The benefit of collective reputation

• Author: Aniko Öry,Jungju Yu,Zvika Neeman
• DOI: http://doi.org/10.1111/1756-2171.12296
• Published date: 01 December 2019
• Date: 01 December 2019

RAND Journal of Economics

Vol.50, No. 4, Winter 2019

pp. 787–821

The benefit of collective reputation

Zvika Neeman∗

Aniko ¨

Ory∗∗

and

Jungju Yu∗∗∗

Westudy a model of reputation with two long-lived firms who operate under a collective brand or

as two individual brands. Firms’investments in quality are unobserved and can only be sustained

through reputational concerns. In a collective brand, consumers cannot distinguish between the

two firms. In the long run, this generates incentives to free-ride on the other firm’s investment,

but in the short run, it mitigates the temptation to milk a good reputation. The signal structure

and consumers’ prior beliefs determine which effect dominates. We interpret our findings in light

of the type of industry in which the firms operate.

1. Introduction

Firms make substantial investments to build strong brands. The American Marketing As-

sociation defines a brand as “a name [ ...]that identifies one seller’s good [...] as distinct from

those of other sellers.”1Sometimes, firms sell their products under a shared name or a collective

brand that carries a collective reputation that is shaped by the firms who bear the name. For ex-

ample, a bottle of wine carries an appellation, such as Bordeaux or Champagne, which applies to

many producers in the same region. Many lay consumers cannot distinguish among the names of

individual producers and rely on appellations to make their purchase decisions. Country of origin

labelling serves a similar function. For example, Volkswagen advertises “the power of German

engineering” and Swiss watchmakers, even the ones with strong individual brands, emphasize

that their watches are “Swiss made.”

∗TelAviv University; zvika@post.tau.ac.il.

∗∗Yale University; aniko.oery@yale.edu.

∗∗∗City University of Hong Kong; jungjuyu@cityu.edu.hk.

We thank Joyee Deb, Anthony Dukes, Jack Fanning, Johannes H¨

orner, Larry Samuelson, Jiwoong Shin, K. Sudhir, and

Robert Zeithammer for helpful comments. We also thank seminar participants at Four School Conference (Columbia

University, 2016), International Conference on Game Theory (Stony Brook, 2016), Israel IO Day Conference (Hebrew

University, 2018), McGill University (2016), Marketing Science–Federal Trade Commission Economic Conference on

Marketing and Consumer Protection (Washington DC, 2016), NEMC conference (MIT, 2017), SICS conference (UC

Berkeley,2016), University of Munich (2017), Yale University Marketing Lunch (2016), Yale University Theory Lunch

(2019).

1www.ama.org/resources/pages/dictionary.aspx.

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Collective reputation building is also relevant in other domains. Any physical good that

is purchased online is essentially an “experience good” whose quality cannot be ascertained

by consumers at the time of purchase (Nelson, 1970).2Nosko and Tadelis (2015) show that

a consumer who has a bad experience with one seller in an online platform, such as eBay or

Amazon, is less likely to buy through that platform again, which is evidence of a “reputational

externality” that sellers in the platform exert over one another. Such a reputational externality is

characteristic of a collective brand.3

Both individual and collective brands are means to build a good reputation. When building

a reputation, a firm faces a moral hazard problem; its investment in quality is unobservable to

current consumers, and the reputational return on its investment can only be collected in the

future. In this article, we study how sustaining reputation in a collective brand is different from

that of an individual brand.4

At first glance, collective brands may seem like a bad idea. If several firms operate under

one brand name, each firm has an incentive to free-ride on other firms’ investments. Moreover,

a firm’s investment in its quality has a weaker effect on the brand value of a collective brand

because consumers are uncertain about the relationship between the collective brand’s reputation

and the specific firm with which they interact. In other words, the “precision” of the signal that

is generated by a firm’s investment in quality is lower in a collective brand, which weakens the

incentive to invest in quality.

Nevertheless, under some circumstances, a collective reputation can serve as a commitment

device for investment in high quality. I f a brand is already very successful, then a firm might

be discouraged from additional investment because the short-run return from it is small. Such

a firm might become complacent or rest on its laurels. Analogously, if a brand develops a bad

reputation, then additional investment may be insufficient to improve its reputation in the short-

run. Collective brands can mitigate these short-run “discouragement effects” faced by individual

firms after very good or very bad histories by making extreme beliefs about the value of the brand

less likely.

However, a member of a collective brand may also be tempted to free-ride on future efforts

by other members of the brand, which is irrelevant in the case of an individual brand. So, in the

long-run, a collective brand provides weaker investment incentives than an individual brand. It

follows that when short-run incentives are more important, then a collective brand can provide

stronger incentives to invest than an individual brand, and when long-run incentives are more

important, then the opposite result holds.5Below, we describe specific conditions where the

short-run benefit of a collective brand outweighs the long-run benefits of an individual-brand.

To compare the two branding regimes, we consider a model in which two or more long-

lived firms sell their products over time under an individual or a collective brand. There are two

types of firms, competent and incompetent. In every period, competent firms can make a costly

investment to increase the probability of producing good quality in that period. Incompetent

firms lack this ability. Firms’ investments are unobservable to consumers. Consumers observe

past quality realizations, which are noisy signals of firms’ investments and competence.

The critical distinction between an individual and a collective brand lies in consumers’

observation of past quality realizations. Consumers observe a firm-specific record under an

2Experience goods include nondurables such as wine, durables such as appliances and cars, and many service

providers such as lawyers,doctors, and mechanics.

3Another example for the reputational externality is provided by organizationsthat require their members to wear

uniforms, such as the police, military forces, and Girl and Boy Scouts. Uniforms foster the creation of a reputational

externality among their wearers because they blur individual identities.

4In practice, firms are often endowed with features of both individual and collective brands. For example, Volk-

swagen belongs to the group of German automakers, and also possesses a strong individual brand. Weabstract from such

hybrid situations to present the difference between individualand collective brands in the starkest terms.

5As shown in Section 4 below, in some circumstances, collective brands dominate individual brands even if firms

are infinitely patient.

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individual brand and a group-specific record under a collective brand. This has two implications.

First, each signal produced by a collective brand is noisier because, unlike in the case of an

individual brand, consumers facing a collectivebrand cannot trace the signal back to the fir m that

produced it. Second, a collective brand generates more signals than an individual brand because

each one of its members can produce a signal.

In both cases, we focus on the most efficient equilibrium in which a competent type always

invests. We call this equilibrium the “reputational equilibrium.” Weexamine whether it is “easier”

for an individual or a collective brand to sustain this reputational equilibrium in the sense that the

equilibrium can be sustained for a broader set of parameter values.

We focus the analysison two extreme cases: the case where the observation of good quality

indicates competence, which we call “exclusive knowledge;” and the case where the observation

of bad quality indicates incompetence, which we call “quality control.” In the former case,

specialized exclusive knowledge is required in order to produce high quality (as in the case of

expensive watches and cars); in the latter case, investment is needed to perform good quality

control, so the production of low quality reveals incompetence (as in the case of mass products

and generics). This emphasis has two reasons. It simplifies the analysis,and it allows us to focus on

clearly identified circumstances where collective reputation is superior to individual reputation.

Weshow that a collective brand can support a reputational equilibrium for higher investment

costs than individual brands in “exclusive knowledge” markets when the ex ante probability of

competence is high. Individual brands perform poorly in such markets because it is relatively

easier for them to establish an excellent reputation quickly (as the production of high quality

reveals competence), which they can then milk. The opposite result (namely, a collective brand

supports a reputational equilibrium for higher investment costs than individual brands when the

ex ante probability of competence is low) holds in “quality control” markets where production of

low quality reveals incompetence.

The benefits from the additional commitment powerthat is provided by a collective brand can

be significant enough to induce a competent firm to form a collective brand with an incompetent

firm voluntarily.In such a case, the socially optimal branding regime coincides with firms’ optimal

choice, so no regulation is required. However, it is also possible that a competent firm would

prefer an individual to a collective brand, even though the latter induces incentives to invest and

the former does not. In such cases, a regulation that promotes collective brands would improve

social welfare.

The article is structured as follows. The next section discusses the related literature. In

Section 3, we present the model, define the equilibrium concept, and introduce the critical

distinction between an individual and a collective brand in terms of consumers’ beliefs. In

Section 4, we describe circumstances under which an individual or a collective brand provides

stronger incentives for investment. In Section 5, weexamine a competent type’s brand formation

decision and consider whether it would want to form a collectivebrand with an incompetent fir m.

In Section 6, we present extensions of the basic model that allow for a longer memory and more

than two firms, respectively. Section 7 concludes. All proofs are relegated to Appendix A and

Appendix B.

2. Related literature

Our work is related to the theoretical economics literature on reputation in markets for

experience goods, as well as to the literature on umbrella branding, country-of-origin, and ca-

reer concerns.

The idea that reputational concerns may induce a firm to produce high quality even though

consumers are unable to verify the quality of an experience good goes back to Klein and Leffler

(1981). The subsequent literature has explored the implications of this argument and has argued

that it must contend with two major difficulties: first, for reputation to be sustainable, it must

generate profits, and it is not clear how this is possible in a competitive environment where

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