Some qualities cannot be observed before purchase. Whether somebody is diligent. Whether a supplier will still be there in three years. Whether the work will be good.

Saying so is free, which means everybody says it, which means saying it carries no information. What carries information is doing something that would be too expensive for somebody without the quality to do.

That is a signal, and the cost is not a side effect. The cost is the entire mechanism.

The condition that makes it work

A signal is informative only if it is cheaper for the person who has the quality than for the person who does not.

Michael Spence's original case was education. Suppose a degree taught nothing useful whatever — and the argument does not require that, only allows it. It would still be informative to an employer, provided that getting one is easier for a capable and persistent person than for somebody who is neither. The employer cannot observe capability and can observe the degree, and the correlation holds because of the differential cost.

That is the uncomfortable part of the theory: a signal can be socially wasteful and individually rational at the same time. Everybody spends years on something that teaches nothing, and each person is right to, and nobody can unilaterally stop.

What signals in a business

A warranty or guarantee. Expensive if your work is bad, cheap if it is good. That differential is exactly what makes it credible, and it is why a strong guarantee outperforms any amount of claimed quality.

Price. A high price signals confidence and is costly to maintain if the work does not support it, because you lose the clients who would have paid less and gained the scrutiny of those who paid more. This is a real part of why raising rates can increase demand.

Specialization. Turning down work outside your niche is expensive and signals that you have enough demand inside it. Generalists cannot send this signal, which is much of what positioning is buying.

Unrequested effort. The detailed audit before the proposal, the diagnostic nobody asked for. It works because it would be irrational for somebody who did not intend to do careful work.

Visible investment. An office, a team, a long track record. These signal durability, which is why buyers of services care about them more than the service quality alone would justify.

Where it goes wrong

Signals detach from the thing signaled. Once a signal is established, effort goes into producing the signal rather than the quality. That is Goodhart's law in the market rather than inside a firm, and performance theater is its internal form.

Cheap imitation arrives. Any signal that becomes cheap to fake stops working. The credential that everybody now has, the testimonial page that every site has, the guarantee that is standard — each was informative and then was not.

Reading signals as substance. The buyer's version of the error. A polished deck signals investment in the deck. Whether it signals anything about delivery depends entirely on whether a bad supplier would have found the deck expensive, and increasingly they do not.

The use

When you want to communicate something unobservable, ask what you could do that a person without the quality could not afford to do. The answer is the signal, and it is almost never the claim.

And when you are assessing somebody else, ask the same question in reverse: what did this cost them, and would it have cost somebody worse more? A signal that is equally available to everyone is decoration, and it is where most marketing spend goes.