1: not to tarnish the reputation of an established product (e.g. Wernerfelt, 1988 Rand) • Mechanism 2: not to endanger the reputation for future product inclusions under the umbrella (e.g. Choi, 1998 RES)

7. Literature Guide: Empirics • Marketing literature: Provides evidence that umbrella branding is used as a signaling strategy • Experimental evidence: • E.g. Aaker and Keller (1990, Journal of Marketing) • Evidence from field data: • Erdem (1998, Journal of Marketing Research) • Balachander and Ghose (2003, Journal of Marketing)

8. Literature Guide: Theory • Economics literature: • umbrella branding as a signal • Adverse selection: e.g. Wernerfelt (1988, Rand), Cabral (2000, Rand), Miklós-Thal (2007, mimeo), Hakenes and Peitz (forthcoming, EER) • Moral hazard: e.g. Andersson (2002, IJIO), Cabral (2007, mimeo), Hakenes and Peitz (2008, IJIO)

9. This paper: Idea • Both the seller´s technology and its effort are unobservable • Mixed model: hidden action and hidden information • Complementarity between technology and effort in every time period • Technology is uniform across all products of the seller and constant over time • Umbrella branding can mitigate the asymmetric information problem with respect to technology

10. Setting • Positive effort only due to type uncertainty • First-period effort provides means for the firm to affect second period quality reputation. • Umbrella branding may affect • Precision of information about technology/type • Incentives to provide effort

11. Contribution • Umbrella branding • good for information transmission (adverse selection) • possibly bad for effort provision (moral hazard) • A firm with high-quality technology may exert less effort if it can use an umbrella branding strategy than if it can only sell the product under a product-specific brand.

12. The Model 1/3 • Two experience goods, 1 and 2, sold in periods 1 and 2. • Period 1 has weight period 2 weight • Quality (reliability) of technology of both technologies high or low • Quality constant over the two periods.

13. The Model 2/3 Perfect Information • Continuum of non-competing firms; measure zero of firms has possibility to use an umbrella brand • Two technologies with inherent success probabilities ql and qh. Low technology with probability • Success probability for product i in period t • Cost of providing effort: c(e)

14. The Model 3/3 • Consumers homogeneous with unit demand • Willingness to pay is • Performance of all products in a badge (= time period) is the same • Performance of each product observed at the end of period 1

15. Timing • t = 0: Firms observe their quality and decide whether to use umbrella branding (if feasible). Branding decision is observed by consumers. Consumers observe branding but not quality. • t = 1: Firms decide on period 1 efforts and prices. Consumers condition beliefs on the firm’s branding decision and decide which products to buy. After the purchase, consumers observe whether product functioned well. • t = 2: Firms decide on period-2 (efforts and) prices. Consumers update beliefs and decide which products to buy.

16. The moral hazard problem • Remark 1: Firms never provide effort in period 2. • Remark 2: Firms do not provide effort in period 1 in the absence of type uncertainty (i.e., ) irrespective of whether umbrella branding is used. • Reason: Effort in period 1 only used to convince buyers of the seller´s high quality. • Umbrella branding DOES NOT affect the moral hazard problem absent type uncertainty.

17. Analysis: Single product brand • Ex ante expected reliability • Simplification: vh=1,vl=0 • Profit: where

18. Analysis: Single product brand • Suppose from now on ql = 0 • Thenel = 0 • eh determined by

19. Analysis: Two-product brand • Ex ante expected reliability where is the share of low-quality firm that decide in favor of using an umbrella brand • Profit: where we recall that

20. Analysis: Two-product brand • Recall that ql = 0 • Single positive realization reveals high technology. Hence, • Profits then become • where

21. Analysis: Two-product brand • ehdetermined by • where

22. Analysis: Comparison • Preliminary Analysis: All firms move from separate branding to umbrella branding • Umbrella branding provides additional information and thus affects the (equilibrium) expected value: • “information extraction effect ̋ • Ceteris paribus, this effect implies higher effort incentives under an umbrella brand

23. Analysis: Comparison • Another, possibly countervailing, effect • How sensitive are consumer beliefs with respect to effort? • Hence, “sensitivity effect̋

24. Analysis: Comparison • If then umbrella branding unambiguously leads to more effort • Sensitivity effect: +/- • Information extraction effect: +

25. Analysis: Comparison • Full Analysis: Firms decide whether to use umbrella branding • A share of low-technology firms may refrain from umbrella branding • since consumers have a worse expectation of a product that failed in the previous period if sold under an umbrella brand • Effect on effort provision under umbrella branding: • Umbrella branded products are on average of higher quality than products sold under mono-product brands. • High quality firms have lower incentives to exert effort so as to separate themselves from low quality firms! • “composition effect ̋ unambiguously negative

26. Summary of results • Firms use effort to build up reputation for quality of a long-run, unobservable factor (technology). • Three possible effects of umbrella branding on effort: • information extraction effect: + • sensitivity effect: +/- • composition effect: - • Overall, effort provision may be weaker under an umbrella brand.

27. Discussion • Reputation and quality distribution • Comparative statics in market characteristics: Empirically testable predictions • Dynamic reputation building in multi-period models