Signaling Strategies in Competitive Interaction: Building Reputations and Hiding the Truth

Author(s): Jaideep Prabhu and David W. Stewart

Source: Journal of Marketing Research, Vol. 38, No. 1 (Feb., 2001), pp. 62-72
Published by: American Marketing Association
Stable URL: http://www.jstor.org/stable/1558571
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 JAIDEEP PRABHU and DAVID W. STEWART*

The authors develop a conceptual framework of how managers inter-

pret competitors' signals over time in various market contexts. From the
framework, the authors generate hypotheses about the relative effective-
ness of signaling strategies used by firms in different market contexts. The
authors conducted two empirical studies involving a repeated entry-
pricing game to test the hypotheses. The results of Study 1 show that the
entrant's perceptions of the aggressiveness of the incumbent depend on
the focus and strength of the incumbent's signals. The results of Study 2
show that the strength of the entrant's responses to the incumbent's sig-
nals depends on the incumbent's use of bluffs and the cost of information
about the factors driving the incumbent's signals. The implications of
these findings for how firms should signal to achieve such strategic objec-
tives as revealing or concealing information, developing a desired reputa-
tion, and influencing competitors' responses over time are discussed. The
authors conclude by discussing the limitations of the article and its
implications for further research.

Signaling Strategies in Competitive

Interaction: Building Reputations and
Hiding the Truth

Markets are rife with signals: Firms regularly make ket demand, providing an opportunity for a price increase.
announcements and take actions that convey information This same announcement could be interpreted as a sign of
about themselves to various external constituencies. A firm's weakness on the part of the sender of the signal, providing
signals may be directed at, among others, its customers an opportunity to capture market share by holding price or
(Gerstner 1985; Inman, McAlister, and Hoyer 1990), its even lowering price.
channel members (Anderson and Weitz 1992), and its com- Signaling to competitors in different situations has been
petitors (Eliashberg and Robertson 1988; Heil 1989; Moore widely studied in the business and economics literature. The
1992). Whatever the purpose of signaling to other con- research has typically employed game-theoretic (Friedman
stituencies, signaling to competitors often takes on strategic 1977; Harsanyi 1967; Kreps 1990; Kreps and Wilson 1982;
intonations. To determine how to respond to a competitor's Milgrom and Roberts 1982; Shubik 1959; Tirole 1990; von
signal, a firm often must make inferences about the inten- Neumann and Morgenstern 1953) and reaction function
tions behind the signal and predict future actions by the (Hanssens 1980; Lambin, Naert, and Bultez 1975; Little
competitor. Senders of signals also must consider how their 1970; Little and Lodish 1981) approaches to identify nor-
signals are likely to be interpreted by competitors. Thus, a mative solutions for signaling strategies. A major limitation
competitor's announcement of a price increase in the face of of this research is that it has tended to be outcome rather
growing demand might be interpreted as a response to mar- than process oriented (see Weitz 1985; Zajac and Bazerman
1991). Such research has tended to assume a hyperrational
process in which information has the same meaning inde-
*Jaideep Prabhu is University Lecturer in Marketing, The Judge Institute
pendent of context or other information (Simon 1976;
of Management Studies, Cambridge University (e-mail: J.Prabhu@jims.
Thagard 1992). For example, most game-theoretic studies
cam.ac.uk). David W. Stewart is Robert E. Brooker Professor of Marketing
and Deputy Dean of Faculty, Marshall School of Business, University of assume that a signal is interpreted by the recipient as it is
Southern California (david.stewart@marshall.usc.edu). The authors thank intended by the sender; few studies have examined how
Jennifer Aaker, Douglas Andrews, Jill Grace, Stephen J. Read, Jaideep receivers actually interpret signals in different contexts. The
Sengupta, Charles Swenson, and several anonymous reviewers for their
helpful comments and suggestions regarding the design of the research and
interpretive ambiguity of signals in various contexts sug-
previous drafts of the present article. gests that the success of a sender's signaling strategy
depends on how the receiver interprets signals or, at least,

Journal of Marketing Research

Vol. XXXVIII (February 2001), 62-72 62

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 Signaling Strategies 63

what the sender

lead tobelieves
different inferences about the the
meaning of arec
signal
contexts. than would be the case were the sender's market share small.
In contrast to prior research, this article addressesRecent
the work suggests that repeated interaction among firms
question of how firms should send signals by examining
often results in the development of perceptions and beliefs
about
how receivers interpret them in different contexts. We inte-individual competitors. These perceptions and beliefs
grate work on the psychology of inference and decision
frequently have been referred to as the reputation of the firm
making in developing specific hypotheses regarding
andthe
have been shown to be an important variable in the
interpretation of signals and the response to these signals.
firm's interaction with competitors (Smith, Grimm, and
We test these hypotheses in two experiments conducted in 1992) and an important asset firms can use to gen-
Gannon
the context of a computer-based entry-pricing game.erate We future rents (Weigelt and Camerer 1988; Wilson 1985).
However, research has been relatively silent on how
then discuss the implications of the findings of these studies
for the design and use of signals to competitors. We end receivers
with develop reputational beliefs about senders and
a discussion of the limitations of these studies and the what signaling strategies firms might employ to develop a
opportunities they raise for further research. particular reputation. Although Moore (1992) examines the
role of signal interpretation in belief formation, she does not
THE LITERATURE ON COMPETITIVE SIGNALING
consider the role of the context in which the signals are sent.
Although other definitions of signals exist (e.g., Spence
Finally, little research has focused on how firms might use
1973), the most common is Porter's (1980) conceptualiza-
signals to conceal information.1 Indeed, the extensive litera-
ture
tion of signals as the actions and/or announcements of a on cheap talk (Farrell 1993, 1995; Rabin 1990) has
firm
that convey information about its intentions and abilities. tended to be skeptical of the long-term effectiveness of
Recognition of the limitations of game-theoretic and bluffs,
reac- because bluffs, being cheap, are not credible and
tion function approaches has led to alternative conceptual would not be part of an equilibrium strategy. In real interac-
and methodological frameworks. For example, considerable tion, however, firms sometimes bluff to confuse competitors
descriptive survey research has examined the link between a succeed. For example, Microsoft Inc. is particu-
and often
sender's signals and receivers' responses. Gatignon, larly adept at this tactic and frequently announces new prod-
Anderson, and Helsen (1989), Eliashberg and Robertson ucts that either never appear on the market or appear long
(1988), Robertson, Eliashberg, and Rymon (1995), and after the announced date of introduction (Ray 1992).
Bowman and Gatignon (1995) study responses to competi- Recognizing the role of bluffs in competitive interaction,
tor's preannouncements and new product entry decisions Eliashberg, Robertson, and Rymon (1996) examine the use
and find that characteristics of both the sender and the sig- of bluffs in various industries. These researchers define
nal influence receivers' responses. bluffs as signals designed to mislead, that is, create erro-
Other work has alluded to the importance of signal inter- neous inferences among competitive firms that result in
pretation as the mediator of signal reception and response these firms taking or not taking an action to the benefit of
(e.g., Heil and Langvardt 1994; Heil and Robertson 1991), the sender.2 They suggest that bluffs can be of various types
but few studies have explicitly examined the issue. An but focus on the use of price increase announcements that
exception is Heil and Walters (1993), who examine why are not followed with corresponding action. These scholars
managers react more or less aggressively to the price reduc- examine how the characteristics of the signal, the sender,
tions of a competitor. These authors conclude that competi- and the industry in which the signal appears influence the
tive reactions are partly dependent on the motives and inten- likelihood that a signal is a bluff. Although this work has
tions that a receiver infers about the actions of the sender. drawn attention to the potential importance of bluffing, it
Another exception is Moore (1992), who examines the role does not address the issue of when and why bluffs work.
of price and verbal signals on managers' beliefs about com- Indeed, Eliashberg, Robertson, and Rymon (1996, p. 31)
petitors and how these beliefs influence the managers' com- recommend that further research "take the receiver's point
petitive decisions. Using a repeated prisoners' dilemma of view and study how effectively managers distinguish
game, Moore finds that managers who interpret a competi- between bluffs and truthful signals."
tor's signals as cooperative are more likely to respond coop- In summary, existing research on signaling sheds little
eratively, whereas managers who infer a competitor's sig- light on the process by which managers interpret and
nals to be competitive are more likely to respond in a respond to competitive signals over time in different market
retaliatory fashion. These empirical findings clearly suggest contexts. Recommendations to integrate research on the
that the interpretation of a signal plays a critical role in the psychology of inference and decision making into a theory
determination of a response. of signaling (see Weitz 1985; Zajac and Bazerman 1991)
Nevertheless, the literature is remarkably silent on three remain largely unheeded. The primary objective of this arti-
issues: (1) how the context in which a signal is sent influ- cle is to begin to fill this gap in the literature by developing
ences its interpretation; (2) how, through repeated interac- and testing a conceptual framework for explaining the
tion, receivers first form beliefs about senders and then use process(es) by which signals are interpreted. This frame-
these beliefs in making decisions; and (3) whether signals work identifies specific features of signals that influence the
can be used to deceive as well as inform. The context in
which signals are sent and received is as much a source of IAn exception is the research on moral hazard and other problems of
asymmetric information. However, this literature, being game theoretic,
information as the signals themselves, and the context may
suffers the limitations of such studies discussed previously.
change the way a signal is interpreted. For example, infor-2Eliashberg, Robertson, and Rymon (1996) operationalized signals as
mation that a sender's market share is large may signal its
only announcements, in contrast to Porter (1980), who defines both
competitive strength (Karnani 1982), and this in turn may announcements and actions of a firm as potential signals.

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 64 JOURNAL OF MARKETING RESEARCH, FEBRUARY 2001

interpretative process and incorporates Response.

the role Receivers'
of the responses
con- to competitive signals
text in which signals occur and the effects
may differof repeated
along inter-such as their strength,
several dimensions,
speed,a and
action. This framework is used to derive setdirection. Strength of a response refers to
of hypotheses,
which are tested in two empirical studies.
whether the receiver's signals are aggressive or cooperative.
A deep price cut in response to a competitor's announce-
CONCEPTUAL FRAMEWORK
ments or actions is an example of a strong response, whereas
Robertson, Eliashberg, and Rymon (1995) have presented a shallow price cut, or no price cut at all, is an example of a
a comprehensive conceptual framework for the study weak of sig-
response. Speed of response refers to how quickly the
naling and signal interpretation in competitive interaction. receiver responds to a competitive signal; a signal may be
We base our framework on theirs and focus on four main sent immediately after receipt of a competitor's signal or
features in keeping with our objectives: information, inter- after considerable delay. Direction of response refers to
pretation, response, and repeated interaction (Figure 1). whether the response is in the same or the opposite direction
as the sender's announcement or action. For example, a
Features of Signaling Framework
price cut in response to a price cut would be a response in
Information. As Figure 1 suggests, receivers may obtain the same direction, whereas a price hike in response to a
two broad types of information about senders that they must price cut would be an action in the opposite direction.
interpret: signals and contextuals. Signals are the actions or Repeated interaction. Finally, when interaction is
announcements of a firm that convey information about its repeated, receivers have an opportunity to update their rep-
intentions and abilities (Porter 1980). Contextuals are the utational beliefs about senders. These updated reputational
observable features of the sender of the signal or of the envi- beliefs constitute the sender's reputation. They become a
ronment in which signals are sent and received. Examples ofpart of sender-related contextuals that influence receivers'
sender-related contextuals include the sender's size, market subsequent interpretation of and response to signals.
share, location, product portfolio, and reputation. Examples Updated reputational beliefs will, in turn, influence
of environmental contextuals include technological receivers' subsequent signal interpretation and response.
advances, changes in demand, and changes in the economy. Moreover, depending on the relative clarity or ambiguity
Interpretation. Before receivers respond to information with which the receiver can make inferences about the
contained in senders' signals, they must interpret the infor- sender's signals over time, updated reputational beliefs may
mation received. Receivers' interpretations of signals are be more or less accurate reflections of the sender's true
inferences about the sender's intentions and abilities that
intentions and abilities. Accordingly, such beliefs will result
lead to beliefs about the relatively enduring characteristics
in more or less accurate interpretations of senders' signals
of the sender. These beliefs about the sender are the basis of over time.
the sender's reputation among its competitors. Reputational The framework in Figure 1 suggests several dependent
beliefs about the sender may include beliefs about its abili- variables of importance to competitive interaction.
ties, intentions, relative aggressiveness, truthfulness, com- Specifically, it suggests both process variables (reputational
petitive strength, and other characteristics of relevance to beliefs) and outcome variables (the strength, speed, and
competitive interaction. Because receivers may be fallible in direction of responses) that influence receivers' perceptions
making inferences or because senders may be able to and responses over time. The influence of various features
deceive receivers by skillful use of signals and contextuals, of senders' signals on these variables has not been systemat-
reputational beliefs may differ in the extent to which they ically explored in previous research.
reflect the true intentions and abilities of senders.
Features of Senders' Signals
Prior research indicates that process and outcome variables
Figure 1
are influenced by specific features of signals. However,
CONCEPTUAL FRAMEWORK FOR THE STUDY OF SIGNAL
because prior research on signaling rarely has focused on the
INTERPRETATION AND RESPONSE WITH REPEATED
issue of signal interpretation, there has been a tendency to
INTERACTION
confound the features of a signal with the process of interpre-
tation. Features such as clarity and credibility have been con-
sidered intrinsic to the signal itself and independent of the
Information Interpretation Response
context and the receiver's inferences about the signal.
Signals Reputational Nature of However, from the receiver's perspective, interpretation
*Actions Beliefs Response involves giving meaning to an observed signal. Interpretation,
*Announcements *Strength *Strength together with observation of a signal and its features, will
CAccuracy *Speed result in signals being perceived as credible, clear, and so
Contextuals *Direction
*Sender-related forth. Therefore, it is important to differentiate objective fea-
-Environmental
tures of signals from the interpretation of the signals in dif-
ferent contexts (Brunswik 1956; Hammond, McLellan, and
Mumpower 1980). An examination of the literature suggests
three features of signals that are of particular importance to
Repeated interpretation and response: the focus of signals, the strength
of signals, and the extent to which the signals are bluffs.
Interaction
Focus of signals. Focus refers to the source of underlying
factors that drive the signal. Signals may be based on inter-

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 Signaling Strategies 65

nal considerations senders must knowwithin the

what factors influence receivers' reputa- fi
external considerations (marke
tional beliefs about them. Attribution theory suggests that two
ment), or a mixture of
features of signals, strength the
and focus, two.
influence receivers'
be aggressive, an
beliefs aboutinternal facto
the sender and thus the sender's reputation.
ment of an The strength of signals.price
intended Attribution theory suggests
cut. that
ment of an intended
the stronger the sender's signal,price
the more likely thecutreceiver
demand (consumer is to develop a belief that that the sender has a built-in dis-
environment
focused signal. position
Senderstoward aggressiveness. Thus, may a deep price cut, em
crafting signals. Day
being stronger and
than a weak price cut, is more Wens
likely to result
firms have in the sender developing a reputation
internally focused for aggressiveness. s
nally focused This hypothesis is consistent with existing
strategies, andwork that sug- sti
tion of internalgests andthat firms will gain a reputation for aggressiveness
external fact if
Strength of they have demonstrated a predilection
signals. The for aggressive
stre price
defined as the cutting (see Oster 1990; Smith,
extent to Grimm,which
and Gannon 1992).
(Heil and Walters This hypothesis is also consistent with
1993). nonexperimental,
Thus, a
signal than a empirical research that shows
shallow cut that aggressive
or signals
no by
direction of signals-for exam
senders are more likely to be interpreted as threatening by
hikes-would also influence
receivers and therefore to be met with retaliation (see Heil, t
focus on the Morrison, and
case of Walters price
1993). cuts
previous work The
in focus of signals.
signaling, Attribution theory also suggests that
in
Walters when a sender's behavior is attributed to factors external to
(1993).
Bluffs. Bluffs are
the sender, the receiver defined
is less likely to interpret the sender'sin
designed to behavior as due to characteristics
mislead other of the sender. This is a
firms
action to result ofthe
benefit the discounting principle (Ross and Anderson(
signaler"
Porter's definition includes both actions and announcements 1982), which states that when behavior can be explained
as potential instruments of deception, we focus on sufficiently by external or situational factors, the behavior is
announcements rather than actions. This is consistent with attributed to the situation, and no inference is made about
existing work on bluffs in competitive interaction (see the dispositions of the sender (Jones and Nisbett 1971;
Eliashberg, Robertson, and Rymon 1996). Furthermore, Kelley 1973; Kelly and Stahelski 1970). Conversely, accord-
Porter's definition confuses the feature of the signal ing to the principle of correspondent inference (Jones and
(whether it is a bluff) with its interpretation (whether the Davis 1965), when a behavior occurs in the absence of
receiver is fooled by the bluff and therefore responds in a external, situational causes, the receiver "infers the exis-
manner beneficial to the receiver). We separate the feature of tence of some trait, ability, intention, feeling, or other dis-
the signal from its interpretation because we consider the position that could account for the behavior" (Ross and
case that a receiver may not be able to detect a bluff-- Anderson 1982, p. 132). In a signaling context, internally
namely, that the receiver will be fooled by the bluff. focused signals are more likely to result in internal attribu-
tions. Thus, the more internally focused the sender's signals,
Effects of Features of Signals on Receivers' Interpretation the more likely the receiver will be to consider those signals
and Response diagnostic of the sender's characteristics and the more likely
Several theories address the processes by which people these signals are to contribute to the development of a repu-
make inferences and decisions over time. Attribution theory tation of the sender consistent with the signal.
(Jones and Nisbett 1971; Kelly 1971) has focused on how Interaction of strength and focus of signals. Attribution
people infer the causes of behavior and develop reputational theory also suggests an interaction between the strength and
beliefs. In a signaling context, this theory explains how focus of a sender's signals. Specifically, given internal attri-
receivers make inferences about the sender's intentions and butions of behavior, the stronger the sender's signal, the
abilities from the sender's signals and thus develop reputa- stronger the receiver will perceive the sender to be, whereas
tional beliefs about the sender. Information processing the- the weaker the sender's signal, the weaker the receiver will
ory has considered how people employ information versus perceive the sender to be. In contrast, given external attribu-
prior beliefs in making decisions (Pechmann and tions of behavior, regardless of whether the signal is strong
Ratneshwar 1992; Stayman, Alden, and Smith 1992). or weak, the receivers will attribute the signal to the situa-
Research on organizational learning has also examined the tion. Consider a firm that sends a strong signal such as a
impact of prior beliefs on managerial judgment and decision deep price cut. If the receiver attributes the action to internal
making (Diehl and Sterman 1995; Paich and Sterman 1993; causes (the sender's strategic intentions and abilities), the
Senge 1990). In a signaling context, these theories explain sender is more likely to be seen as aggressive than if the
how, with repeated interaction, receivers use new informa- receiver attributes the action to causes external to the sender
tion to update their existing reputational beliefs and how new (environmental pressures due to demand or competition).
information and existing beliefs together influence receivers' For example, if the receiver attributes the deep price cut to
subsequent interpretations of and responses to signals. the sender having low costs (an internal cause) rather than to
falling demand (an external cause), the attribution will lead
Signaling to Achieve a Desired Reputation the receiver to perceive the sender as more competitive than
A sender's reputation depends on how the receiver inter- if the reverse attribution were made. Conversely, consider a
prets the sender's signals. To develop a desired reputation, firm that sends a weak signal such as a shallow price cut. If

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66 JOURNAL OF MARKETING RESEARCH, FEBRUARY 2001

the receiver attributes the weak action to internal

taining causes, beliefs.
these false reputational the In addition, bluffs
sender is more likely to be seen asmay weak (less
be revealed onlyaggressive)
when they are called; a firm that estab-
than if the receiver attributes the action to external causes. lishes reputational beliefs that discourage calling its bluff
Finally, regardless of whether the signal is strong or weak, may reap benefits for a long period of time.
external attributions will result in no great differences in the The use of bluffs and cost of information. The effect of
receiver's perceptions of the sender's competitiveness. For bluffs on the receivers' reputational beliefs over time depends
example, if the signal is a weak price cut and the receiver on whether new information dominates current beliefs in the
attributes this to rising demand (an external cause), the process of interpretation with repeated interaction. Because
receiver's perceptions of the sender will remain unchanged, bluffs are usually announcements, they are cheap both for the
as they will if the signal is a deep price cut and the receiver sender to send and for the receiver to receive. (An exception
attributes this to falling demand (also an external cause). In would be the case in which announcements are backed by
summary, therefore, a sender's reputation in descending resource commitments, legal obligations, or other strong
order of strength would be as follows: Strong signal, inter- preludes to action.) Other types of information, such as data
nal attribution; strong signal, external attribution; weak sig- on market demand or competitors' costs, are not always read-
nal, external attribution; and weak signal, internal attribu- ily available to receivers, and such information may have a
tion. Therefore, cost even if it is available. Because such information is costly
and because receivers with strong prior beliefs may be unmo-
HI: Senders of strong signals will be regarded as more aggres-
sive when their signals are internally rather than externally tivated to acquire it (Deshpand6 and Zaltman 1982, 1983;
focused, whereas senders of weak signals will be regarded Lee, Acito, and Day 1987), receivers may interpret senders'
as less aggressive when their signals are internally rather signals without the benefit of new contextual information. In
than externally focused; strength of signals will have no such cases, receivers may make inferences about the sender's
effect on how senders are regarded when their signals are goals and abilities that would not be supported by currently
externally focused. available evidence. In other words, incorrect beliefs are more
likely to develop and receivers are more likely to be fooled by
Signaling to Achieve a Desired Response bluffs when information is costly. In addition, when there are
potential costs associated with calling a bluff, receivers have
Although prior work has suggested that the receivers' rep-
a disincentive to call the bluff, and the bluff then merely adds
utational beliefs about the sender may be an asset or a lia-
to receivers' existing reputational beliefs about the sender's
bility to the sender (Weigelt and Camerer 1988), the extent
competitive strength. Therefore,
to which this is true depends on how receivers' reputational
beliefs influence their responses to the senders' signals. H2: Senders will be more successful in using bluffs and their
Recent nonexperimental, empirical research has demon- success using bluffs is more likely to be attributed to their
strated that receivers' reputational beliefs about the sender greater competitiveness by receivers when information is
influence receivers' responses (Smith, Grimm, and Gannon costly than when it is free; cost of information will have no
effect on receivers' perception of senders that do not bluff.
1992). However, this research has not examined how repu-
tations first develop and influence receivers' responses over Because receivers are more likely to rely on their beliefs
time. Moreover, this research has only examined the case in than on information when information is costly, they will
which beliefs about the competitor are accurate, that is, intend to make greater use of reputational beliefs rather than
which a receiver's beliefs about the sender are consistent
new information when interpreting new signals and formu-
with the sender's actual intentions and abilities. However,lating appropriate responses. This suggests that when infor-
the link between beliefs and responses is more interestingmation is costly; receivers have an incentive to develop
strategically when receivers' reputational beliefs about thebeliefs early and use these beliefs in responding in the future.
sender are inaccurate. Research in managerial decision mak-Bluffing by a competitor may result in these beliefs being
ing suggests that managers' prior beliefs are often so strong
inaccurate. Furthermore, because receivers are likely to
that they swamp managers' strategic decisions, even in envi-believe that bluffers are more competitive when information
ronments in which these beliefs are inaccurate or dysfunc-is costly, receivers are also likely to be more careful toward
tional (Senge 1990). Thus, it would be useful to determine these competitors and act less aggressively than might oth-
the extent to which this is true in competitive interaction-erwise be the case. For example, receivers are less likely to
in particular, whether senders can create false reputationalprice low against a sender with a reputation for low costs
beliefs, whether such reputational beliefs influence
and/or the intention to be aggressive. In contrast, the cost of
receivers' responses in a way that is advantageous to the
information will have no effect on receivers' reputational
sender, and how long such beliefs and their influence last. Inbeliefs about senders that do not bluff, nor will it have an
other words, can senders bluff and get away with it? effect on how receivers respond to these senders. Therefore,
One way senders may benefit from developing false rep-
utational beliefs is by creating strong reputational beliefs in H3: Receivers' responses toward senders using bluffs will be less
aggressive when information is costly than when it is free;
early interaction and sustaining these in later interaction. there will be no effect of the cost of information on
Receivers' well-formed beliefs may dominate subsequent
receivers' responses to senders not using bluffs.
information processing. For example, receivers may ignore
new and contradictory information, especially when infor- Although hypotheses H1-H3 are based on existing theo-
mation is costly, lacking, or too complex to process (Diehlries in psychology and management, they have not been
and Sterman 1995; Paich and Sterman 1993; Pechmann andtested before in a competitive signaling context. Moreover,
Ratneshwar 1992; Stayman, Alden, and Smith 1992). existing empirical work on signaling has largely been con-
Ignoring new information may have the consequence of sus- ducted in nonexperimental contexts. Experiments, however,

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 Signaling Strategies 67

provide an ideal context

the quarter. The cycle of information receipt, in decisionwhi
mak-
nal interpretation, ing, and feedback wasspecifically
repeated for every quarter until the
tional beliefs end and
of the game. At two theirpoints in the game, afterinfluthe sixth
over time. Weand now turn
fifteenth quarters, subjects toto ath
were asked to respond
mental studies questionnaire
designed that elicited their reputationalto beliefs abouttes
the incumbent. At the end of the game, subjects' total pay-
METHOD
offs were displayed and the subjects were thanked for their
participation.
Both experimental studies examined signal interpretation
and response to competitors' signals and contextual infor-
mation in an entry-pricing game. Creation of the Incumbent's Signaling Strategy
The incumbent's price is the focal signal in the entry-
The Entry-Pricing Game
pricing game. This signal was programmed to be a function of
The entry-pricing game, commonly used by game theo-
four possible factors: two factors internal to the incumbent
rists (Kreps and Wilson 1982; Milgrom and Roberts and two factors external to the incumbent. The two internal
1982)
and marketing scientists (Hauser and Shugan 1983), pro-
factors were operationalized as the incumbent's announce-
vides a particularly appropriate setting for the studyments (intentions) and costs (abilities). The two external fac-
of com-
petitive interaction. The game features a playoff between tors wereanoperationalized as demand (consumer environment)
established firm (the incumbent) and a competitor trying to
and the entrant's previous move (competitive environment).
enter the market (the entrant). The incumbent uses The general formula used to determine the incumbent's
announcements of future prices and actual prices as signals price had two types of parameters that were varied to produce
to keep the entrant at bay, and the entrant may retaliate with different signaling strategies: states of the specific factors in
market entry at various offering prices. Thus, the game cen- each quarter and the weights attached to each factor in deter-
ters on two important signals in competitive interaction: mining price. The state parameters allowed each of the four
announcements of future prices and actual pricing behavior. factors to take one of two levels in each quarter: high or low.
A computer version of the entry-pricing game was devel- Thus, the incumbent might have high or low costs, make
oped for data collection.3 The computer version of the entry- announcements of high or low prices, and face high or low
pricing game was played over several periods by two play- market demand. The weight parameters determined the extent
ers: an incumbent and a potential entrant. Subjects played to which each factor influenced the incumbent's price. Thus,
the role of the potential entrant against the computer, which the incumbent's price might be based on uniquely internal,
was programmed to play the role of the incumbent. Before uniquely external, or a combination of internal and external
playing the game, subjects received explicit instructions (mixed) factors. Manipulation of the state and weight parame-
about the strategic nature and structure of the game. Each ters provided the means for creating various incumbent signal-
subject played one game against an incumbent programmed ing strategies. These strategies served as the independent vari-
to use a consistent but randomly assigned signaling strategy, ables of interest. Specifically, the effects of the strength and
and each game consisted of 15 quarters. Subjects were told focus of signals were used to test H1, and the use of bluffs
to expect approximately 20 quarters, however, to mitigate (along with the cost of information) was used to test H2 and H3.
potential end-game effects.
Entrants' Payoffs
At the beginning of each quarter, entrants were given four
types of information: the incumbent's abilities (whether its To represent the oligopolistic nature of competition,
production costs are high or low), its stated intentions (an entrants' payoffs were a function of both their own moves and
announcement of an intention to price high or low), the mar- the incumbent's moves. The incentive structure was typical of
ket environment (whether demand has risen or fallen), and an entry-pricing encounter in that entrants' payoffs were
the competitive environment (whether the entrant entered designed to encourage them to enter when the incumbent
with a low or high price in the previous quarter or chose to priced high and to stay out of the market when the incumbent
stay out). The last piece of information was provided to priced low. For experimental convenience, entrants that
remind entrants of their previous move and to ensure that decided to enter could choose only a low or a high price.
they did not ignore the possibility that the incumbent reacts
Study I
to competition.
In each quarter, entrants then entered their decision to stay Study 1 was designed to examine how senders' signals
out of the market, enter with a low price, or enter with a high influence receivers' reputational beliefs about the sender
price. The computer program simultaneously determined the (H1). This study examined the influence of two features of
price of the incumbent in that quarter. Subjects had the same senders' signals, strength and focus, on receivers' reputa-
three choices in every quarter regardless of whether they had tional beliefs about senders.
already entered the market. If they had entered in one quar- Subjects and procedure. Sixty junior and senior under-
ter, they were free to stay out or stay in with a low or a high graduate business students participated in the study. The
price in the next quarter. study was conducted in a large computer lab, and subjects
After decisions were made for the quarter, the program were randomly assigned to experimental conditions.
was run and entrants were automatically given two types of Experimental design. The experimental design was a 2
feedback: the incumbent's price and the entrant's payoff for (strength of signals) x 3 (focus of signals) full-factorial
design. Strength of signals was manipulated by program-
3Details regarding the structure of the computer game and the various ming the incumbent to have prices that were generally high
measures of dependent variables are available from the authors on request. and therefore signals that were weak or to have prices that

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 68 JOURNAL OF MARKETING RESEARCH, FEBRUARY 2001

were generally low and therefore signals that were Figure strong.
2
The focus of signals was manipulated by REPUTATIONAL
SUBJECTS' programming the
BELIEFS ACROSS CONDITIONS
incumbent's prices to be driven by internal factors (STUDYonly
1) (i.e.,
the incumbent's announcements and costs only), external
factors only (i.e., consumer demand and the entrant's previ-
ous move only), or mixed factors (i.e.,.8 a combination of the
incumbent's announcements and costs as well as demand .68

and the entrant's previous move) (see Table 1). .6-

.55
Dependent measure. H1 predicts an interaction effect of
strength and focus of the sender's signals on the receivers'
reputational beliefs about the sender's competitiveness. The
0

receivers' reputational beliefs about the sender's competi-

tiveness were measured by entrants' ratings of the incum-
bent on several semantic differential scales derived from . External Mixed Internal
-.4
prior research on attribution (specifically McArthur 1972;
Mizerski 1978; Newtson 1973). These ratings were sub-
jected to a principal components analysis. Most of the items -.6
-.4-

loaded on the first factor, which was interpreted as a -.82

competitiveness-aggressiveness dimension, and the scores -.8-

on this factor were then used as the operational measure of Focus of Senders' Signals
reputational beliefs.
Results. H1 was tested by means of an analysis of variance -+- Strong Signals
-&- Weak Signals
(ANOVA) with two main effects (strength and focus of sig-
nals) and an interaction effect. H1 was supported. The
ANOVA on the factor scores of subjects' ratings produced a
significant main effect for focus of signals (F = 5.99, p < nals had an internal focus than when they had a mixed or
.01) and a significant interaction effect for strength and external focus (.49 versus -.19 and -.29, respectively).
focus of signals (F = 6.33, p < .01) (see Figure 2). Discussion. These findings suggest that senders of strong
Specifically, senders of strong signals were perceived as signals will be regarded as more competitive if their signals
more aggressive when their signals were internally ratherare driven by internal rather than external factors and that
than externally focused (.68 versus .30, p < .05), whereas senders of weak signals will be regarded as less competitive
senders of weak signals were perceived as less aggressive
if their signals are driven by internal rather than external fac-
when their signals were internally rather than externallytors. Furthermore, if signals are driven by external factors,
focused (-.67 versus .21, p < .05). Furthermore, when there is no difference in how competitive senders of weak
senders' signals were externally focused, there was no sig-versus strong signals are perceived to be. Thus, these find-
nificant difference between how senders of strong and weak ings support the attribution effect that actions are seen to
signals were perceived (.30 versus .21). reflect dispositions when external causes of the action are
Replication. We replicated Study 1 using MBA students absent or improbable.
in a class on marketing strategy. We randomly assigned 45 Taken together, these results provide strong evidence that
students to incumbents whose signals had an internal, exter-
context matters in competitive interaction. Specifically, the
nal, or mixed focus and were always strong. Thus, themeaning of a signal--how it is interpreted and the influence
design was I (strength) x 3 (focus) full factorial. it has on receivers' beliefs about the sender--depends on the
The results of the main study were replicated. Thecontext in which the signal is sent and received. The same
ANOVA of subjects' reputational beliefs produced a signif-signal-for example, a price cut-leads to different infer-
ences and beliefs about the sender when the context favors
icant main effect for the focus of signals (F = 6.22, p <
.005). As in the original study, subjects perceived senders ofinternal versus external explanations of the signal. This sug-
strong signals to be more competitive when the senders' sig- gests that firms might design their signals in such a way as

Table 1
TYPICAL INFORMATION STATES AND WEIGHTS FOR STUDY 1

Manipulation Condition
(Strength/Focus of Signals) Announcement Cost Demand Competition
Strong/internal Lowa (50b) Low (50) Low (0) Low (0)
Strong/mixed Low (0) Low (30) Low (50) Low (20)
Strong/external Low (0) Low (0) Low (50) Low (50)
Weak/internal High (50) Low (50) Low (0) High (0)
Weak/mixed Low (0) High (30) Low (50) High (20)
Weak/external High (0) Low (0) Low (50) High (50)
a"High" and "low" indicate states that favor high and low prices, resp
price below $500, the highest possible price.
bNumbers in parentheses indicate weights attached to the variables

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 Signaling Strategies 69

to exploit the market Figure and 3 enviro

reputations SUBJECTS' REPUTATIONAL
favorable to BELIEFSthem.
ACROSS CONDITIONS Ul
developing such reputational (STUDY 2) bel
acting on these beliefs in a mann
In Study 2, we examine the exte
.5
beliefs about the sender influen
senders' signals in .4-.39 repeated inter
.3.39
Study 2
.2

Study 2 was designed to examine how senders' use of

bluffs and the cost of information influence receivers' repu- 01

tational beliefs about senders and responses to senders' sig-

oFree Costjv
nals over time (H2-H3).
Subjects and procedure. Forty MBA students participated IL, -.1
-.2

in the study. The study was conducted in a large computer -.3

lab, and subjects were randomly assigned to experimental
-.4
conditions.
Experimental design. The experimental design was a 2 -.5
Cost of Information
(use of bluffs or not) x 2 (cost of information) full-factorial
-f- No bluff
design. Senders' bluffs were manipulated by ensuring that in [-m-
-e- Bluff
one case the incumbent's announcements were misleading
and in the other they were not. Specifically, in the no-bluff
condition, the incumbent was programmed to follow up
announcements of high and low prices with high and low responses as docile if subjects decided to stay out of th
prices, respectively, whereas in the bluff condition the oppo- market in quarters after the incumbent's use of a bluff. Th
site was true. The cost of information was manipulated by analysis supported H3 (chi-square = 4.20, p < .05) (see
making information on the incumbent's costs and on con- Figure 4). Specifically, against senders using bluffs, subject
sumer demand freely available in one condition and costly were less aggressive and stayed out more often when infor
in the other (see Table 2). mation was costly than when it was free (39.13% versu
Dependent measures. We measured receivers' reputa- 21.74% of docile responses). Finally, H2 and H3 include an
tional beliefs about the sender using the same semantic dif- implicit assumption that less information will be gathere
ferential scales and competitiveness-aggressiveness factor when information is costly. A manipulation check verifie
used in Study 1. We measured strength of response by clas- that this was the case. When information was costly, sub
sifying entrants' decisions to stay out as docile and entrants' jects requested information on costs and demand onl
decisions to enter as aggressive. 73.9% and 36.84% of the time, respectively.
Results. To test H2, we ran an ANOVA with two main Discussion. Study 2 examined how the sender's use o
effects (use of bluffs and cost of information) and an inter- bluffs interacts with the cost of information to create false
action effect, using receivers' reputational beliefs as the reputational beliefs about the sender and how reputation and
dependent measure. The ANOVA on the factor scores of cost of information together influence receivers' responses.
subjects' ratings produced a significant interaction effect The primary finding of the study is that receivers' responses
(F = 4.5, p < .05) (see Figure 3). Thus, H2 was supported. are less aggressive against senders that bluff in an environ-
Specifically, senders using bluffs were perceived as more ment of high information costs. When information is costly,
aggressive when information was costly than when it was receivers rely more on the sender's announcements, first to
free (.39 versus -.38, p < .05). Furthermore, there was no develop beliefs about the sender and then to make responses
significant difference in how aggressive senders not using to the sender's actions. Senders' bluffs were therefore more
bluffs were perceived to be when information was costly successful in creating desired beliefs in receivers and evok-
versus when it was free. ing desired responses when information on other factors
To test H3, we conducted a chi-square analysis on the driving signals was costly. However, there was no such
strength of receivers' responses. We coded subjects' effect on receivers' reputational beliefs and their responses

Table 2
TYPICAL INFORMATION STATES AND WEIGHTS FOR STUDY 2

Manipulation Condition
(Bluff/Cost of Information) Announcement Cost Demand Competition
Bluff/free Higha (Oh) Low (30) Low (30) Low (40)
No bluff/free Low (0) Low (30) Low (30) Low (40)

a"High" and "low" indicate states that favor high and low pr
price below $500, the highest possible price.
hNumbers in parentheses indicate weights attached to the
Notes: Typical information states and weights for the costly
information on costs and demand.

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 70 JOURNAL OF MARKETING RESEARCH, FEBRUARY 2001

Figure 4 the studies confirm the importance of receivers' prior bel

SUBJECTS' ENTRY-PRICING RESPONSES ACROSS relative to new information contained in a signal and its c
CONDITIONS (STUDY 2) text. In particular, the findings of Study 2 suggest t
receivers with incorrect prior beliefs about senders are m
likely to rely on these beliefs rather than costly new inf
43
mation in interpreting senders' subsequent signals. A
8 39.13
result, receivers will be more likely to misread senders' s
C
* 38
nals and to respond with less-than-optimal respons
though naturally this will work in favor of the sender.
o 33
The findings of these studies also have implications fo
the design of signaling strategies: how firms might signa
S 28
o 26.09 conceal or reveal information, develop a desired reputatio
and influence competitors' responses. The results of Stud
S23
23 21.74 suggest that to develop a desired reputation, firms mig
exploit the context in which they send their signals. Stro
C 18
firms will be regarded as more competitive if they focu
13.04
13,1 their signals on internal rather than external or mixed f
Free Costly tors. Such firms will benefit from strong signals that do
Cost of Information
coincide with competing external explanations for the s
--- No bluff
-a- Bluff
nal. Weak firms will be regarded as more competitive if th
focus their signals on external or mixed signals. Wea
firms, and firms desiring to mask their true intentions
abilities, will tend to benefit by timing signals to coinc
with
in the case when the sender did not use bluffs, regardless ofcompeting external explanations for the signal. Th
the cost of information. findings of Study 2 suggest when and how firms mi
These results of Study 2 provide further support for the employ bluffs to influence competitors' responses.
role of the environmental and market context in the inter- Specifically, when information is costly, senders may u
pretation of signals. Specifically, senders will be more suc- bluffs to achieve reputations for competitiveness that th
cessful in their use of bluffs in a market in which informa- induce receivers to be less aggressive than they might b
tion on contextual factors of importance, such as costs and when information is free.
demand, is costly. Senders in such environments can use
LIMITATIONS AND FURTHER RESEARCH
bluffs to develop desired false reputational beliefs about
themselves in the minds of receivers and then use these One limitation of our studies is that though they inf
contextual realism into how receivers interpret and resp
beliefs to influence receivers' responses in a desired fashion.
Thus, these results suggest that senders can use the market to signals, they remain somewhat artificial. In real-wor
context to bluff and get away with it in repeated competitivecompetitive interaction, more factors than announcemen
interaction. costs, demand, and competitors' actions are likely to dr
senders' signals. How does increased complexity influen
GENERAL DISCUSSION
the process of interpretation and response? To address
Taken together, the two studies lead to three new question,
and it would be useful to test the hypotheses develo
here in a more complex environment-for example,
important conclusions. None of these conclusions would
have been obvious a priori. Indeed, each of these threecomplex
con- business game or in a natural setting. Furtherm
because real-world, naturalistic settings lack the impos
clusions is contrary to what is usually assumed in traditional
game-theoretic models of signaling. First, the studiesorder
sug- of given information, fixed decision periods,
immediate
gest that there is more to signaling than the signal itself. A feedback, an interesting question is how
signal has meaning only within a specific context;receivers
thus, determine which events or signals to attend to
how their interpretation of these events influences sub
interpretation matters to the success of a signaling strategy,
and the context in which a signal is sent influences itsquent
ulti- competitive interaction.
A second limitation of our studies is that they exami
mate meaning to the receiver (Study 1). Furthermore, a bluff
may be interpreted as truthful or as a bluff depending onlyontwo signals-announcements of intended prices
actual
whether information critical to the correct interpretation of prices. In real-world interaction, firms use ot
the announcement is costly at the time the announcement announcements
is and other actions as signals of their int
made (Study 2). Thus, the timing of signals may play tionsanand abilities. Furthermore, different firms within
especially important role in how they are interpreted,
same industry may exhibit different patterns of signals
more
because contextual information and the availability of low or less emphasis on particular kinds of signals-pr
announcements versus new product announcement
cost information may vary over time. Second, the studies
announcements
suggest that concealing information may be easier than is versus actual behavior, and so on. How
receivers
generally assumed. Therefore, using the context as sub- in such environments decide which subset of
terfuge, senders may appear stronger than they really senders'
are signals to focus on? Furthermore, how do receivers
interpretations of multiple signals influence their reputa-
(Study 1), or by exploiting the high cost of information,
tional beliefs about senders and their responses to senders'
senders may employ bluffs in order to create false beliefs
about themselves in the minds of receivers (Study 2). Third,
signals? A third limitation of our studies is that though they

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 Signaling Strategies 71

infuse psychological
Personality and Social Psychology,realism
Vol. I1, C. Hendrick and M.
they do not doClark,
so eds. Newbury Park, CA: Sage Publications, 74-97.
completely.
izations are Friedman,
often J.W. (1977),
made Oligopoly and the Theory
by of Games. New
gr
sions may differ York: North-Holland Publishing Company.
qualitatively
A final limitation Gatignon, H., E. Anderson,
of and K. Helsen
our (1989), "Competitive
stud
Reactions to Market Entry: Explaining Interfirm Differences,"
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Journal of Marketing Research, 26 (February), 44-55.
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