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Advertising effectiveness and spillover: simulating strategic interaction using advertising. 25 th International Conference of the System Dynamics Society Boston, Massachusetts 29 th July to 2 nd August, 2007. Dr. Malcolm Brady Dublin City University Business School [email protected]

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advertising effectiveness and spillover simulating strategic interaction using advertising

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

[email protected]

costs
Costs

No fixed costs

Cost is linear in quantity

ie. no economies or diseconomies of scale

inverse demand
(inverse) Demand

p

a

monopoly

b = slope

q

a: reservation price

b: own price effect (market response)

product differentiation
Product differentiation

duopoly

d: represents the cross price effect

d/b: represents the extent of product differentiation

Dixit, BJE, 1979

cournot nash equilibrium
Cournot Nash equilibrium

…(3)

Game theory

Strategic interdependency

Cournot, 1838; Nash, 1951

advertising
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
slide8

Profit

Π = pq – cq - A

Dorfman-Steiner

Advertising elasticity

of demand

Price elasticity

of demand

Δai = φiAi + ρφjAj

i =1,2, j=3 - i

Friedman

…(4)

assumptions
Assumptions
  • Production adjusts instantaneously to demand
  • No lags or delays; no spikes or step changes
the model
The model
  • five stock variables
  • five flow variables
  • ten auxiliary variables
  • eight parameters
initial and parameter values
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.
slide12

+

advertising

elasticity

advertising

B1

+

-

R1

quantity

+

+

reservation price

slide13

price

elasticity

-

-

+

R2

R3

advertising

+

price

-

B2

quantity

+

+

reservation price

two firms arrays
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.
slide16

Neither firm advertises

φ1 = φ2 = 0

One firm advertises

Both firms advertise

φ1 = 0.000015; φ2 = 0

φ1 = φ2 = 0.000015

φ1 = 0.000013; φ2 = 0

φ1 = φ2 = 0.000013

slide17

One firm advertises

with spillover

Spillover is predatory

φ1 = 0.000015; φ2 = 0; ρ = 0.1

φ1 = φ2 = 0.000013; ρ = -0.3

φ1 = 0.000013; φ2=0; ρ = -0.3

φ1 = 0.000015; φ2 = 0; ρ = 0.3

some conclusions
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
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