The study of information asymmetry has been a part of economics since the early 1970s. The core question that motivated the research was how sellers of high quality goods can best distinguish themselves from sellers of poor quality goods, when quality was entirely dependent on experiencing the product itself. In instances where perceptions of quality are impaired or incomplete, the perceived risk of the purchase is considerably higher for consumers, making it less likely to occur. The issue of how customers can reliably avoid purchasing a “lemon” led to broader studies in information asymmetry. Information asymmetry is the situation where sellers have reliable information about products (including their quality) but consumers are forced to make assessments with little or no information, and are unlikely to expend the mental energy to uncover it. Despite the lack of concrete information regarding the products, producers can “signal” quality to consumers in a variety of ways. The customers receive and interpret the quality signals, and find the quality claims credible because they recognize that if the claims are invalid (i.e. the product is of poor quality), the company will suffer significant losses in terms of future sales and a damaged reputation. Signaling theory considers how sellers of quality goods can signal to buyers that their products are high quality and should not be considered “lemons” and, as such, signaling theory is highly applicable to the core issues faced by private label brand builders.

Perceptual categorization is a cognitive process that “bucketizes” external stimuli into memory structures to enhance information processing and aid recall. Of greatest significance for our purposes, private label brands and national/name brands have been shown to occupy their own distinct perceptual categories in consumer minds. This is not to say that the products or brands are categories, it means that consumers maintain perceptual categories called “national brands” and “private labels” and then place objects or stimuli into those categories as they encounter them. There are sets of associations that help define the categories, and these associations aid in placing objects into categories. Furthermore, the associations themselves are “attached” to the objects.

The fact that private label brands are one type of perceptual category has implications for brand perception and market strategy. Private label brands are inherently associated with lower perceived quality, regardless of the actual objective quality of the product. This is largely a function of the long-standing purpose and market position of PLs, which is to provide a basic product that saves consumers money. This is not to suggest that the PL products are actually of poor quality, just that they are perceived by consumers to be lower quality than the national/name brands (NBs). There is also a substantial halo effect in play as well, which is likely reinforcing this perception. Customer evaluation of PL products from other companies, and indeed other categories, impacts their perception of all PLs, regardless of the source or manufacturer. This is a function of the perceptual categorization process, where products and brands are grouped together into cognitive categories based on perception.

It is generally quite difficult to hide the PL status of products. Research has shown, for example, that one dead giveaway is the fact that many PL brands cut across many product categories (consider, for example, Costco’s Kirkland Signature brand). Consumers in general are also more attuned to the idea of PLs today than in the past. Once PL status has been ascertained, a few perceptions are immediately “attached” to the PL. In addition to lower perceived quality, consumers will exhibit lower levels of trust in the brand, accompanied by higher levels of perceived risk on the part of the purchaser.

Because of lower perceived quality and trust, the purchaser will demand a “reverse risk premium” in terms of price, proportionate to the perceived risk. The higher the perceived risk, the greater the savings must be to offset it. Products with a lower perceived risk (low cost, fast-moving consumables), will not require a large price premium, but more expensive durables will likely require a higher premium. Customers are often willing to take a risk on a product, but it has to be worth it in terms of cost savings.

Though PLs reflect a lower perceived quality, lower trust and perceived reliability, the fact remains that consumers seek out private label products to achieve better value. Value can be thought of as the worth or utility of a product relative to its price. To increase sales of private labels, producers can work to enhance the perceptions of the brands’ quality, accomplished by several different tactics. Because customers evaluate products (and other stimuli) based largely on mental shortcuts, it is essential to provide them with clear and easily digestible cues to help them make those judgments. Signaling theory proves particularly helpful in this regard, specifically the literature around quality signaling.

There is a great deal of research in the marketing and economics literature regarding signaling in instances of asymmetric information. As noted above, signals are actions that are used to convey the genuine nature of products or services, in instances where “hard” information is either not likely to be deemed credible or is absent altogether. Signals can be used in a variety of circumstances, but for the purposes of private label products, this discussion will focus on the key issues PLs face – quality, trust and risk.

Signals can be thought of as a “bond” that a company “posts” to indicate quality, despite not providing substantive data to consumers (Barone, 2005; Kirmani and Rao, 2000). If the claims prove to be false (i.e. the products are low quality), the company will “forfeit” the bond and suffer some financial consequences. The customer infers that producers would not send false quality signals since the backlash against the producers would more than offset the revenue from the initial purchase. The consequences can vary depending on the type of signals used, but the more substantial the perceived cost of default, the more credible the claims are in the eyes of consumers. Thus to avoid a consumer backlash in the longer term, producers are wary of sending inaccurate quality signals.

Signaling is typically intended to initiate a trial purchase, with actual product use enabling a more complete assessment of quality. But research indicates that quality signals can have an impact on consumers’ quality assessment even after the trial purchase and use, although they are moderated somewhat. Private labels in particular are susceptible to issues of perception, as noted in the following example involving orange juice.

Two random samples equivalent in every way tasted orange juices from a national brand and store brands (de Wulf, 2005). The only difference between the two groups was that one was a blind tasting and one was non-blind (tasters could see what brand they were tasting). In the blind survey a store brand won easily, Minute Maid (the NB) finished next to last. But in the non-blind tasting, Minute Maid finished first. The pre-conceived notion that the NB must be of higher quality was so powerful that it was able to override the very tangible evidence of actual taste. Thus the brand signal was able to modify quality perceptions on the parts of consumers even after the product trial. Marketing can often serve to validate a buyer’s choice after the fact, in the same sense that quality signaling can improve product assessment after purchase.

In addition, “umbrella branding” suggests that assessment of one product in a product line can influence the perceptions of another product in a different category. So signaling quality in a product category that has already been purchased may influence perception of the second but as yet untested product category. The strategy of quality signaling, therefore, should not focus exclusively on initiating product trial since signals can have significant cross-category and downstream impacts.

Producers can use a variety of signaling tactics to convey quality to consumers. One of the strongest (and most widely studied) is price, which is typically not a cue available to PLs. A higher price has consistently been shown to indicate quality to consumers, even in the absence of any objective product information. But a high price PL is unlikely to achieve that kind of consideration, due in part to the historic positioning of PLs as lower priced alternative products. In general, price is not a likely signaling candidate for PLs, so the following discussion focuses on other tactics.

Key signaling tactics available to PL producers to enhance perceptions of quality include advertising spend, certification and reputation. A quick discussion of warranties is included, though it appears to have only ancillary effects.

Advertising works to enhance perceived quality through two mechanisms, by increasing awareness and by “posting a bond” that customers perceive will prove costly to the producer if it defaults on its quality promise (Barone, 2005; Moorthy, 2000).

As a signal, ad spending suggests to consumers that the company would not be willing to incur such significant expenses if the company did not believe in the quality of the products being advertised. Note that the content of the ad is likely to be entirely irrelevant, since “hard” information is typically not consumed. In this sense, the ad spend is the “bond” that the company posts, and the consumer infers that the producer must be confident that they will more than recoup the costs of the ads via the sale of (quality) products. If the products are actually of poor quality, consumers infer that the producer will have spent significant resources but will suffer a backlash from unhappy customers, loss of sales, and a damaged reputation. The producer will have “defaulted” on the bond, having incurred the cost of the ads without achieving sufficient revenue to offset it. Since no rational producer would undertake such an expense only to lose the benefits of it, customers infer that the products must be high quality.

This may sound as if it requires significant cognitive resources on the part of the consumer to make these judgments, but it is in fact instantaneous and intuitive. To readers of Kahneman’s Thinking, Fast and Slow this will immediately bring to mind System 1, the fast, intuitive and heuristic-based thought process. It is so fast and powerful, in fact, that research has shown that actual knowledge about the objective quality of the product does not diminish the effect of advertising on perceived quality.

While research has repeatedly shown that advertising spend improves perceptions of quality, there are some caveats. This type of signal is particularly important in markets where repeat purchases are highly desired. Defaulting on a one-off purchase is less costly to the producer and thus carries less weight with consumers. Most importantly, if spending is perceived as excessive, advertising can actually have a negative effect on quality perceptions since it is seen as a tactic of desperation. Super Bowl advertising for unknown companies may not enhance perceptions of quality at all, and may actually detract (Kirmani and Wright, 1989).

It is hardly surprising that marketing research has shown that advertising and other marketing programs increase brand and product awareness. However, awareness itself has an important impact on quality perceptions. Frequent advertising increases brand familiarity, but what is of particular interest in this case is that brand familiarity in and of itself increases perceptions of quality. That is, holding actual quality and product information constant, simply being familiar with the brand or product improves consumer perceptions of its quality. This is very much in line with Kahneman’s discussion of the “mere exposure effect” which shows that repeated exposure to a stimuli (even if the stimuli is literally incomprehensible to test subjects) results in overwhelmingly positive associations by respondents. Repeated exposure results in increased familiarity, comfort and trust, which leads to positive associations. Thus, advertising does double duty, building quality perceptions through familiarity as well as the aforementioned signaling process.

Certification refers to the independent validation of quality by a third party (Mishra, 2005; Ku, et al, 2012). Quality awards (JD Power), or certifications from well-known institutions or labs (UL, ISO, Standard and Poor’s) can improve quality perception by customers. The mechanism is straightforward—approval from respected third party reviewers reduces the perceived risk that consumers have regarding claims about quality. It provides an easy cue (ideally though a logo or icon) that requires almost no cognitive energy to consume. In addition, the “bond” that is posted is not just that of the producer, but also that of the third party reviewer. In essence, there are two reputations on the line if quality is actually poor. If the claims regarding quality prove to be false, not only does the producer suffer default (in terms of future sales) but the credibility of the certifier is also undermined with potentially significant consequences to their entire business. As in all signals, as the stakes increase, the perceived value of the “bond” increases and the perceptions regarding quality achieve greater credibility. Research suggests that certification is the strongest signal that a producer can send, due to the costs the producer incurs to get products certified, the costs of falsely signaling quality, and the potential risk to the certifier (Dewally and Ederington, 2006).

In light of the foregoing discussion, the length of the warranty period would seem to be an obvious indicator of quality by reducing the perceived risk on the part of the purchaser. The warranty service cost that would be incurred as a result of poor quality is the “bond” that is posted. Hyundai’s 10-year 100,000-mile warranty is an oft-cited example that served the purpose of signaling quality though pain of default. Indeed a Hyundai executive noted recently that had the cars not lived up to expectations it may very well have bankrupted the company.

However, the importance of warranties as a signal appears mixed. Despite seeming obvious, warranty is not likely to be a significant signal to consumers for private label products. Some research indicates that consumers discount the importance of warranties, possibly figuring that the “hassle factor” makes it unlikely that they will take advantage of them even if the need arises (Dewally and Ederington, 2006). There may also be some element of perceived “desperation” attached to it, much like excessive “Hail Mary” ad spending can be seen as a desperate bid for sales. Similarly, warranties well outside the industry norm may appear to be a last ditch effort to drive sales.

There is some evidence that suggests warranties can serve as a signal for durable goods, when a consumer may be more likely to actually take advantage of it when needed (e.g. automobiles) (Moorthy, 2000). In addition, the effects of a warranty appear to be related to the reputation of the producer, which provides some credibility to the warranty promise. The research also seems to suggest that there may be some positive effect if a warranty is offered in conjunction with other quality signals (advertising spend, certification, etc.), but overall relying on the warranty alone as a quality signal appears to be a bad idea.

Brand reputation as a signal can work a couple different ways. Brands, almost by definition, exist to help consumers reduce perceived risk and lend credibility to claims of quality. In essence, consumers perceive that a brand with a good reputation would not be willing to risk that reputation by endorsing or selling low quality goods. To default on this bond would bring economic pain to the business and future revenues would suffer.

Brands can also ally themselves with other brands via endorsement, and pass along quality signals through that mechanism. When NutraSweet was first introduced, it was the endorsement of Coca Cola and Pepsi that allayed any concerns over its safety (Rao, et al, 1999). Why, the thought process went, would Coke take such a huge business risk if they had not vetted the sweetener thoroughly?

In the case of private label products, the ability of the corporate endorser to signal quality through an endorsed branding strategy makes this type of brand architecture compelling. Though “hiding” the corporate entity through a “house of brands” strategy has some merit, the PL-savvy consumer combined with the increasingly cluttered brand landscape lobbies for a corporate endorsed strategy. The brand building challenges associated with an unknown PL are significant, and endorsement helps PLs achieve differentiation in a competitive marketplace, and can signal quality at the same time. The caveat, of course, is that the corporate endorser must be well-known and have a positive reputation with consumers.

One additional quality signal is third party reviews. While they do not necessarily work in the same way as the other signals discussed above, buyers are increasingly likely to look for, and lend credibility to, product reviews. In this case, there is not really a “bond” that is posted, and there is no action the purchaser can effectively take on the reviewer if the product does not live up to the standards implied or indicated in the review. But because they are seen as a credible source of information regarding quality, private labels can use customer testimonials to support quality claims. There are challenges with this process, not the least of which is legal use of a customer quote for promotional purposes, but to some extent that “cost” only adds to the credibility of the quotes.

There are a few other signals that have been researched that touch on private label products.

Country of origin (COO) does impart a quality signal (Teas and Agarwal, 2000), but the concern from a tactical point of view is how this perception shifts over time. One study from several years ago noted that COO signaled poor quality, but the country in question was South Korea. Just a few years later South Korea was associated with much higher quality, with China taking over as the low quality COO. Since this information is not likely to impact how products are actually sourced by U.S. companies, it is mentioned here only for the sake of completeness.

As noted earlier, price is also a well-known signal. In general high price signals high quality, but private label products by their very nature are expected to be lower in cost than name brands. As it happens, a low introductory price can also signal quality, since the message that is being sent is “we’re going to take a loss up front, but we’re confident that once you try it you’ll buy it again at full price.” What is essential here is that the introductory price be so low that there is no doubt in consumers’ minds that the producer is taking a loss on it, and that it is in a product category or market where repeat purchase is essential to the producer’s success.

There is some research that indicates consumers are becoming slightly more sophisticated regarding PLs and while they are not placing them in the same conceptual space as national brands, they are, in some cases, creating a new space for “better” PLs, referred to as Premium PLs, or PPLs. So while higher priced PLs may soon become something other than an oxymoron, what is essential is that there is an “anchoring” PL at the low end to provide context to potential purchasers. A PPL without an anchoring PL will likely be seen as a wildly overpriced PL.

Private label products suffer from some unique challenges, most significant of these is the lower perceived quality of the products. There are limits to any marketing strategy, but there are a number of strategies that high quality PLs can take to overcome quality perceptions in cases of asymmetric information.

Certification is the strongest quality signal a producer can send. It is costly, but this cost is part of the bond posted that is subject to default if the claims are invalid. The perceived expense is precisely the element that adds credibility to the claims. Ideally, certification comes from a well-known organization, preferably tested against industry standards, and is signified in some easy-to-consume fashion (e.g. a logo or icon) since consumers tend to work off mental shortcuts or cues. Because marketing budgets for PLs tend to be smaller, conveying this certification is potentially challenging.

However, quality signals are stronger when several of them work in unison, so additional tactics like advertising are advisable. Advertising spend is another strong signal of quality that seems to work consistently regardless of product type or industry, and provides a medium for promoting the certification signal. Advertising has the added benefit of increasing familiarity with the brand, and can be used to convey product information as well, in the event that a consumer is actually willing to take the time to consume it. It should be noted that not just any ad will be sufficient to post the bond that infers quality. A free ad in a low budget industry directory will not convey the desired signal since there is no perceived cost to the producer. The signal is more likely to be sent and received if the spend is in major, nation-wide (and perceived costly) publications with established reputations.

Warranties may be better received in conjunction with other quality signals, but relying on warranties as the sole quality signal would likely be a mistake. They may have more credibility in the context of durable goods, but should not be significantly outside industry norms.

Lastly, a corporate endorsement strategy and customer testimonials can add another quality signal through the brand equity of the endorser (assuming it is positive) and other purchasers. Building the reputation of the brands, both corporate and PL, can also be helped through a “brand ally” strategy (Rao, at al, 1999), but aligning one’s business with another adds significant risks if the ally fails to live up to consumer expectations.

In sum, the challenges facing PLs are significant, but a focused strategy of altering initial quality perceptions through the utilization of signaling theory can help the process of brand building that is so essential to the success of private labels.

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