LECTURE 8: EMPIRICAL STUDIES OF ADVERTISING

LECTURE 8:EMPIRICAL STUDIES OF ADVERTISING AEM 4550:Economics of AdvertisingProf. Jura Liaukonyte

1964 1970 Cigarette Advertising on TV • All US tobacco companies advertised heavily on TV • Surgeon General issues official warning • Cigarette smoking may be hazardous • Cigarette companies fear lawsuits • Government may recover healthcare costs • Companies strike agreement • Carry the warning label and cease TV advertising in exchange for immunity from federal lawsuits.

Strategic Interaction • Players: Reynolds and Philip Morris • Strategies: Advertise or Not Advertise • Payoffs: Companies’ Profits • Strategic Landscape: • Each firm earns $50 million from its customers • Advertising costs a firm $20 million • Advertising captures $30 million from competitor • How to represent this game?

PAYOFFS Representing a Game PLAYERS STRATEGIES

What to Do? If you are advising Reynolds, what strategy do you recommend?

Solving the Game • Best reply for Reynolds: • If Philip Morris advertises: • If Philip Morris does not advertise:

Dominance • A strategy is dominantif it outperforms all other choices no matter what opposing players do • Games with dominant strategies are easy to play • No need for “what if …” thinking

DominanceA Technical Point • Strict Dominance: Advertise is strictly dominant forReynoldsif: • Profit (Ad , Ad) > Profit (No , Ad) • Profit (Ad , No) > Profit (No , No)

Dominance COMMANDMENT If you have a dominant strategy, use it. Expect your opponent to use her dominant strategy if she has one.

Prisoner’s Dilemma • Both players have a dominant strategy • The equilibrium results in lower payoffs for each player Optimal Equilibrium

Equilibrium Illustration The Lockhorns

Cigarette Advertising • After the 1970 agreement: • Cigarette advertising decreased by $63 million • Industry Profits rose by $91 million • Prisoner’s Dilemma • An equilibrium is NOT necessarily efficient • Players can be forced to accept mutually bad outcomes • Bad to be playing a prisoner’s dilemma, but good to make others play

Empirical Studies of Advertising Effectiveness

Advertising–Sales Relationship • Lambin (1976) uses various sales, quality, price and advertising data • 107 individual brands from • 16 product classes • 8 different Western European countries • How changes in the advertising expenditures for one brand may affect the current sales of that brand and rival brands? • Evaluate goodwill effects and the rival-brand response that an advertising expenditures may induce

Lambin (1976) Findings • Brand advertising has a significant and positive effect on the brand's current sales and market share • Evidence for advertising's goodwill effect • The quantitative impact of advertising on (current and future) sales is limited: • Sales appear more responsive to price and product-quality selections • Firm's sales and market share are negatively related to rival advertising • Evidence of what?

Advertising Goodwill • Clarke (1976) identifies a “data-interval-bias” problem: • The use of annual advertising data when the effects of advertising on sales depreciate over a shorter period of time can lead to biased estimates of the depreciation rate. • “The duration of cumulative advertising effect on sales is between 3 and 15 months; thus this effect is a short-term (about a year or less) phenomenon.” • More recently, several studies offer further evidence that the effect of advertising on sales is often largely depreciated within a year (if not less). • Latest studies: Beyond 3 months = miniscule effect.

A. Concave-Downward Response Curve B. S-Shaped Response Function Sales Sales Initial Spending Little Effect High Spending Little Effect Middle Level High Effect Range A Range B Range C Advertising Expenditures Advertising Expenditures Sales Response Models Saturation Point Threshold

Sales Response Model Saturation Effect Sales Adv Expenditures Threshold Effect

Overall Advertising Impact (Gerard J. Tellis) • The average sales-to-advertising elasticity is 0.1 • Higher for new products than established products • For Europe than the United States • For durables than nondurables • For print than TV • Advertising elasticity is also lower in models that use disaggregate data and include advertising carryover, quality, or promotion

Determinants of Advertising Impact(Demetrios Vakratsas) • Advertising impact depends on the product category. • Specifically, advertising elasticities are as much as 50% higher for durables as for nondurables. • Advertising is more effective for experience than for search products.

Advertising Impact and Competition(Demetrios Vakratsas) • Higher competitive intensity (clutter) will result in lower advertising effectiveness. • Competitive advertising may reduce elasticities by as much as 50%.

Advertising Reference Price(Dhruv Grewal and Larry D. Compeau) • The presence of an advertised reference in a price offer enhances perceptions of value • Lowers their intention to search for a lower price.

Advertising Impact Duration(Robert P. Leone) • The average advertising duration interval on sales is brief—typically between six and nine months.

TV Advertising Effect • The average TV advertising to sales elasticity is 0.11 for established consumer products. • It is higher for tests after 1995 than those before. • There is a high variability in effects around these average elasticities. Some tests had elasticities over 0.5 and others were below -0.05.

Advertising and Business Cycles • Advertising is more sensitive to business-cycle fluctuations than the economy. • Average co-movement elasticity is1.4. • Hence, a 1% increase in the cyclical component of GDP translates, on average, into a 1.4% increase in the cyclical component of the demand for advertising. • The extent of this sensitivity varies systematically across countries. • When companies tie advertising spending too tightly to business cycles, they experience higher losses: • A lower long-term growth of the advertising industry • A higher private-label share • Lower stock prices

Empirical Studies • A firm's current advertising is associated with an increase in its sales, but this effect is usually short lived. • Advertising is often combative in nature. • An increase in advertising by one firm may reduce the sales of rival firms, and rivals may then react with a reciprocal increase in their own advertising efforts. • The overall effect of advertising on primary demand is difficult to determine and appears to vary across industries.

Firm Specific Factors • When assessing the goodwill impact of advertising, it is important that firm-specific factors not be omitted. • Recall Nelson’s theory: • It may be that advertising affects initial sales but that long-term sales are driven by firm-specific factors, like product quality. • Given that higher-quality firms may advertise more, the effects of advertising on future sales may be overstated in an empirical analysis that omits product quality. • Kwoka (1993) examines the determinants of model sales in the U.S. auto industry, finding that the effect of advertising is short-lived while product styling has a much longer impact.

Advertising and Entry • Advertising as a response of incumbent firms to entry: • Alemson's (1970) studies Australian cigarette industry: new entrants advertise to gain market share and induce increased advertising by incumbents, who seek to maintain market share. • Thomas (1999) studies the ready-to-eat cereal industry and reports that incumbent firms often respond to entry with advertising, in order to limit the sales of new entrants. • Cubbin and Domberger (1988) examine 42 consumer-goods industries and report evidence that dominant incumbent firms in slow-growth markets often respond to entry with an increase in advertising.

Advertising and Brand Loyalty • No clear consensus. • The studies do not provide strong evidence that advertising consistently increases brand loyalty or stabilizes market shares.

Brand Loyalty • Recall Persuasive view: • The direct effect of advertising is that brand loyalty is created and the demand for the advertised product becomes less elastic. • Lack of high detail data – need exposure and brand-purchase data as well as the advertising and pricing behaviors of rival firms. • Partly remedied by advent of supermarket scanner data. • 2 ways to test for brand loyalty: • Estimate demand functions for individual brands, in order to see if consumers exhibit more “inertia” in highly advertised markets. • See if the estimated price elasticities are lower in magnitude in product groups with high advertising intensity. • Infer the extent of brand loyalty, by further examining the relationship between advertising and market-share stability.

Advertising Costs and Media

Media Selection • Coverage is the theoretical maximum number of consumers in the retailer’s target market that can be reached by a medium and not the number actually reached. • Reach is the actual total number of target customers who come in contact with an advertising message. • Cumulative Reach is the reach that is achieved over a period of time.

Media Selection • Frequency is the average number of times each person who is reached is exposed to an advertisement during a given time period.

When High Frequency Is Used • A new brand • A smaller, less known brand • A low level of brand loyalty • Relatively short purchase and use cycle • With less involved (motivated and capable) target audiences • With a great deal of clutter to break through

Media Selection • Cost Per Thousand Method (CPM) is a technique used to evaluate advertisements in different media based on cost. • The cost per thousand is the cost of the advertisement divided by the number of people viewing it, which is then multiplied by 1,000.

Media Selection • Cost Per Thousand – Target Market (CPM-TM) Is the cost of the advertisement divided by the number of people in the target market viewing it, which is then multiplied by 1,000. • Impact refers to how strong an impression an advertisement makes and how well it ultimately leads to a purchase.

CPMs • Cost measured per thousand impressions (CPM)‏ • Broadcast TV: $10 CPM for 30 second impr • Superbowl 30 second spot: $25-40 CPM • Around 1 cent per 30 sec impression; 2 cents for 1 minute; 20 cents for 10 minutes • Conclusion: TV network is paid 20 cents an hour of content for your attention

Typical CPMs • Outdoor: $1-5 CPM • Cable TV: $5-8 CPM • Radio: $8 CPM • Online • Display $5-30 CPM • Contextual: $1-$5 CPM • Search: $1 to $200 CPM • Network/Local TV: $20 CPM • Magazine: $10-30 CPM • Newspaper: $30-35 CPM • Direct Mail: $250 CPM

Network TV CPMs • CSI $19.59 • Without a Trace $13.83 • CSI Miami $17.30 • Desperate Housewives $11.81 • Everybody Loves Raymond $25.19

Gross Rating Points • GRPs = Reach X Frequency. • GRPs measure the total of all Rating Points during an advertising campaign. • A Rating Point is one percent of the potential audience. For example, if 25 percent of all targeted televisions are tuned a show that contains your commercial, you have 25 Rating Points. • If, the next time the show is on the air, 32 percent are tuned in, you have a total of 25 + 32 = 57, and so on through the campaign.

Media Tactics • Three ways to schedule the same number of GRPs • Continuous • Flighting • Pulsing

Selling Network Television NETWORKS SELL THEIR TIME IN 3 STAGES: The Upfront Market The Scatter Market The Opportunistic Market

Television Sells Spots Like Airlines Sell Seats • If a flight leaves with empty seats, revenue for the seat is zero. • To assure full planes, sell the seats at a price that will sell them out early. • Charge last -minute buyers highest price

THE UPFRONT MARKET • Annual purchase of commercial time well in advance of the telecast time. • Upfront advertisers buy 70% of prime time and 50% of other dayparts. Most buy for one year. Get best price. • Biggest national advertisers buy children’s programs, prime time, daytime, news, and late night.

SCATTER MARKET • Sale of most of the year’s remaining inventory not sold at upfront. • Inventory generally tight. • Prices usually 50% higher than upfront.

OPPORTUNISTIC MARKET • Last-minute buying of inventory due to: • Changes in programming • Advertisers don’t want to be on controversial programs • Advertiser inability to pay

Cancellations and Guarantees • Most network orders are non-cancelable. If an advertiser cannot or does not want the time, it is the advertiser’s responsibility to sell the time - not the network’s. • Networks cancel programs with no notice to the advertiser with the provision that commercials will run in another program that delivers the same audience profile.

Ratings Guarantees • The cost of network time is based on network guarantees of spot price vs. audiences, computed in cost per thousand. • If the ratings projected by the network to the advertiser are not achieved, the network runs the spot in other programs to accumulate sufficient ratings to bring the CPM down to the promised level. • The extra spots the advertiser gets are called MAKEGOODS

LECTURE 8: EMPIRICAL STUDIES OF ADVERTISING