Academic journal article Economic Inquiry

The Impact of External Parities on Brand-Name Capital: The 1982 Tylenol Poisonings and Subsequent Cases

Academic journal article Economic Inquiry

The Impact of External Parities on Brand-Name Capital: The 1982 Tylenol Poisonings and Subsequent Cases

Article excerpt

THE IMPACT OF EXTERNAL PARTIES ON BRAND-NAME CAPITAL: THE 1982 TYLENOL POISONINGS AND SUBSEQUENT CASES

I. INTRODUCTION

On September 30, 1982 Johnson & Johnson announced that three people had been kiled as the result of ingesting cyanide-laced Tylenor capsules. (1) Four more Tylenol-related deaths were reported within the next two days. Culminating in 125,000 stories in the print media alone, the poisonings were an event without precedent in American business (Dun's Business Month [1983]). The Tylenol brand received over $1 billion in adverse publicity. (2) As a result, many analysts claimed the brand was dead. But the company president, James Burke, ignoring the advice of government officials and even some of his close associates, decided to spend millions to revive Tylenol. Burke's decision will be studied in business schools for years to come. The general opinion today is that Johnson & Johnson and Tylenol made a prodigious comeback, one unparalleled in American business.

The event provides an opportunity to study the effect that an external party can have on the brand name of reputation of a firm. That is, to what degree does a firm's brand name suffer a loss in value when the firm clearly did not intentionally lower product quality? In other words, do consumers hold firms responsible for the damaging actions of parties not associated with that firm? What is the proper gauge to use in measuring the recovery from such an event? Many would favor market share, while others might argue that the stock price is a better barometer to measure recovery. This study attempts to resolve these issues.

II. BRAND NAMES AND PRODUCT TAMPERING

The theory of brand names as quality-assuring devices has emerged formally in the last decade. Klein and Leffler [1981], following the arguments by Klein, Crawford and Alchian [1978], developed a model in which the presence of firm-specific sunk capital investments, such as those incurred in developing a brand name, provide a mechanism for assuring contractual performance. (3) According to their model, if a firm cheats by reducing products quality below the expected level, the value of its brand-name capital declines to zero and the price premium which consumers were willing to pay for the firm's products is lost. Recent empirical studies by Jarrell and Peltzman [1985], Chalk [1986; 1987], Mitchell and Maloney [1989] and Benjamin and Mitchell [1989] have presented evidence in support of the theory.

Can a firm suffer a loss in brand-name capital even if management did not intentionally cheat and lower product quality or fail to prevent cheating by distributors and retailers? While the development of a brand name is largely under the control of management with firm-specific capital invesments and consistent product quality, forces external to a firm may seriously damage the value of its brand name. The classic example is product tampering.

To the extent that product tampering reduces the expected safety level of a product, consumers will shy away from that product. If consumers perceive that the tampering is targeted at a firm, they will reduce their demand for similar products produced by the firm as well, at least until the tamperer is captured, the safety level is improved so that tampering cannot occur again, or the firm eliminates whatever may have triggered the tamperings. Additionally, when product tampering reveals information about the safety level of similar products produced by other firms, consumers will reduce their demand for products of those firms as well. However, as long as consumers perceive the tampering was directed at a specific firm, demand for the tampered product will exhibit a reduction relative to competing products. To summarize, the decline in the expected safety level of a product should cause consumers to revise their consumption patterns and shy away from that product, and to the extent that the product is identified with the firm, the brand-name capital of the firm itself will depreciate as well. …

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