13 May 2015

Branding in Services Explained through Prospect Theory

Branding and brand building are important activities in marketers’ jobs and brands are important for consumers, too. Yet, there is, in my own view, a considerable fuzzy area on what exactly does branding mean and why consumers choose branded services (and products) over non-branded ones.

From the business’ point of view, brands are seen as identification means, differentiation means, assets etc. The process of branding (building a brand) is very well defined and structured in various stages.

From a consumers’ point of view, brands are cues for certain expectations, while the process of branding is a learning / memory process.    

Maybe one day I will write on memory and branding, but for now I want to focus on why people choose branded services over non-branded ones.

The key to this preference is in Prospect Theory (click here if you want to read about PT).

Let’s see the issue of choosing between a branded and non-branded service as a gamble (in prospect theory terms). For simplicity we will use the example of restaurant services.

A person has to choose between Restaurant B – a restaurant belonging to a well-established corporate chain – and Restaurant P – a privately owned, single location restaurant.

Eating at Restaurant P is seen as a gamble with the following probabilities and outcomes:

There is a 10% chance that the food & service will be great (+100).

There is a 80% chance that the food & service will be average / acceptable (+50)

There is a 10% chance that the food & service will be terrible (-100).

Eating at restaurant B is seen as a certainty (100%) for as the food and service will be average / acceptable (+50).

Eating at restaurant P can be translated as:

EV Restaurant P = W(0.1)*100 + W(0.8)*50 + W(0.1)*(-100*λ)

Based on prospect theory, we will consider:
W(0.1) = 0.17;

W(0.8) = 0.55;

λ = 2.1;

 EV Restaurant P = 0.17*100 + 0.55*50 + 0.17*(-100)*2.1 = 17 + 27.5 – 35.7 = 8.8.

Eating at restaurant B can be translated as:
EV Restaurant B 1*50 = 50

Basically, the choice between restaurants B and P is heavily tilted towards the branded one, even if the branded restaurant will deliver only average food and service, without any chance of the client getting great food & service.

The reason for which people prefer branded services is not that they want mediocrity or that they want to avoid getting great food and service; rather it is that (most) people want to avoid the risk of getting terrible food and service.

I am fully aware that what I presented here is an oversimplified situation. I am also aware of the fact that in making a choice between a branded and non-branded service there are more elements that come into play. Nonetheless, Prospect Theory has the power to fundamentally explain what is going on when we make these types of choices.

Thank you Rory Sutherland for the inspiration for this post.

Check out my new website: www.naumof.com

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