The product indicator approach involves multiplying each indicator of the exogenous latent variable with each indicator of the moderator variable (Chin, Marcolin, & Newsted, 2003). Hence, the product indicators become the indicators of the interaction term.

If all constructs are reflective then a product indicator approach is the best.

The indicator multiplication builds on the assumption that the indicators of the exogenous construct and the moderator each stem from a certain construct domain and are in principle interchangeable.

This approach is NOT APPLICABLE when the exogenous construct and/or the moderator are measured formatively. Since formative indicators do not have to correspond to a predefined theoretical concept, multiplying them with another set of indicators will confound the conceptual domain of the interaction term.

The product indicator approach requires the indicators of the exogenous construct and the moderator variable to be reused in the measurement model of the interaction term. This procedure, however, inevitably introduces collinearity in the path model. To reduce collinearity problems, researchers typically standardize the indicators of the moderator prior to creating the interaction term. Standardization converts each variable to a mean of 0 and a standard deviation of 1, which reduces the collinearity that is introduced by indicator reuse.