Advertising effectiveness and spillover: simulating strategic interaction using advertising

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Advertising effectiveness and spillover
simulating strategic interaction using
advertising

• 25th International Conference of the System
  Dynamics Society
• Boston, Massachusetts
• 29th July to 2nd August, 2007

Dr. Malcolm Brady Dublin City University Business
School malcolm.brady_at_dcu.ie
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Profit
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Costs
No fixed costs Cost is linear in quantity ie. no
economies or diseconomies of scale
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(inverse) Demand
p
a
monopoly
b slope
q
a reservation price
b own price effect (market response)
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Product differentiation
duopoly
d represents the cross price effect d/b
represents the extent of product differentiation
Dixit, BJE, 1979
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Cournot Nash equilibrium
(3)
Game theory Strategic interdependency
Cournot, 1838 Nash, 1951
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Advertising

• Selection of amount of advertising
• Optimal amount Dorfman Steiner
• Impact of advertising on demand
• Shifts demand function to the right
• ie. changes intercept of inverse demand function
• Tilts demand function
• ie. changes slope of inverse demand function
• Friedman
• Cumulative
• Interfirm (Spillover) effect
• Cost of advertising
• Reduces profit

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Profit
? pq cq - A
Dorfman-Steiner
Advertising elasticity of demand
Price elasticity of demand
?ai fiAi ?fjAj i 1,2, j3 - i
Friedman
(4)
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Assumptions

• Production adjusts instantaneously to demand
• No lags or delays no spikes or step changes

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The model

• five stock variables
• five flow variables
• ten auxiliary variables
• eight parameters

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Initial and Parameter Values

• a high volume low price product
• Unit variable cost c set at 8.
• The initial reservation price a is set at 25.
• Own-price effect b is set at 0.0001
• Cross-price effect d at 0.00005.

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Two firms Arrays

• Two sets of loops exist one for the firm and one
  for its rival.
• Additional interaction loops, generated by
  equation 3, exist they are as above but with
  signs reversed.
• Additional interaction loops, generated by
  equation 4, exist they are as above but all
  variables except reservation price refer to the
  rival firm.
• When advertising is predatory all signs are
  reversed.

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Neither firm advertises
f1 f2 0
One firm advertises
Both firms advertise
f1 0.000015 f2 0
f1 f2 0.000015
f1 0.000013 f2 0
f1 f2 0.000013
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One firm advertises with spillover
Spillover is predatory
f1 0.000015 f2 0 ? 0.1
f1 f2 0.000013 ? -0.3
f1 0.000013 f20 ? -0.3
f1 0.000015 f2 0 ? 0.3
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Some conclusions

• Advertising can be an effective competitive
  weapon and can lead to competitive advantage
• Bifurcation in industry behavior at threshold
  levels of advertising effectiveness
• Some industries advertise and some do not
• Spillover
• Where advertising is a public good firms are less
  likely to advertise unless
• all firms in the industry advertise
• or firms advertise collectively
• EU Olive Oil Ads/ Ireland Licenced Vintners Ads
  
• Reduces the impact of advertising
• Predatory may be more effective than
  complementary advertising