There is an old debate in economic theory, which goes back at least to Marshall (1919), about whether advertising increases or decreases the prices of consumer goods. Some have argued that advertising provides information to consumers, such as information on prices or the existence of products (for example Butters 1977 or Stahl 1989). This information increases the degree of competition in a market, and thereby lowers consumer prices. On the other hand, there is the view that advertising changes the preferences of consumers, for example by shifting demand curves outwards, increasing the monopoly power of brands or decreasing elasticities of substitution. All these effects should lead to an increase of market prices. These different effects of advertising have been called, respectively, the ‘informative’ and ‘persuasive’ effect of advertising. Show
The distinction is relevant for policymakers that consider taxing or banning advertising of certain goods, as a case could be made to tax primarily goods for which the persuasive effect dominates. On the other hand, informative advertising might be welfare increasing, and some models even suggest that a subsidy for informational advertising would increase welfare. Existing empirical evidence has demonstrated that prices of various goods react to changes in advertising costs differently. For example, advertising seems to decrease prices for eyeglasses (Kwoka 1984), children’s breakfast cereals (Clark 2007) and drugs (Cady 1976), while it increases the supply price in brewing industries (Gallet and Euzent 2002). In a recent study (Rauch 2011), I use a policy change in Austria to identify this price reaction for all industries. Austria is the only country in the OECD that charges a tax on advertising, which directly affects the cost of advertising. Before 2000, when a nationwide harmonisation introduced a 5% tax rate, each region had a different rate. Thus in 2000 the advertising tax, and therefore the cost of advertising, increased in parts of the country while simultaneously decreasing in other parts, as highlighted in Figure 1. Figure 1. Change in advertising costs I interpret this change of policy as a natural experiment, and collect data on prices of regional products to investigate its effects. I first show that the taxation of advertising is indeed a powerful instrument to restrict advertising expenditures of firms. I also show that advertising increased consumer prices in some industries such as alcohol, tobacco and transportation, in which the persuasive effect dominates. But it also decreased consumer prices in other industries such as food. I use data from existing marketing studies which make it possible to relate different responses of market prices to characteristics of advertisements in industries. I can indeed show that those industries which exhibit the informative price include more information in their advertisements, consistent with the interpretation of informational and persuasive forces of advertising. The aggregate effect is informative, which means that, on average, advertising decreases consumer prices. This suggests that the Austrian advertising tax increases consumer prices and probably affects welfare adversely. I estimate that if the current 5% tax on advertising in Austria were abolished, consumer prices would decrease by about 0.25 percentage points on average. References Butters, Gerard, ‘Equilibrium Distributions of Sales and Advertising Prices’, The Review of Economic Studies, Vol 44, 465-510, 1977. Cady, John, ‘An estimate of the price effects of restrictions on drug price advertising’, Economic Enquiry, Vol 14(4), 493-510, 1976. Clark, Robert, ‘Advertising Restrictions and Competition in the Children’s Breakfast Cereal Industry’, The Journal of Law and Economics, Vol 50, 2007. Gallet, C and P Euzent, ‘The Business Cycle and Competition in the US Brewing Industry’, Journal of Applied Business Research, Vol 18, 2002. Kwoka, John, ‘Adverting and the price and quality of optometric service’, The American Economic Review, Vol 74(1), 1984. Marshall, Alfred, Industry and Trade, Macmillan Publishing, Stadt ist wichtiger als Verlag 1919. Rauch, Ferdinand, ‘Advertising Expenditure and Consumer Prices’, CEP Discussion Paper 1073, 2011. Stahl, Dale O, Oligopolistic Pricing with Sequential Consumer Search, The American Economic Review, Vol 79, No 4, 1989.
What, if any, is the relationship among prices, advertising expenditures, and return on investment? Prior research has yielded inconclusive answers to this question, but in analyzing data from 227 consumer businesses, the authors have found a consistent pattern. Companies with relatively high prices and high advertising expenditures, for instance, had higher profits than companies with relatively low prices and high advertising budgets. Such consistency remains important when one is considering the impact of factors like product quality, stages in the product life cycle, product risk, and market share on the price-advertising relationship. The authors also address the issue of whether advertising increases consumer prices. A few years ago, a leading ketchup maker significantly increased its advertising and promotion expenditures and simultaneously lowered its prices. The company gained market share at the expense of the top ketchup manufacturer, Heinz, and other brands, but the victory was a hollow one. The combination of increased advertising expenditures and low prices caused its profits to suffer, and the company eventually abandoned this strategy. Would the company eventually have improved its profit margins? Maybe, but waiting would have required a commitment of cash reserves and extreme patience on the part of its management and stockholders. Beyond the implications for the ketchup maker seeking to improve its competitive position, the experience has relevance for other companies in consumer goods markets because many have tried the same strategy and had similar unsatisfactory results. The reason for the lack of success, we believe, lies in their failure to take seriously enough into account what we have discovered to be an extremely close relationship between advertising expenditures, prices, and profits. One outgrowth of the relationship is that companies doing the most relative advertising tend to command premium prices for their products and also to obtain the best margins. Consumer goods marketers have long recognized a correlation between advertising and pricing strategies. When a product is successfully differentiated from competitive offerings, distribution in retail stores is almost ensured and premium prices can be commanded from retailers and consumers. Less well-known brands, on the other hand, struggle for distribution and consumer acceptance by positioning themselves as lower-priced alternatives of satisfactory quality; they cut factory prices and hope retailers will pass on some of their savings to consumers. Examples of this phenomenon abound. Heinz ketchup usually sells at wholesale prices that are about 10% higher than Hunt’s or Del Monte’s and as much as 20% over private labels’. In the supermarket, the spread between Heinz’s prices and its competitors’ is somewhat less. (See the sidebar “Prices, Advertising, and Ketchup.”) Advertised aspirin brands command even larger wholesale and retail price premiums and hold 90% of the total market. (To appear price-competitive, most retailers mark up less advertised brands at a higher percentage than they do advertised brands and thus make the differential in retail prices between the two groups less than the spread in wholesale prices.) The notion that prices, advertising expenditures, and profits are related comes as no surprise to at least one consumer product marketer. According to Richard B. Patton, president of Heinz U.S.A., makers of Heinz Ketchup, “We are convinced that our continued success in the ketchup category has resulted from uncompromising product superiority, which we have advertised extensively, coupled with a commonsense pricing policy. “Advertising definitely helps us to sell our product at a price higher than competitors’. But we must also remain aware that, even with heavy advertising support, a limit exists to the premium the consumer will pay for the superior quality of Heinz Ketchup. “Our goal is to blend advertising support and pricing to produce optimum market share and profit margins. “Our feeling is that consistency in advertising and pricing strategies is important to the success of any consumer product. Heinz Ketchup is premium priced because it is made from more expensive ingredients and also because it is perceived by consumers as being a superior value compared with competitive products.” Another example comes from the liquor industry, where a 1978 study showed fast-growing, premium-priced brands to be spending $7.26 per case on advertising. The industry average for all distilled spirits is only $1.75.1 Heavily advertised brands, as a rule, sell for more. Although these examples illustrate that premium prices and high advertising expenditures can march hand in hand, this is not the only successful marketplace strategy, nor is such a strategy a guarantee of success. What is important to keep in mind is that consistency between the two is crucial for short-term and medium-term profitability. In most markets, consistency means that relative prices and relative advertising levels are coordinated. In other words, high relative advertising expenditures should accompany premium prices, and low relative advertising expenditures should be tailored to low prices. Unfortunately, no hard quantitative evidence concerning the prevalence of the relationship between premium price and high advertising expenditures has previously been gathered. Nor has the degree to which premium prices stem from advertising as opposed to other differences among products such as product quality been ascertained. (For a discussion of previous research in this area, see the sidebar “Difficulties of Researching the Price-Advertising Relationship.”) Economists have devised theoretical models that assess how advertising affects price sensitivity, how prices affect advertising levels, and how the two work together to influence profits. Unfortunately, the theoretical and the empirical research have both yielded conflicting results. Some studies suggest that advertising is associated with less price sensitivity (i.e., higher prices). Others indicate the opposite. Surprisingly, both findings may be correct. The studies that showed that advertising led to less price sensitivity were done on the sensitivity of sales to factory prices, while studies that found that advertising led to increased price sensitivity were done on consumer prices. Robert L. Steiner, a University of Cincinnati economist, has several theories that help reconcile this apparent conflict.* He suggests that advertising makes consumers more price sensitive in their purchases because they use advertised brands to make price comparisons among retailers. Retailers react by lowering their prices and profit margins to increase turnover. But, because of the consumer demand that advertising creates, the manufacturer of the advertised product is in a stronger position than the retailer and may maintain or actually increase factory prices. Thus advertising can lead to more price sensitivity to consumer prices and less sensitivity of factory sales to factory prices and can make conclusions about advertising and consumer price levels difficult to draw from studies of price sensitivity. Also, price is extremely difficult to measure in any meaningful fashion. In addition to the obvious problems of adjusting for things like different sizes and package forms, product quality must somehow be measured. Immediately the researcher’s problems multiply. How is quality measured? Anacin claims that its product dissolves faster than many other aspirin brands. Is this true? How much faster? What is the value of the “speed of relief”? Will all consumers appreciate this to the same degree? What about variability of product quality? Some manufacturers have based claims of product quality on the uniformity of their product from purchase to purchase. In view of these complexities, it is not surprising that little evidence exists linking manufacturers’ advertising to higher relative prices, either at the wholesale or the retail level. However, the realities of the marketplace dictate that unadvertised brands of a quality less than or equal to that of advertised brands must almost always sell for less than advertised brands. Consumers and retailers have no incentive to buy relatively unknown brands at the same price if the unadvertised brands are only of equal quality. Therefore, even if advertising tends to lower the overall costs of production, distribution, and communications in an industry, common sense would lead us to expect that advertised brands would sell for more than unadvertised brands of equal or lower quality. How much more is a question we still need to answer. As Steiner has pointed out: “It is always the case that advertised brands sell for more than their unadvertised counterparts, even allowing for any superiority in advertised brand quality. But this is simply an observation of the relative prices of different kinds of brands, which is quite consistent with the possibility that, in the absence of advertising, the absolute prices of all brands in the category might be higher. And, of course, many of the imitative private labels might not exist at all.”† It is particularly important to understand the difference between the concepts of relative price and absolute price. Let us take the price of bread as an example and look at three possible scenarios in terms of market share and prices (see Table):  Table Difference Between Relative Price and Absolute Price Under all three scenarios, the relative price of B is 25% greater than that of A. The average prices consumers actually paid, however, are in absolute terms quite different. Evidence also exists that advertising may contribute to lower prices through such means as lowering the cost of production through economies of scale, increasing marketing communications efficiency, stimulating price competition among retailers, and contributing to the development of efficient self-service retail outlets. And as one company raises its advertising, the response from competitors could conceivably be to lower prices. The net effect can easily be lower average absolute prices.‡ * Robert Steiner, “Does Advertising Lower Consumer Prices?” Journal of Marketing, October 1973, p. 19. † Steiner, personal correspondence shared with authors. ‡ For a discussion of these issues and a summary of the available empirical evidence, see Paul W. Farris and Mark S. Albion, “The Impact of Advertising on the Price of Consumer Products,” Marketing Science Institute Report No. 79–109 (Cambridge, Mass.: Marketing Science Institute, 1979). Analyzing the Price-Advertising RelationshipWe set out to accumulate such evidence by analyzing price and advertising data for consumer goods manufacturers. Specifically, we wanted to answer three questions: 1. How strong is the association between price and advertising strategies among consumer goods businesses? 2. Does the strength of this association depend on certain characteristics of the business’s strategy and market, such as product quality, market share, and stage in the product life cycle? 3. Finally, do businesses that maintain consistent advertising and pricing strategies earn higher profits than those that fail to maintain some consistency between the two? Our analysis shows that the general association between price and advertising strategies is strong and statistically significant. Our analysis also demonstrates that the strength of the relationship depends on some product and market factors and not on others. To the third and perhaps most important question, the answer is yes—that is, consistent strategies result in higher profits. Businesses with inconsistent pricing and advertising strategies earn lower profits than do businesses with consistent strategies. These are strong statements that have broad and significant implications for marketing strategy formulation. They are not based solely on isolated examples. They are supported by what we believe is solid statistical analysis that is relevant to a large number of consumer goods marketers. Discussion of the more technical statistical safeguards of our research has been relegated to the Appendix; we will concentrate in this discussion on the most important aspects of the research techniques as well as on the results and implications of our findings. The data used in this study were four-year averages from 227 consumer goods businesses participating in the PIMS program at the Strategic Planning Institute in Cambridge, Massachusetts. The overall objective was to determine how relative price and relative advertising levels covary. To analyze this data, we postulated a simple bivariate regression: RP = β0+ β1RA+ ε, where RP is the relative price level, RA is the relative advertising level, Î’0 is the constant term, Î’1 is the slope, and ε is the error, or disturbance term assumed to be normally distributed with mean zero and variance equal to one. This is the basic model that was used throughout the descriptive part of this study. When estimated across the entire sample, the results were: RP = 92.86 + 2.82 RA (.44)* with R2 = .155. This result can be interpreted as the forecasted relative price being equal to 92.86 plus 2.82 for each unit of reported relative advertising level. In this descriptive analysis, we split the sample into subsamples along a criterion variable (e.g., product quality, market share) and estimated within each subsample. (We split the sample for each criterion at a level that balanced the number of observations in each subsample.) We then compared the separate slope coefficients to test the probability that the subsamples had the same relationship between relative price and relative advertising. For example, we divided the sample into businesses with products of high quality and businesses with products of low quality. The corresponding estimated slope coefficients were 2.72 and 2.19, respectively. Given the uncertainties in the estimates, the probability of the relationship between relative price and relative advertising being different was low. The parameter estimates for each of the splits described in the text are shown in Table A. Table A Regression Results for Descriptive Analysis To test whether consistency between advertising and pricing strategies had an impact on performance, we postulated two alternative models. The first was simply that return on investment is a function of the price-advertising consistency index (PACI), described in the text as: ROI = β 0+ β 1 PACI + ε. The estimated slope of this model, β1, estimated across the entire sample, was –3.02, suggesting that each unit of the consistency index was associated with a decrease in ROI of slightly more than three percentage points. In another approach to validate the impact of price-advertising consistency on ROI, we split the sample according to the level of relative advertising and put the relative price on ROI through a regression: ROI = β0 + β1 RP + ε. We estimated this model separately for businesses with advertising levels that were (1) lower than average, (2) average, and (3) higher than average. The results of these three regressions are shown in Table B. The relationship between ROI and relative price had a high probability (greater than 95%) of not being equal. Table B Regressions on Return Investment The implications of these regressions confirm earlier results. If a company had been advertising at a level lower than competition, its predicted ROI decreased nearly one-half of a percentage point (–.46) for each percentage increase in its relative price. Conversely, companies that advertised at levels higher than competition have predicted ROIs that increased by more than one-half of a percentage increase in its relative price. Thus, to maximize ROI, companies that advertise more should generally charge more than competition and companies that advertise less should charge less. As a final check, we took the data through the five regressions shown in Table C. We feared that the price-advertising consistency index was serving as a surrogate measure for some underlying phenomenon. For example, if the consistency index was highly correlated with market share and it was really this latter measure that was affecting ROI, the consistency index could have appeared to be the driving force when used in a model in the absence of market share. As such, we took the entire sample for the following model through a regression with the indicated parameter estimates: Table C Regressions on Return on Ivestment where ROI is the predicted return on investment, PACI is the price-advertising consistency index, MS is the market share, PLC is the stage in the product life cycle, MSΔ is the sum of the market share changes, PQ is the product quality, and the values shown in parentheses are the standard errors of estimate. Each of the parameter estimates was stable, for there were minimal levels of multi-collinearity. More important, the interpretation was reasonable because as advertising and pricing strategies became inconsistent, ROI dropped (–2.18), whereas the higher a business’s market share, the higher its ROI (+.28); the further along the business was in the product life cycle, the lower the corresponding ROI (–4.42); other factors had minimal direct impact. The R2 associated with this model was .15, which is quite remarkable given all the factors that could affect ROI. The argument could be made that other functional forms should have been applied. Yet even after other factors were accounted for, the conclusion remained that failure to maintain consistency in advertising and pricing strategies is directly associated with a lower level of ROI. Gathering the DataTo determine the general relationship between advertising and pricing strategies, we used information on 227 consumer businesses from the Profit Impact of Market Strategies (PIMS) project of the Strategic Planning Institute in Cambridge, Massachusetts.2 Our analyses were based on data covering the 1971–1977 period and included two variables that are central to the rest of this article:
Assessing the ResultsHow strong is the association between relative price and relative advertising? Our analysis of the data, which is shown in Exhibit I, indicates that brands with high relative advertising budgets are also charging premium prices, and vice versa. For example, the 58 businesses in the PIMS data base that spend “much less” on advertising than their competitors also charge prices that average almost 3% below the market average for their products. (Some businesses charge higher and some lower prices, but the average for the 58 businesses is clearly well below their respective market norms.) Exhibit I Relative Advertising and Average Relative Price (Compared with Competition) Contrast this finding with the average relative prices of the 23 businesses that have relative advertising budgets of “much more” than their competitors. These high advertisers command prices that average 7% above the competition. (Again, some businesses in this group have prices that are even higher and some have lower prices.) The overall pattern is one of strong association between businesses that have high relative advertising budgets and businesses that charge high relative prices. Of course, high-quality advertising is probably more effective than low-quality advertising. But measuring advertising quality is difficult enough for a single company, let alone for 227. Two explanations can be offered for the association between price and advertising. First, retailers and consumers are willing to pay higher prices for known products than for unknown brands. Second, marketers are willing to advertise more when gross profit margins are high. For the purposes of our research, it does not matter which of these explanations is most true. From the managers perspective, as we shall show later, the key is to keep advertising and pricing consistent—regardless of what is driving what. We shall return later to the question whether advertising increases the prices consumers pay, but first we wish to take a closer look at the basic advertising-price pattern. Relating Advertising & Prices to Other FactorsIf we look again at Exhibit I, a number of additional issues arise beyond the conclusion that relative prices commanded by high advertisers exceed those commanded by low advertisers. Don’t businesses with high advertising budgets and high relative prices also market products of high quality? Also, how accurate is an analysis that lumps together big-ticket durables with convenience goods? Is this relationship true for all stages of the product life cycle? Effect of Product QualityMarketers often argue that their products command higher prices not merely because they are advertised but also because they are of high quality. This is undoubtedly true in many cases but may or may not have an effect on the relationship between relative advertising and relative price. Even if one accepts the proposition that Anacin dissolves faster than private-label aspirin, the price differential between the two would probably not be as great as it is without advertising. Exhibit II shows that businesses with high-quality products charge high relative prices for the extra quality but that businesses with high quality and high advertising levels obtain the highest prices. Conversely, businesses with low quality and low advertising charge the lowest prices. Businesses that consider their products of higher quality and that advertise at levels higher than competition charge prices that average 6.5% above competitors’. For high-quality producers with less relative advertising, this figure is –.1%. Thus quality alone does not enable the business to command the same price as quality that is communicated to consumers. Exhibit II Effect of Product Quality on Relationship Between Relative Price and Relative Advertising Marketers who tell consumers about quality differences in their products command higher prices than marketers who depend on high quality to communicate itself to consumers. For mass-produced items, advertising is the most efficient way of communicating superior quality—especially when consumers may not be able to judge quality differences from inspection or use. Protein content in food products is an example of a product feature that advertising can communicate to consumers.3 Even visible product attributes may require advertising to explain their value. Frank Perdue has “educated” his customers to appreciate his chickens’ yellow skins, and as a consequence, he has been able to charge premium prices. Unfortunately, product quality is not easy to measure with any degree of precision. We have used management judgments about the quality of their products relative to their competition. One might expect managers to overrate their products. However, unless the degree of exaggeration is related to advertising expenditure levels, the pattern we show would remain unchanged. In other words, if all managers overrated their products by a factor of 20%, those with the highest product quality would still be highest, and those with the lowest product quality would still be lowest. Effect of Product Life-Cycle StagesExhibit III illustrates differences between relative advertising and relative prices for businesses at various stages of the product life cycle. The exhibit shows a stronger relationship between relative advertising and relative price levels when products are in the late stage of the life cycle than when they are new to the market. In new product categories, a considerable amount of confusion with respect to price is likely to exist in the market. Also, prices are probably changing fairly frequently. Exhibit III Effect of Product Life Cycle on Relationship Between Relative Pricing and Relative Advertising The electronic calculator is an example of a product category that experienced considerable market turmoil before prices stabilized. During the early stages of the calculator’s life cycle, improvements and new features were added at a rate that may have left the trade and consumers alike somewhat confused about price-quality relationships. Options for programmable calculators, rechargeable batteries, memories, and many other functions were introduced over a relatively short period. Prices changed frequently as well (usually downward) in the early stages of the life cycle. Also, when new brands are introduced in an established product category, marketers often use trade and consumer promotions to encourage distribution and trial. Advertising expenses during these periods are likely to be high and prices low. Competitors react with promotions of their own, and the resulting advertising-price relationships are usually ill-defined and unstable compared with periods when businesses have settled on long-term positioning strategies. Thus the earlier the stage in the life cycle, the more confused the relationship between relative advertising and relative pricing. Effect of Product RiskExhibit IV suggests that the relationship between relative advertising and relative prices is somewhat weaker for products that cost more than $10. We believe consumers deem these products high-risk purchases. Thus for product purchases where risk is high, the relationship between advertising and price is not quite as strong. Exhibit IV Effect of Price Risk on Relationship Between Relative Price and Relative Advertising When consumers purchase big-ticket products such as appliances or automobiles, advertising alone is unlikely to convince them to pay substantial percentage price premiums. A small percentage difference in such cases may loom large in dollar terms. For small-ticket items such as beer and cigarettes, the relative percentage price differential between premium and nonpremium brands will naturally be greater. This analysis reflects only the financial risk inherent in a purchase and not the other consequences of poor product performance. Drugs and personal-care products would probably show even stronger relationships between relative advertising and relative prices. Branded aspirin commands relatively large price premiums primarily because the consumer is willing to pay more to ensure good quality in a product that is ingested. Similarly, the consequences of poor product quality are different for canned green beans than for deodorants. (However, if botulism were more prevalent, advertised brands of canned vegetables might command greater price premiums.) Unfortunately, we have no measures of these other risks and cannot quantify their effect on the price-advertising relationship. We emphasize, however, that even for big-ticket products, average relative prices are higher when businesses also have higher relative advertising budgets. Effect of Market Share & CompetitionLet us turn now to the question of the effect of a business’s market position and competitive environment on the price-advertising relationship. As we can see in Exhibit V, businesses with high market shares show stronger relationships between relative advertising and relative price than businesses with low market shares, primarily, we believe, because consumers rely on a brand’s position in the market as a clue (often correctly so) to product quality. Exhibit V Effect of Market Share on Relationship Between Relative Price and Relative Advertising In addition to level of market share, the stability of the competitive relationship is important. Exhibit VI indicates that businesses in unstable competitive environments show stronger relationships between relative advertising and relative price than businesses in stable environments. (Market stability is measured by the amount of market share changes that occur from year to year.) Exhibit VI Effect of Market Stability on Relationship Between Relative Price and Relative Advertising Note: Stable markets are markets that exhibited less than 13 percentage points of market share changes for the four major competitors within a four-year period. (Changes were measured from year to year.) Unstable markets are markets that showed more than 13 percentage points of market share changes over the same period. Fashion goods and cosmetics are examples of businesses that experience relatively short life cycles. Because of the extra risk inherent in such businesses, marketers may adopt “fast payback strategies” and charge even higher prices to recoup advertising investments over a short time period. In most types of consumer business, managers behave as if premium prices and high relative advertising strategies were related and therefore make them a consistent part of the marketing mix. This pattern holds true for products of both high and low quality. Businesses that seem to be most consistent in their pricing and advertising strategies are those in the later stages of the life cycle and companies with few new products. Businesses with high market shares, businesses in unstable competitive environments, and businesses marketing low-dollar-value consumer products also show especially high correlations between relative price and relative advertising expenses. What About Return on Investment?The most important question for managers is, of course, whether companies with consistent pricing and advertising strategies produce higher returns on investment than companies with inconsistent strategies. To test this question, we devised a measure of the consistency between the two. We looked at the businesses’ relative advertising and price strategies and classified them as shown in Exhibit VII. Exhibit VII Price-Advertising Consistency Note: Compared with the total sample of businesses, comparatively few businesses were in the “much or somewhat more” relative advertising category. These businesses were put into a single category to improve the reliability of the consistency measure. The average value of ROI for businesses with various levels of consistency is shown in Exhibit VIII. The more inconsistent the pricing and advertising strategy is, the lower the average ROI. The differences are significant at almost all levels. Businesses that deviate from the general pattern of consistency between pricing and advertising strategies do not perform as well as those that follow the pattern. This finding holds regardless of whether the inconsistency results from the relative price exceeding the level of relative advertising or vice versa. Exhibit VIII Relationship Between Price-Advertising Consistency and Return on Investment Note: The measure of return on investment is calculated from gross book value. It has a correlation of 92 with measures that relate return to net book value—i.e., the two are almost identical. Exhibit IX indicates that companies with high-quality products have higher ROIs in general than companies with low-quality products. However, of greatest importance to this study is that the companies with high-quality products appear to suffer most from inconsistent advertising and price strategies. Similarly, companies with products in the later stages of the product life cycle sacrifice substantial ROI by pursuing inconsistent advertising and price strategies. Exhibit IX Factors Affecting Price-Advertising Consistency and Return on Investment One Last CheckWe performed a final test of the price-advertising relationship. For this test, we divided the sample of consumer businesses into three groups: low relative advertisers, medium relative advertisers, and high relative advertisers. For each of these subsamples, we explored the relationship between relative price and ROI with linear regression analysis. The result suggests that for low relative advertisers, relative price is negatively associated with ROI. For high advertisers, the reverse is true. These regressions provide further support for the idea that advertising increases businesses’ need to charge high relative prices or vice versa. Also important to note is the fact that, while no single advertising or pricing strategy is right, some combinations are wrong. Possible Reactions & Final ConclusionsAt this point, we envision two possible reactions to our research findings. One may be that the findings are nothing but common sense and that managers should be aware of the need for consistency in advertising and pricing. But the fact that a substantial number of businesses are not pursuing consistent advertising and pricing strategies is what enabled us to uncover the relationship we found. A second possible reaction could be that the profit impact of inconsistent pricing and advertising strategies is short-term—that businesses with low prices and high advertising expenditures are building market share, while businesses with high prices and low advertising budgets are milking their companies for profits. If the latter were true, then we should have observed higher ROIs for businesses with low advertising budgets and high prices. We found the opposite, however, and can only conclude that this sort of milking strategy does not usually succeed. The first possibility—market share building—is more difficult to evaluate. In that case, one would expect to find, as we did, lower ROIs from investment spending. Worth noting, however, is that our data and analyses are based on four-year averages, so the payout must be long-term indeed. Baron Bich employed substantial advertising and low prices to dominate the markets for ballpoint pens in Europe and the United States. Isn’t this an example of an inconsistent strategy that was enormously successful, one might ask? Well, maybe, but Bich is also reputed to have spent millions of dollars and several years waiting for his U.S. acquisition to become profitable. Had the felt tip pen been introduced a few years earlier, we suspect, the whole strategy might have failed. The baron also had no stockholders to answer to at that time. And the Bic shaver and pantyhose market entries have not duplicated the results of the ballpoint pen. What about L’eggs pantyhose and Timex watches? Compared with the total market, these brands were definitely highly advertised and relatively low priced. They also became profitable fairly quickly. Both of these products, however, were accompanied by major changes in the markets, shifts in distribution channels, product characteristics, and favorable socioeconomic trends. L’eggs and Timex helped create new markets and were not competing in established segments. (In fact, L’eggs came in at a price higher than other pantyhose brands being sold through supermarkets, even if lower than department store brands.) A willingness to gamble that changes in product or production technology will not make manufacturing facilities obsolete4, considerable financial resources, and a tolerance for long payback periods seem to be prerequisites for the baron’s strategy. Our analysis suggests that the approach to strategy that uses high advertising budgets and low relative prices fails more often than it succeeds. Major market innovations may enable inconsistent strategies to end happily, but they appear to be a risky bet for most marketers. We believe this research provides strong evidence that relative pricing and advertising strategies go together and that most businesses which deviate from this pattern suffer in terms of profitability. The patterns we found in the analysis of both management behavior and profitability are strong enough to suggest that businesses should have very good reasons for deviating from the rule of consistency before they do so. 1. “Liquor Imports Threaten to Drown U.S. Distillers,” Business Week, April 2, 1979, p. 92. 2. The PIMS program is a large-scale, ongoing statistical study of the market and the individual competitive characteristics, strategies, and financial performances of business units. For details on the data base, its advantages, and its limitations, see Robert D. Buzzell, Bradley T. Gale, and Ralph G. M. Sultan, “Market Share—A Key to Profitability,” HBR January–February 1975, p. 97. 3. Neil H. Borden, in The Economic Effects of Advertising (Chicago: Richard D. Irwin, 1942), describes such features as “hidden values.” 4. Michael E. Porter, “How Competitive Forces Shape Strategy,” HBR March–April 1979, p. 137. See, for example, his discussion of the experience curve as a barrier to entry. A version of this article appeared in the November 1979 issue of Harvard Business Review. How does advertising affect prices?price level. On the one hand, advertising enhances product differentiation, which leads to a higher price. On the other hand, advertising reduces consumers' search costs as it provides consumers with more product information, which leads to a lower price level.
Does advertising increase or decrease the cost of the product?Advertising is expensive and thus raises the cost of goods, but it may encourage competition that keeps prices down.
How does advertising affect price elasticity of demand?If advertising draws more price sensitive consumers into the set that are willing to pay for a particular brand, this will increase the price elasticity of demand facing the brand.
What is the effect of advertising when it comes to a business's product quizlet?Advertising can add value to a brand by educating customers about new uses for a product. The firms eliminated by competition tend to be those that served the consumers most efficiently. The abundance principle states that advertising has little effect on a wealthy economy.
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