Brand names lead consumers to make what these economists consider to be artificial distinctions between different products. Companies with respected brand names, therefore, can increase prices without losing significant sales.
The claim that brand names lead to unnecessarily high prices is often based on a comparison between the real world and a world of "perfect" consumer information, where every company in an industry is assumed to sell identical, unbranded "homogeneous" products.
These are the assumptions made in the model of "perfect competition," a simplifying construct sometimes employed by economists. Although imperfect information is completely natural and unavoidable, many economists find the unattainable ideal of perfect competition to be a desirable yardstick for policy. That is because under perfect competition no company has any power at all over the prices it charges. If a company raised its price even one cent above the market price, it would not sell anything.
With perfect competition, therefore, no consumer would knowingly pay even one cent more for an identical product that could be obtained elsewhere at a lower price. Not surprisingly, the assumption that homogeneous products are the ideal leads to the incorrect implication that brand names that differentiate products decrease consumer welfare.
That, in turn, leads to the policy, advocated by Harvard economist Edward H. Chamberlin in , that trademarks should not be enforced. More and more of the economics profession, however, has come to recognize the problem with assuming that brand name products are identical. One cannot understand the economic purpose served by brand names without dropping the assumption that we live in a world of perfect information where consumers are omniscient.
Consumers, in fact, are not fully informed, and they know they are not. Therefore, they value company reputations—and they are willing to pay more for a product whose producer has a reputation for consistently supplying quality. By doing so, consumers are not acting irrationally. They are simply trying to protect themselves without having to devote huge amounts of time to learning all the details about each company's product.
Reputations, and the brand names that go with them, are an efficient source of information for consumers. Because consumers rely on and pay for reputations, companies have incentives to establish reputations by maintaining and improving the quality of their products. This incentive would be lost if all companies were required by law to sell indistinguishable, homogeneous products.
If consumers could not identify the companies that produced the products they bought, individual companies would have no incentive to improve the quality of their products; in fact, each company would have an incentive to decrease the quality of its products.
Economist Marshall Goldman has pointed out that this is exactly what occurred in the Soviet Union when brand names were eliminated after the communist revolution.
That is why firms in the Soviet Union were required to identify their output with "production marks. Not only do consumers have no legal recourse, but more important, they have no economic recourse. Without brand names consumers do not know from current purchase experiences which products to buy—and which ones not to buy—in the future. This repeat-purchase mechanism, where good past performance and a good reputation are rewarded with future profitable sales, and where poor performance is punished with the withdrawal of future profitable sales, provides companies with the incentive to perform in the marketplace.
As a result, companies with superior reputations, representing good past performance and the likelihood of future profitable sales, have something to lose if they perform poorly. If people think highly of a brand, it has positive brand equity.
When a brand consistently under-delivers and disappoints to the point where people recommend that others avoid it, it has negative brand equity. On a smaller scale, regional supermarket chain Wegmans has so much brand equity that when stores open in new territories, the brand reputation generates crowds so large that police have to direct traffic in and out of store parking lots.
Financial brand Goldman Sachs lost brand value when the public learned of its role in the financial crisis, automaker Toyota suffered in when it had to recall more than 8 million vehicles because of unintended acceleration, and oil and gas company BP lost significant brand equity after the U.
Gulf of Mexico oil spill in Achieving positive brand equity is half the job; maintaining it consistently is the other half.
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