Branding – The Balance Between Competition and Innovation

One of the most exciting things for me as an entrepreneur is helping bring innovation to people. When people develop close interactions with innovative products or services, it can be considered as a form of human expression. Furthermore, when a product or service is fully adopted, it manages to flesh out customers` real personalities. On the other hand, competition brings products and services closer to truly fulfilling the needs of people.

Joseph Schumpeter and Kenneth Arrow number among the first theoreticians that have formalized the idea that there is a significant difference to be made between the capacity to innovate and the incentives to innovate. Large firms generally have more powerful resources than smaller ones to undertake research & development – some important reasons for this are the fact that they can benefit from economies of scale, have better access to capital markets and are not that vulnerable in front of uncertainty. However, large companies have also lower incentives to innovate than smaller ones, because they have more to lose. Too much competition discourages innovation. When competitive pressures are too strong, companies are no longer in a position to innovate, because the latter process is costly and risky. Any additional expenditure would need to be justified by the potential profit margin (Romer, 1990).

On the other hand, too little innovation also prevents innovation. When companies are not challenged by rivals, they are less likely to innovate because of the lack of motivation. Innovation is best incentivized when competition is neither too strong nor weak. If we draw this relationship in a graph, we will notice an inverted U-shaped figure – innovation increases as competition intensifies. Another remarkable problem is related to the so-called “innovator’s dilemma” described in the book of Clayton Christensen, “The Innovator’s Dilemma”. This refers to firms that succeed in one generation of innovation but fail in the next wave. This phenomenon lends credence to the idea that companies with more market power (like monopolies) have lower incentives to innovate than firms facing a higher degree of competitions. I remember Steve Jobs’ words back in 2004: “What is the point of focusing on making the product even better when the only company you can take business from is yourself?”

But why does branding matter?
Branding shapes how consumers perceive a company’s offerings. It shapes people’s perception of what kind of innovation the firm pursues, how customers are treated and to which environmental standards it adheres. A strong brand value – whether induced by reputation or by image – might have a crucial impact on the growth potential of a certain company.

First of all, branding reduces search costs, by informing potential customers about products and services, highlighting their unique traits and making it easier for customers to choose between competing items. This informational role of branding reduces uncertainty and links products and services to companies producing them. Such associations help promote innovative products. Branding enables firms to capitalize on their past successes and build a reputation that will continuously reduce consumers’ search costs. On the other hand, the trust built over time – also known as consumer goodwill – acts as an incentive for companies to continue producing innovative products. Actually, branding is one of the ways that helps businesses recover investments they have made in innovating.

Firms also use branding activities in order to promote product or service innovation. Studies show that companies that invest more in research and development are in the same time more likely to invest in branding as well. A great example of balancing innovation and competition via branding is that of Bayer. In 1897, one of the researchers of Bayer discovered a pure and durable form of acetylsalicylic acid. This turned into Aspirin. Bayer applied for a patent on the process innovation and it also registered a trademark on the name. The company also invested in building its brand name by imprinting the Aspirin tablet with Bayer’s name and logo. Whenever people would consume the medicine, they would associate it with its original manufacturer. And this would happen even when the patent expired and was followed by competition. In other words, branding – through the use of trademark protection and advertising activities – help firms to extend their market power and build consumer goodwill.

Branding has two effects on product innovation: either helps selling innovation-based products or complements innovation. In some cases, branding may therefore substitute for innovation. In the meantime, effective branding channels can create market entry barriers – for instance, relevant branding may cause higher advertising costs for the other players in the market. Branding is a way of balancing competition and innovation. It is an important investment component of creating sustainable competitive advantages for companies. It also helps firms to appropriate their investments in innovation. Because branding channels and marketing activities can extend firms’ market power. Those companies that invest more in innovation also invest in branding.

Sources:
Porter, M.E. (1976). Interbrand Choice, Media Mix and Market Performance. The American Economic Review, 66(2), 398-406
Romer, P. (1986). Increasing Returns and Long-Run Growth. Journal of Political Economy, 94(5), 1002-1037