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Media experts: helping competitive firms reduce "wasted" advertising

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A major challenge for mass marketers is allocating advertising media spending so that it is not wasted on viewers that have low interest in the category. As a result, the number of companies that offer services to assist companies with media allocation has grown. Beyond the media buying arms of major advertising companies, there are now companies that describe themselves as media experts who enhance the effectiveness of media by using knowledge about the media habits, behavior and lifestyle of consumers. The specific service provided by media experts is that of assisting clients to organize and coordinate media activity (by choosing media vehicles, programmes, and timing) to achieve maximum impact with high potential consumers. The author builds a model to provide normative insight about how media services will be priced as a function of downstream market characteristics and to understand the incentives that media experts have to limit the number of firms within a market that access their services (by granting exclusivity). The model consists of a sole media expert and two firms that compete in a horizontally differentiated downstream market. The author assumes a first stage in which the media expert prices and offers its services to downstream firms. After deciding whether to engage the media expert, the firms choose advertising levels and prices. A firm's advertising coveys full and accurate information about the characteristics of its product to consumers. Without the advertising, consumers do not have information about the existence of the product and will not consider it for purchase. The author's major finding is that differentiation in a downstream market is inversely related to the profit earned by the media expert. The reason for this is that the profit of the media expert is positively related to the profits of downstream firms. In general, the profit of downstream firms are inversely related to the level of differentiation. This finding belies conventional wisdom about the benefits of differentiation. The well-known Principle of Differentiation states that firms want to differentiate themselves in order to reduce price competition and increase profit. Thus, the model underlines an important limitation to this principle. How does the author explain this unusual finding? The explanation follows from consumer heterogeneity that is endogenously created by advertising. There are two groups of consumers that each downstream firm considers in its profit function (consumers who have only its advertising and those who have also seen advertising from the competitor). When downstream differentiation is high, the defining characteristic of the equilibrium is that many consumers who only see advertising from one firm find the products too expensive. The higher is the level of differentiation, the larger is the fraction of consumers who find the products too expensive. This reduces both demand and consequently profit for the downstream firms. When downstream differentiation is low, the market dynamics are different but the relationship is the same: the profits of the media expert and the downstream firms are inversely related the level of differentiation. When differentiation is low, prices are sufficiently low to make the products affordable for all informed consumers. Both mixed and pure pricing strategies are observed when differentiation is low but in both cases, the profits of downstream firms are a function of the highest price that firms charge. This price is inversely related to the level of differentiation. Thus, when differentiation is low, for very different reasons, the profits of downstream firms are inversely related to the level of downstream differentiation. Two further findings are noteworthy. First, the analysis identifies situations where two weakly differentiated competitors set prices as if they were monopolists. When levels of advertising are sufficiently low, demand from consumers who are only aware of one firm dominate downstream firm incentives and firms essentially choose not to compete for consumers who are aware of both firms. Even in the absence of price fixing or collusion, this finding shows that monopolistic pricing can be observed in a market with low differentiation. Second, the model indicates that media experts have limited incentive to sell exclusively to one firm. Media expertise generally leads to higher downstream demand creating a winwin situation for competing firms. As a result, a media expert earns greater profit by selling to both downstream firms. There are however, situations where selling exclusively can be advantageous. In low differentiation markets, increased levels of media can transform a market where firms price like monopolists to a market where firms reduce price aggressively to capture demand from consumers who see advertising from both firms. When the impact of the media expertise is sufficient to create such a change, a media expert can earn higher profit by selling its services exclusively.

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