The Simple Economics of Brand Stretching Author(s): Lynne M. Pepall and Daniel J.

Richards Source: The Journal of Business, Vol. 75, No. 3 (July 2002), pp. 535-552 Published by: The University of Chicago Press Stable URL: http://www.jstor.org/stable/10.1086/339888 . Accessed: 25/03/2011 13:39
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Lynne M. Pepall Daniel J. Richards

Tufts University

The Simple Economics of Brand Stretching*

I. Introduction In January 1999, the Coca-Cola Company announced its plan to launch a new product line: fashion and sports apparel carrying the Coca-Cola label. In making this move, Coca-Cola appears to be following the lead of many other name brand companies that, in recent years, have launched and marketed new products under the original brand name. This phenomenon is called brand stretching; the term refers to the extension of an established brand name identied with a product in one market to a new product in another market.1 The list of brand stretchers is a long one. Some well-known examples include the Ralph Lauren Polo label from clothing to mens toiletries, the Virgin brand name from recordings to airlines to beverages to nancial products, the Martha Stewart label from a magazine title to both linen and paint product lines, and the Dr. Martens brand from a well-known U.K. shoe and boot product to a new record label. Our article is about the phenomenon of brand stretching. This is an important topic for economists
* We thank Luis Cabral, George Norman, two referees, and the editor of this journal for many valuable comments. 1. See, e.g., Coke Clothers to Be the Next Real Thing: To Be Unfolded Worldwide (National Post 1999, p. C12). Examples of entry via brand extension are numerous and include Disneys entry into toys and television, Harley Davidsons marketing of an aftershave, and Cadburys entry into the cream liqueur market. See These Boots Are Made for Your CD Player (Independent 1997, p. 9). (Journal of Business, 2002, vol. 75, no. 3) 2002 by The University of Chicago. All rights reserved. 0021-9398/2002/7503-0006$10.00 535

We analyze brand stretchingthe extension of a successful brand label from an initial home market to a different product lineusing a model that assumes that brand identity is a complementary feature that enhances consumer willingness to pay. Our analysis implies a pattern of brand-stretching entry in which (1) rms with strong brand identities may prefer to extend their brands to markets that are far from their original product line, and (2) fragmented or unconcentrated markets with no strong incumbent brands are attractive entry targets for brand extension.

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because, fundamentally, brand stretchingis about market entry. Our perspective on brand stretching is somewhat different from that taken in previous work in this area, such as that by Wernerfelt (1988), DeGraba and Sullivan (1995), Choi (1998), and Cabral (2000). In these papers, brand stretching is often viewed as a way for a monopoly rm to extend its monopoly power into a new market. In that framework, brand stretching is protable either because it confers some sort of scope economies or because it serves as a way to signal the quality of the new product. The question of how brand stretching affects competition in the new product market is not, however, a part of the brand-stretching story in this earlier work.2 Quality signaling and scope economies may explain why some rms choose to brand stretch. But many actual cases cannot be understood by these factors alone. Often the new market into which the brand name is leveraged is, from the perspective of production technology or SIC number, far from the market in which the brand name was developed. For example, it seems doubtful that consumers will view a sports apparel line as high quality simply because it carries the Coca-Cola label. Nor is it likely that the Ralph Lauren label enjoys signicant economies of scope between the production of clothing and aftershave products. Equally important, most actual cases of brand stretching involve entry by an established brand name into a market where there are at least a few, and often many, existing incumbent rms. Hence, the monopoly models used in most formal analysis are inappropriate. It is for this reason that we focus on brand extension as a way to enter existing markets, that is, markets that are already open and have incumbent rms. The widespread incidence of brand stretching suggests that a strong brand identity can facilitate entry or, more precisely, can enhance an entrants ability to compete against the incumbent rivals. Supportive evidence on this point is offered by Court, Leiter, and Loch (1999), who nd that those rms extending their brand identities to new markets generate a return to stockholders that averages 5% more than that earned by comparable rms not so leveraging their brands.3 In this article, we model explicitly the brand-name advantage in entering a new market and then proceed to investigate how brand stretching affects competition and protability in that market. To model the brand-name ad2. We say almost totally because both Sappington and Wernerfelt (1985) and DeGraba and Sullivan (1995) do present a model with duopoly competition. However, Sappington and Wernerfelt (1985) have no price competition in their model. DeGraba and Sullivan (1995) consider a duopoly model only after focusing on a monopoly setting. Moreover, even in the duopoly case, their analysis considers brand stretching only from the perspective of spillovers to a rms reputation for quality on brand versus new name entry. In addition, they set their work in the context of entry into a new or just-opening market. The competition they examine is one of timing, specically, whether a brand-stretching rm will open a new product market sooner or later than would a rm entering that market as a new-name product. 3. In Cabrals (2000) model, for instance, consumers pay their full reservation price, i.e., all surplus goes to the monopolist. Thus, the equilibrium in that model is such that the entire market would move to any rival offering to sell for just one penny less than the price charged by the one rm assumed by the model. The absence of price competition in such a model therefore seems to be a serious omission.

Brand Stretching

537

vantage, we assume that consumers are willing to pay more for brand-name products because of the complementary consumption effect of a brand namean effect similar to the one in Becker and Murphy (1993) for the case of advertising. Simply put, consumers get greater utility or enjoyment from consuming products that are well known to other consumers. This is so even if the brand-name recognition was established in a different product market. For example, a consumer may be willing to pay more for a Coca-Cola T-shirt because the brand name Coca-Cola is widely known to others. Wearing the shirt then permits the consumer to talk with others about the shirt or about the label or about Coca-Cola products and, in general, to share and to enhance the experience of wearing it. Thus, the Coca-Cola brand name in and of itself has value to the consumer. Evidence that consumers value recognition is offered by Grossman and Shapiro (1988), who point out that consumers who buy a counterfeit Gucci or Coach product from street vendors typically know that the item is not an authentic Gucci or Coach product (and hence, not of the same quality). Nevertheless, such buyers are still willing to pay something for the forged name. Indeed, they would not likely buy the product without the forged brand name. Some formal evidence that a brand name can, like advertising, act as a potential complement in consumption that raises consumer willingness to pay is provided by Smith and Park (1992). They nd that rms using brand extension spend less on advertising per unit of sales than do rms launching unbranded new products. In other words, brand-name recognition is a substitute for advertising and therefore should work in much the same manner as promotional efforts. An important preliminary issue is, of course, identifying precisely what constitutes a well-known brand name. Here, we follow much of the marketing literature that centers on market share as a proxy for the strength of a brand in its current market. However, we adjust this measure further in considering the extent to which such brand recognition transfers to other markets and the nature of brand competition that will prevail in such potential target markets. Our goal is to identify the various factors that affect the protability of brand extension into a particular market, as well as the pattern of entry that this implies. Target markets that are relatively easy to enter are likely not only to have many incumbent rms already in the market but also to attract more than one brand-stretching entrant. Any rm contemplating extension of its brand into such a market must, therefore, consider the potential brand-name competition from another brand-stretching rm entering the same market. Accordingly, in our rst model of brand stretching, we examine the entry of two branded rms into a new market with many unbranded incumbents. In contrast, a highly concentrated market is one in which entry is likely to be difcult.4
4. This accords with empirical evidence (see Caves [1998] for a summary) that generally nds entry rates increasing as concentration declines.

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Journal of Business

Moreover, in this case, the incumbent rm itself is likely to have strong brand recognition. Therefore, we also offer a second model of entry in which the target market is monopolized and so brand competition is between the incumbent and just one brand-stretching entrant. II. Two Simple Models of Brand Stretching Consider a rm that wishes to extend its brand name into a new market. This rm already has a known brand in some market referred to as the home market. Because the rms brand has an identity in that market, the rm has a proprietary name that could enhance its competitive position in other product markets, which we call target markets. Again, in keeping with much actual practice, we assume that the brand stretchers recognition in a target market will depend on the market share of the rms brand in its home market, denoted by S. All else equal, the larger is that share S, the stronger or more known is the rms brand.5 Of course, market share in the home market is not the only determinant of the brand stretchers recognition in a target market. To capture how well identity in the home market translates into similar recognition in a specic target market, we dene the parameter a, normalized so that 0 ! a ! 1. The greater is a, the more fully does the brands home-market recognition transfer to the target market. The size of a could be related to some measure of the commonality between the home and target markets, for example, to the degree to which they share common consumers or the degree to which the products in the two markets share similar attributes. For example, the Godiva name in chocolate probably carries over more to ice cream than it does to tires. Hence, the Godiva name would likely have a higher a in the ice cream market than in the tire market. Alternatively, a could be related to some measure of closeness, in terms of fashion or image, between the home market and the target market. In the case of Coca-Cola, sportswear is a market that in this sense lies closer to the soft drink market than to the market for power tools. The parameter a is also likely related to the actual size of the home market. This is because in our model brand recognition comes not so much from being known for some special feature, for example, quality, as from simply being known. A sizable market share in a large or thick market is likely to carry over as brand strength more effectively than would the same market share in a small market. In short, there are a host of factors other than homemarket share that determine the potential brand stretchers image strength in
5. For example, the marketing rm Interbrand employs a measure of brand strength in its frequent ranking of brand identities. Of the four criteria used to measure such strength, the most important by far in their index is market share. Another criterion is how far the market examined was from the brands home market. The two other criteria are breadthas reected in the number of different countries the brand sold inand a measure of customer loyalty. These last three criteria may all be taken as factors inuencing our parameter, a, discussed below. See, e.g., Broad, Deep, Long and Heavy: Assessing Brands (Economist 1996, pp. 7273). Court, Leiter, and Loch (1999) also link brand strength to market share.

Brand Stretching

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a specic target market. The parameter a stands in as a proxy for all of these factors. The overall brand recognition of a brand-stretching rm in a given target market is, therefore, dened as aS. A. Brand Stretching into a Target Market with Many Incumbents As noted above, target markets that have many incumbent rms are likely to be markets that are relatively easy to enter. This feature is likely to make such markets attractive to more than one brand-stretching rm. For this case, then, we will consider the entry of two brand-stretching entrants. They are called rm b1 and rm b 2 , respectively. Because the brand strength of each rm is exogenously given by a i Si , it does not matter whether these two rms enter the target market sequentially or simultaneously. What is important is that each rm anticipates the entry of the other. That is, in considering branded entry into a new market, each rm understands that there will be some rival brand doing the same thing. It will not necessarily be the same rival in all potential target markets. Ralph Lauren may expect to confront Calvin Klein in one market extension but perhaps Coca-Cola in another. In addition to these two potential entrants, the target market has N identical incumbent rms, denoted as rm i, i p 1, . . . , N, where N 2. Each incumbent rm has the same unit constant cost of production, c, where 0 ! c ! 1. In other words, there is no dominant incumbent rm. The incumbent rms compete symmetrically for consumers. We assume as well that the brandstretching rms have the same constant unit production cost as the incumbent rms. That is, the advantage of the brand-stretching rms is rooted in their brand identities and not in any cost advantage. Firms in the target market compete in prices for consumers, of whom there are L in total. Each consumer buys at most one product per period. Consumer willingness to pay for each of the incumbent rms substitute products is determined by an index v, which is distributed continuously and uniformly between 0 and 1. However, consumers value recognition and so are willing to pay more for the products that are more recognized. Accordingly, price competition among the two brand-stretching rms and the incumbent rms will be affected by consumers perception of the differences in their brand strength. For the brand-stretching entrants b1 and b 2 , brand recognition depends on their market shares in the home market, denoted by S1 and S 2, respectively, and on how well their visibility there translates into the target market, as given by the parameters a1 and a 2 . Brand recognition, or the factor a i Si , of each entrants product, is a highly rm-specic variable, and so it is unlikely that the two brand stretchers would have exactly the same brand recognition in the target market. The more likely scenario is that one entrant will have more brand recognition than the other. Without loss of generality, we will assume here that a1 S1 1 a 2 S 2. That is, brand stretcher b1 has greater brand recognition in the target market than does brand stretcher b 2.

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Journal of Business

Because consumers value visibility, they are willing to pay more for a product that has a stronger brand image or that is more widely recognized by others. The increase in consumer willingness to pay for a brand stretchers product depends, therefore, on the relative difference in brand recognition between the brand stretchers product and an incumbents product. In keeping with our basic modeling strategy, we assume that an incumbent rms brand strength in the target market is equal to its market share in that market. In other words, because an incumbent rm is extending its brand recognition, the parameter a would be equal to one in this case. Because there are N such incumbents, each identical in the eyes of consumers, the brand strength of each is equal to (1/N). Recall, though, that the brand strength of either brandextending rm is a i Si. Accordingly, relating a consumers extra willingness to pay to the relative brand strength of a brand-extending rm means linking this willingness to pay to a i Si (1/N), where (i p 1, 2). We make this link by assuming that consumer vs willingness to pay for brand stretcher bis product is v

a i Si

1 (1 N

v),

where

0 ! a i ! 1,

i p 1, 2.

(1)

Relating the willingness to pay for the entrants product to the difference between a i Si and 1/N means that consumers are willing to pay more for the brand stretchers product only if it has greater brand strength than an incumbent rms product. Equation (1) also implies that the value of brand recognition is proportionally greater for those consumers with a lower willingness to pay. Those consumers with a relatively high v value the basic product more and brand name recognition less. As v falls, the impact of an entrants brand identity on willingness to pay grows. The intuition is that those with a high willingness to pay or a high v are knowledgeable consumers who understand the basic functioning of the product and the essential elements of quality. For example, blue jeans may have initially been bought by those high-v consumers who valued the pure consumption benet of such a good. Later, when Calvin Klein, DNKY, and others started to market blue jeans, there were many consumers who previously had not been a part of the basic blue jean market but who were then enticed into that market by the prospect of buying designer jeans. In our model, this second group is made up of relatively low-v consumers whose willingness to pay is so affected by brand names. Consumers who were already wearing blue jeans before the arrival of designer jeans are the high-v consumers who care relatively more about the functionality of the good and not its brand name.6
6. It could also be the case that brand identity has a larger effect on the intramarginal consumer rather than on the marginal one. That is, the high-v consumers are most affected by brand image. Such an effect is captured by modeling consumer willingness to pay for the entrants product as [aSE (1/N)]v. It is easy to show that this alternative specication of consumer preferences will lead to the same basic results as those obtained here.

Brand Stretching

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From the consumers point of view, the incumbent rms market perfectly substitutable products. When there are two or more incumbent rms, price competition among them for consumers is tough, and in equilibrium, this will lead each one to set a price equal to unit cost c. If one incumbent rm set a price greater than another incumbent rm did, it would serve no customers, and this could not be an equilibrium outcome. Moreover, if some incumbent rm set a price greater than unit cost c, then another incumbent rm would have an incentive to undercut that rms price to serve more customers. Therefore, in the preentry equilibrium we have that each incumbent rm sets a price equal to c. For any N 2, competition among the incumbent rms for consumers will exert the same amount of price pressure on the entrants. Nevertheless, concentration, or the number of rivals N in the target market, is still an important factor affecting the protability of entry via brand stretching. As N gets larger and the target market becomes increasingly competitive, the brand identity 1/N of the incumbent rms becomes ever weaker relative to the identity of either brand-stretching rm a i Si (i p 1, 2). Thus, as N increases, the brandextending rms can enter with an increasingly strong advantage relative to the initial incumbents in terms of consumer willingness to pay. A consumer who is willing to pay v for a good marketed by any of the incumbent rms is willing to pay the additional amount [a i Si (1/N)](1 v) for the brand-stretching entrants product bi . Since price competition among the incumbent rms leads these rms to set a price equal to unit cost c, a necessary condition for the brand stretcher bi to earn prot by entering the target market is that a i Si (1/N) 1 0. Otherwise, no consumer will buy the brand stretchers product at a price above cost. Suppose that, for each brand-stretching rm bi , the condition a i Si (1/N) 1 0 is satised, and so entry into the target market is potentially profb b itable for each rm. Denote by p1 and p 2 the prices set by brand-stretching rms b1 and b 2, respectively, and denote by piI the price of each incumbent rms product. As already noted, in any price equilibrium piI p c, for all i p 1, . . . , N. Observe as well that, in any price equilibrium in this target market, the price of brand stretcher b1 s product must be greater than the price b b of brand stretcher b 2s product, or p1 1 p 2 . If this were not true, then given our assumption that a1 S1 1 a 2 S 2 , brand stretcher b 2 would serve no consumers in the target market. Clearly, this cannot be a price equilibrium since brandstretcher rm b 2 could always decrease its price and capture some consumers. More specically, we will assume that, in any price equilibrium,

p 1

b 1

(a S
1

1 N

a2 S2

1 ) N

b p 2.

(2)

Later we will show that condition (2) is satised in a price equilibrium.

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We begin by describing the rms demand functions in the price region for B which a price equilibrium can exist. Dene v12 to be the consumer who is indifferent between buying from brand stretcher b1 and brand stretcher b 2 at b b I prices p1 and p 2. Dene vbi to be the consumer who is indifferent between buying from brand stretcher bi or an incumbent rm i at prices pib and piI p c, where pib 1 c. These denitions imply that
B v12 p 1 b ( p1 b p2 )

(a1 S1 ( pib

a2 S2 ) c)
1 N

I vbi p 1

(a S
i

(3)

B I I When condition (2) holds, it is straightforward to show that v12 ! vbI ! vb2. I This means that consumers with a relatively high v, specically v 1 vb2 , prefer B I to buy an incumbents product. Consumers with v such that v12 ! v ! vb2 prefer B to buy brand stretcher b 2 s product. Finally, consumers with v ! v12 prefer to buy brand stretcher b1 s product or no product at all. When the price of brand b stretcher b1s product, pib, is such that [a1 S1 (1/N)] p1 1 0, then consumer v p 0 buys a product, and the entire market is served. Otherwise, dene by v the consumer who is indifferent between buying brand stretcher b1 s product and buying no product at all. For v 1 0, we have that

v or

a1 S1

1 (1 N

v)

b p1 p 0,

[p
vp

b 1

(a S
1

1 N 1 N

)]
. (4)

(1

a1 S1

The demand for brand stretcher b1s product is q (p , p ) p

b 1 b 1 b 2

B b b L[v12 ( p1 , p 2 ) b b LvB ( p1 , p 2 ) 12

b v( p1 )] for v 1 0,

(5)

otherwise.

Demand for brand stretcher b 2s product is

b b I b q2 ( p 2, piI ) p L[v2 ( p 2, piI ) B b b v12 ( p1 , p 2 )].

(6)

Firms in the target market set prices to maximize prot given the demands for their products. For the moment, we will solve for the equilibrium prices and prots in the postentry target market under the assumption that the unit cost of production c p 0. This assumption simplies the algebra without too much loss of generality. By making this assumption, essentially we guarantee that the entire market is served, both before and after the entry of the brand stretchers. That is, each consumer v buys a product in the target market. If,

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543

on the other hand, the unit cost of production c were high relative to the distribution of v, then the entire market would not be served in the preentry target market. We will discuss the implications of brand stretching in such high-cost target markets later in this section. We solve for the equilibrium prices (again, assuming that c p 0) in the appendix, and we report the results here. In equilibrium, each incumbent rm sets a piI p 0 and earns zero prot, whereas the brand-stretching rms set prices 2(a1 S1 p p
b 1

a 2 S 2 ) (a1 S1
1 1

1 N 3 N

)
,

(4a S
(a1 S1

a2 S2

)
1 N

a 2 S 2 ) (a 2 S 2
1 1

)
, (7)

p p and earn prots

4(a

b 2

(4a S

a2 S2

3 N

) )

p pL

b 1

S1
1

a 2 S 2 ) (a1 S1
1

1 2 N 3 2 N

(4a S
1

a2 S2

2 2

(a
b p2 p L

S1

a 2 S 2 ) (a1 S1

1 N

(4a S
1

a2 S2

)(a S )
3 2 N

1 N

(8)

Observe that these equilibrium prices satisfy condition (2). Furthermore, we show in the appendix that rm b1 has no prot incentive to deviate and charge 1 1 b b a price p1 p 2 (a1 S1 N )/(a 2 S 2 N ). Doing so would only lower its prot. We can learn several things about brand stretching from the equations above. Consider, rst, the brand stretcher with the stronger recognition, rm b1. The prot of rm b1 is always increasing in its own brand recognition, p1b/ a1 1 0 and p1b/ S1 1 0.7 This rms prot also increases as the number of incumbent rms N grows, p1b/ N 1 0. However, rm b1s prot is decreasing in the strength of the rival brand stretcher, rm b 2 , or p1b/ a 2 ! 0 and p1b/ S 2 ! 0. In short, for the rm with the strongest brand image, the protability of brand stretching increases as the rival brand stretchers identity becomes relatively weaker (either because this strongest rms brand becomes stronger or its rivals brand becomes weaker) and increases as the target market becomes less concentrated. Matters are somewhat different for the weaker brand stretcher, rm b 2. First, note that the protability of brand stretching for rm b 2 increases with the b b brand strength of its rival, rm b1 , or p2 / a1 1 0 and p2 / S1 1 0. The weaker
7. These derivations and the derivations below are found in the appendix.

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brand name is better off competing in a target market with a strong brand name. The intuition behind this result has to do with price competition. The stronger the brand recognition of rm b1 , the higher is the price that it can charge to brand-conscious consumers in the target market. This softens price competition and makes it easier for the weaker brand-stretching rm b 2 to attract less brand-conscious consumers to its product. Second, the prot of rm b 2 is not always increasing in its own brand recognition. Rather, there is an optimal brand recognition for the weaker brand stretcher to have in this target market. Specically, the most protable brand strength for the relatively weaker brand stretcher to have is a2 S 2 p (4/7)a1 S1 [3/(7N)] ! a1 S1. For example, when rm b 2 has the optimal brand strength in the target market or when a2 S 2 p (4/7)a1 S1 [3/(7N)] ! a1 S1 ,, it b earns a prot p2 p [a1 S1 (1/N)]/48, which is increasing in a1 , S1 , and N. Finally, rm b 2s prot islike rm b1sincreasing in the number of b incumbent rms in the target market, p2 / N 1 0. All else (in particular the value of a) equal, rm b 2 will also prefer a less concentrated market. In sum, the most protable strategy for the brand-stretcher rm b 2 is to seek entry into a nonconcentrated target market in which the rival with the stronger brand has roughly double the brand strength. The market shares of the rms in the postentry target market are 2 (a1 S1
b q1 p

1 N

)
3 N

(4a S
1

a2 S2
1 1

) ) )

(a S
b q2 p

1 N

)
3 N

(4a S
1

a2 S2 a2 S2 ) a2 S2

(9)

QI p

(a1 S1

(4a S
1

3 N

where Q I is the market share of all the incumbent rms. Note that the market share of the incumbent rms is larger the more differentiated are the two brand stretchers, or the larger is the difference a1 S1 a 2 S 2 . Again, the intuition is clear. The greater is the difference between the two brand stretchers in terms of perceived brand strength, the softer is price competition, and softer price competition benets the incumbent rms whose low prices then serve to capture more easily the less brand-conscious consumers. When the unit cost of production is greater, or c 1 0, then brand-stretching entry increases the number of consumers served in the target market. Before entry, the marginal consumer v, that is, the one indifferent between buying an incumbents product and not buying at all, is v p c. After the brand stretchers enter the market, it is straightforward to show that the marginal consumer is such that v ! c. In other words, brand stretching expands the

Brand Stretching

545

market. Of course, this is not surprising, because it is the lower-v consumers who care proportionately more about brand names. The size of the target market, both preentry and postentry is, however, smaller the higher is the unit cost of production. Moreover, the higher the unit cost, the less protable it is to enter this target market. It follows that both brand stretchers will prefer to enter large markets, or ones with relatively lower unit costs of production. Increasing market size, as measured by the density of consumers or the parameter L also raises the protability of brand-stretching entry. B. Brand Stretching into a Monopolized Target Market A target market that is monopolized, or highly concentrated, is likely to be a market that is difcult to enter. For this case, therefore, we consider the potential entry of only one brand-stretching rm. Within the framework used here, this implies that this rm enters at a brand name disadvantage relative to the incumbent. In the preentry market, the incumbent has 100% market share or brand recognition equal to one, whereas the entrant has brand recognition equal to aS ! 1. Given the strong brand name recognition of the incumbent, consumers in the target market would not be willing to pay more for an entrants less well-known product. Specically, a consumer who is willing to pay v for the good marketed by the incumbent monopolist would be willing to pay only v (1 aS)(1 v) for the brand-stretching entrants new product. In contrast with the previous case, it is the relatively low-v consumers who are more interested in the product of the incumbent rm. The brand-stretching entrant in this case would compete for high-v consumers who care less about brand name recognition. Denote by p b and p I the prices set by the brand-stretcher rm and the incumbent monopoly. In a price equilibrium in the postentry market, we must have that p I 1 p b. If the price of the brand stretchers product were greater than the price of the incumbents well-known brand, then no consumer would buy from the brand stretcher. Clearly, that cannot be an equilibrium, since the brand stretcher could always decrease its price and capture some less brandI conscious consumers. Dene vb to be the consumer who is indifferent between buying from the brand stretcher and the incumbent at prices p b and p I, where I p I 1 p b. From above, it follows that vb p 1 [( pI pb )/(1 aS)]. Consumers I whose v is such that 1 v 1 vb prefer to buy the brand-stretching entrants product at its lower price. The consumers who prefer to buy the better-known I incumbents product are those with v such that vb 1 v v, where v is the marginal consumer who is just indifferent between buying the incumbents product and buying no product at all. In this case, the marginal consumer is v p p I 1 0. The entire market is never served in a monopolized target market. The demand for the brand stretchers product is q b ( p b, p I ) p L[1
I vb ( p b, p I )],

(10)

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Journal of Business

and the demand for the incumbents product is

I q I( p b, p I ) p L[vb ( p b, p I )

v( p I )].

(11)

Thus, in the postentry target market, the brand stretcher sets p b to maximize prot, p b ( p b, p I ) p ( p b c)q b ( p b, p I ) p ( p b c) (pI 1 p b )L aS , (12)

and the incumbent sets price p I to maximize its prot, p I( p b, p I ) p ( p I c)q I( p b, p I ) p ( p I c) 1

pb

(2 aS)p I L. 1 aS

(13)

Equations (12) and (13) imply the following best response functions for the brand stretcher and incumbent, respectively: pb p pI p pI 2 c , c . 2 (14) (15)

1 aS p b 2(2 aS)

To solve for the equilibrium prices and prots of the rms, we will, for symmetry with the previous case, make the same assumption that unit cost of production c p 0. Given this assumption, equations (14) and (15) yield equilibrium prices pb p pI p Equilibrium prots are given by pb p L pI p L

1 7

aS 4aS

, (16)

2(1 aS) . 7 4aS

1 aS , 4aS) 2 (7
4(2

aS)(1 aS) . (7 4aS) 2

(17)

Observe that these equilibrium prices satisfy the condition that p I 1 p b . If the incumbent rm deviated and charged a price p I p b, it is easy to show that such a deviation would not be protable. As was the case with brand-stretching rm b 2 in the previous model, the prot of the brand stretcher in equation (17) implies that too strong a brand identity aS can be a hindrance rather than a help in entering a monopolized target market. Both rms face a similar problem, namely, the presence of

Brand Stretching

547

another rm with an even stronger brand identity. In the former case, it was the other brand-stretching rm, b1 . Here, it is the established monopolist that already has a clear brand image of its own. As the entrants brand image strengthens, consumers become willing to pay more for its product. However, it is also the case that the stronger the entrants brand image, the closer its product substitutes for that of the incumbentsa feature that intensies price competition. The issue is, of course, to balance these two opposing forces. As it turns out, when the brand-stretching entrant takes on a monopoly in the target market, the optimal or prot-maximizing balance is achieved when its brand strength is aS p 1/4 and the entrants prot is p b p L/48. Entry with a stronger brand image than this will reduce prot. In this light, it should perhaps not be surprising that markets dominated by one or a few dominant brands, such as the cigarette and cereal markets, have been the loci of entry by small or less well-known private labels rather than by equally well-known brands from other sectors. III. Some Lessons from the Model Our model investigates why a rm with brand recognition in its home market has an incentive to leverage its asset of a recognized brand name into other markets. Abstracting from entry costs, brand stretching is generally protable. However, it is likely that such entry costs are present and, more important, that they will affect the number of target markets entered. Our analysis serves to illuminate the several factors that inuence the choice of the target market and to make equally clear that there is no one size ts all rule for making this selection. One important insight of the model is that the target market that is the most protable to enter is not necessarily the one in which the rm has the greatest brand recognition, that is, the one for which the term aS is greatest. The protability of brand stretching depends on the nature of the price competition in the target market, and this, in turn, depends on the brand recognition of the brand-stretching entrant relative to that of other rms. A target market that is close to a rms home market, that is, one whose a is high, may be less protable than one far away with a lower a for several reasons. First, it may be that the nearby market is highly concentrated, perhaps even a monopoly, so that the rms relative brand strength in that market will be weak in comparison with that of the incumbent rm or rms. Second, a rival with an even stronger brand image may be entering the nearby target market, which again will weaken the rms relative brand strength. In considering this possibility, one should recall as well that a rm that enters as the secondstrongest brand really prefers to do so in a market in which the strongest brand is relatively much stronger. Thus, a rm for whom the choice set of target markets is limited to ones in which it knows it will be second best may again wish to pursue a somewhat distant market in which the loss from consumer willingness to pay (as a result of a low a value) is more than offset

548

Journal of Business

by the benet of softer price competition. In other words, the model helps us to understand the decisions of rms such as Coca-Cola and Dr. Martens to extend their brand names into markets that appear to be somewhat distant from their home base. A related lesson from our model is that it is generally more protable to stretch a well-known brand into target markets with decreasing concentration whether another stronger brand is also entering that market or not. Part of the value of this insight is, again, its ability to explain the frequent decision to stretch the brand name to a distant or low-a market. Such a choice may be justied if it permits entry into such a less concentrated industry that the rms brand advantage is now sufciently strong that the protability of entry is increased despite the lower a-value. The attraction of low-concentration markets may also explain the results of Court, Leiter, and Loch (1999) in a study of brand extension for McKinsey and Company. These authors nd that many strong companies are using their brands to move quickly into industries with low brand intensity, thereby pursuing markets in which competition is fragmented and where their brand enjoys a competitive advantage (p. 107). Among others, they cite the highly protable extensions of American Express into the actual planning and operation of travel packages and of Sears into such services as pest control and appliance repair.8 IV. Concluding Remarks We have argued that a rms decision to leverage its brand to a new product line is of interest to economists because it is an important manifestation of the process of entry, perhaps increasingly so. We have further argued that both this perspective and a consideration of actual cases of brand stretching suggest that prior analyses of the brand extension phenomenon based on scope economies or quality signaling are unlikely to reveal the entire story of this entry process. This is because such entry typically occurs in existing markets with one or more incumbents and, therefore, in markets in which the nature of price competition in the postentry market is crucial. It also occurs in markets that seem distant from the home market of the brand-extending rm in which a reputation or scope economy-based explanation is less plausible. We have modeled brand recognition as a complement to the product itself much in the way that Becker and Murphy (1993) model advertising. In this view, consumers prefer to consume a good that is well known by others rather than to consume one that is not. A brand name is a measure of this market recognition factor. Having a brand name permits a rm to enter an existing
8. One limitation of the above model is that the initial incumbent rms in the target market are assumed to offer perfect substitutes. There is no differentiation among these initial products. However, in a separate appendix to this article that is available upon request, we consider this issue by modeling the target market along the lines of the circle model originally pioneered by Salop (1979). Our results suggest that the same basic insights as those obtained herein emerge in that context as well.

Brand Stretching

549

market where less well-known rivals cannot, primarily because the rm with brand identity can charge a higher price. However, we show that, if this is the mechanism by which brand identity works, the entry behavior that follows depends very much on how price competition is affected by brand name recognition. While generally brand stretchers will prefer entry into markets that are less concentrated, the protability of such entry will also depend on whether a rival rm with a well-known brand is also entering the target market and precisely which rm has the relatively stronger brand recognition. Market size is also important. Thus, nding a target market that gives the greatest return to the brand-name asset is not clear-cut. Brand-extending rms may often seek out markets that are, in some sense, far from their initial product line, where their brand strength may not be as great as it would be in a nearer market. The reduction in the brand image that the rm can project in such a market may be offset by the advantages such a market offers in terms of lower concentration or the strength of the rival entrants brand in that market. While the models that we have presented assume no scope economies and have no consumer uncertainty regarding a products quality, we do not mean to imply that such factors are unimportant. Rather, our objective has been to illuminate the entry process beyond the insights that attention to these alternative factors reveal. At the same time, we nd that the rich pattern of entry suggested by our results is roughly consistent with empirical observation.

Appendix Post Brand-Stretching Price Equilibrium in the Target Market

In this appendix, we solve for the equilibrium prices (again assuming that c p 0) in the target market after the brand stretchers have entered. Given the equilibrium conditions

(E1) p 1 p

b 1

b 2

(a S (a S
1 2

1 N 1 N

) , )

and

(E2) piI p c p 0 for all incumbent firms i p 1,2, . . . , N, it is straightforward to show that rm b1s and rm b 2s demands are, respectively,

b b b q1 ( p1 , p 2 ) p

L 1

( p1 a1 S1 ( p1 a1 S1 p2

p2 ) , a 2 S 2 p2 ) a2 S2 ( p1 a1 S1 p1 1 a1 S1 a1 S1
1 N 1 N

(A1) for v 1 0,

L 1

b b b q2 ( p1 , p 2 ) p L

a2 S2

1 N

p2 ) . a 2 S 2

(A2)

550

Journal of Business

b b b b b b b b Firm b1 chooses p1 to maximize p1b ( p1 , p 2 ) p p1q1 ( p1 , p 2 ), and rm b 2 chooses p 2 to b b b b b b b maximize p2 ( p1 , p 2 ) p p 2 q2 ( p1 , p 2 ). Suppose that the entire market is served. Later we will show that, for rm b1 , v 1 0 is not a prot-maximizing strategy. In this case, prot maximization leads to the best response functions,

b p1 p

a1 S1

a2 S2 2
1 N 1 N

p2

p1 ( a 2 S 2 p p
b 2

2 (a1 S1

) , )

(A3)

and to the Nash equilibrium prices, a 2 S 2 ) (a1 S1

1 1

2(a1 S1 p p
b 1

1 N

)
,

(4a S
(a1 S1

a2 S2

3 N

)
1 N

a 2 S 2 ) (a 2 S 2
1 1

)
. (A4)

p p

b 2

(4a S

a2 S2

3 N

These prices imply prots a 2 S 2 ) (a1 S1

1 1

4(a1 S1 p p
b 1

1 2 N

(4a S
(a1 S1

a2 S2

3 2 N

a 2 S 2 ) (a 2 S 2

1 N

p p

b 2

(4a S
1

a2 S2

)(a S )
1

1 N

)
. (A5)

3 2 N

Next we need to show (i) that rm b1 could not increase its prots by serving fewer customers, that is, have v 1 0, and (ii) that rm b1 could not increase its prots by deviating from condition (A1) and undercutting rm b 2 s price so that rm b 2 serves no customers: 1 1 (i) Suppose that v p ( p1 a1 S1 N )/(1 a1 S1 N ) 1 0, and so rm b1 chooses p1 to maximize

p1 ( p1 , p 2 ) p p1 q ( p , p ) p p1 1

b 1

b 1

b 2

( p1 (a1 S1

p2 ) a2 S2 )

( p1 (1

a1 S1 a1 S1

1 N 1 N

(A6)

Brand Stretching

551

b b b b b b b b and rm b 2 chooses p 2 to maximize p2 ( p1 , p 2 ) p p 2 q2 ( p1 , p 2 ), as previously dened. The candidate equilibrium prices in this case are

2(a1 S1 1 pb p 3 (a1 S1
1 N

a 2 S 2 ) (a1 S1

1 N 1 N

)
a1 S1 ,
1 N 1 N

)(1

a2 S2

)
1 N

(a1 S1 2 pb p

a 2 S 2 ) (a1 S1
1 1

)(a

S2

)
(a1 S1)

(a S
1

1 N

) [3 (a S

1 N

)(1

a2 S2

(A7)

Given these prices, v ! 0, which is a contradiction. b b (ii) Suppose now that rm b1 deviated and charged a price p1 p p 2{[a1 S1 b (1/N)]/[a 2 S 2 (1/N)]}, where p 2 is dened in (A4). When rm b1 makes such a deviation, it captures all of rm b 2s market and serves consumers v, where 0 v 1 1 {(pb /[a1 S1 (1/N)]}. Firm b1 , therefore, earns a prot
b 1 1 pb (pb ) p p 2

a1 S1

1 N 1 N

a2 S2

)(
)

b p2

a2 S2

1 N

. (3/N)] implies that

b Substituting p 2 p {(a1 S1

a 2 S 2 )[a 2 S 2 a 2 S 2 ) (a1 S1 a2 S2
3 N

(1/N)]}/[4a1 S1
1 N

a2 S2

(a1 S1 p p
b 1

(4a1 S1
3(a1 S1

) )

[
)

(a1 S1

a2 S2 ) a2 S2
3 N

(4a1 S1

a 2 S 2 ) (a1 S1
1 1

1 2 N

(4a S

a2 S2

3 2 N

which is less than the prot earned in (A5). Such a deviation is not protable. Given that the two brand stretchers prices and prots in (A4) and (A5) characterize the postentry equilibrium in the target market, we now investigate what factors make a target market more protable. To simplify the analysis, we dene the brand-recognition factor bi p a i Si, or for i p 1, 2, and we consider how increases in bi and N affect protability in the target market. Consider, rst, the stronger brand-stretcher rm, b1: p1 p b1 p1 p b2 4 (b1
1 N

) [(4b )(

2 1

3b1 b 2 (4b1

2 2b 2 )

1 N

(5b1

b2 )

3 N2

]
1 0,

b2

3 3 N

4 (b1

1 2 3 N N

2b1
3 3 N

b 2)
! 0,

(4b1
1

b2

8 (b1 N ) (b1 b 2 ) 2 p1 p 2 1 0. 3 N N (4b1 b 2 N ) 3

552

Journal of Business

For brand-stretcher rm b 2 , we have that p2 p b2

(b

1 N

) (4b
1

7b 2
3 N

3 N
3

)
p0

(4b
2 (b1

b2

4 for b 2 p b1 7

3 , 7N

p2 p 2 b2

1 2 15 N N

)(
1

8b1
3 N

7b 2)

(4b
b2
1 2 N

b2
1

! 0,

p2 ( p b1

) (2b
1

b2
3 N

3 N
3

)
1 0,

(4b

b2

p2 (b1 b 2 ) 2[N(4b1 p N N 3 4b1 b 2

b2 )
3 N

5]

1 0.

References
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