LECTURE 6-7: OTHER TYPES OF ADVERTISING

1. LECTURE 6-7:OTHER TYPES OF ADVERTISING AEM 4550:Economics of AdvertisingProf. Jura Liaukonyte

2. Lecture Plan • Homework 1, HW 2 • Review of Persuasive View of Advertising • Complimentary view • Examples • Informative view • Model and Examples • Signaling as Information • “Memory Jamming” view

3. Persuasive Advertising

4. Persuasive Advertising • The persuasive view holds that advertising alters consumers' tastes and creates spurious product differentiation • The demand for a firm's product becomes more inelastic • Advertising results in higher prices • Such advertising by established firms may give rise to a barrier to entry, which is naturally more severe when there are economies of scale in production and/or advertising differentiation and brand loyalty

5. $ * Demand with advertising  Demand without advertising Profit MC Quantity Model of Persuasive Advertising

6. Complementary Advertising

7. Complementary View • Consumers possess stable preferences • Advertising directly enters these preferences in a manner that is complementary to the consumption of the advertised product • Advertising may contain information and influence consumer behavior for that reason • The consumer may value “social prestige” that is created by advertising

8. Complementary vs. Persuasive • The lines between complementary and persuasive are blurred, because it is hard to know whether ads change preferences or are part of consumer’s utility.

9. Complementary View • Associated with the Chicago School • When a firm advertises more, its product becomes more attractive to the consumer • “The household is made to believe – correctly or incorrectly – that it gets a greater utility of the commodity from a given input of the advertised product” • Consumer may value social prestige and advertising thus positions the product so that its consumption provides social prestige

10. Complementary View • An implication is that: • Firms may compete in the same commodity (e.g., prestige) market even though they produce different market goods (e.g., jewelry and fashion) and advertise at different levels. • Component of most luxury goods marketing.

11. Who is the Target? Affluent Consumers • The $50,000 income level is considered to be the starting point for consumers to purchase luxury products (Cline, 2004) • 5.6 million households earn over $150,000 • Purchase most vehicles over $50,000, homes over $750,000, and second homes and resort-related investments (Luxury Marketing Council, 2004) • 87% claim they would spend more if they could find “better” products or services (Accenture, 2004) • Spending more time with family and friends provides the greatest pleasure to this group (Revealing new insights, 2004) • Reputation of brand is more important than even price / value proposition for experiential products (Unity Marketing, 2004)

12. Mission Statement “Louis Vuitton must continue to be synonymous with both elegance and creativity. Our products, and the cultural values they embody, blend tradition and innovation, and kindle dream and fantasy.”

13. Price • Premium Pricing • Luxury image • Selling Point • Never on sale!! • Price range: • Handbags: $550 - $3,700 • Wallets: $200 - $700

14. LVMH Moët Hennessy • Louis Vuitton French holding company and one of the world's largest luxury goods conglomerate.

15. Mass-Commercialization of Luxury • Many luxury handbags are mass-produced in China. • The average markup for a luxury handbag is ten to 12 times production cost (marginal cost!). • Louis Vuitton's markup is up to 13 times production cost. • Family-owned companies that used to create exquisite bags, shoes and clothes, have been taken over by multi-billion dollar conglomerates.

16. Luxury Markets • Asia is now the biggest market for luxury brands • Strange? the U.S. and Europe are wealthier (per capita) • Luxury market in Japan is most alive: • 40 % of all Japanese own a Vuitton item • Why such a global discrepancy?

17. Is True Luxury Dead? • Not all • E.g. Hermes Kelly and Birkin bags are painstakingly made in workshops in France; • Classic perfume Chanel No.5 is still created using the finest ingredients in a small scale operation.

18. Example Credit Card Industry

19. Complementary Advertising • American Express • Ranked #1 most trusted company  • 24th best global brand • Targets consumers with $100,000 to $1 million annual income • Consumers see card as a luxury • Gold Card, Platinum Card • Other companies are competing with "metallic" or "gem" cards

21. Informative Advertising

22. Informative View • Advertising is attractive to firms as a means through which they may convey information to consumers. • Advertising effectively reduces consumers' search costs, since it conveys information about products. • Advertising may have pro-competitive consequences. • Advertising is a valuable source of information for consumers that results in a reduction in price dispersion • “Chicago School” view.

23. Model of Advertising as Information • Total of N identical consumers in the market. • Each consumer will buy Q(P) if informed about the product. • Advertising informs consumers about the existence and/or usefulness of the product. • Number of consumers informed depends on the amount spent on advertising.

24. $ Demand with high advertising Profit Demand with low advertising MC Quantity Model of Advertising as Information

25. Model of Advertising as Information • As ad expenditures increase, so does demand and profit. • Firms select advertising to maximize profit, i.e., where MR from ads is equal to the MC of ads. • In this model, higher levels of advertising do not lead to higher prices. • Advertising does increase total consumer surplus as well as firm profit, since advertising increases the number of consumers that get a surplus.

26. 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

27. 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

28. 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 price–cost ratios are lower when area-wide advertising intensity is greater • These studies all support the informative view

29. 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.

30. 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.

31. 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.

32. 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.

33. 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.

34. 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.

35. 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

36. 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

37. 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