Brand Management and Strategies Against Counterfeits

• Author: Yi Qian
• Date: 01 June 2014
• Published date: 01 June 2014
• DOI: http://doi.org/10.1111/jems.12057

Brand Management and Strategies Against

Counterfeits

YIQIAN

Kellogg School of Management

Northwestern University

2001, Sheridan Road

Evanston, IL 60208 and National Bureau of Economic Research

yiqian@nber.org

In this paper,I provide a theory for brand-protection strategies to reduce counterfeiting under weak

intellectual property rights. My theoretical framework has general implications for endogenous

sunk cost investments as a means of deterring counterfeiters. My model incorporates two layers

of asymmetric information that counterfeits can incur: counterfeiters fooling consumers and

buyers of counterfeits fooling other consumers. Brands have a number of tools at their disposal to

maintain a separating equilibrium in the face of counterfeits. One of the theoretical predictions

of this study is that counterfeit entry induces incumbent brands to introduce new products. This

helps to explain the innovation strategies that authentic firms employ in response to entry by

counterfeiters in practice. Authentic prices rise if and only if the counterfeit quality is lower than

a threshold level. In addition, the model demonstrates how authentic producers could invest in

self-enforcement to increase counterfeiters’ incentives to separate themselves from brands. Better

channel management through company stores and other costly devices are forms of nonprice

signals and complement a company’s own enforcements against counterfeits. These predictions

are validated using unique panel data collected from Chinese shoe companies covering the years

1993–2004. Data further reveal that companies with worse relationships with the government

invest more in various self-enforcement strategies, which are effective in reducing counterfeit

sales, and that the set of strategies are complements rather than substitutes for each other.

1. Introduction

Brand names have significant economic value and offer a guarantee of quality that

generic products often do not match. The inherent value that brand names carry gen-

erates incentives for imitation and counterfeiting. The World Customs Organization

(WCO, 2004) estimates that 512 billion euro’s worth of traded world merchandise may

have been counterfeits (WCO, 2004). Besides the business stealing effect that industries

have blamed counterfeits for, counterfeiting can also bring ethical costs (Gino et al.,

2010). Therefore, it is pertinent to study and propose marketing strategies that original

producers could employ to appropriately countervail counterfeits.

Demand for counterfeits has been explored to some extent in the marketing liter-

ature (Bloch et al., 1993; Wee et al., 1995; Cordell et al., 1996; Tom et al., 1998; Kwong

et al., 2003; Wilcox et al., 2009), with price, attitudes toward big branded companies, and

The author is grateful to Daniel Spulber, the anonymous coeditor and referees, and Philippe Aghion, Eric

Anderson, Kevin Bryan, Richard Caves, Anne Coughlan, Josh Lerner, and Scott Stern for helpful advice and

comments, and to Diane Culhane for copyediting. Cooperation from the Chinese Quality and Technology

Supervision Bureau (QTSB) and the companies I interviewed and surveyed is gratefully acknowledged. The

results in this paper do not necessarily represent the views of QTSB.

C2014 Wiley Periodicals, Inc.

Journal of Economics & Management Strategy, Volume23, Number 2, Summer 2014, 317–343

318 Journal of Economics & Management Strategy

the need for status signaling being cited as main factors driving counterfeit demand. On

the supply side, a few studies have examined the piracy network effects (Conner and

Rumelt, 1991), the legal responsibilities of firms and government (Olsen and Granzin,

1992), and the way firms’ internal organizations complement weak intellectual prop-

erty rights enforcement (Zhao, 2006). Enlightening as these studies are, the economic

impacts of counterfeits and the corresponding marketing strategies are still not fully

understood. Grossman and Shapiro (1988) discuss counterfeit impacts primarily in the

international trade setting and their theoretical predictions cannot fully explain recent

empirical findings. In particular,counterfeiters attempt to infringe upon brands and may

generate asymmetric information complexities to fool consumers. The findings in Qian

(2008) that authentic companies strive to upgrade quality and build company stores after

counterfeiters enter demonstrate the value of disentangling asymmetric information for

consumers. These strategies can also broadly be considered as endogenous sunk costs

(ESCs), a term introduced by Sutton (1991).

I build upon a vertical differentiation model (Gabszewicz and Thisse, 1979, 1980)

with endogenous quality and other ESC to analyze brand-protection strategies to counter

counterfeit entry. I introduce quality options for the authentic producer who chooses

quality according to its potential to yield higher profits. I first analyze price competition

with a given quality (one per firm) under the entry game, and then look at the ex ante

choice of quality.This endogenization of quality setting helps to resolve the counterintu-

itive observations in practice that authentic prices often rise after entry by counterfeiters

(Barnett, 2005). This study derives conditions under which quality can be used as one

of the key strategic decision variables to combat counterfeits.

In addition, I model two layers of asymmetric information that counterfeits fre-

quently generate. First, and perhaps more important, asymmetric information lies be-

tween the counterfeiter and buyers. I model this through a fraction of consumers who

cannot distinguish counterfeits from authentic goods when they are sold at the same

price. National surveys indicate that the majority of consumers who purchased counter-

feits (98% for cigars and 70% for footwear) thought they were authentic. Second, some

buyers may show off counterfeits to signal their fake status. I model such asymmetric

information among consumers by a positive probability that a consumer who wears

counterfeits cannot be discerned by others, and hence this consumer derives the full

utility on brand premium.

I take into account asymmetric information by building on the literature of qual-

ity uncertainty. Price is the conventional signal for product quality, but Nelson (1974)

points out the importance of advertising as a nonprice signal for quality. Milgrom and

Roberts (1986) argue that prices are better signals for quality than nonprice signals (no-

tably advertisements) unless repeated purchases are assumed. Moorthy and Srinivasan

(1995) propose money-back guarantees as another effective signal for quality. Despite

the sophistication of the previous literature, the models considered only a monopolis-

tic market and assumed exogenous quality levels. Since counterfeiters attempt to copy

authentic products and usually produce inferior quality, the competition is more ver-

tical in nature. Metrick and Zeckhauser (1999) use a simplified vertical differentiation

framework to model competition under asymmetric information. However, their mod-

els are still confined to exogenous quality, and they derive equilibrium market shares in

a price-pooling equilibrium, which is helpful for explaining certain sector equilibria but

not applicable to most counterfeit markets.

In sum, my model captures the defining characteristic of counterfeits, that is,

the intent to deceive, by incorporating both layers of asymmetric information pertain-

ing to counterfeits. The framework enriches the analysis of a broad set of instruments