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Advertising Spending and Quality for Services: The Role of Capacity

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  • Ignatius Horstmann
  • Sridhar Moorthy

Abstract

In this paper we explore the relations among advertising spending, capacity and quality for services. Data from a sample of New York City restaurants show that mid-quality restaurants spend more on advertising than either high quality or low quality ones, contradicting the usual Nelson-type prediction that advertising spending increases with quality. Also, controlling for quality, restaurants with larger capacities advertise more. We present a model of services to explain these observations. The key features of the model are: (1) capacity constraints, (2) uncertain demand, (3) the presence of both informed and uninformed consumers, and (4) a technological link between capacity and quality. We argue that for services, advertising not only informs consumers, but it also can improve capacity utilization. Given this dual role, advertising is more valuable to firms with larger capacities and higher price-cost margins. The variation of these two elements with quality determines the advertising-quality relation. Copyright Kluwer Academic Publishers 2003

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  • Ignatius Horstmann & Sridhar Moorthy, 2003. "Advertising Spending and Quality for Services: The Role of Capacity," Quantitative Marketing and Economics (QME), Springer, vol. 1(3), pages 337-365, September.
    • Handle: RePEc:kap:qmktec:v:1:y:2003:i:3:p:337-365
    DOI: 10.1023/B:QMEC.0000003333.38298.ed
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    3. David Godes, 2012. "The Strategic Impact of References in Business Markets," Marketing Science, INFORMS, vol. 31(2), pages 257-276, March.
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    6. Ivan Pastine & Tuvana Pastine, 2000. "Coordination in Markets with Consumption Externalities : The Role of Advertising and Product Quality," Working Papers 0003, Department of Economics, Bilkent University.
    7. Tingting Nian & Arun Sundararajan, 2022. "Social Media Marketing, Quality Signaling, and the Goldilocks Principle," Information Systems Research, INFORMS, vol. 33(2), pages 540-556, June.
    8. Yasui, Yuta, 2021. "Controlling Fake Reviews," MPRA Paper 108177, University Library of Munich, Germany.
    9. Tariq Mahmood, 2015. "Mediating Effect of Advertising Expenditure on Labour Productivity - A Case of Manufacturing Industries in Pakistan," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 54(1), pages 1-15.
    10. James D. Dana Jr. & Kevin R. Williams, 2018. "This paper develops an oligopoly model in which firms first choose capacity and then compete in prices in a series of advance-purchase markets. We show the existence of multiple sales opportunities cr," Cowles Foundation Discussion Papers 2136R4, Cowles Foundation for Research in Economics, Yale University, revised Nov 2021.
    11. Dina Mayzlin, 2006. "Promotional Chat on the Internet," Marketing Science, INFORMS, vol. 25(2), pages 155-163, 03-04.
    12. James D. Dana & Kevin R. Williams, 2022. "Intertemporal Price Discrimination in Sequential Quantity-Price Games," Marketing Science, INFORMS, vol. 41(5), pages 966-981, September.

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