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Pricing and persuasive advertising in a differentiated market

Abstract

This paper examines the effects of consumer preferences, firms’ costs, and advertising efficiencies on firms’ pricing and persuasive advertising strategies. We show that as the firms’ horizontal differentiation increases, the firm with a lower value-added product tends to increase persuasive advertising, whereas its competitor tends to reduce advertising. Second, the firm receiving a favorable shock in product valuation will complement the favorable change with additional persuasive advertising rather than reduce advertising spending. Third, an equal improvement in advertising efficiency in the industry will lower the profits for both firms, whereas a decrease in advertising efficiency in the industry can benefit both firms. Fourth, a larger shock that improves a firm’s product valuation or unit cost is more likely to induce higher advertising spending in the industry. Lastly, an exogenous increase in the separation between firms’ product valuations or perceived qualities may actually reduce the price dispersion in the industry.

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Notes

  1. The authors also study two alternative models of advertising; one assumes that advertising changes the ideal product variety, and the other assumes that advertising increases perceived product differences. To provide direct comparison in marketing implications, we focus on their case that assumes advertising raises the consumer’s willingness to pay since this is consistent with our model.

  2. The parameter region of interest is k i  > k (c) i for i ∈ {1, 2}, where \( {k}_i^{(c)}\equiv \frac{1}{3\left[3t-{V}_i+{V}_j+{c}_i-{c}_j\right]} \) for i ≠ j. In this paper, when the subscripts i and j appear in the same expression, it is always assumed that i ≠ j.

  3. This relates to the Bertrand supertrap result by Cabral and Villas-Boas (2005), which shows that, in the presence of intra-firm product interactions, a positive shock in the industry (e.g., an increased degree of economies of scope or demand synergies) may lower equilibrium profits for all firms that compete on prices. Our result shows that a Bertrand supertrap is also possible for single-product firms that strategically compete on both prices and advertising.

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Correspondence to Baojun Jiang or Kannan Srinivasan.

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Jiang, B., Srinivasan, K. Pricing and persuasive advertising in a differentiated market. Mark Lett 27, 579–588 (2016). https://doi.org/10.1007/s11002-015-9370-1

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  • DOI: https://doi.org/10.1007/s11002-015-9370-1

Keywords

  • Competitive strategy
  • Persuasive advertising
  • Pricing
  • Product differentiation
  • Competition
  • Game theory