AEM 4550: Economics of Advertising Prof. Jura Liaukonyte

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LECTURE 7OTHER TYPES OF ADVERTISING

• AEM 4550Economics of AdvertisingProf. Jura
  Liaukonyte

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Lecture Plan

• HW2
• Exam 1
• Informative View
• Memory Jamming View
• Empirical Studies of Advertising Effectiveness
• Advertising and Media Planning
• Definitions
• Costs
• Upfront Market

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Model of Advertising as Information
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Example Auto Industry

• Interaction between Persuasive and Informative
  advertising

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Manufacturers vs Dealers

• Brand Advertising advertising geared towards
  brand positioning and communication of product
  attributes and brand benefits
• Price Advertising advertising that informs
  consumers about price and availability of a brand

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Manufacturers vs Dealers

• Manufacturers often use brand advertising
• Ex Ford Tough or V-8 Engine
• Dealers often use price advertising
• Ex 2,000 rebate or Labor Day Sales Event

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Manufacturers vs Dealers

• Manufacturer Brand Advertising (MBA) and Dealers
  Price Advertising (DPA) interact positively
• This suggests that brand advertising and price
  advertising may work together when they are sent
  by different channel members
• Attribution Theory when consumers accredit auto
  dealers discount advertisements to addressing
  competition in the industry, the price
  advertising increases purchase intent.

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Manufacturers vs Dealers

• Manufacturer Brand Advertising (MBA) and
  Manufacturer Price Advertising (MPA) interact
  negatively.
• This suggests that brand advertising and price
  advertising do not complement each other when
  they come from the same channel.
• Unlike Dealers Price Advertising, when
  manufacturers use price advertising, consumers
  connect a lower price to a defect in the product.
• This is consistent with the informative view of
  advertising because advertising about price makes
  demand more elastic.

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Manufacturers vs Dealers

• When Dealers advertise about price, it increases
  consumers intent to purchase.
• When manufacturers advertise about price, it
  decreases consumers intent to purchase.

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Manufacturers vs Dealers

• As a result, brand advertisements by
  manufacturers and price advertisements by dealers
  should be coordinated to appear at similar times.

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Empirical evidence Setting

• In the 1960s, considerable variation existed
  across US with respect to the legal treatment of
  advertising in the eyeglass industry
• Some states prohibited all advertising
• Some states prohibited price advertising but
  allowed non-price advertising
• Some states had no restrictions
• This variation provides a natural experiment

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Empirical Evidence

• Eyeglass prices were substantially higher in
  states that prohibited all advertising than in
  states that had no restrictions
• The association between price advertising and
  lower prices is striking and directly supports
  the informative view

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Other Studies

• Cady (1976) considers the U.S. retail market for
  prescription drugs in 1970
• Retail prices are significantly and positively
  related to advertising restrictions
• Maurizi and Kelly (1978) compare retail gasoline
  prices across major cities
• Both the mean and variance of prices are lower in
  states where price advertising is allowed
• Schroeter, Smith and Cox (1987) use survey data
  for the routine legal service market in 17 U.S.
  metropolitan areas
• Evidence that pricecost ratios are lower when
  area-wide advertising intensity is greater
• These studies all support the informative view

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Comparison

• Persuasive/Complementary Model
• Higher advertising leads to higher demand for
  each consumer, which leads to higher prices.
• Informative Model
• Higher levels of advertising leads to more
  consumers but not a higher demand for each
  consumer, so prices are not affected by
  advertising levels.

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Signaling as Information

• For experience goods, advertising can also be
  used to signal quality.
• If a company engages in an expensive ad campaign,
  you might infer that the good is high quality
  because only high quality firms could afford the
  campaign.
• Price is can also be used as a signal of high
  quality.

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Signaling as Information

• Nelson, 1970 begins with a simple question
• How, exactly, does advertising provide
  information to consumers?
• The informative content of advertising is clear,
  when the advertisement contains direct
  information as to the existence, location,
  function or price of a product.
• But what about all of the advertising that does
  not contain direct information of this kind? Is
  it persuasive?
• Nelson argues rather that such advertising still
  plays an informative role, although the role is
  indirect.

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Signaling as Information

• To develop this argument, Nelson (1970) makes a
  distinction between search and experience goods.
• Recall, a search good is one whose quality can be
  determined prior to purchase (but perhaps after
  costly search),
• The quality of an experience good can be
  evaluated only after consumption occurs.
• Indirect information contained in advertising is
  especially important for experience goods.

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Signaling as Information

• 3 reasons why advertising may provide indirect
  information about experience goods.
• Signaling-efficiency effect.
• The demand expansion that advertising induces is
  most valuable to efficient firms,
• By advertising, a firm signals that it is
  efficient, which implies in turn that it offers
  good deals.

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Signaling as Information

• Match-products-to-buyers effect.
• Consumers may have heterogeneous tastes, and it
  may be difficult to efficiently match products
  and buyers.
• A seemingly uninformative ad can assist in this
  process, since a firm has the incentive to direct
  its advertising toward the consumers that value
  its product the most.

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Signaling as Information

• Repeat-business effect.
• Ads may remind consumers of their previous
  experience with the product, and such
  recollections are of more value to sellers of
  high-quality goods.
• Even new consumers may draw a positive
  association between advertising and quality, and
  advertising thus may signal quality.
• Similar to Memory Jamming View

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Signaling and Search Products

• Ads can provide indirect information here as
  well.
• Recall signaling-efficiency effect even if a
  search good advertisement contains no direct
  information, the fact that the good is advertised
  may suggest that the seller is efficient
• However, search goods offer greater potential for
  direct information transmission through
  advertising
• I.e., ads for experience qualities is dominantly
  indirect information and advertising for search
  qualities is dominantly direct information

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Evidence of the Signaling Theory

• Advertising intensity is higher for experience
  goods
• The ratio of TV to magazine advertising is
  significantly higher for experience goods
• Search goods are especially conducive to the
  transfer of direct information
• Advertising intensity is higher for non-durable
  experience and lower-priced experience goods
• For major purchases, a consumer relies more on
  WOM, whereas for more frequent, low-cost
  purchases, a consumer relies on advertising as a
  source of indirect information

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Memory Jamming View of Advertising
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Memory Jam

• Why do familiar brands such as Coca-Cola and
  McDonalds advertise so heavily?
• With the average American drinking 10 gallons of
  Coca-Cola each year, its hard to believe there
  is much left for most consumers to learn about
  whats inside the can.
• Advertising might also influence the way
  consumers encode and recall their consumption
  experiences.

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Memory Jam

• Psychological studies show that people can quite
  easily forget the origin of a memory.
• E.g. the strangers face is familiar, the
  individual cannot remember why.
• When people dont directly recall the source of a
  memory, they use what they know to fill in the
  gaps.

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Memory Jam Experiment

• Researcher gave participants orange juice spiked
  with salt and vinegar.
• Results showed that people who watched
  advertisements for the juice after the taste test
  remembered the juice as tasting good.
• Even though what they actually consumed was
  designed to taste terrible.
• Ads changed recollection of the sensory
  experience of tasting the juice, even in the very
  short-term.

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Memory Jamming View Formalized

• Economic theory of advertising based on limited
  consumer memory
• Consumers learn through experience how much they
  enjoy consuming a firms product
• Each consumer stores in memory the utility he has
  received from consuming the product during each
  past experience
• At the point of purchase, the consumer recalls
  the utility of these experiences to memory

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Memory Jamming View Formalized

• The firm can use advertising to change the
  likelihood that the consumer will remember a
  favorable consumption experience
• Consistent with a large literature in the
  psychology of memory

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Example Breakfast Cereal Industry
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Memory Jamming

• Average preschooler sees 642 ads/year on TV
• Memorable slogans
• Lucky Charms Theyre magically delicious!
• Paired with creative cartoons- easily recall
  figures and mascots

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Student Example

• Soft Drink Industry

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MEMORY JAMMING

• Need for the players to advertise heavily
• Reminds the experience more than what is inside
  the can
• Changes the way a consumer remembers an
  experience
• Coca-Colas main type of advertising

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Combative Advertising

• Combative advertising, a characteristic of mature
  markets, is defined as advertising that shifts
  consumer preferences towards the advertising
  firm, but does not expand the category demand.
• Not about influencing the consumer preferences,
  but rather about the supply side and advertising
• Redistributes consumers among brands. If the real
  differences between brands are modest, then
  combative advertising may be excessive
• Basis of Prisoner's dilemma in advertising

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Prisoner's Dilemma
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Advertising Wars

• The prisoner's dilemma applies to advertising
• All firms advertising tends to equalize the
  effects
• Everyone would gain if no one advertised
• Advertising WarsTwo firms spend millions on TV
  ads to steal business from each other. Each
  firms ad cancels out the effects of the other,
  and both firms profits fall by the cost of the
  ads.

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Cigarette Advertising on TV

• All US tobacco companies advertised heavily on TV
• Surgeon General issues official warning
• Cigarette smoking may be hazardous
• Cigarette companies fear lawsuits
• Government may recover healthcare costs
• Companies strike agreement
• Carry the warning label and cease TV advertising
  in exchange for immunity from federal lawsuits.

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Strategic Interaction

• Players Reynolds and Philip Morris
• Strategies Advertise or Not Advertise
• Payoffs Companies Profits
• Strategic Landscape
• Each firm earns 50 million from its customers
• Advertising costs a firm 20 million
• Advertising captures 30 million from competitor
• How to represent this game?

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Representing a Game
PLAYERS
STRATEGIES
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What to Do?

• If you are advising Reynolds, what strategy do
  you recommend?

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Solving the Game

• Best reply for Reynolds
• If Philip Morris advertises
• If Philip Morris does not advertise

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Dominance

• A strategy is dominant if it
  outperforms all other choices
  no matter what opposing players do
• Games with dominant strategies are easy to play
• No need for what if thinking

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DominanceA Technical Point

• Strict Dominance
• Advertise is strictly dominant for Reynolds if
• Profit (Ad , Ad) gt Profit (No , Ad)
• Profit (Ad , No) gt Profit (No , No)

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Dominance
COMMANDMENT If you have a dominant strategy, use
it. Expect your opponent to use her dominant
strategy if she has one.
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Prisoners Dilemma
Optimal
Equilibrium

• Both players have a dominant strategy
• The equilibrium results in lower payoffs
  for each player

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Equilibrium Illustration

• The Lockhorns

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Cigarette Advertising

• After the 1970 agreement
• Cigarette advertising decreased by 63 million
• Industry Profits rose by 91 million
• Prisoners Dilemma
• An equilibrium is NOT necessarily efficient
• Players can be forced to accept mutually bad
  outcomes
• Bad to be playing a prisoners dilemma, but good
  to make others play

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Empirical Studies of Advertising Effectiveness
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AdvertisingSales Relationship

• Lambin (1976) uses various sales, quality, price
  and advertising data
• 107 individual brands from
• 16 product classes
• 8 different Western European countries
• How changes in the advertising expenditures for
  one brand may affect the current sales of that
  brand and rival brands?
• Evaluate goodwill effects and the rival-brand
  response that an advertising expenditures may
  induce

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Lambin (1976) Findings

• Brand advertising has a significant and positive
  effect on the brand's current sales and market
  share
• Evidence for advertising's goodwill effect
• The quantitative impact of advertising on
  (current and future) sales is limited
• Sales appear more responsive to price and
  product-quality selections
• Firm's sales and market share are negatively
  related to rival advertising
• Evidence of what?

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Advertising Goodwill

• Clarke (1976) identifies a data-interval-bias
  problem
• The use of annual advertising data when the
  effects of advertising on sales depreciate over a
  shorter period of time can lead to biased
  estimates of the depreciation rate.
• The duration of cumulative advertising effect on
  sales is between 3 and 15 months thus this
  effect is a short-term (about a year or less)
  phenomenon.
• More recently, several studies offer further
  evidence that the effect of advertising on sales
  is often largely depreciated within a year (if
  not less).
• Latest studies Beyond 3 months miniscule
  effect.

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Sales Response Models
Saturation Point
Threshold
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Sales Response Model
Saturation Effect
Sales
Adv Expenditures
Threshold Effect
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Overall Advertising Impact (Gerard J. Tellis)

• The average sales-to-advertising elasticity is
  0.1
• Higher for new products than established products
• For Europe than the United States
• For durables than nondurables
• For print than TV
• Advertising elasticity is also lower in models
  that use disaggregate data and include
  advertising carryover, quality, or promotion

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Determinants of Advertising Impact(Demetrios
Vakratsas)

• Advertising impact depends on the product
  category.
• Specifically, advertising elasticities are as
  much as 50 higher for durables as for
  nondurables.
• Advertising is more effective for experience than
  for search products.

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Advertising Impact and Competition(Demetrios
Vakratsas)

• Higher competitive intensity (clutter) will
  result in lower advertising effectiveness.
• Competitive advertising may reduce elasticities
  by as much as 50.

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Advertising Reference Price(Dhruv Grewal and
Larry D. Compeau)

• The presence of an advertised reference in a
  price offer enhances perceptions of value
• Lowers their intention to search for a lower
  price.

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Advertising Impact Duration(Robert P. Leone)

• The average advertising duration interval on
  sales is brieftypically between six and nine
  months.

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TV Advertising Effect

• The average TV advertising to sales elasticity is
  0.11 for established consumer products.
• It is higher for tests after 1995 than those
  before.
• There is a high variability in effects around
  these average elasticities. Some tests had
  elasticities over 0.5 and others were below -0.05.

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Advertising and Business Cycles

• Advertising is more sensitive to business-cycle
  fluctuations than the economy.
• Average co-movement elasticity is1.4.
• Hence, a 1 increase in the cyclical component of
  GDP translates, on average, into a 1.4 increase
  in the cyclical component of the demand for
  advertising.
• The extent of this sensitivity varies
  systematically across countries.
• When companies tie advertising spending too
  tightly to business cycles, they experience
  higher losses
• A lower long-term growth of the advertising
  industry
• A higher private-label share
• Lower stock prices

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Empirical Studies

• A firm's current advertising is associated with
  an increase in its sales, but this effect is
  usually short lived.
• Advertising is often combative in nature.
• An increase in advertising by one firm may reduce
  the sales of rival firms, and rivals may then
  react with a reciprocal increase in their own
  advertising efforts.
• The overall effect of advertising on primary
  demand is difficult to determine and appears to
  vary across industries.

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Firm Specific Factors

• When assessing the goodwill impact of
  advertising, it is important that firm-specific
  factors not be omitted.
• Recall Nelsons theory
• It may be that advertising affects initial sales
  but that long-term sales are driven by
  firm-specific factors, like product quality.
• Given that higher-quality firms may advertise
  more, the effects of advertising on future sales
  may be overstated in an empirical analysis that
  omits product quality.
• Kwoka (1993) examines the determinants of model
  sales in the U.S. auto industry, finding that the
  effect of advertising is short-lived while
  product styling has a much longer impact.

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Advertising and Entry

• Advertising as a response of incumbent firms to
  entry
• Alemson's (1970) studies Australian cigarette
  industry new entrants advertise to gain market
  share and induce increased advertising by
  incumbents, who seek to maintain market share.
• Thomas (1999) studies the ready-to-eat cereal
  industry and reports that incumbent firms often
  respond to entry with advertising, in order to
  limit the sales of new entrants.
• Cubbin and Domberger (1988) examine 42
  consumer-goods industries and report evidence
  that dominant incumbent firms in slow-growth
  markets often respond to entry with an increase
  in advertising.

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Advertising and Industry Demand

• Empirical studies suggest that advertising may
  increase primary demand in some industries but
  not others.
• Positive relationships between industry
  advertising and sales
• UK cigarette industry
• U.S. cigarette industry
• U.S. orange market
• U.S. auto industry
• No effect
• U.S. beer market
• UK instant-coffee market

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Advertising and Brand Loyalty

• No clear consensus.
• The studies do not provide strong evidence that
  advertising consistently increases brand loyalty
  or stabilizes market shares.

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Brand Loyalty

• Recall Persuasive view
• The direct effect of advertising is that brand
  loyalty is created and the demand for the
  advertised product becomes less elastic.
• Lack of high detail data need exposure and
  brand-purchase data as well as the advertising
  and pricing behaviors of rival firms.
• Partly remedied by advent of supermarket scanner
  data.
• 2 ways to test for brand loyalty
• Estimate demand functions for individual brands,
  in order to see if consumers exhibit more
  inertia in highly advertised markets.
• See if the estimated price elasticities are lower
  in magnitude in product groups with high
  advertising intensity.
• Infer the extent of brand loyalty, by further
  examining the relationship between advertising
  and market-share stability.

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Advertising Costs and Media
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Media Selection

• Coverage is the theoretical maximum number of
  consumers in the retailers target market that
  can be reached by a medium and not the number
  actually reached.
• Reach is the actual total number of target
  customers who come in contact with an advertising
  message.
• Cumulative Reach is the reach that is achieved
  over a period of time.

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Media Selection

• Frequency is the average number of times each
  person who is reached is exposed to an
  advertisement during a given time period.

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When High Frequency Is Used

• A new brand
• A smaller, less known brand
• A low level of brand loyalty
• Relatively short purchase and use cycle
• With less involved (motivated and capable) target
  audiences
• With a great deal of clutter to break through

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Media Selection

• Cost Per Thousand Method (CPM) is a technique
  used to evaluate advertisements in different
  media based on cost.
• The cost per thousand is the cost of the
  advertisement divided by the number of people
  viewing it, which is then multiplied by 1,000.

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Media Selection

• Cost Per Thousand Target Market (CPM-TM) Is the
  cost of the advertisement divided by the number
  of people in the target market viewing it, which
  is then multiplied by 1,000.
• Impact refers to how strong an impression an
  advertisement makes and how well it ultimately
  leads to a purchase.

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CPMs

• Cost measured per thousand impressions (CPM)?
• Broadcast TV 10 CPM for 30 second impr
• Superbowl 30 second spot 25-40 CPM
• Around 1 cent per 30 sec impression 2 cents for
  1 minute 20 cents for 10 minutes
• Conclusion TV network is paid 20 cents an hour
  of content for your attention

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Typical CPMs

• Outdoor 1-5 CPM
• Cable TV 5-8 CPM
• Radio 8 CPM
• Online
• Display 5-30 CPM
• Contextual 1-5 CPM
• Search 1 to 200 CPM
• Network/Local TV 20 CPM
• Magazine 10-30 CPM
• Newspaper 30-35 CPM
• Direct Mail 250 CPM

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Network TV CPMs

• CSI 19.59
• Without a Trace 13.83
• CSI Miami 17.30
• Desperate Housewives 11.81
• Everybody Loves Raymond 25.19

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Gross Rating Points

• GRPs Reach X Frequency.
• GRPs measure the total of all Rating Points
  during an advertising campaign.
• A Rating Point is one percent of the potential
  audience. For example, if 25 percent of all
  targeted televisions are tuned a show that
  contains your commercial, you have 25 Rating
  Points.
• If, the next time the show is on the air, 32
  percent are tuned in, you have a total of 25 32
  57, and so on through the campaign.

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Media Tactics

• Three ways to schedule the same number of GRPs
• Continuous
• Flighting
• Pulsing

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Selling Network Television

• NETWORKS SELL THEIR TIME IN 3 STAGES
• The Upfront Market
• The Scatter Market
• The Opportunistic Market

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Television Sells Spots Like Airlines Sell Seats

• If a flight leaves with empty seats, revenue for
  the seat is zero.
• To assure full planes, sell the seats at a price
  that will sell them out early.
• Charge last -minute buyers highest price

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THE UPFRONT MARKET

• Annual purchase of commercial time well in
  advance of the telecast time.
• Upfront advertisers buy 70 of prime time and 50
  of other dayparts. Most buy for one year. Get
  best price.
• Biggest national advertisers buy childrens
  programs, prime time, daytime, news, and late
  night.

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SCATTER MARKET

• Sale of most of the years remaining inventory
  not sold at upfront.
• Inventory generally tight.
• Prices usually 50 higher than upfront.

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OPPORTUNISTIC MARKET

• Last-minute buying of inventory due to
• Changes in programming
• Advertisers dont want to be on controversial
  programs
• Advertiser inability to pay

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Cancellations and Guarantees

• Most network orders are non-cancelable. If an
  advertiser cannot or does not want the time, it
  is the advertisers responsibility to sell the
  time - not the networks.
• Networks cancel programs with no notice to the
  advertiser with the provision that commercials
  will run in another program that delivers the
  same audience profile.

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Ratings Guarantees

• The cost of network time is based on network
  guarantees of spot price vs. audiences, computed
  in cost per thousand.
• If the ratings projected by the network to the
  advertiser are not achieved, the network runs
  the spot in other programs to accumulate
  sufficient ratings to bring the CPM down to the
  promised level.
• The extra spots the advertiser gets are called
  MAKEGOODS