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Advertising-price competition and market stability
T .
he use of advertising ar,d price cGmpetitlt3n iea:‘js 32 mark! xistak~!!ity
Advertising-Price Competition and Market St&bib@ M. M. Metwally
I.
INTRODUCTION ‘The stllciy of
competition anlong ;I few firnis hlls OpCnd two important (rdatud) fields of rc’wircll: . nonprice cclmpcti tion rend consurncr loq’;rIt\. 12, 6, 101. ‘I’hc latter is particularly inip0rf3nt When only two or three firms dominate the niarkct (a situation which is c0nim0n in many markets f0r manufactured goods). In such a situation Mach firin many have succc~dcd in the past (using cliffmnt marketing efforts) to gain the loyalty of a certain scgmcnt of the market 18, IO]. This scgmcM ~ilI not (in the short run and in the abseixt’ 0f‘ aitthroat price competition) niovt‘ to anotha- c’o~npctitor. WC have, thcreforc, : loyal customa I!+0 arc attached to a particular brand. The implicatiun of this is obvious. If ;I nc~w firm is to cntcr this particular market (or an existing firm is to expand its ma-kct sllarc) the stratqg would lx to attract the unatt;lch~d (floating or indifferent) customers [ 13, 131. The “tlollattacheif” customers of the firm could become b~l~yr~l”and the “non;i t tachod ” customers of the competitors niliy bc attracted to lhc firnl’s product. ThC firnj may try to attract these custonic\rs by enibarki~~~
G.M. Davy
Ilacl~ manager was asked six questions: I. IJo you use advert isin,0 in dealing with probltms
-I _.
3. 4.
5. (I.
()I’ cxccss supply. i.e., unwarranted increase in stocks’! your currerlt prices. is there a I i7 changing particular “tatgct” price which you take into consideration? DOL*Syour firm react inmediately ,fo achieve the target price? In fixing your price do you take into account ~IJC magnitude of advertising expenditure spent on promoting the product’? Is your advertising budgct related to the “tarFcbt” price‘? \Vh;rt dons dcterminc the “target” price’?
‘1‘h~ ;tncwcrs to the first five questions art shown in ‘1‘ablc*1 . As to question 6. firms mentioned the --.---
--
G. M.
DAVY
teaches in the
Department of Economics at the University of Queensland, and is presently completing his Ph.D. there, which he begun in 1974. His interests include appli.,?d
volun~e of desired stock. the prices of competitors. the nl;@tude of costs of production and distribution and the securing of ;I reasonable profit lJJW!iIJ ;ls the IJJailJ factors determining the “target” price. TA ‘11~ the questions of the survey wt‘rc f’ranJd to allc)w responses concerning firms conipet ition not only through the price mechanism, but also through variation of their advertising budWs. A further point about the marketing survey cwtww the employment of “target” pricing. As will 1~ seen b&x4. the sdcs managers of the firms conccrncd overwhelmingly answered in the affirm t ivc regarding the use of “target” pricing by their firm. In a recent study, Kan~erschcn [ 7 1 questions whether such ;I policy is followed in reality and whether it is consistent with profit inaxinlizati~~n. However. he finds that the rcsults arc inconclusiv~~: also. his study ~.onceriicil U.S. firm.’ The data in Tablt: 1 reveal that: ( 1 ) chgcs ill advertising expenditure are related to excess supply: (2) firms adjust their actual price towards a “target” price: (3) firms react almost iruinedi~tcly to achic%vc the “target” price; (4) the target price is related to advertising expenditure: and (5) the cieternlin:~tioll of the advertising budget is not indcpcndcnt from the dctcrntination of the selling price.
microeconomics,
econometrics and mathematical economics. He has published articles on consumer surplus in the Inrerrlational Journa! of Transport Economics 2(2) (19751, and on Australian consumptiQn functions with money ill usion in Economic
Analysis
and
TABLE 1 Results of Survey on Determining Firms
P&icy
Question I.
Yes _.-___-I_
No -.---
1 3
II 12 ‘1
I
3 4
6(2) (1975).
5 M. M. Reader in Economics
METWALLY is a the Department of in Queensland Uni-
versity. He did his postgraduate studies in Economics at Leeds University where he obtained his M.A. in 1962 and his Ph.D. in 1964. He is the author of &the matical Formulation of Microeconomics (Asia .1974) and Price and Non -Price competition: Dynamics of Marketing (Asia 1975). He has written a considerable number of articles on the economics of industry and advertising in scholarly journals and taught mathematical economics in six universities.
----.
of 13 Australian
Sometimes --_. .-_- _--.. .._. L 2 .!
2
IO I0
2
I 1
MODEL AND STABILITY
III.
Using tltc above information it is possible to prove using a simple dynamic modcj ht. where the market COilSiStS of il small numhcr of firIlls producing claw substitutes,3 the LISCof both ;I& vertising and price competition my 1~1 to ~111 --* In another uontcst, O~C of the authors [ I I 1 1~6 t’()ulltj tjlat fll,,r_ kcting behavior is we ul profit maximization for instant c()ffcr: antl toilct soap, for ewnplc. while this appears not to be the case for tllc cigarette industry. 31~XanIld~s of such industries arettcs and instant
238
the Marketing-Mix
1111.
included in tho\c !:urveyetJ ;trc cig_
coffee. I*or some further
exarnplcs, sec Mctwally
unstable market situation. For the rrn;nlysis which ~llld kc]s. ( .5 ) and (0) give follows, based on the survey results. WC employ ,.?‘:-_ 11.. /?< the common assumption of linear functions. I hi Where a lqc segment of the inarkc~t is c‘att;kkP to a particular brand. the attempt of any f‘irnl to if l’, ti /“’ \() tjl;lt I I‘I’{ -ti I‘*. ;111(1 expand its share may lead it to by fi~ccd uith cxcc54 /,[ = ,‘[ ,‘** supply. This excess supply is a function of the scllitlg price or. ,\‘( = pI p.*J and
ii,,
whcrc g and 11arc’ positive constants. then
=
il, = l~llli,
( ll’f
{ 7)
(S4) (‘1)
Since the tcrnls under the’root sign have ;1 positive value, WC get two real roots that arc distinct. One’ root, however. will bc positive while the other root will bc negative. Hcncc the system will be ullstrlbie.” by maintaining that thcrcfore. \Vt’ conclude, the firm’~ potential ability to expand their market ~1~~~:s in this particular situation using price and could lead to an unstable nonpricc competition system.? This system may ,cnd with “cut-throat” priCtba$ nonprice competition. IV.. &NCLUSIONS Dcspitc its limitations, major conclusions.
this study
leads to t~:o
‘) _.
1. Firms’ efforts to txpand their market shares a-re limited by the resultant cf*feCts on the stability of the systcni. Wlicrc tlitxc is only ;I small number of producers. selling close substitutes. and relyin g on nonprice competition to expand their market shares, such as exists in a number of Australian industries. their efforts may result in t’xccss capacity. If the particular firm. with excess capacity. then tries to cut price. the result could be a very’ unstable system. 6 Kuehil 19, p.S] has argued a similar cask from I-1.5. studies. i.e., that firms should just incrcasc advertising and salts lx-omotion rather than doing so md cutting prices. _. ’ Conclusion 1 above is important in txplaining ~11~
t’irm
m
IIJ/I/C~UI~/
to
USC hot!;
advertising
rely mart‘ on the first in their efforts to maintain (or expand 1 their mxket shares. This rcliancc on nonprictl competition may rtlso help to explain why cliarg’cs of “cxCcssivl!*’ advcrtisinrr arc and
pi-k
conipetition
i.
am!
.3.
4. c5 . 6.
7. r:. Iiiofkc, I*. J.. Market Entry IC’CW.~‘iwlor~l.
./,
~h!cclIlber
and rhc C’hatacltx ()I‘ (‘ompctific~n, 1966).
9. Kuchn. A. A., Ilo\c Advertising Pctt‘otm;mcc Dcpcnds on Olllc’t Xiatkctmg l.actors. J. ilIII*LW. Rcs. 2 (I ), Z-10 ( I%2). IO.
Lambin,
J. J., Advertising Competition
;ItId Market (‘ondu1.t in
Oligolx~ly Ovzt Time, Amsterdam, North-Holland,
1976.
1 I.
Metwally, M. M., Advertising and Compctitivc Sclcctcd Australian I,itms. Rw. I:‘wmw. Stat. 427 f IL)75).
II.
MCtW;tll) . Xl. Xl.. lkwnomic Sttatcpie\ of ICitnb I:;tcing As) Itlljli)~j~
instead
Bchaviout ot 57 (3). 3 I7-
A C’asc Study. /I/@. Etwrotit. 5 (41, 271-280 ( 1~73). 51. M.. Entry (;ilp in New Zealand blatkcts fat Manut’aclutcd Consumer Goods, Erotwtrr. KU-. 49 (I 2X), 575-588 1973. ihmnd:
13. Mctivally,
14.
T;rylot. iti’. .l.. and Shaw, Jr., R. T.. Slarkrtinl* .Awl) licxl Apptcwh. Cincinn;lti. 14161.
An In tc;rt;il
he use of advertising ar,d price cGmpetitlt3n iea:‘js 32 mark! xistak~!!ity
Advertising-Price Competition and Market St&bib@ M. M. Metwally
I.
INTRODUCTION ‘The stllciy of
competition anlong ;I few firnis hlls OpCnd two important (rdatud) fields of rc’wircll: . nonprice cclmpcti tion rend consurncr loq’;rIt\. 12, 6, 101. ‘I’hc latter is particularly inip0rf3nt When only two or three firms dominate the niarkct (a situation which is c0nim0n in many markets f0r manufactured goods). In such a situation Mach firin many have succc~dcd in the past (using cliffmnt marketing efforts) to gain the loyalty of a certain scgmcnt of the market 18, IO]. This scgmcM ~ilI not (in the short run and in the abseixt’ 0f‘ aitthroat price competition) niovt‘ to anotha- c’o~npctitor. WC have, thcreforc, : loyal customa I!+0 arc attached to a particular brand. The implicatiun of this is obvious. If ;I nc~w firm is to cntcr this particular market (or an existing firm is to expand its ma-kct sllarc) the stratqg would lx to attract the unatt;lch~d (floating or indifferent) customers [ 13, 131. The “tlollattacheif” customers of the firm could become b~l~yr~l”and the “non;i t tachod ” customers of the competitors niliy bc attracted to lhc firnl’s product. ThC firnj may try to attract these custonic\rs by enibarki~~~
G.M. Davy
Ilacl~ manager was asked six questions: I. IJo you use advert isin,0 in dealing with probltms
-I _.
3. 4.
5. (I.
()I’ cxccss supply. i.e., unwarranted increase in stocks’! your currerlt prices. is there a I i7 changing particular “tatgct” price which you take into consideration? DOL*Syour firm react inmediately ,fo achieve the target price? In fixing your price do you take into account ~IJC magnitude of advertising expenditure spent on promoting the product’? Is your advertising budgct related to the “tarFcbt” price‘? \Vh;rt dons dcterminc the “target” price’?
‘1‘h~ ;tncwcrs to the first five questions art shown in ‘1‘ablc*1 . As to question 6. firms mentioned the --.---
--
G. M.
DAVY
teaches in the
Department of Economics at the University of Queensland, and is presently completing his Ph.D. there, which he begun in 1974. His interests include appli.,?d
volun~e of desired stock. the prices of competitors. the nl;@tude of costs of production and distribution and the securing of ;I reasonable profit lJJW!iIJ ;ls the IJJailJ factors determining the “target” price. TA ‘11~ the questions of the survey wt‘rc f’ranJd to allc)w responses concerning firms conipet ition not only through the price mechanism, but also through variation of their advertising budWs. A further point about the marketing survey cwtww the employment of “target” pricing. As will 1~ seen b&x4. the sdcs managers of the firms conccrncd overwhelmingly answered in the affirm t ivc regarding the use of “target” pricing by their firm. In a recent study, Kan~erschcn [ 7 1 questions whether such ;I policy is followed in reality and whether it is consistent with profit inaxinlizati~~n. However. he finds that the rcsults arc inconclusiv~~: also. his study ~.onceriicil U.S. firm.’ The data in Tablt: 1 reveal that: ( 1 ) chgcs ill advertising expenditure are related to excess supply: (2) firms adjust their actual price towards a “target” price: (3) firms react almost iruinedi~tcly to achic%vc the “target” price; (4) the target price is related to advertising expenditure: and (5) the cieternlin:~tioll of the advertising budget is not indcpcndcnt from the dctcrntination of the selling price.
microeconomics,
econometrics and mathematical economics. He has published articles on consumer surplus in the Inrerrlational Journa! of Transport Economics 2(2) (19751, and on Australian consumptiQn functions with money ill usion in Economic
Analysis
and
TABLE 1 Results of Survey on Determining Firms
P&icy
Question I.
Yes _.-___-I_
No -.---
1 3
II 12 ‘1
I
3 4
6(2) (1975).
5 M. M. Reader in Economics
METWALLY is a the Department of in Queensland Uni-
versity. He did his postgraduate studies in Economics at Leeds University where he obtained his M.A. in 1962 and his Ph.D. in 1964. He is the author of &the matical Formulation of Microeconomics (Asia .1974) and Price and Non -Price competition: Dynamics of Marketing (Asia 1975). He has written a considerable number of articles on the economics of industry and advertising in scholarly journals and taught mathematical economics in six universities.
----.
of 13 Australian
Sometimes --_. .-_- _--.. .._. L 2 .!
2
IO I0
2
I 1
MODEL AND STABILITY
III.
Using tltc above information it is possible to prove using a simple dynamic modcj ht. where the market COilSiStS of il small numhcr of firIlls producing claw substitutes,3 the LISCof both ;I& vertising and price competition my 1~1 to ~111 --* In another uontcst, O~C of the authors [ I I 1 1~6 t’()ulltj tjlat fll,,r_ kcting behavior is we ul profit maximization for instant c()ffcr: antl toilct soap, for ewnplc. while this appears not to be the case for tllc cigarette industry. 31~XanIld~s of such industries arettcs and instant
238
the Marketing-Mix
1111.
included in tho\c !:urveyetJ ;trc cig_
coffee. I*or some further
exarnplcs, sec Mctwally
unstable market situation. For the rrn;nlysis which ~llld kc]s. ( .5 ) and (0) give follows, based on the survey results. WC employ ,.?‘:-_ 11.. /?< the common assumption of linear functions. I hi Where a lqc segment of the inarkc~t is c‘att;kkP to a particular brand. the attempt of any f‘irnl to if l’, ti /“’ \() tjl;lt I I‘I’{ -ti I‘*. ;111(1 expand its share may lead it to by fi~ccd uith cxcc54 /,[ = ,‘[ ,‘** supply. This excess supply is a function of the scllitlg price or. ,\‘( = pI p.*J and
ii,,
whcrc g and 11arc’ positive constants. then
=
il, = l~llli,
( ll’f
{ 7)
(S4) (‘1)
Since the tcrnls under the’root sign have ;1 positive value, WC get two real roots that arc distinct. One’ root, however. will bc positive while the other root will bc negative. Hcncc the system will be ullstrlbie.” by maintaining that thcrcfore. \Vt’ conclude, the firm’~ potential ability to expand their market ~1~~~:s in this particular situation using price and could lead to an unstable nonpricc competition system.? This system may ,cnd with “cut-throat” priCtba$ nonprice competition. IV.. &NCLUSIONS Dcspitc its limitations, major conclusions.
this study
leads to t~:o
‘) _.
1. Firms’ efforts to txpand their market shares a-re limited by the resultant cf*feCts on the stability of the systcni. Wlicrc tlitxc is only ;I small number of producers. selling close substitutes. and relyin g on nonprice competition to expand their market shares, such as exists in a number of Australian industries. their efforts may result in t’xccss capacity. If the particular firm. with excess capacity. then tries to cut price. the result could be a very’ unstable system. 6 Kuehil 19, p.S] has argued a similar cask from I-1.5. studies. i.e., that firms should just incrcasc advertising and salts lx-omotion rather than doing so md cutting prices. _. ’ Conclusion 1 above is important in txplaining ~11~
t’irm
m
IIJ/I/C~UI~/
to
USC hot!;
advertising
rely mart‘ on the first in their efforts to maintain (or expand 1 their mxket shares. This rcliancc on nonprictl competition may rtlso help to explain why cliarg’cs of “cxCcssivl!*’ advcrtisinrr arc and
pi-k
conipetition
i.
am!
.3.
4. c5 . 6.
7. r:. Iiiofkc, I*. J.. Market Entry IC’CW.~‘iwlor~l.
./,
~h!cclIlber
and rhc C’hatacltx ()I‘ (‘ompctific~n, 1966).
9. Kuchn. A. A., Ilo\c Advertising Pctt‘otm;mcc Dcpcnds on Olllc’t Xiatkctmg l.actors. J. ilIII*LW. Rcs. 2 (I ), Z-10 ( I%2). IO.
Lambin,
J. J., Advertising Competition
;ItId Market (‘ondu1.t in
Oligolx~ly Ovzt Time, Amsterdam, North-Holland,
1976.
1 I.
Metwally, M. M., Advertising and Compctitivc Sclcctcd Australian I,itms. Rw. I:‘wmw. Stat. 427 f IL)75).
II.
MCtW;tll) . Xl. Xl.. lkwnomic Sttatcpie\ of ICitnb I:;tcing As) Itlljli)~j~
instead
Bchaviout ot 57 (3). 3 I7-
A C’asc Study. /I/@. Etwrotit. 5 (41, 271-280 ( 1~73). 51. M.. Entry (;ilp in New Zealand blatkcts fat Manut’aclutcd Consumer Goods, Erotwtrr. KU-. 49 (I 2X), 575-588 1973. ihmnd:
13. Mctivally,
14.
T;rylot. iti’. .l.. and Shaw, Jr., R. T.. Slarkrtinl* .Awl) licxl Apptcwh. Cincinn;lti. 14161.
An In tc;rt;il