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In this paper, we develop a structural model of household behavior in an environment where there is uncertainty about brand attributes and both prices and advertising signal brand quality. Four quality signaling mechanisms are at work: (1) price signals quality, (2) advertising frequency signals quality, (3) advertising content provides direct (but noisy) information about quality, and (4) use experience provides direct (but noisy) information about quality. We estimate our proposed model using scanner panel data on ketchup. If price is important as a signal of brand quality, then frequent price promotion may have the unintended consequence of reducing brand equity. We use our estimated model to measure the importance of such effects. Our results imply that price is an important quality-signaling mechanism and that frequent price cuts can have significant adverse effects on brand equity. The role of advertising frequency in signaling quality is also significant, but it is less quantitatively important than price.
Key words: consumer choice under uncertainty; Bayesian learning; signaling; advertising and price as signals of quality; brand equity; pricing policy; dynamic choice
History: This paper was received February 28, 2005, and was with the authors 20 months for 3 revisions; processed by Russell S. Winer. Published online in Articles in Advance May 23, 2008.
1. Introduction
Consumers may learn about experience goods through several channels. We estimate a dynamic brand choice model in which consumers learn about brand quality through four kinds of signals: use experience, advertising content, advertising intensity,1 and price. The relative importance of these mechanisms influences how demand responds to changes in price and advertising intensity. Thus, our work is of interest to both marketing and industrial organization.2
Prior work has modeled a subset of the signaling mechanisms that we consider here. For instance, in Erdem and Keane (1996) and Anand and Shachar (2002), advertising content and use experience provide noisy signals about brand attributes. In Ackerberg (2003), advertising intensity and use experience signal product quality. But, to our knowledge, prior empirical work has not incorporated price as a signal of quality in brand choice models. Nor has it allowed for the possibility that advertising may signal quality through both its content and its quantity.
In the theoretical literature, Milgrom and Roberts (1986) developed a model in...