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Costs, Institutional Mobility Barriers, and Market Structure: Advertising Agencies as Multiproduct Firms

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  • Alvin J. Silk
  • Ernst R. Berndt
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    Abstract

    What accounts for the diversity and limited concentration that has long characterized the organization of the advertising agency industry? This question is addressed by treating an advertising agency as a multiproduct firm. The firm's product line or service mix is defined in terms of the set of different media categories where an agency places the advertising messages which it creates on behalf of its clients. Evidence is presented indicating that the structure of demand and costs in the advertising agency industry conforms to the conditions that MacDonald and Slivinski (1987) showed were required for an industry to sustain an equilibrium with diversified firms. Building on this framework, we formulate a set of three hypotheses relating to the realization of product-specific scale and scope economies. The first two hypotheses posit that given low fixed costs and minimal entry barriers, both media-specific scale and scope economies are available and can be exploited by relatively small-size agencies. The third hypothesis suggests that large agencies may experience diseconomies of scope as a consequence of excessive diversification induced by two pervasive industry institutional phenomena: (i) 'bundling' of agency services to match client demand for a mix of media advertising; and (ii) 'conflict policy' which prohibits an agency from serving competing accounts and operates as a mobility constraint. Utilizing a multiproduct cost function, we estimate media-specific scale and scope economies for a cross-section of 401 U.S. agencies in 1987. The results obtained support the set of three hypotheses outlined above.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4826.

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    Date of creation: Aug 1994
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    Publication status: published as Journal of Economics and Management Strategy, Vol. 3, no. 3, Fall 1994pp. 437-450
    Handle: RePEc:nbr:nberwo:4826

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    References

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    1. Porter, Michael E, 1976. "Interbrand Choice, Media Mix and Market Performance," American Economic Review, American Economic Association, vol. 66(2), pages 398-406, May.
    2. Silk, Alvin J. & Berndt, Ernst R., 1992. "Scale and scope effects on advertising agency costs," Working papers 3381-92., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    3. Alvin J. Silk & Ernst R. Berndt, 1993. "Scale and Scope Effects on Advertising Agency Costs," Marketing Science, INFORMS, vol. 12(1), pages 53-72.
    4. MacDonald, Glenn M & Slivinski, Alan, 1987. "The Simple Analytics of Competitive Equilibrium with Multiproduct Firms," American Economic Review, American Economic Association, vol. 77(5), pages 941-53, December.
    5. Gollop, Frank M & Monahan, James L, 1991. "A Generalized Index of Diversification: Trends in U.S. Manufacturing," The Review of Economics and Statistics, MIT Press, vol. 73(2), pages 318-30, May.
    6. Bailey, Elizabeth E & Friedlaender, Ann F, 1982. "Market Structure and Multiproduct Industries," Journal of Economic Literature, American Economic Association, vol. 20(3), pages 1024-48, September.
    7. Eaton, B Curtis & Lemche, S Q, 1991. "The Geometry of Supply, Demand, and Competitive Market Structure with Economies of Scope," American Economic Review, American Economic Association, vol. 81(4), pages 901-11, September.
    8. Caves, Richard E, 1986. "Information Structures of Product Markets," Economic Inquiry, Western Economic Association International, vol. 24(2), pages 195-212, April.
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    Cited by:
    1. J. Vernon Henderson & Mohammad Arzaghi, 2005. "Networking Off Madison Avenue," Working Papers 05-15, Center for Economic Studies, U.S. Census Bureau.
    2. Mohammad Arzaghi & Ernst R. Berndt & James C. Davis & Alvin J. Silk, 2008. "Economic Factors Underlying the Unbundling of Advertising Agency Services," NBER Working Papers 14345, National Bureau of Economic Research, Inc.
    3. Mohammad Arzaghi, 2005. "Quality Sorting and Networking: Evidence from the Advertising Agency Industry," Working Papers 05-16, Center for Economic Studies, U.S. Census Bureau.

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