ADVERTISING AS BARRIER TO ENTRY
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ADVERTISING AS BARRIER TO ENTRY
The purpose of advertising is to promote sales and to increase producer’s share of market. However, no firm is able to capture the whole market, as any increase in advertising by a seller is usually offset by that of its rivals, leading to an all-around increase of advertising.
Potentially, when every major producer’s advertising strategies are equal, there is no effect on advertising shares, and the net effect is that resources are wasted by advertising campaigns. Theoretically, an increase in market share gives a producer some additional market power with an option to influence price of a product. Under monopolistically competitive structure of a market, however, producers of a product might not increase prices strategically.
While firms realize that an advertising program is a key to successful business with all its positive factors like differentiating their products and possibly increasing profits, many economists argue that advertising increases product differentiation and, as a consequence, the monopoly power of individual firm. However, even if the monopoly power of brewers increases due to advertising, it is not necessarily a negative factor, as variety-loving consumers can benefit. For those some additional knowledge about more brands of a product increases their utility. There are two possible ways to analyze the economic issue of advertising.
Role of Advertising
Advertising's main role is to reinforce feelings of satisfaction with brands already bought (Ehrenberg, 2000). Advertising is in an odd position. Its extreme protagonists claim it has extraordinary powers and its severest critics believe them. Advertising is often effective. But it is not as powerful as is sometimes thought, nor is there any evidence that it actually works by any strong form of persuasion or manipulation. Instead, the awareness, trial and reinforcement seems to account for the known facts. Under this theory, consumers first gain awareness or interest in a product. Next, they may make a trial purchase. Finally, a repeat buying habit may be developed and reinforced if there is satisfaction after previous usage.
Advertising as a Barrier to Entry
Usually producers are able to maintain their monopoly power if there are some barriers to entry. Those barriers might be a one or more of the following: economies of scale, absolute cost advantage, product-differentiation advantage, capital requirements, blockaded, and deterred entry (Tirole, 1998).
If a firm exhibits economies of scale, it is more likely that it has more possibilities to advertise than the others. So, there is a simultaneity problem present, and we cannot cay for sure that advertising causes economies of scale and not the other way around. There is, however, economies of another scale present. As the evidence shows (Tirole, 1998; Comanor & Wilson, 1967), the more funds a firm can devote for advertising, the lower the cost per advertising message becomes. More to the point, as Comanor and Wilson (1967) pointed out, that the effect of advertising on firms revenue is subject to economies of scale” in the sense that bigger firms are able to spread those lower costs of advertising per message “over more units of output. This simply means that the cost of one unit produced is decreasing with a size of a firm.
Comanor and Wilson (1967) see advertising expenditures as both a symptom and a source of differentiation. The proper measures of product differentiation, which reflect “height of barriers to entry”, are cross elasticity's of supply and demand for products of incumbents and new comers. From the supply side, for the product like beer, differentiation comes from impossibility to imitate product by rivals, and that is why firms are to have sufficient funds available to make their product original, which includes advertising at some stage. From the demand side, if consumers are not fully informed about the product, advertising leads to certain product differentiation providing some information to consumers by lowering cross-price elasticity of demand, which makes it difficult for newcomers to induce brand switching (Kessides, 1986).
There are some problems that newcomers might face in case where incumbents indeed produce differentiated product (Comanor & Wilson, 1967). First problem is that entrants should sell their product at a price somewhat lower than price of branded product in order to attract consumers. Second, newcomers are to pay higher advertising costs, as they usually do not have enough funds to pay for advertising services “in bulk”. Third, buyers normally are loyal to already known brands of a product, and that is why entrants should advertise more than incumbents in order to become recognized and to attract consumers for their product. This fact makes advertising to be a barrier to entry through absolute cost advantage of incumbents.
However, an entrant would suffer “cost disadvantages” (Comanor & Wilson, 1967) only in case if her firm has a relatively small scale. In the opposite case, though, when the scale of production of an entrant is comparative to the one of an incumbent, the situation is more comprehensive, as we are to take into considerations the reaction of the latter firms, which could increase the risk and cost of entry (Comanor & Wilson, 1967).
According to Kessides (1986), advertising expenditures should be seen as certain investment with high degree of sunkness characteristics. In his model, advertising has a long-lasting effect on sales. Nevertheless, there are still some important implications that could be made on the basis of that model. Mainly, a firm-entrant invests money (liquid assets) into “advertising capital”, which does not pay back to the firm in case of the forced exit. The situation is somewhat different, although not riskless, for already established firms, as they are at least not afraid of absence of consumers. Thus, sunk cost of advertising itself is a sufficient criterion for being a barrier to entry. Many times it is combined with an economies of scale and product differentiation, which simply means that advertising is a barrier to entry. However, advertising with described characteristics is not always a sufficient entry deterrent.
The Internet Case
The use of the Internet as a marketing tool and as communication medium is one of the new challenges for marketing management. Online firms are evidently affected by advertising in relation to barrier entry. According to a study by Jupiter Media Metrix, online eyeballs are significantly more concentrated on the sites of a shrinking number of players, as advertising-related troubles knock out players and put up barriers to entry (Saunders, 2001). This is attributed to the shortcomings in advertising revenue.
Considering the falling online ad spending, it is not surprising that media players have fallen out of contention, while the biggest continue to capture market share as a result. According to Jupiter senior analyst Aram Sinnreich, online media companies have been busy boosting their own profiles (Saunders, 2001). Efforts to improve presentation quality and brand identity are paying off for the remaining players. As a result, the biggest hurdles for an aspiring Web media player are no longer site design and technical implementation.
As Sinnreich said, infrastructure as the key barrier to online entry and success has shifted dramatically to advertising and marketing (Saunders, 2001). One particular way that the big players are hyping their offerings is through the oft-maligned house ad. While critics often complain that too many house ads dilute a site's advertising effectiveness, Sinnreich said the major online media players leverage them effectively to hoard eyeballs (Saunders, 2001).
One of the industries that exploit the benefits of advertising is the hotel industry. In order to achieve monopoly, preventing competitors from attracting potential customers, hotel firms are resorting to the Internet. Bacchus and Molina (2001) state that the increasing needs of customers in availing hotel or airline reservations are being addressed by the tourism industry through the online Internet reservation system (OIRS). This reservation system enables travelers to find schedules and fares, seat and room availability, car hire tariffs and make reservations directly (Bacchus & Molina, 2001). Today travelers can book a room from almost anywhere in the world as many hotel websites allow online booking with a confirmation being given instantly (Kasavana & Brooks, 2001).
An advantage to Internet usage for the hospitality industry falls in the marketing realm (Watson, et al., 1996). Almost 9% of all Internet users made travel reservations through the Internet in 1998 (Domke-Damonte & Levsen, 2002). By having an interactive Web site online, hotels are offering their services to a global market at an inexpensive rate. Through this, they can empathize their individual services and competencies, a capability not available within a cooperative marketing plan; thus, this could increase competitive moves by offering niche services the industry does not usually provide (Domke-Damonte & Levsen, 2002).
In a study by Alreck and Settle (2002), Internet shopping was perceived to be more time saving than other traditional approaches of shopping. However, the respondents reported that convenience was an important factor that was considered when deciding whether or not to shop online (Alreck & Settle, 2002). Moreover, Roberts, Xu and Mettos (2003) state that Internet shopping helps to support the needs of busy working people as it is convenient for them to shop online. Even so, the difficulty in judging the quality of the product being purchased and the loss of social contacts inhibit people from shopping online (Roberts, Xu & Mettos, 2003).
As noted by Aksu and Tarcan (2002), websites have now become a popular medium for advertising and reaching a large group of people. Therefore, implementing OIRS is an effective tool for reaching a larger market. Higley (2003) further states, big chain hotel companies are aiming to improve their websites to increase bookings. At Marriott International hotels, 85% of the online reservations came from Marriott International’s own website (Higley, 2003). From the literature, it can be concluded that usage of OIRS poses huge obstacles for traditional hotel firms in achieving increased market share.
Whether advertising increases or decreases competition has been debated for decades. On one hand, Kaldor (1950), Bain (1956), and others argue that advertising reduces competition by enabling the leading firms in an industry to increase product differentiation. This lowers the existing elasticity of demand for the firm's output and erects barriers to the entry of new firms into the industry. On the other hand, Telser (1964), Nelson (1975), and others argue that advertising increases competition by disseminating information about the price and other product attributes more widely among consumers. This increases the demand elasticity's facing the existing firms and facilitates the entry of new firms.
The results of empirical studies of these alternative theories conflict, and so the debate continues. Empirical studies generally focus on large cross-sectional industry samples and compare various measures of competition between high-advertising consumer-goods industries and low advertising producer-goods industries. The principal drawback of this approach is that one must control for the many differences among industries in addition to advertising which might affect the proxies for competition.
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