Entry Deterrence, Product Quality: Price and Advertising as Signals

I analyze the marketing strategy of an incumbent monopolist facing a threat of entry. Product quality is unknown to consumers, and the monopolist's cost is unknown to the potential entrant. The incumbent uses both price and advertising to signal cost and quality. The monopolist faces a dilemma because signaling a high quality attracts customers but requires a high price, whereas signaling low cost prevents entry but requires a low price. I characterize the unique (stable) separating equilibrium and show that dissipative advertising may be used, while it is never used if either quality or cost is known. Some equilibria may involve pooling on cost. A welfare analysis indicates that potential entry may improve welfare and that the effect of unknown quality is not always negative when it interferes with entry deterrence.     

Advertising as Information: Matching Products to Buyers

We consider communication of quality via cheap talk and dissipative advertising expenditures, when consumers have heterogeneous tastes for quality, and price information must be acquired through costly search. For search pods, cheap talk communicates quality when fixed costs are roughly constant across quality levels, while if fixed costs vary greatly with quality, then firms having the higher fixed-cost quality level use dissipative advertising. For experience goods, quality can be communicated by cheap talk in a range where low-quality firms have greater fixed costs, and low-quality firms use dissipative advertising if their fixed costs are greater still.     

Upstream Pricingand Advertising Signal Downstream Demand

This paper considers price and advertising decisions by a monopolist manufacturer who is privately informed about the strength of consumer demand. Consumers respond to advertising and to the retail price chosen by an uninformed retailer on the basis of his beliefs about demand. This signaling game has a unique intuitive equilibrium outcome in which a high-demand manufacturer chooses his full-information pair of wholesale price and advertising. When demand is low, the wholesale price is distorted downward from its full information level, whereas demand-enhancing advertising may be distorted in either direction. Dissipative advertising is not distorted because it is never used.     

Optimal targeting with entry

We study an advertising agency's optimal choice of targeting technology with endogenous market structure, namely, when targeting changes firms' entry strategies into the advertising and product market. We show that the advertising agency faces a trade‐off between demand‐expansion and profit‐dissipation: The former arises as targeting induces more entry and increases the demand for advertising; the latter refers to that targeting relaxes competition by inducing more differentiation. We show that perfect targeting is not optimal for the advertising agency. Compared to social optimum, the advertising agency underinvests in targeting when investment cost is low and overinvests when targeting is costly.     

Information markets, product markets and vertical merger

In many markets, firms have the option of advertising at price comparison sites to broaden their market reach. Such sites are often controlled by profit-maximizing “information gatekeepers” charging advertising fees. This paper considers vertical merger between such a monopoly information gatekeeper and a firm in the product market. We find that: (i) If the integrated firm can act as a price leader before independent firms make advertising and pricing decisions, then the merger is profitable. (ii) If the integrated firm cannot move first, then the merger is unprofitable, or divestiture is optimal in the case where the firm has already created the gatekeeper. As a result, the merged entity has an incentive to invest in technologies to support a price leader.     

Minimum Advertised Price

This paper examines minimum advertised price (MAP), a vertical restraint that is observed in manufacturer-retailer interactions. Under MAP, the manufacturer announces that it will reimburse retailers for a fraction of their advertising expenditures if retailers do not advertise the product at below a specified price. MAP can be considered a combination of resale price maintenance (RPM) and a cooperative advertising subsidy. Current antitrust law treats RPM as illegal per se, whereas MAP is judged according to a rule of reason. A framework is presented within with neither a minimum retail price nor a cooperative advertising subsidy is individually sufficient to enable maximization of profits in the complete manufacturer-retailer structure, but the two instruments together are. MAP is therefore a sufficient instrument for the maximization of joint profits. We argue that MAP can also be designed as a second-best instrument that replicates RPM.     

Privacy Regulation and Market Structure

This paper models how regulatory attempts to protect the privacy of consumers' data affect the competitive structure of data‐intensive industries. Our results suggest that the commonly used consent‐based approach may disproportionately benefit firms that offer a larger scope of services. Therefore, though privacy regulation imposes costs on all firms, it is small firms and new firms that are most adversely affected. We then show that this negative effect will be particularly severe for goods where the price mechanism does not mediate the effect, such as the advertising‐supported Internet.     

When to haggle,when to hold firm? Lessons from the used‐car retail market

Though haggling has been the conventional way for auto retailers to sell cars, the last two decades have witnessed the systematic adoption of no‐haggle prices by many large dealerships, including the largest new‐ and used‐car dealership chains. This paper develops a structural empirical model to estimate sellers' profits under posted price and haggling, and investigates how market conditions affect sellers' optimal pricing formats. The model incorporates a simple class of bargaining mechanisms into a standard random‐coefficient discrete‐choice model. With the extension, the product‐level demand system is estimated using data with only list prices, and the unobserved price discounts are also recovered in the estimation. The counterfactual experiments yield a few interesting findings. First, dealers' adopted pricing formats seem superior to the alternative ones. Second, dealers enjoying larger market power through vertical differentiation and carrying a large number of models are more likely to have posted price as their optimal pricing format.     

Learning quality through prices and word‐of‐mouth communication

This paper studies the effect of word‐of‐mouth communication on the optimal pricing strategy for new experience goods. I consider a dynamic monopoly model with asymmetric information about product quality, in which consumers learn in equilibrium from both prices and other consumers. The main result is that word‐of‐mouth communication is essential for the existence of separating equilibria, wherein the high‐quality monopolist signals high quality through a low introductory price (lower than the monopoly price), and the low‐quality one charges the monopoly price. The intuition is simple: low prices are costly, and will only be used by firms confident enough that increased experimentation (and therefore communication among consumers) will yield good news about quality and increased future profits. Additional results are the following: for the high‐quality seller, the expected price (quantity) is increasing (decreasing) over time; whereas for the low‐quality one, the opposite is true. Moreover, signaling becomes more difficult when consumers pay less attention to their peers' reports and more attention to past prices. Finally, word‐of‐mouth communication improves consumer welfare.     

Price and Nonprice Competition with Endogenous Market Structure

This paper examines the effect of the intensity of short-run price competition and other exogenous variables that affect gross profit margins—such as the degree of product differentiation and the consumers' responsiveness to quality—on market structure and on advertising and R&D expenditure. A key result is that more intense short-run competition can lead to lower concentration in industries with high advertising or R&D intensity, unlike exogenous-sunk-cost industries. Also, price competition has a negative effect on advertising or R&D expenditure. A case study is also presented, which is consistent with the theoretical results of the paper.     

Product Rivalry with multiple Strategic weapons: an Analysis of price and advertising Competition

A dynamic model of product rivalry is developed for a market in which firms choose price and advertising intensity. The model, a state-space game, is implemented using data that consist of weekly price, sales, and promotional activity for four brands of saltine crackers sold by four chains of grocery stores in a small town. A number of questions can be asked of this data. First, is advertising predatory (merely changing market shares) or cooperative (shifting out market demand)? Second, are price and advertising own and cross-strategic complements or substitutes? And finally, do investments in stocks of goodwill and in price reductions make firms tough and aggressive or soft and accommodating?     

Coupon Advertising Under Imperfect Price Information*

This paper studies sales promotions through coupons in an oligopoly under imperfect price information. Sellers can distribute either ordinary coupons, or coupon (price) advertising, or both types of coupons, at distant locations to attract consumers from their rivals' markets. A unique symmetric pure-strategy equilibrium exists where rebates and couponing intensity are always positive. In the ordinary-coupon equilibrium, prices, promotional efforts, and sellers' profits are higher than in the coupon-advertising equilibrium. However, if sellers are allowed to distribute both types of coupons, only coupon advertising is sent out in equilibrium.     

Voluntary Quality Disclosure under Price‐Signaling Competition

We analyze an oligopolistic competition with differentiated products and qualities. The quality of a product is not known to consumers. Each firm can make an imperfect disclosure of its product quality before engaging in price‐signaling competition. There are two regimes for separating equilibrium in our model depending on the parameters. Our analysis reveals that, in one of the separating regimes, price signaling leads to intense price competition between the firms under which not only the high‐quality firm but also the low‐quality firm chooses to disclose its product quality to soften the price competition. Copyright © 2011 John Wiley & Sons, Ltd.     

Price and quality competition with quality positions

In this study, we investigate price and quality decisions in a duopoly in the presence of firms’ quality positions , which are determined by the quality levels of their existing core products. Into a standard model of vertical differentiation, we incorporate a “repositioning cost” that is proportional to the quality differences between firms’ current and new products. By varying the levels of quality positions, we analyze the impact of this cost on the equilibrium outcomes. Our results show that the presence of repositioning costs restricts firms’ abilities to improve profitability and differentiate themselves vertically. As a result, a high‐positioned firm does not necessarily have a competitive advantage over a low‐positioned firm, even if the former offers a superior new product in equilibrium. In addition, if a low‐positioned firm is significantly cost‐efficient compared with its rival with regard to repositioning, then that firm can earn higher profits than those of a high‐positioned firm by strategically offering its low‐end product. These results contrast sharply with those based on the standard vertical differentiation model.     

Advertising Media Planning,Optimal Pricing,and Welfare

This paper analyzes optimal media planning strategies in a pricing‐advertising competition model where firms can use mass and specialized advertising. We find that although targeted advertising avoids the wasting of ads, firms might find it optimal to mix specialized advertising with the mass media. We also show that the characteristics of the specialized media available crucially affect the outcome of price competition between firms, which can range from a full fragmentation of the market into local monopolies to lower average prices (compared to the case where firms had only mass advertising available). Regarding welfare, we prove that although the use of specialized advertising can lower consumer surplus and drive a fragment of consumers out of the market, this advertising technology is welfare‐improving, and can be Pareto superior.     

存在消费者搜寻的双寡头企业广告竞争模型

针对泰勒尔（1997）广告竞争模型中不允许消费者搜寻这一问题，应用两阶段博弈模型，建立了一个存在消费者搜寻的双寡头广告竞争模型，模型中的消费者具有偏好异质性，且搜寻成本企影响企业产品价格和广告水平。结果表明，在发现成本高的情况下，均衡是两企业定价水平相同，广告水平则随消费者保留值的增大先增大再减小。     

Winner Take All: Competition, Strategy, and the Structure of Returns in the Internet Economy

In this paper, we develop an economic rationale for the following stylized fact: Web-based firms spend profligately on advertising and marketing and usually lose money. Our rationale is based on the winner-take-all structure of high fixed cost, low marginal cost, markets for information goods. This market structure ensures that market participation and investment policy are highly stochastic. Moreover, if a firm chooses to participate in a Web market, it is optimal to act very aggressively through saturation advertising. Although increases in advertising costs reduce the probability of entry, once the decision to enter is made, firm strategies are insensitive to advertising price. Consistent with empirical studies of the profitability of internet firms ( Hand, 2001 ), our model predicts returns that are highly positively skewed, that is, even the firms that survive the competition for market position have a small chance of huge gains combined with a large probability of very modest returns. In dynamic competition, firms weakened by early rounds are less likely to challenge in subsequent rounds. However, when a challenge is attempted, it is always aggressive. In addition, because large expenditures in the first period produce valuable strategic real options in later periods, which are treated as expenses using traditional accounting methodology, the financial valuation of Internet firms may actually be negatively related to performance when using standard accounting measures of profitability that fail to capitalize these strategic real options.     

Trade spends and profitability of promotions

This paper examines the prevalent mechanism of financing advertising and temporary price reductions through trade spend budgets. A manufacturer and a retailer interact for a number of periods with a plan to hold a sale in the last period. During the nonpromotional periods, the retailer accumulates the funds in this budget in proportion to the size of its order from the manufacturer. In the sale period, the budget is used to finance the discount offered by the manufacturer and advertising. I find that the manufacturer drops its price in the sale period to increase the profitability of promotions for the retailer. To be able to sell more units during the sale period, the retailer needs to accumulate a larger trade spend. This is accomplished by setting a smaller mark-up over the manufacturer's price in the regular periods. The manufacturer takes advantage of the retailer's softer pricing by increasing its regular wholesale price. As long as such trade spends are used to finance advertising, the total profits of each firm increase. Using fixed trade spends, where the manufacturer allocates a fixed amount for the retailer, does not lead to an increase in profits.     

Random Advertising and Monopolistic Price Dispersion

We investigate the role of price advertising in a market where consumers are imperfectly informed about prices. We consider a monopolist whose demand depends on price and advertising expenditure. This demand function is derived from optimizing behavior of consumers. Uninformed consumers may pay a cost to visit the seller and obtain price information. Advertising enables the monopolist to increase the number of informed consumers. In equilibrium the uninformed consumers form rational price expectations, and the seller necessarily adopts a random pricing and advertising strategy.