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Informative Advertising: An Alternate Viewpoint and Implications

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  • David Soberman

    (INSEAD)

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    Abstract

    Our objective is to broaden the current understanding of how horizontal differentiation interacts with both advertising and pricing by extending the analysis of Grossman and Shapiro (1984) to look at a full range of differentiation conditions. We seek to offer a useful perspective on the relationship between advertising and pricing by focusing attention on competitors whose essential difference prior to advertising and price decisions is product differentiation.We construct a model where demand for a firm's products is driven by three factors: consumers' awareness of products and their attributes, pricing, and the degree of fit between a product's attributes and the needs of the consumer. Following Salop (1979), differentiation is captured by representing the firms as equally spaced points in a unitary circular spatial market. We assume that product attributes are fixed and the firms make decisions about how much to advertise and what prices to set for their products.A distinct element of the model is the mechanism by which advertising makes consumers aware of products. Similar to Grossman and Shapiro (1985), advertising is represented as a series of messages received randomly by consumers in the market and consumers only have interest in a product if they have seen advertising about it. It is important to underline that advertising only affects consumers' awareness of a product and not their valuation of it. In addition, the probability of a consumer seeing a firm's advertising is independent of the consumer's location.The primary finding of our analysis is that the impact of informative advertising on market prices and profits is a function of the pre-existing level of differentiation in the market. Advertising is observed to create distinct groups of consumers based on the advertising to which they have been exposed. The optimal pricing is a function of competing firms balancing the needs of each of the groups that have interest in their products.When the level of differentiation between products is high, increases in advertising have no effect on observed prices. However, when the level of differentiation between products is moderate, increases in advertising tend to drive up prices. Finally, when the level of differentiation is low, we show that higher advertising leads to lower prices and profits.We also find that total welfare can increase when higher advertising leads to higher prices. This highlights the risk of reaching conclusions about the anti-competitive effects of high advertising based solely on an observed relationship between advertising and pricing.In a modified version of the model, we assume that the probability of a consumer seeing a firm's advertising depends on that consumer's location. More specifically, we consider situations in which firms can target heavier advertising to a) customers that are locationally close to them or b) customers that are locationally distant from them. This captures the notion of two different types of markets, one in which firms aggressively pursue the competitor's customers and the other in which firms focus their effort on loyal customers. We find that the targeting of advertising does affect the relationship between advertising and pricing. While the general pattern of results regarding the impact of differentiation on the advertising/price relationship is consistent across the three conditions examined, targeting has a particularly interesting effect in conditions of moderate differentiation. In fact, when distant consumers are targeted, the positive relationship observed with no targeting is reversed and prices fall with higher levels of advertising. However, the most interesting effect of targeted advertising is its effect on overall pricing. In conditions of low differentiation, targeting consumers who are nearby exacerbates price competition and reduces price below the no-targeting price. On the other hand, targeting consumers who are distant results in equilibrium prices that are higher than the no-targeting price. Exactly the opposite is observed when differentiation is moderate. These findings underline the importance of existing differentiation between firms for determining the effect that targeted advertising has on pricing. They also provide a potential explanation for offensive or defensive postures that firms employ in media buying that has not been considered previously.

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    Bibliographic Info

    Paper provided by Berkeley Electronic Press in its series Review of Marketing Science Working Papers with number 1-3-1009.

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    Date of creation: 01 Mar 2002
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    Handle: RePEc:bep:rmswpp:1-3-1009

    Note: oai:bepress:roms-1009
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    Web page: http://www.bepress.com

    Related research

    Keywords: Advertising/price competition; informative advertising; persuasive advertising; spatial competition; targeted advertising ;

    References

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    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    1. Sam Peltzman, 1980. "The Effects of FTC Advertising Regulation," University of Chicago - George G. Stigler Center for Study of Economy and State 19, Chicago - Center for Study of Economy and State.
    2. Comanor, William S & Wilson, Thomas A, 1979. "The Effect of Advertising on Competition: A Survey," Journal of Economic Literature, American Economic Association, vol. 17(2), pages 453-76, June.
    3. Paul L. Joskow & Roger Noll & William Niskanen & Elizabeth E. Bailey, 1994. "Economic Regulation," NBER Chapters, in: American Economic Policy in the 1980s, pages 367-452 National Bureau of Economic Research, Inc.
    4. Gruenspecht, Howard K. & Lave, Lester B., 1989. "The economics of health, safety, and environmental regulation," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 2, chapter 26, pages 1507-1550 Elsevier.
    5. Gilbert, Richard J., 1989. "Mobility barriers and the value of incumbency," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 1, chapter 8, pages 475-535 Elsevier.
    6. Meurer, Michael & Stahl, Dale II, 1994. "Informative advertising and product match," International Journal of Industrial Organization, Elsevier, vol. 12(1), pages 1-19, March.
    7. Cady, John F, 1976. "An Estimate of the Price Effects of Restrictions on Drug Price Advertising," Economic Inquiry, Western Economic Association International, vol. 14(4), pages 493-510, December.
    8. Noll, Roger G., 1989. "Economic perspectives on the politics of regulation," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 2, chapter 22, pages 1253-1287 Elsevier.
    9. Drew Fudenberg & Jean Tirole, 2000. "Customer Poaching and Brand Switching," RAND Journal of Economics, The RAND Corporation, vol. 31(4), pages 634-657, Winter.
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    11. Ganesh Iyer & David Soberman, 2000. "Markets for Product Modification Information," Marketing Science, INFORMS, vol. 19(3), pages 203-225, February.
    12. Yehuda Kotowitz & Frank Mathewson, 1979. "Advertising, Consumer Information, and Product Quality," Bell Journal of Economics, The RAND Corporation, vol. 10(2), pages 566-588, Autumn.
    13. Von der Fehr, N.H.M. & Stevik, K., 1996. "Persuasive Advertising and Product Differentiation," Memorandum 01/1996, Oslo University, Department of Economics.
    14. George J. Stigler, 1971. "The Theory of Economic Regulation," Bell Journal of Economics, The RAND Corporation, vol. 2(1), pages 3-21, Spring.
    15. Nelson, Philip, 1974. "Advertising as Information," Journal of Political Economy, University of Chicago Press, vol. 82(4), pages 729-54, July/Aug..
    16. Lester G. Telser, 1964. "Advertising and Competition," Journal of Political Economy, University of Chicago Press, vol. 72, pages 537.
    17. Butters, Gerard R, 1977. "Equilibrium Distributions of Sales and Advertising Prices," Review of Economic Studies, Wiley Blackwell, vol. 44(3), pages 465-91, October.
    18. Greg Shaffer & Z. John Zhang, 1995. "Competitive Coupon Targeting," Marketing Science, INFORMS, vol. 14(4), pages 395-416.
    19. Benham, Lee, 1972. "The Effect of Advertising on the Price of Eyeglasses," Journal of Law and Economics, University of Chicago Press, vol. 15(2), pages 337-52, October.
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