Brand value – for whom?
Over in the business school here at Berkeley, they talk a lot about brand values. The MBAs are taught that one of the most important strategic activities of a firm is to invest in building and protecting the value of its brands.
Usually when a firm increases its value, that’s good for the economy. Inventing a new product, or finding a way to produce using fewer inputs, increases the value of the firm and also increases the wealth of the economy and makes everyone better off.
But some ways of increasing a firm’s value are not good for the economy as a whole – for example, if they merely transfer surplus from consumers to producers, reduce efficiency by reducing competition, or exploit negative externalities.
Does the economy as a whole benefit from an increase in brand value? Or do brands just increase benefits to the producer at the expense of the consumer? What are the economic benefits of brands?
Brands serve a number of purposes:
1. They enable firms to extract rents from consumers; brands reduce price competition, by differentiating between similar products on the basis of something other than price (i.e. brand ‘values’).
2. They deter new entrants from competing in the market, by increasing the cost of entry for new firms; this can make some markets hard to contest.
3. In game theory terms, they signal to possible entrants that the firm has invested a great deal in the brand and is therefore likely to defend its position; this signalling is designed to deter entry by competitors.
4. They signal to consumers that the firm has invested in the reputation of the brand, and is therefore more likely to provide high quality products and good service; this may create an incentive for firms to provide good products and service.
5. They provide some information to consumers (eg Duracell last longer than Eveready).
6. They may provide some psychological benefit to consumers, who apparently like associating themselves with particular brands (presumably there is a benefit to consumers, or they wouldn’t buy branded goods).
What is striking about this list is that few of these effects create additional value to the economy, as opposed to transferring value from consumers to producers.
(1) is a transfer within the economy from consumers to producers. (2) and (3) transfer from consumers to producers and reduce total welfare by reducing competition. (4) and (5) may create incentives for better products, which is good. (6) is perhaps a benefit because it increases overall welfare, though arguably it creates and fulfils an artificial need, and is beneficial only in the same sense as a heroin dealer is beneficial to the welfare of his customers.
Branding is an inefficient way to achieve the narrow objective of increasing consumer information; most brand marketing has no information content; and much of the information is inaccurate (for example, Special K is sold as if it were healthier than other cereals but it is not). Mandatory government labelling, or support for consumer magazines, could achieve the information benefits of branding much more cheaply.
It is hard to guess what the total cost to the economy is of activity to create and promote brands. The total US advertising budget is about $150 billion a year, but that does not include a lot of activities by firms related to designing and promoting brands, ranging from research to packaging. I’d guess we are looking at activity worth at least $500 billion a year in the US, or about 4% of total GDP. This spending is effectively the dissipation of economic value through rent-seeking. There is almost no value added to the economy as a result of the activity. Furthermore, the welfare costs to the economy of the reduction in competition that results from investment in brands must be large – I guess at least twice as large as the direct costs.
Overall, then, the creation and protection of brand value, which is central to the activities of many businesses, is predominantly an exercise in rent-seeking. It has huge direct costs, in terms of economic activity with little value to the economy, and it has huge indirect welfare costs resulting from reduced competition.
What should we do about it? My starting point would be a hefty tax on advertising and marketing, reflecting the substantial cost that it imposes on the economy. In general, we should be aiming to shift the burden of tax from good things, like working and saving, to taxing behaviour with negative effects – such as polluting the environment or rent-seeking through brand-building.
You can run but you can’t hide… (!)
“Does the economy as a whole benefit from an increase in brand value? ”
How do you measure this? GDP?
Do you really think that perfect compeition is an ideal type that govt. policy should actively create?
Do you think that firms face a weeding out process if they waste their revenue?
Have you read “I, Pencil”?
interesting –
Surely we want companies to be able to promote products, especially new products, in a way that would not be achieved by state mandated descriptive labels etc.? How would you distinguish between wasteful brand building (these jeans are worth £100 because they have D&G on the back!) from advertising and marketing that conveys genuine information about the product availablity that allows consumers to make more effective choices (this product is available, it has these characteristics and this price)? You say most advertising doesn’t contain information, but I’d like to see your data. Off the top of my head financial services, telecoms, consumer eletronics retailing, books & music advertising is often heavily informative rather than pure ‘branding’. Even arch brand builders, like the ipod adverts, are also telling consumers hey, this nifty new product is available – how would I have found out about it otherwise?
I think your idea of taxing advertising is a problematic. If you tax ‘creative’ agencies, what would you do to a company that takes in advertising in-house? Tax the media outlets? What would the effects be on a free-to-air TV, radio, magazines and newspapers? Don’t advertising dollars end up funding lots of things that we’d otherwise have to pay more for, or that might not otherwise exist at all (advertising funded blogs!)? Surely that needs adding to any cost benefit analysis.
Another idea (that I haven’t thought through) is what if you are successful in changing things so that people don’t think they need to buy trendy new clothes so often, or try fancy new foods etc. what impact would that have on the level of economic activity? If we manage to tone down the consumerism of our consumer economy, what impact would that have on producers – especially as most consumer items are now produced in the developing world, aren’t they?
I sympathise with what you’re driving at, I just suspect intervention would be a mistake.
While I’m not an economist like you, I would have thought that rent-seeking implied the input of government. How can you seek unrecompensed value from someone who is free to walk away from the deal? Your analysis would therefore seem to imply that consumers are all being brainwashed which seems a little unlikely.
I think also you miss the great value of brands to consumers. If I’m in a supermarket and see Heinz beans and Somerfield own brand beans and E-Zee-Beanz, I know exactly which one I would buy- Heinz – because I know it, I like it and I know the quality will always be exactly the same. In return for paying slightly more I can eliminate nearly entirely the risk of being disappointed. This is of course why brands came about in the first place. In a world where you don’t know who is making your beans/clothes/hifi, it is very valuable to know who makes good beans clothes and hifi.
When you say that brands “may create an incentive for firms to provide good products and service” you are completely understating what happens in practice. All the branding in the world will not save a crap product.
BH
Thank you for your thoughtful comment.
There are lots of circumstances in which firms can extract rent without government intervention. Exchange does not have to be involuntary to involve rent extraction – all that is needed is a deviation from perfect competition which enables firms to capture consumer surplus. Such a lack of perfect competition may follow from increasing returns to scale, network externalities, asymmetric information, or collusion – all of which can and do occur without government intervention. Indeed, many government interventions are aimed at preventing this sort of behaviour.
Your baked beans example is rather a good one to illustrate my original point. Most of the own-brand products that you buy in supermarkets are made by one of the leading brand manufacturers, but sold more cheaply as a supermarket branded product.* So when you pay a premium for a branded product, that is rent extraction – you are paying extra (ie more than the cost of prodution) for exactly same product in a different packet. Companies invest in brands – linking purchase decisions to your lifestyle aspirations, etc – in order to persuade you to pay a higher price for their product. We know the firm can turn a profit selling the (unbranded) product more cheaply, so the additional price you pay, for which you get no actual benefit over the supermarket own-brand version, is pure rent. It is a transfer of consumer surplus to the firm. Some of it ends up as higher company profits; most of it is dissipated in the costs of the rent-seeking behaviour (advertising, sponsorship etc) which was needed to get you to pay extra in the first place. And all that rent-seeking is economically wasteful.
If the supermarket own-brand tin of beans said on the label “This tin of beans is identical in every way to the Heinz beans on the shelf above” then you would presumably buy it instead. In other words, if you had perfect information, you would’t buy the branded product, you’d buy the cheaper, unbranded product. Every time you buy the branded product, firms are exploiting your lack of information to extract your consumer surplus.
For many of the products we buy every day – from soap powder to soft drinks – a large percentage of the price is branding. (In the case of soap powder, substantially more than half the price you pay). The branding industry is designed to turn what would otherwise be fairly competitive markets – in which they do not make big profits – into uncompetitive ones in which they do. And those profits come from extracting rent from consumers.
Paddy – I admire your vigilance to prevent unnecessary government regulation. But widespread behaviour by firms to choke off competition to extract consumer surplus is just the kind of circumstance where government intervention is needed to ensure that markets work properly to produce efficient outcomes. On the whole, taxes and subsidies are a better way to achieve policy objectives than regulation, which is why my instinct is to begin with a hefty tax on the thing that is doing the damage, namely advertising and marketing. I am not wedded to that as the best or only policy response. But I don’t think that doing nothing should be an option in the face of such a huge economic welfare cost.
Owen
*IIRC, Heinz used to say that it does not manufacture for supermarket own-brands; but I think it has stopped saying that now, in which case I suspect it now does.
“What should we do about it?” WE, you say, but you probably mean government, don’t you? Usually the answer that suits the population best is “nothing” because YOU, the government, will so often make matters worse. So why not push off and show us all that you can run something, indeed anything, properly before offering to run our beans supply? That’s what many, very wisely, will think.
Owen, I have no problem with government intervention (pollution taxes for example) where I think that there’s a sensible mechanism for doing do, without too many adverse consequences (I fear you may have pegged me as a free market zealot, which I am not).
In this case though, I think I have raised some potential difficulties with what you propose – enough to make me think that state intervention would be a mistake. If you think otherwise, I’d be interested to see you address those points.
There’s no doubt that most marketing (and, just as importantly, most of the fashion industry) is inherently evil. If it weren’t, the messages would all be factual, to allow comparison between products, rather than emotive, to encourage feelings of insecurity in consumers. But as many of the commentators have pointed out… whaddayagonnado? I’d rather plough my lonely furrow against personality-disorder consumerism than have the government decide what we can and can’t say in adverts or impose additional taxes on communication.
Companies advertise to try and get product differentiation and thus extract rents. True, obviously so. But this does not mean that brands provide no value to the consumer. If they provided no such value then consumers wouldn’t care about them, would they?
Something of a root thought in economics, that while people might be trying to get the better of us it isn’t necessarily so that they are. You know, this enlightened self interest thing.
Advertising can reduce the number of new entrants, yes, but it is also the method by which new entrants enter the market. Your desire to heavily tax it simply entrenches the incumbents, who already have brands, even further.
I’d also point out that heavy taxation of advertising would kill commercial media. Newspaper, TV and so on. I would argue that the existence of a free press is worth more than that 4% of GDP you seem to think is being extracted from us dupes.
Finally, how are you going to define “good advertising” from “bad”? No tax on personal ads for sex but heavy taxes on condom advertising?
Nah, bad idea I think.
If they provided no such value then consumers wouldn’t care about them, would they?
Tim, this is an axiom of some kinds of economics, not an empirical truth.
Thank you all for your interesting comments. They fall broadly into two categories: (a) the damage done by branding is not such a big deal; and (b) there is no cure that isn’t worse than the disease.
It is odd that the same people who get very hot under the collar about a few pennies on the price of a bra are so blasé about market distortions that may be costing us 20% of national income. (That number is invented, but it is in the right ballpark.) That kind of welfare loss sure sounds like a serious issue to me. A fifth of national income would pay for the WHOLE of government final expenditure. Move along, nothing to see …
It is claimed that consumers have a choice so it can’t be doing them harm. But consumers will choose the least bad option. The theorem of revealed preference (that we can glimpse consumers’ real welfare function by the choices they make) only holds in competitive markets. If consumers had perfect information and had a choice to buy identical but unbranded goods, most would. That they don’t is an example of market failure, not a window into their underlying preferences. However you spin it, limiting competition to increase producer capture of consumer surplus is a bad thing.
My original post noted that there are some possible economic benefits to brands – either in the form of better information or incentives to provide better goods and services. So the comments restating these benefits did not shed much light: the question is whether they are anything like worth the costs.
I have more sympathy for the point that the cure may be worse than the disease – or, as Richard asks, ‘whaddayagonnado?’
My suggestion for a tax on advertising was greeted with some generic arguments against government intervention, broadly: we don’t like “social engineeringâ€Â. But in a country that did not have a petrol tax, the same arguments could be used against introducing one. That is ideology, not sensible policy-making. I am not arguing for an overall increase in taxation; nor for government management of advertising. The simple proposition is that governments should use taxes to bring markets towards competitive equilibrium by taxing rent-seeking and so increase overall welfare, in preference to taxes on labour and savings that reduce welfare. A tax on advertising would not be difficult to administer or expensive to collect.
Most Chutzpah Award goes to Tim. If anyone else suggested that we should endure an economic distortion costing us maybe 20% of GDP in order to maintain a hidden cross subsidy for newspapers, he would jump straight down their throat, and rightly so. If we want to subsidize newspapers, let’s have a debate about how much we want to pay (probably less than a fifth of our income) and set up an explicit transfer with a rational allocation mechanism. (Such a subsidy would be low down my list of priorities.)
The simple proposition is that governments should use taxes to bring markets towards competitive equilibrium by taxing rent-seeking and so increase overall welfare
1. There is no attainable competitive equilibrium
2. Rent-seeking doesn’t occur when exchange is mutually beneficial – it is a socially costly pursuit of existing rents and therefore incompatable with a market where firms seek profit.
3. There is no way to measure overall welfare.
AJE
Codswallop.
1. There is no attainable competitive equilibrium
It is true that there is no single competitive equilibrium; as we know from the 2nd Fundamental Theorem of Welfare Economics, there are infinitely many possible competitive equilibria. None is attainable because the conditions for perfect competition do not exist and because there is no such thing as static equilibrium. But moving the economy towards competitive equilibria – which is what I advocated – is nonetheless a legitimate and sensible policy goal.
2. Rent-seeking doesn’t occur when exchange is mutually beneficial
That is just tripe. There is no inconsistency between the existence of rent-seeking and voluntary, mutually beneficial exchange. Rent seeking is about the allocation of the gains from those trades. You may want to review the original 1967 Tullock paper which began the literature, which is all about the social cost of monopoly. People buy things from monopolies, voluntarily, and benefit from doing so. But because of rent-seeking by the monopolist, they benefit less than they could. It is true that many monopolies or uncompetitive practices have their roots in government interventions of various sorts (import quotas, tariffs, patents etc) but that does not mean (a) that the trades that occur under these conditions are not voluntary and mutually beneficial or (b) that rent-seeking behaviour only occurs in the presence of such government distortions.
3. There is no way to measure overall welfare
So what? There is no way to measure an individual’s happiness. But that doesn’t mean that it doesn’t exist or that it doesn’t matter.
Owen
Owen
Is Fairtrade rent-seeking?
I would argue that Fairtrade is not the same for the following reasons:
(a) it is open – the Fairtrade label explicitly and opens means that you are going to be paying more for something of the same quality – you are buying on the basis of full disclosure, unlike the Heinz baked beans example;
(b) the premium is not paid as profit to the company selling to consumers. I am not an economist and I don’t know the full technical definition of rent-seeking, but the payment of the premium (the ‘rent’, I suppose) to the original producer seems to me to be somewhat different to the payment of the premium to the marketing company.
(c) as a consumer, if I buy Fairtrade products, I do so not because of the brand ‘Fairtrade’ but because of the politics behind it. If another brand were to arrive purporting to do the same thing as Fairtrade then I would consider buying that too, on the basis of the politics, not the branding.
Fair Trade is definitely branding even if it is not rent seeking (although I would argue that it is rent seeking. Pay me more because I’m a poor guy is just as much rent seeking as pay me more because your jeans have a cool label on them.).
Owen, conjouring up 20% of the economy is like if my grandmother had balls she’d have been in jail (pre-Wolfendon you see).
The reason I’m blase is rather because of the other point…that as consumers do value brands, otherwise they’d ignore them, then we don’t have this huge distortion you speak of.
The proof of which is:
“If consumers had perfect information and had a choice to buy identical but unbranded goods, most would.”
Some do and some don’t as the experience with supermarket own brands shows us. Some people value the information that branding gives them and pay more for it. Others do not and don’t.
So we appear to have an increase in choice as a result of branding. Isn’t this supposed to be a good thing?
And could you explain further how restrictions on advertising would not entrench the current suppliers, new entrants not being able to inform consumers of their offerings? It’s a fairly standard part of the analysis on the tobacco advertising ban that the large current suppliers love it for exactly that reason.
Tim Worstall: Fair Trade is definitely branding even if it is not rent seeking (although I would argue that it is rent seeking. Pay me more because I’m a poor guy is just as much rent seeking as pay me more because your jeans have a cool label on them.).
I wouldn’t describe either as rent-seeking, I’d reserve that term for “Pay me more because I’ve bribed the government so you have to”.
Some brand-building certainly is about deliberately giving a false impression so that misinformed consumers pay more for a product. A good example would be the “Intel inside” campaign which seeks to give the totally erroneous impression that a computer with an Intel processor will be able to do more somehow than one with a competing x86 processor, such as one manufactured by AMD.
Where advertising seeks to give a false impression, perhaps prosecution for fraud might be appropriate.
When you say “government”, Owen, do you mean some Socratic ideal government, or Messrs Blair, Blunkett, Mandleson, Byers etc?
“If consumers had perfect information and had a choice to buy identical but unbranded goods, most would.â€Â
Some do and some don’t as the experience with supermarket own brands shows us. Some people value the information that branding gives them and pay more for it. Others do not and don’t.
Er, no – self-evidently, “the experience with supermarket own brands” doesn’t tell us what would happen “if consumers had perfect information”.
Phil,
“I wouldn’t describe either as rent-seeking, I’d reserve that term for “Pay me more because I’ve bribed the government so you have toâ€Â.”
So what Owen describes is not rent seeking?
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Talking of chutzpah: you admit that the 20% figure is ‘invented’ (although ‘in the right ballpark’), and then further down in your comment treat it like it’s the product of some careful empirical work.
It’s not like there hasn’t been any research on this. Not my field, but here’s a fairly recent informal survey: http://www.columbia.edu/~kwb8/advertisingintrofv2.pdf. It would be nice to see some of these papers discussed.
Re the comment (subsequently dissed) about there not being an attainable competitive equilibrium, pehaps the commenter was thinking along Grossman-Stiglitz lines (see http://ideas.repec.org/p/nbr/nberre/0121.html). Parallel here: if info is costly to obtain, in any perfectly competitive market I would free-ride on others’ information-gathering. Everyone would do this, so in equilibrium nobody would gather the info; therefore p.c. can’t happen. Would have to model this in the context of advertising/market structure (no doubt someone has; again, not my field), but presumably the result would be that there MUST be some imperfect competition (and therefore profits/rents somewhere) for any information-gathering to occur. In a Repo Man world with tins labelled merely ‘food’, we would have no idea which tins were any good. Not even if some of them said ‘tasty food’.
And as for doubting the government’s ability to intervene being mere ‘ideology’, one could presumably throw that one right back atcha. Inviting the state to dictate which informational exchanges are pernicious and which are beneficial is dangerous. Better to let the private sector do it: if a company is making misleading or even just irrelevant claims re its product, let another company call them on it.
Put it another way: if the government believes that a particular industry is rife with this sort of destructive behaviour, there’s no need to tax. Why not just tell consumers this is the case? If Big Fashion’s jeans are over-priced and there are better ones to be had at Aldi, have a junior minister point it out. This would also encourage other firms to enter, safe in the knowledge that the government would ensure a steady flow of customers. Of course, in order for their pronouncements to be believed the government would need a reputation for competence and good judgement, as well as for thorough knowledge of their subjects’ utility functions. Which, presumably, would be a form of branding.
What no one has discussed so far is the critical value brands provide to consumers in reducing risk.
When consumers try a new products, there is a risk of it being different than what they want or expect. Buying a branded product is a way for consumers to increase the likelihood that the product will be of quality or consistent with positive experiences in the past.
It’s a form of trust built up over time. Also, products with heavy branding ads that stand the test of time are indicators of success and suggest that if so many other consumers liked it, maybe you would too.
Reducing risk is something valuable.
I’m not an economist or a marketing expert, but at the end of the day consumers are still free to make choices whenever they enter the supermarket to purchase goods. No one holds them at gunpoint, so if choosing a brand other than an unbranded good suits them (and not just financially- everybody knows brands cost more, thats no secret), but because of the quality, the ‘risk reduction’ factor or just simply emotional or sentimental reasons, then thats okay. I’m an advocate of limited government intervention in markets forces and I would not agree that taxing advertising is an appropriate measure for two reasons:
1) Free market forces will determine the level of competition- who is to say that a free market that becomes dominated by just a few companies is ‘unnatural’ or ‘unbalanced’ and therefore a target for govt. intervention? After all, it was consumer choice in purchasing the goods that made these companies successful that created the situation!
2) Consumers should be given credit for being intelligent beings, free to make their own choices. Rather than the government intervening by taxing advertising for the sake of ‘protecting the poor little consumer from evil compnies holding them to ransom by coercing them to buy expensive branded products that are really no better than the unbranded one’, I think a much more proactive approach would be to advocate independent consumer groups who provide unbiased information to allow people to make informed decisions. There seems to have been an assumption made in these discussions that a better awareness about the different products would convince consumers to choose the cheaper product that is supposedly no different from the brand. I’m not convinced this would be the case- I honestly believe that even with more information, many people would still choose to buy the brand. I believe this is largely because of the ‘risk reduction factor’ which is linked to product quality. Having vast experience in comparing brands with ‘own label’ myself, nine times out of ten, brands are better quality. Not just becuase they say they are. Not just because the adverts convince you to think that they are. Not because the pretty packaging makes you perceive that they are- because they actually are!!
On the baked bean issue. Yes Heinz do manufacture baked beans for supermarket own label, but they do not use the same recipe or quality of beans. Why would they put their prize product into an own label and undermine the very quality that makes the brand so popular!
People know that when they pay for brands they are paying for more than just the increase in quality, or the unique tangible benefits that it provides compared to the competition. But if they are happy to do so, then why take that away from them?