The Risk Reduction Role of Advertising

Abstract

This study shows theoretically and empirically that exposure to advertising increases consumers’ tendency to purchase the promoted product because the informative content of advertising resolves some of the uncertainty that the risk averse consumers face and thus reduces the risk associated with the product. We call this effect the “risk-reduction” role of advertising. The risk-reduction model implies that advertising effectiveness depends on (a) the risk preference parameter, (b) the precision of the advertising message, (c) the familiarity of the consumer with the product, (d) the consumer’s sensitivity to products’ attributes (and thus, her involvement level with the product), and (e) the diversity of products offered by multiproduct firms. These findings suggest that ads spending should be higher (a) for new and relatively unknown products, (b) for high-involvement products, (c) when ads can be quite precise, and (d) when the firm offers a diverse product-line. It also implies that ads should target consumers (a) who are more sensitive to risk, (b) who are more involved, and (c) those who are not familiar with the promoted product.

The model allows ads to affect choices also through a direct effect on the utility (i.e., the standard approach to formulate the effect of advertising). In our empirical example (where the products are television shows) the risk-reduction effect is significant and strong and the direct effect is negligible behaviorally. We discuss the welfare implications of these findings, and illustrate the quantitative differences in managerial implications between our model and the traditional one.