When products contain experience or credence attributes that are important in the consumer’s purchasing decision, consumers often look to the brand name of the item as an assurance of quality. A firm’s brand name can be regarded as a “stock of infor-
l0 See Wall Street Journal, December 13, 1984, p. 8; February 9, 1984; April 24, 1985; September 10, 1985, p. 8; and “Coke’s Man on the Spot," Business Week, July 29, 1985, pp. 56-61.
mation” that has been built up by the firm in the past. It includes information concerning the experience and credence attributes in products purchased under that brand name on previous occasions, information gleaned from advertisements as to current quality attributes, the image of the firm as community-conscious or environment-conscious, a benevolent employer, and so on. Some brand names are better than others, in terms of the level of quality that they imply will be found in a product, but all are the sum total of the firm’s previous efforts to build up its brand name recognition and quality image.
When a firm has an established brand name, it can introduce a new product or a new version of an existing product, and consumers will feel they already know something about the product’s quality and will be more likely to purchase the product than if it were the same product introduced by a firm with a lesser brand name. This increased probability of purchase, which derives from the greater information stock embodied in the brand name, is what we mean by brand name advantage. When a product has a brand name advantage, other firms will have to offer a “compensating price differential,” meaning a lower price, in order to compete effectively with that firm.
Example: ReaLemon, a well-known brand name for processed lemon juice, was priced 10 to 15 cents per quart above the prices of Golden Crown and other lesser- known brands of processed lemon juice in the late 1970s. Borden, Inc., producer of ReaLemon, was prosecuted by the Federal Trade Commission for conspiring to monopolize its market through predatory pricing. Borden had reduced the price of ReaLemon to a level that served to force its rivals’ prices below their costs. (Rivals had to set their prices 10 to 15 cents lower in order to compete.) This practice was also argued to restrict new entry, since new firms would have an even greater brand name disadvantage. Whether or not Borden was fairly treated by the courts is not the issue here. Rather, the point is that the information content of the ReaLemon brand name was apparently worth a price premium of about 25 percent. If Borden had avoided this predatory pricing charge, it might have been able to enjoy superior profitability on a sustained basis as a result of its differentiation strategy."
When buyers pay a price premium for a well-known brand, they are effectively paying an insurance premium to assure themselves of product quality. The consumer could avoid the premium by buying a lower-priced product with a lesser-known or unknown brand name, but at the same time the buyer would bear a greater risk of quality variation. As noted in Chapter 10, if the cost of information exceeds the price premium, the buyer may use the higher price as an indicator (or assurance) of higher quality.
Having established a brand name advantage, the firm’s asking price can be higher than its rivals’, and its costs are likely to be higher as well, given that higher quality typically costs more than lower quality and that part of the brand name advan-
"See Clement G. Krouse, “Brand Name as a Barrier to Entry: The ReaLemon Case,” Southern Economic Journal, 51 (October 1984), pp. 495-502.
tage will derive from a relatively high level of advertising expenditures emphasizing experience and credence attributes. If the firm is able to raise price by a greater amount than cost per unit is raised by the expenses of differentiation, it will have gained a competitive advantage in the market.
The firm could conceivably cheat its customers by reducing its quality below what has come to be expected from that brand name. Thus its costs would be reduced but its price would remain at the premium level. This strategy would increase profit for only a short while, however, because the information content of the brand name will deteriorate, and it will no longer command a premium price. Firms have an incentive to maintain the quality of their brand name products, since future sales depend on the quality of products sold today. The firm’s brand name is, in effect, a forfeitable “bond” that the firm stands to lose if it does not follow through with its implicit promise to maintain the quality level of its products. Firms having the most invested in a brand name will have the most to lose by cheating on quality and thus will be less likely to cheat, other things being equal. 12