Pre-entry advertising, entry deterrence and multi-informational signaling

Advertising is commonly regarded as a strategic tool to increase demand and steal business from competitors. The present work studies the competitive effects of advertising in a two-period game with incomplete information about the opponent's cost structure. Bagwell and Ramey (1988) showed that deterring entry is possible by signaling lower costs even if the post-entry game is independent of the pre-entry advertising decision. Assuming that pre-entry advertising by an entrant affects the post-entry game, then the incumbent is forced to do more than in the Bagwell/Ramey case to deter entry; he needs to distort costs downwards more extensively. On the other hand, introductory advertising does not facilitate entry if the entrant learns from the signal that competition with the incumbent is unprofitable. In this case, the entrant abstains from entry after performing introductory advertisng. Furthermore, if the incumbent has private information on cost and advertising effectiveness, then he can deter entry by acting as if he had lower production costs and a better advertising effectiveness. In this scenario, entry deterrence is associated with overinvestment in advertising but not with limit pricing, which is a new prediction. The use of multi-informational signals, i.e. pooled information on more than one type of private information transferred by one signal, is methodologically a new development of the classical signaling game.