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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 l.jpg

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 l.jpg
Costs

No fixed costs

Cost is linear in quantity

ie. no economies or diseconomies of scale


Inverse demand l.jpg
(inverse) Demand

p

a

monopoly

b = slope

q

a: reservation price

b: own price effect (market response)


Product differentiation l.jpg
Product differentiation

duopoly

d: represents the cross price effect

d/b: represents the extent of product differentiation

Dixit, BJE, 1979


Cournot nash equilibrium l.jpg
Cournot Nash equilibrium

…(3)

Game theory

Strategic interdependency

Cournot, 1838; Nash, 1951


Advertising l.jpg
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 l.jpg

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 l.jpg
Assumptions

  • Production adjusts instantaneously to demand

  • No lags or delays; no spikes or step changes


The model l.jpg
The model

  • five stock variables

  • five flow variables

  • ten auxiliary variables

  • eight parameters


Initial and parameter values l.jpg
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 l.jpg

+

advertising

elasticity

advertising

B1

+

-

R1

quantity

+

+

reservation price


Slide13 l.jpg

price

elasticity

-

-

+

R2

R3

advertising

+

price

-

B2

quantity

+

+

reservation price


Two firms arrays l.jpg
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 l.jpg

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 l.jpg

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 l.jpg
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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