Vertical Differentiation, Branding, and Product Confusion

Abstract

The decision whether a multi-product firm offers its goods under a joint or separate brands is essential for its success. When selling vertically differentiated products, it needs to consider pricing, cannibalization, and---when branding jointly---product confusion, i.e., consumers associating characteristics with the wrong product. The extent of product confusion crucially depends on the accuracy of available information. In this paper, we study the branding and pricing problem of a firm selling vertically differentiated products to a mix of naive and sophisticated consumers. The analysis accounts for the spillover arising from product confusion. Our findings suggest that joint branding is optimal when the spillover is either high or low but not in between. When low, firms jointly brand to save the cost of erecting a second brand. In contrast, when spillover effects are high, the firm brands jointly since it is inherently more profitable even if building additional brands is free. In between, firms opt for separate branding despite the additional cost of building more brands. We also find that a higher fraction of sophisticated consumers does not necessarily push the firm towards joint branding. Moreover, firms are inclined to jointly brand more similar products, and, if doing so, decrease price dispersion. Similarly vertically differentiated firms choose different branding regimes under competition, while low-end (high-end) strategic competition pushes a multi-product line firm towards joint branding. Finally, we investigate when firms want to provide consumers voluntarily with accurate information about the quality of its products.

Keywords: Vertical differentiation, product confusion, branding, cannibalization, information provision