Investigating Dynamic Multifirm Market Interactions in Price and Advertising

Abstract

Diagnosing the nature and magnitude of competitive interactions among firms is important for developing effective marketing strategies. In this paper, we formulate a game-theoretic model of firm interaction to analyze the dynamic price and advertising competition among firms in a given product market. Firm (or brand) level demand functions account for the contemporaneous and carry-over effects of these marketing activities, and also allow for the effects of competitor actions. Firms take into consideration the actions of their rivals, as well as their own demand and cost functions (both production and advertising) when determining the profit-maximizing price and advertising levels. Our formulation enables us to quantify not only the direction and magnitude of competitive reactions, but also to identify the underlying form of market conduct that generates the particular pattern of interaction. We specify and estimate a fully structural econometric model for three firms constituting a distinct sub-market within a personal-care product category. We estimate the demand and competitive interaction parameters, as well as the production and advertising cost functions for each firm. We then derive implications for competitive interactions and market structure. Interestingly, we find that while firms seem to compete on advertising, they price cooperatively, thereby enhancing their price-cost margins.competitive interactions, marketing mix, econometric estimation

Product and Marketing Actions in a Competitive Scenario

“…To this aim, firms may use aggressive pricing, advertising competition (Vilcassim, Kadiyali, & Pradeep, 1999), differentiation (Caves & Ghemawat, 1992), or a broad combination of these and other actions (Ferrier, Smith, & Grimm, 1999), thus assuming the risk of competitive retaliation (Arora, Allenby, & Ginter, 1998).…”

“…While some strategic actions are aimed mainly at increasing market share to the detriment of competitors, such as aggressive pricing (Vilcassim, Kadiyali, & Pradeep, 1999), others -such as generic advertising (Friedman & Friedman, 1976;Krishnamurthy, 2000) -are concerned to strengthen a firm's market size with scarce effects on rival positions. However, some interrelationships may exist.…”

Optimal Distributed Dynamic Advertising

“…Note that in the absence of the diffusion term, i.e. for A = −ρ, the optimal strategies (19) and (21) would remain unchanged (because the dual arc p would not change), even though the corresponding optimal trajectory do not coincide, as a simple calculation reveals. However, this if of course not a general phenomenon, but just a consequence of the equality ∂φ = −1 in the above examples.…”

“…The second term on the right-hand side of (2) is introduced to capture the effect of the spatial diffusion of goodwill (more detailed rationale for the use of this term is described in the next section) and reflects the main modeling difference between our analysis and that of Nerlove and Arrow [16]. The last term on the right-hand side of (2) represents another new feature of our model: we describe advertising effort using GRP parameter, which recent trend in advertising literature ( [19], [10]) defines as more appropriate than the traditional expenditure rate. Note that (2) reduces to the NA model if x does not depend on the spatial coordinate ξ and if b(ξ) ≡ 1.…”

The Stochastic Goodwill Problem

“…We use gross rating points (GRPs) to measure advertising effort, instead of the rate of advertising expenditure, following a recent trend in the marketing literature -see e.g. Dube and Manchanda [8], Vilcassim, Kadiyali and Chintagunta [27]. As briefly mentioned in the introduction, there are several reasons to study stochastic extensions of the Nerlove-Arrow model.…”