Pousset, Joanna (2008) Comparative and Targeted Advertising in Competitive Markets. PhD thesis Economia i d’Història Econòmica, Departament d’Economia i d’Història Econòmica, ENSAE p.118.

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Abstract

”What makes the advertising issue fascinating... is that it is fundamentally an issue in how to establish truth in economics.”

(Phillip Nelson, 1974a)





By its very nature, advertising is a pervasive feature of economic life. It is an increasingly important tool in strategic interactions in competitive markets.



Whether the role of advertising is to enhance the image of the product in the eyes of consumers and change their preferences, or to inform them about the release of a new product in the market, or rather to provide information on prices or qualities of existing products, an important question puzzles the economists: Why do consumers respond to advertising? As economists have struggled with this question, three views have emerged. The first view is that advertising is persuasive, that is, it alters consumers' tastes and creates spurious product differentiation and brand loyalty. As a consequence, it has no "real" value to consumers, but rather induces artificial product differentiation. The second view is that advertising is informative. According to this approach, many markets are characterized by imperfect consumer information, since search costs may deter a consumer from learning of each product's existence, price and quality. Advertising is the endogenous response that the market offers as a solution: when a firm advertises, consumers receive information. The third view is that advertising is complementary to the advertised product. According to this perspective, advertising does not change consumers' preferences, as in the persuasive view; furthermore, it may, but need not, provide information. Instead, it is assumed that consumers possess a stable set of preferences into which advertising enters directly in a fashion that is complementary with the consumption of the advertised product. For example, consumers may value "social prestige," and the consumption of a product may generate greater prestige when the product is (appropriately) advertised. Hence, advertising can influence consumer behavior for different reasons. Accordingly, advertising affects demand, because: (i) it conveys information to consumers, with regard to the existence of sellers, and the price and qualities of products in the marketplace, and (ii) it alters consumers' "wants" or tastes.



Regardless of the role of advertising, economists struggle with another important question: What marketing techniques are more efficient for the advertisers? At this point, it is useful to remark on some recent trends in the marketing literature: comparative versus generic advertising, and targeted versus mass advertising. Comparative advertising by one brand against another is such a promotional technique that suggests superiority of one's own brand and stresses the inferiority of the rival's. The European Commission defines it as follows: "comparative advertising is such that explicitly or by implication, identifies a competitor or goods or services offered by a competitor". In other words, "comparative bashing" is identified by one brand comparing itself favorably with a competing brand. This type of advertising exhibits interesting externalities, which are absent in generic advertising. Targeted advertising is meant to "target" the individual consumers to whom their respective ads are delivered, that is it returns from mass-audience advertising towards specific consumer groups.



This dissertation takes a stand in the literature on advertising, wherein economists debate the purpose and the effects of advertising. The first two chapters analyze how the fact that advertising be comparative rather than regular affects price competition and advertising volume itself. In particular, the first chapter is based on the persuasive view on comparative advertising, and the second one advocates the informative view. The third chapter analyzes the trade-off for an advertiser between using targeted advertising and mass-audience advertising.



The first chapter of this dissertation deals with persuasive advertising. A theoretical analysis of advertising wars is performed, where firms engage in deceptive comparative advertising against each other. In a symmetric duopoly set-up with fixed market size it does not matter whether a firm mentions the rival in an advertisement or not, since in both cases the ad reduces the relative valuation of the competing brand. In contrast, if there are three firms in the market, comparative advertising exhibits a directionality, i.e. a firm can choose to target just one of its rivals. Even so, in symmetric scenarios, where none or all firms collude, advertising becomes irrelevant for the price equilibrium irrespectively of whether it is comparative or not. In contrast, if two of the three firms collude, then the fact that advertising is comparative becomes crucial: it is not only true that prices change due to advertising, but also the impact of advertising on prices depends on the derogatory power of advertising. Thus, it is argued in the chapter that there exists a noticeable distinction between comparative advertising and generic advertising due to the difference in effects they bring to the market outcomes. Moreover, we demonstrate how the fact that advertising be comparative rather than regular affects advertising intensity itself: (i) colluding firms suppress their mutual comparative advertising (due to internalizing the negative externality of comparative advertising), (ii) colluding firms decrease the advertising volumes against their rival (from the fear of fierce price competition), (iii) the rival may intensify or trim down the advertising efforts against colluding firms, depending on the derogatory power of comparative advertising. The total amount of advertising in the market decreases. The persuasive advertising is generally believed to be anti-competitive as it tends to make the demand for an advertised product more inelastic. Thus, it is argued that consumers would be better-off in the absence of advertising as they would face lower prices. It is shown in the chapter that the impact of comparative advertising on price competition depends on the vicious power of advertising.



Chapter 2 examines the determinants of the strategic decision of a high quality producer to advertise comparatively against a low quality rival. The intuition suggests that the high quality producer faces a trade-off. First, comparative advertising reveals the existence of rival's brand, which gives the incumbent incentives not to use this promotional technique. This effect is the stronger the more people are unaware of the existence of the competitor in the market. Second, comparative advertising raises product differentiation at the informed segment, which makes it worth it for the incumbent to announce the lower quality of the new brand. This effect is the stronger the larger the difference between the expected quality and true quality of the rival product. Moreover, we investigate the role of price competition in the model. We discover that advertising makes low quality firm decrease her price. The fear of fierce price competition makes the high quality firm refrain from using comparative advertising.



Finally, chapter 3 analyzes the determinants of advertising strategies of an industrial producer on the media market. In particular, we first highlight the pricing strategies of advertising space in magazines not only as a function of the readership size, but also as a function of the quality of the readers. Second, we analyze the relation between the media market and the market of industrial products, that is, the impact of readers' profile on the product prices via the advertising rates. Consequently, the following factors are endogenized: the size of the demand and the quality of readers, whose probability of purchasing the industrial products varies with the degree of content specialization of the media. Consequently, in the strategic decision to buy advertising space in magazines, the firm will face a trade-off between the large readership size and the interesting profile of a reader. It is shown that a monopolist on the product market is able to segment the market by targeting its ads to certain groups and then practicing price discrimination by internalizing the difference in demand elasticities for the product among the two groups of consumers (readers of both newspapers).

Table of content

Contents

1 Introduction

2 The Effects of Collusion in a Model of Persuasive Comparative Advertising and Price Competition

2.1 Introduction -

2.2 The Model -

2.3 Stage 2: Price Competition -

2.4 Stage 1: Advertising decisions -

2.4.1 Non-cooperation -

2.4.2 Collusion of all firms -

2.4.3 Collusion between firms A and B -

2.5 Derogatory power of comparative advertising -

2.6 Special cases of parameters -

2.7 Conclusions -

2.8 Appendix A -

2.9 References -

3 Naming a Rival in Informative Comparative Advertising: Disclosure Game of Quality (and Existence)

3.1 Introduction -

3.2 The Model -

3.3 Price equilibrium -

3.3.1 Price equilibrium with no advertising -

3.3.2 Price equilibrium with advertising -

3.4 Advertising equilibrium -

3.5 Advertising in the absence of price competition -

3.6 The impact of advertising on the low quality producer -

3.7 Market coverage -

3.8 Conclusion -

3.9 References -

4 New determinants of advertising rates and pricing strategy in the product market: an application to the press industry

4.1 Introduction -

4.2 The Model -

4.3 The equilibrium analysis -

4.4 Results -

4.4.1 The impact of readership size on advertising rates -

4.4.2 The impact of specialization (readers’ profile) on advertising rates

4.4.3 Determinants of price discrimination -

4.5 Discussion -

4.6 References

List of Figures

2.1 The positions of firms on the unit circle -

2.2 Market division among firms -

2.3 The effects of the degree of comparativeness of advertising on advertising volumes among firms A and B -

2.4 The effects of the degree of comparativeness of advertising on advertising efforts of firms A and B against firm C -

2.5 The effects of the degree of comparativeness of advertising on advertising efforts of firm C against firms A and B -

2.6 The effects of the degree of comparativeness of advertising on the aggregate advertising efforts -

3.1 Possible actions of the game -

3.2 Demand configurations under no advertising -

3.3 Configurations of parameters for which the equilibrium candidate falls in the interior of case 4 -

3.4 Profit functions of each firm at the optimal price of the rival -

3.5 Advertising decisions of firm H -

3.6 The impact of advertising on price competition -

3.7 The impact of price competition on the advertising decision of firm H -

3.8 Constellations of firm L's profits when her true quality is low -

3.9 Constellations of firm L's profits when her true quality is high -

4.1 An exemplary structure of the press market -

4.2 The impact of readers' devotion to the product on advertising rates -

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