The visible hand in economics

The Halo Effect

Posted on: August 21, 2007

I was reading the New Zealand Commerce Commission’s public release on the potential Warehouse merger with one of the two massive supermarket chains. On page 15, paragraph 81 of this document, Ian Morrice of the Warehouse mentions ‘the halo effect’. He states that this is a term that the Warehouse invented to describe what happens when a firm introduces a new product, with the aim of increasing consumer throughput, which will lead to an increase in demand for the original set of goods sold.

This concept makes sense as there is a transaction cost of going somewhere to buy something. So once you introduce groceries into a Warehouse store, people can now get groceries and general merchandise in the same place, lowering the transaction cost of buying a bundle of both types of goods. This allows the Warehouse to increase the price of general merchandise goods, and to increase the quantity of merchandise goods they sell.

Now I thought that the halo effect was a pretty cool term, so I decided to look it up on wikipedia. Much to my surprise the term existed well before the Warehouse used it. Not only did it exist, but it meant something a little different. In industrial organisation terms the halo effect is what happens to the consumers’ perception of a firm’s set of products when a new product is introduced. For example, Sony makes electronic stuff, like DVD players, that I think are pretty high quality. Now say that they make a battery that really sucks. If I use this battery and don’t like it, then I may also downgrade my perception of the quality of other Sony products. Implicitly, people use brands to proxy the value of a product. If a firm makes a shoddy product, consumers will use this as information about the quality of other products under the brand.

These two definitions are both important, but I think it is important to distinguish between them:

  1. Goods as complements: By putting more products under one roof, a firm can reduce the consumers’ transaction costs, allowing the firm to increase sales and prices for the initial set of goods.
  2. Goods as signal of brand quality: The quality and desirability of a new good sold by a firm can change consumer perceptions (and ex-ante expected values) about other products sold by the firm.

Now if you ever hear the term being used, you should ask the person to define exactly what they mean.

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9 Responses to "The Halo Effect"

Interesting but flawed concept, I think. People like to buy groceries from a grocery specialist and veggies from a vegie specialist. That’s why they go to Food Town to buy toilet paper and then walk past the vegie section, drive one mile and buy their vegies from the little chinee green grocer. The financial services industry was all gung ho on this theory ten years ago and it didn’t work. Banks are no bloody good at insurance and insurance companies don’t understand banking. Bankers take risks while insurers avoid them. That’s why actuaries are so boring.

If a golfer walked up the ninth fairway in darkest Africa and saw an actuary buried up to his neck in a sand bunker, what should he do? Call for more sand.

I’m not so sure. I think that the main factor that drives the result (other than preferences) is the time value of money. I would rather pay a little more if I could buy everything in the same place, as it saves me having to travel between places to get the goods I want.

I think a number of people feel this way, which explains why ‘hypermarkets’ perform so well in the US and Europe. However, there is a question about whether these types of stores are sustainable in NZ, but this is a separate question from the discussion of what the halo effect means.

I had the term “halo effect” used about me when I took on a job in 1991. I was advised to make use of my “halo effect” by making the changes I wanted from the outset, rather than waiting to get my feet under the table. In other words, being newly appointed, with all the hope and anticipation invested in me that a new appointee to a senior role always gets, I could get away with challenges to the existing regime that I might find more difficult later on. When you appoint, the new person is perfect, a saint. They have a halo, which can be blinding.

It’s a bit rich of The Warehouse Group to think they coined the term. What nonsense.

It is ridiculous, a term like ‘the halo effect’ is bound to have been used in someway. You just gave us a third meaning.

Now if anyone mentions the halo effect to me I’m going to be extremely confused 😉

[…] a previous post we discussed the Halo effect, and how the Warehouse was trying to claim it was their own idea.  […]

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[…] has been Matt’s pet topic during this saga (posts here and here). The killer for the halo effect, and the reason why I’ve allways beleived the Extra […]

there are bargain dvd players that are sold in our area. i think they are generic low cost dvd players ‘~’

[…] The Halo Effect « The visible hand in economics – I was reading the New Zealand Commerce Commission's public release on the potential Warehouse merger with one of the two massive supermarket chains. On page 15, paragraph 81 of this document, Ian Morrice of the … […]

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