Comparative versus Informative Advertising in Oligopolistic Markets *

Transcription

1 omparatve versus Informatve Advertsng n Olgopolstc Markets * Mara Alprant Evangelos Mtrokostas Emmanuel Petraks Work n progress, please do not uote Abstract The present paper nvestgates the frms ncentves to nvest n nformatve and/or comparatve advertsng, n an olgopolstc market wth horzontal and vertcal product dfferentaton. We show that, n eulbrum the frms optmal decson s to nvest n a combnaton of nformatve and comparatve advertsng where, the expendture levels on each type of advertsng are beng determned by the degree of substtuton between products. Further, through the comparson wth the benchmark case wthout advertsng actvtes and the mere nformatve advertsng case, we show that frms nvestment n both types of advertsng always leads to hgher output and lower profts. Fnally, the mpact of advertsng on socal welfare s also dscussed. Keywords: Informatve Advertsng, omparatve Advertsng, Olgopoly, Product Dfferentaton. JEL lassfcaton: L13, M37 * Acknowlegements: The authors wsh to thank Smon Anderson and all the partcpants at 8 th onference on Research on Economc Theory and Econometrcs, Tnos 009, and ASSET Meetngs 009 at Istanbul for ther helpful comments and suggestons. Full responsblty for all shortcomngs s ours. Department of Economcs, Unversty of rete; e-mal: alprant@stud.soc.uoc.gr Department of Economcs, Unversty of yprus; e-mal: mtrokostas.evangelos@ucy.ac.cy orrespondng author. Department of Economcs, Unversty of rete, Unv. ampus at Gallos, Rethymnon 74100, Greece, Tel: , Fax: {petraks@rector.uoc.gr}.

2 1. Introducton. omparatve advertsng, the form of advertsng that compares rvals brands on obectvely measurable attrbutes or prce, and dentfes the rval brand by name, llustraton or other dstnctve nformaton 1, has receved ncreased attenton by busness, academcs and polcy makers snce, ths aggressve advertsng form has emerged as a prevalent marketng practce. The advertsng wars of Peps and oke, Duckng Donuts and Starbucks, or the advertsng campagn of Avs, We try harder, are few examples of the extended use of comparatve advertsng. 3 However, the emprcal evdence so far, regardng the effectveness of comparatve ads, s nconclusve. On the one hand, comparatve ads tent to be more effectve than the non comparatve n nducng consumers attenton, message and brand awareness, favourable brand atttudes and purchase ntentons, [Grewal et al.(1997), Jung and Sharon (00)]. On the other hand, apart from legal rsks, they may enhance consumers mstrust and lead to msdentfcatons of the sponsorng brands, [Goodwn and Etgar (1980), Wlke and Farrs (1975), Prasad (1976), Barone and Mnard (1999)]. Gven the above evdence, a number of uestons arse over the frms atttude towards the use of such an aggressve advertsng form along wth the tradtonal advertsng technues. Ths papers ams to shed some lght nto ths ssue by explorng endogenously the frms ncentves to nvest n comparatve and/or nformatve advertsng along wth the conseuences of such nvestments n the market outcomes and the socal welfare. In partcular, we am to address the followng four uestons. Frst, whch s the optmal frms decson upon the type of advertsng and the expendture level on each type that frms are wllng to undertake n order to promote ther products? Ths ueston s motvated by the alternatve strategc use that 1 Statement of polcy regardng comparatve advertsng, Federal Trade ommsson, Washngton, D.., August13, Pechmann and Stewart (1990) showed that at the Unted States the 60 percent of all advertsng contaned ndrect comparatve clams, 0 percent contaned drect comparatve clams and only 0 percent contaned no comparatve clams whle, Muehlng et al. (1990) suggested that almost 40 percent of all advertsng content s comparatve. The dfference between drect and ndrect comparatve ads s based on whether the compettor s explctly named (or precsely ndentfed by logos and mages) or not. 3 For more detals and examples see Bargozz and Petz (006)

3 nformatve and comparatve advertsng has. Informatve advertsng s strategcally used by frms as a mean through whch they convey product nformaton to consumers (Bagwell 007); whle comparatve advertsng s manly used as a mean to promote the superorty of the advertsed product aganst the rval products. Second, how does the degree of substtutablty between products affect the frms nvestment levels n each type of advertsng n the eulbrum? Thrd, how does frms nvestment n both types of advertsng affect ther market performance comparng to the benchmark case wthout advertsng actvtes? The fourth ueston s relevant to the socetal effects of the dfferent types of advertsng. To address the above uestons, we consder an olgopolstc market wth horzontally and vertcally dfferentated products, where a porton of consumers are ntally nformed about a characterstc of the product whle, the other are ntally unformed. Frms strategcally use nformatve advertsng n order to transmt all the relevant nformaton about the product attrbutes to consumers and thus, to ncrease the proporton of the nformed consumers. Euvalently, we can say that the use of nformatve advertsng help consumers dentfy the product that covers better ther needs and therefore t ncrease consumers valuaton of the advertsed product. On the contrary, comparatve advertsng s strategcally used by the frms n order to present ther product as superor to the rvals one. Therefore, the use of comparatve advertsng not only ncreases consumers valuaton for the advertsed product but also dmnshes consumers valuaton of the targeted product. However, despte the dfferences between these two marketng strateges they are both accompaned by a suffcently hgh advertsng cost. In ths content, we consder a two stage game where n the frst stage frms decde upon the type and the level of each type of advertsng that they are gong to undertake whle, n the second stage they compete by settng ther uanttes. 4 Regardng the frst ueston, we argue that n the eulbrum, frms optmal decson s to nvest n both nformatve and comparatve advertsng. learly, frms are wllng to undertake both types of advertsng n order to ncrease ther demand not only, by attractng consumers through the use of nformatve advertsng but also, by decreasng the rval s demand through the comparson. 4 In secton 5 we also consder prce competton.

4 As far as the second ueston s consdered, we show that the frms nvestment level n comparatve advertsng s postvely connected to the degree of product substtutablty. In addton, we show that the frms nvestment level n nformatve advertsng tend to decrease when the products are not close substtutes whle, t tend to ncrease as the products tend to be perfect substtutes. It s well know, that as the products tend to be close substtutes, the market competton augments. Therefore, each frm has strong ncentves to nvest n a combnaton of nformatve and comparatve advertsng n order to ncrease ts market share by, nformng the ntally unnformed consumers about the characterstcs of ts product and by convncng them, through the comparson, that ts product s superor to the rval s one. On the contrary, when the products tend to be ndependent, the alternatve characterstcs of goods are easly recognzed by the consumers and thus, frms tend to decrease ther nvestments n nformatve advertsng. Further, a comparson between goods s not effectve any more. onsderng now the market outcomes, we observe that frms expendtures on both types of advertsng always lead to a hgher output level and lower profts comparng to those obtaned at the benchmark case wthout any advertsng actvtes. In partcular, the ncreased competton due to the frms nvestment n both types of advertsng leads to lower frms proftablty whle, the strategc complementarty that we obtan between each frm s nvestment n advertsng and ts output, leads to hgher frms total producton. learly, frms end up n a prsoner s dlemma stuaton where they conclude to be worst off. Further, regardng the welfare effects of the expendtures on advertsng, we show that n eulbrum, f the degree of competton s low, the socal welfare when the frms nvest n both types of advertsng s hgher than that of the benchmark case whle, the opposte holds f the degree of competton s hgh. Ths s so because when the market competton s low, the benefcal effect that the use of advertsng has over the net consumers surplus, due to the hgher output producton and the better nformed consumers, domnate the dmnshng effect that the ncreased competton has over the profts. On the contrary, when the degree of competton s hgh the opposte holds. 5 5 Note that the above results stll hold under prce competton.

5 Expandng our basc analyss, we further analyze the case where frms nvest solely n nformatve advertsng. 6 omparng the eulbrum results of ths case wth those obtaned when the frms nvest n both types of advertsng, we argue that the exstence of comparatve advertsng n the frms sets of strateges lead them to overnvest also n nformatve advertsng n order to confront wth the ncreased competton that the use of comparatve ads cause. Moreover, we show that the use of both nformatve and comparatve advertsng leads always to hgher output, lower frms profts, hgher net consumers surplus and lower socal welfare. The exsted lterature on the economc analyss of comparatve advertsng, despte ts sgnfcance and ts extended use n practce, s lmted. Aluf and Shy (001) usng a Hottelng model, where comparatve advertsng ncreases the transportaton cost to the rval s product, show that the use of comparatve ads weaken prce competton by enhancng the degree of product dfferentaton and lead to hgher prces and profts. In a dfferent ven, Bargozz et al. (006), examne comparatve advertsng as a mean to sgnal ualty. In partcular, they consder a market where an entrant, whose ualty s unknown, decdes between the use of generc advertsng, that s standard money burnng to sgnal ualty, or comparatve advertsng, that mples comparson over the ualtes of the two frms, n order to face the ncumbent whose ualty s known. 7 They conclude that the entrant s ncentves to use comparatve advertsng are close related wth the ualty of hs product and the penalty that he s gong to pay f the content of hs advertsng campagn s manpulatve 8. In the same perspectve, Emons and Fluet (008) examne also the sgnalng role of comparatve advertsng n a duopolstc market where both frms use comparatve advertsng to hghlght ther ualty dfferental and the cost of advertsng ncreases as the frms move away from the truth. Anderson and Renault (009) consder advertsng as a mean through whch frms can dsclosure nformaton about horzontal match characterstcs of the products. In ther context, comparatve advertsng can be used by a frm n order to 6 Ths confguraton also reflects the case where consumers perceve comparatve advertsng as a manpulatng frms marketng practce whch does not capture any trustworthy nformaton. 7 The sgnalng role of advertsng s based on the dea that hgh advertsng spendng work as a devce desgned to sgnal hgh ualty (e.g Nelson, (1974); Khlstrom and Rordan, (1984); Mlgrom and Roberts, 1986). 8 They assumed that when the entrant uses comparatve advertsng, the ncumbent has the opportunty to go to the court and obtan gans f the court verdct s that the advertsng s manpulatve and the entrant s true ualty s low.

6 reveal nformaton about the rval s product attrbutes that the latter mght not wsh to communcate. They show that when the products are of smlar ualty frms have ncentves to advertse only ther own goods. Thus, comparatve advertsng plays no role snce, full product nformaton s provded regardless. On the other hand, when the products are of suffcently dfferent ualtes, only the low ualty frm has strong ncentves to use comparatve advertsng (f t s legal) n order to reveal the horzontal attrbutes of both goods and thus, to have the chance by mprovng ts consumer base to survve n the market. The present paper contrbutes to the exsted lterature on comparatve advertsng n three ways. Frst, unlke the bulk of the lterature that approaches comparatve advertsng exogenously, we examne the frms ncentves to nvest n comparatve and nformatve advertsng endogenously by consderng the nvestment level n each type of advertsng as a strategc frm s decson. Second, by consderng a duopolstc market wth both horzontally and vertcally dfferentated products we provde results on the mpact that the degree of product substtutablty has on the nvestment levels n each type of advertsng. Thrd, by extendng our analyss under Bertrand competton framework we reveal that even f the eulbrum results do not change ualtatvely from those obtaned under ournot competton framework, the ntensve competton when the frms compete n prces reures more advertsng restrctons n order frms to reman actve on the market. 9 The rest of the paper s organzed as follows. In Secton, we present our basc model. In the secton 3, we adduce the eulbrum analyss and the comparson wth the benchmark case wthout advertsng actvtes. Secton 4, ncludes the welfare analyss. In secton 5, we consder the comparson between our basc model and the case of mere nformatve advertsng. In secton 6, we consder the extenson of our model under Bertrand competton. Fnally, secton 7 concludes. 9 Ths s n lne to Peters (1984) and Bester and Petraks (1995) and who clam that frms may be better off when there exst advertsng restrctons.

7 . The Basc Model. We consder an olgopolstc market that conssts of two frms, denoted by, =1,,, each producng one brand of dfferentated good. On the demand sde, we assume a unt mass populaton of consumers composed by ndvduals who have homogenous preferences. In partcular, followng Häckner (000), the utlty functon of the representatve consumer s gven by: 1 U(, ) ( ) ( ) [ γ ] m (1) where,, =1, represents the uantty of good, bought by the representatve consumer and m s the respectve uantty of the composte good. The parameter [0,1] s a measure of the degree of substtutablty, wth γ 0 correspondng to the case of (almost) ndependent goods and γ 1 to the case of (almost) homogeneous goods. Alternatvely, the parameter γ can be nterpreted as the degree of competton n the market wth hgher γ correspondng to lower degree of competton between frms and vce versa. Further, represents the nvestment level n nformatve advertsng whle, denotes the nvestment level n comparatve advertsng. Notce that n our setup, the frms expendtures on nformatve advertsng gve to the ntally unnformed consumers the relatve nformaton to dentfy the product that covers better ther needs and thus, t ncreases ther valuaton for the advertsed product. On the other hand, comparatve advertsng has a dual effect. Frst, t ncreases the consumers valuaton of the advertsed product. Second, t decreases the consumers valuaton of the targeted product of the rval frm (hakrabart and Haller, 007). In other words, followng Anderson et al. (008), the frms expendtures on comparatve ads are benefcal not only due to the drect effect of promotng as superor ther own product but also due to the dmnshng effect on the rval s product. Solvng the utlty maxmzaton problem of the representatve consumer we obtan the nverse demand functon faced by each frm: p, =1,, ; ()

8 where p, p are the frms prces, whle the prce of the composte good has been normalzed to unty. Note that the frm s nvestment n nformatve and comparatve advertsng shfts ts demand curve outwards. On the contrary, the frm s nvestment n comparatve advertsng has a detrmental mpact on the frm s demand snce t shfts the demand curve of the latter nwards. Further, we assume that frms are endowed wth dentcal constant returns to scale producton technologes, wth ther margnal producton cost beng symmetrc and eual to c, 0< c α. In addton, we assume a uadratc advertsng cost, b( ), that mples the dmnshng returns of advertsng expendtures. Thus, the total cost functon of frm s gven by: (.) c b( ). The parameter b reflects the effectveness of the advertsng technology on shftng consumers demand. A hgher b denotes a less effectve advertsng technology: the hgher the b, the hgher the reured expendtures to obtan a gven shft on consumers demand. To guarantee well-behaved nteror solutons n all cases we make the followng assumpton throughout the paper: 4 8 Assumpton 1: b ( 4) Assumpton 1 ndcates that the effectveness of advertsng nvestments s not too hgh; otherwse frms would have ncentves to overnvest n advertsng n order to ncrease ther demand that may lead both of them out of the market. 10 As t follows, the frm s net profts can be expressed as: ( ) c b( ) =1, ; (3) Therefore, the advertsng nvestments by frm (, ), lead to hgher consumers valuaton for ts product and thus, to hgher demand whle, at the same tme they ncrease frm s overall cost. On the contrary, t s clear that the comparatve advertsng expendtures made by frm ( ) have a dmnshng effect n frm s demand and ts overall proftablty. We consder a two stage game wth the followng tmng. In the frst stage, frms decde ndependently and smultaneously upon the type and the nvestment level n 10 The assumpton corresponds wth Peters (1984) and Bester and Petraks (1995) who clam that n some cases frms are better off under advertsng restrctons.

9 each type of advertsng that they are gong to undertake n order to promote ther products. In the second stage, gven the decsons of the prevous stage, they compete n the market by settng ther outputs. The above game s solved backwards by employng the Subgame Perfect Nash Eulbrum (SPNE) soluton concept. 3. Eulbrum Analyss. 3.1 Benchmark ase: no nvestment n advertsng. Before proceedng to the eulbrum analyss of the basc model, we brefly dscuss the benchmark case where frms do not undertake any advertsng actvtes, thus μ =μ =0 and κ =κ =0. Hence, the market outcomes can be descrbed by the standard ournot game wth dfferentated products, where each frm chooses ts output, n order to maxmze ts profts gven by Π = ( γ ) c. Takng the frst order condtons, we evaluate the reacton functon of each frm, gven by: γ c R ( ) (4) Due to symmetry, we obtan that the eulbrum prce; output and proft are, respectvely, c a, γ (1 γ)c a p (α - c), ( ) (5) γ ( γ) Fnally, snce we have assume a unt mass populaton of consumers composed by ndvduals who have dentcal preferences, t turns out that each consumer buys a uantty = of each good. Further, usng (1) and (5), the net consumers surplus and the total welfare are gven, (α - c) ( γ) (α - c) TW (6) ( γ) S net (1 ) (1 ), (3 ) 3. Endogenous choce of advertsng. We proceed our analyss wth case of the frms endogenous selecton of advertsng. In the last stage of the game each frm chooses ts output, takng as gven the rval s output along wth the expenses on each type of advertsng (μ,,

10 κ, ), decded n the frst stage of the game, n order to maxmze ts profts gven by (3). From the frst order condtons of (3), the reacton functon of frm s gven by: c R ( ) (7) omparng R ) wth the reacton functon of the no advertsng case R ), ( n whch only the left term of (7) appears, we observe the dual effect that the use of advertsng has over the output. On the one hand, frm s expendtures on nformatve and comparatve advertsng (μ, κ ) tend to augment ts demand and thus, ts producton and eulbrum output. On the contrary, the rval s frm nvestment n comparatve advertsng (κ ) tends to decrease eulbrum output. Note also that the slope of frm s reacton curve s R ( ) R ( ) (, mplyng that R ( ) s an outward and parallel shft of the respectve curve n the benchmark case. Solvng the system of reacton functons (7), we obtan the eulbrum output on the second stage, ( )( c) ( ) ( ) (.) (8) 4 Usng the above euaton the followng observatons are n order: Frstly, and 0 ndcate strategc complementarty between the frm s nformatve and comparatve advertsng nvestments and ts output. Hence, an ncrease n frm s advertsng expendtures s gong to ncrease ts 1 output. Secondly, 0 shows strategc substtutablty between the frm s comparatve advertsng expendtures and frm s output. Therefore, frm by ncreasng ts comparatve advertsng nvestment has the opportunty to decrease frm s output. In the frst stage of the game, frm chooses the expendture level of each type of advertsng (, ) n order to maxmze ts profts. Thus, frm s maxmzaton problem s:

11 * [( )( c) ( ) ( )] max (.), (4 ) b( ) (9) Applyng frst order condtons, we get the best reply functons for both nformatve and comparatve advertsng gven by: [( )(α - c) ( )( ) ] ( ) (10) b( 4) 4 ( )(α - c) ( ) ( ) (11) [ b( ) 1]( ) As t follows from the best reply functons, 0 b( 4) 4, 1 0, 0, 0 that mples the exstence of b( ) 1 strategc substtutablty between the level of nformatve and comparatve advertsng expendtures wth the correspondng values of the rval s frm. learly each frm s gong to ncrease ts nvestment n both nformatve and comparatve advertsng n order to reduce the advertsng nvestment of the rval frm and thus, to possess comparatve advantage. Moreover, we observe strategc complementarty between each frm s nvestment n nformatve and comparatve advertsng snce, ( ) 0 and 0. Hence, an b( 4) 4 ( )( b( ) 1) ncrease n the frm s nvestment n comparatve advertsng s accompaned by a hgher nvestment n comparatve advertsng and vce versa. By mposng symmetry and solvng the frst order condtons system, we obtan frm s eulbrum nvestment level for both nformatve and comparatve advertsng, * (α - c) 0 (1) b( )( ) * (α - c)( ) 0 (13) b( )( )

12 From (1) and (13) we observe that frms endogenous choce s to nvest both n nformatve and n comparatve advertsng. The ntuton behnd ths result s that, gven the strategc complementary between the nformatve and comparatve advertsng, frms are wllng to undertake both types of advertsng n order to ncrease ther demand not only by attractng consumers through the use of nformatve advertsng but also by decreasng the rval s demand through the comparson. Hence, the followng proposton can be stated: Proposton 1: In eulbrum, frms endogenous choce s to nvest n a combnaton of nformatve and comparatve advertsng. * [b( )( ) b( ) ] Note also that, <0 for [0,0.66] whle [ b( )( ) ] * 0 for (0.66,1 ]. It s obvous that for the relatve low values of competton there exst a negatve relatonshp between the frms nvestment levels n nformatve advertsng and the degree of competton, whle for hgher values * b ( ) 0.66 the opposte holds. Further, 0 for all the [ b( )( ) ] gven values of γ thus, the eulbrum comparatve advertsng expendtures are postvely related to the degree of competton. learly, market competton s fercer when γ s hgh and ths makes frms ncentves to nvest n advertsng even stronger. In partcular, the ntuton behnd the above results s that when the products tend to be close substtutes,.e for the hgher values of γ, the market competton augments. Therefore, each frm has strong ncentves to nvest n both nformatve and comparatve advertsng n order to ncrease ts market share by two alternatve ways: frst, by nformng the porton of the prevously unnformed consumers and second by convncng consumers, through the comparson, that ts product s superor than the rval s one. However, when the products are not close substtutes,.e for the lower values of γ, the alternatve characterstcs of the goods are easly recognzed by the consumers and thus, frms tend to decrease ther nvestments n nformatve advertsng. Further, a comparson between them s not effectve any more.

13 * * 3 ( )( ) In addton, ( )( ) 0, 0 b ( b( )( ) ) b ( b( )( ) ) show that the more effectve the advertsng technology s,.e, the lower values of b, the hgher s the nvestment n advertsng, ceters parbus. The followng lemma summarzes: Lemma 1. ) The eulbrum nvestment n nformatve advertsng s decreasng n the degree of competton for [0,0.66], whle t s ncreasng n the degree of competton for (0.66,1]. Moreover t s always decreasng n the effectveness degree of advertsng technology (b). ) The eulbrum nvestment n comparatve advertsng s ncreasng n the degree of competton (γ) whle, t s decreasng n the effectveness degree of advertsng technology (b). Pluggng (1) and (13) nto (7) and (3), frm s eulbrum output and profts are gven, b(α - c)( 4) 0 (14) b( )( ) (α - c) {b[b( 4) ( 4) 8]} 0 (15) [ b( )( ) ] By comparng the eulbrum values of output and profts n the case where frms nvest both n nformatve and comparatve advertsng, wth the ones obtaned n the benchmark the followng proposton derves, For the extended proof see at the appendx.

14 Proposton : ) Eulbrum output s hgher when frms nvest both n nformatve and comparatve advertsng, than that of the benchmark wthout any advertsng actvtes. That s, > always holds. ) Eulbrum profts are lower when frms nvest both n nformatve and comparatve advertsng, than that of the benchmark wthout any advertsng actvtes. That s, Π < always holds. It s clear that the ncreased competton due to the frms nvestments n advertsng leads to hgher output producton and lower frms profts than those obtaned at the benchmark case. Hence, frms conclude n a prsoners dlemma stuaton that leads them to be worst off. As a conseuence, the optmal decson of frms to nvest n a combnaton of comparatve and nformatve advertsng can be characterzed as the case of wasteful advertsng 1. Further, usng (14) we observe that the eulbrum output s negatvely connected wth both the degree of competton γ and the advertsng effectveness parameter b * * [4 ( 4) ] snce, b b 0 and ( 4) 0. ( b( )( ) ) b ( b( )( ) ) The explanaton behnd ths result s based on two facts. Frst, the augment competton leads frms to produce lower output. Note that the frm 's reacton curve, gven by the analyss after (7) R ( ), has a negatve slope, therefore an ncrease n γ tend to decrease the slope of the reacton curve and as a conseuence, leads to a lower eulbrum output. Second, gven the strategc complementarty between the output and the advertsng levels along wth the strategc substtutablty between advertsng and effectveness parameter b, observed by the analyss after (8) and Lemma 1, we have that an ncrease n b leads to lower advertsng nvestments and thus, to lower eulbrum output. 1 The term of wasteful advertsng was frst ntroduced by Pgou 194, n order to descrbe the prsoner s dlemma whch arses when competng frms n a market nvest eual efforts n advertsng n order to attract the favor of the publc from the others. As Pgou frst showed ths concludes n a prsoner s dlemma where none of the frms gans anythng at all.

15 Moreover, by (15) we have that 0, whle 0 hence, the eulbrum b profts are negatvely connected wth the degree of competton γ and postvely connected to the advertsng effectveness parameter b. 13 learly, as the competton augments,.e for the hgher values of γ, frms obtan lower proftablty. On the contrary, we observe that the lower the effectveness of advertsng s, the hgher s the proftablty of frms. The ratonale behnd the latter result s as follows. Frst, followng Lemma 1 we show that the hgher the b s, the lower are the frms expendtures on nformatve and comparatve advertsng. Hence, gven the proft functon (3), frms lower nvestment n advertsng has a dmnshng effect on ther demand and thus, on ther profts. On the contrary, lower frms advertsng expendtures mples lower frms total cost and thus, hgher frms profts. In addton, t s noteworthy that the lower frms nvestment n comparatve advertsng declnes the dmnshng effect on each frm s demand due to rval s comparatve advertsng and therefore, t acts benefcally to profts. The eulbrum results reveal that the postve effect on profts by the lower advertsng nvestments domnates. Ths s n lne wth the Proposton snce, a less effectve advertsng prevents frms from overnvestng n such marketng practces and as a conseuence, dmnshes market competton and leads to hgher frms profts. The followng Lemma summarzes: Lemma. Eulbrum output s decreasng both n the degree of substtutablty between products γ and n the advertsng effectveness parameter b, whle eulbrum profts are decreasng n γ but ncreasng n b. 13 After some manpulatons t can be testfed that, [ b( )( ) ( 8) ( 4)] 16 and 0 b 3 ( b( )( ) ) 3 b[( ) b ( 4) b( ) ( (4 ) )] always hold. 0 3 ( b( )( ) )

16 4. Welfare Analyss. In ths secton we dscuss the mpact of the frms decson to nvestment n both nformatve and comparatve advertsng on the socal welfare. Total welfare s defned as the sum of consumers and producers surplus: TW S net * (16) wth S net and Π * correspondng to the net consumers surplus and the overall market profts respectvely. In partcular, the net consumer surplus for the representatve consumer s gven by the followng expresson: S net 1 a p p (17) By mposng symmetry, we have that p p p. Thus, (17) can be wrtten as:, * * *, * and * * S net (1 )[ ] (18) Further, wth respect to (16), (18) and (14), the total welfare can be wrtten as: ( c) b{[b( 3)( - 4) -16 ( 4)]} TW (19) [b( - )( ) ] By comparng the eulbrum values of the net consumers surplus and the socal welfare n the case when frms nvest both n nformatve and comparatve advertsng, wth the ones obtaned n the benchmark case the followng Proposton derves 14 Proposton 3. ) In eulbrum net consumers surplus and socal welfare are hgher f frms nvest n nformatve and comparatve advertsng than the correspondng values at the benchmark case n whch frms do not undertake any advertsng actvtes. Hence, S S, always hold. net net 14 For the proof see n the appendx.

17 ) In eulbrum f the degree of competton s low ( [0,0.4] ), socal welfare s hgher when frms nvest n nformatve and comparatve advertsng than the correspondng values at the benchmark case n whch frms do not undertake any advertsng actvtes. The opposte holds f the degree of competton s hgh ( (0.4,1] ). We turn now to dscuss the man arguments that drve the above results. By usng (6) and (18), and snce > always holds, t can be easly checked that S S for all the gven values of the parameters γ and b. The ratonale behnd ths result s based on the dual benefcally effect of advertsng. Frstly, frms nvestment n advertsng leads to more and better nformed consumers whch acts benefcally to the net consumers surplus. Secondly, the ncreased competton among the frms, leads to hgher total producton, that make consumers better off. Note also, that for [0,0.4] TW TW holds whle, for (0.4,1] net net TW TW. learly, when the products are not close substtutes the benefcally effect of the hgher net consumers surplus when frms nvest n advertsng domnates the dmnshng effect of the lower frms proftablty. On the contrary, as the substtutablty between products ncreases the dmnshng effect of the lower profts domnates the benefcally effect of the hgher net consumers surplus. Further we observe that the net consumers surplus when the frms nvest n both nformatve and comparatve advertsng s dmnshng both n the degree of S net S competton and the advertsng effectveness snce, 0 and net 0 b always hold. 15 The ntuton behnd the latter result s straghtforward. Frst, for a gven effectveness of advertsng, as the products tend to be homogeneous the overall expendture on advertsng tend to decrease. Thus, we conclude n less nformed consumers that has a detrmental mpact on the net consumers surplus. Second, as the products tend to be perfect substtutes, the eulbrum output of each frm decreases whch tends to declne the net consumers surplus. Fnally, usng (19) we obtan that the socal welfare s decreasng n all the values of the market competton γ and n the lower values of the advertsng effectveness b 15 After some mathematcal manpulaton one can easly observe that b ( 4){8 [ b( 4) (4 5 )]} 0 3 ( b( )( ) ) S, net S net 4b(1 )( 4) 0 b 3 ( b( )( ) )

18 whle, t s ncreasng for the hgher values of b snce, TW 0, TW 0for [0,0.4] whle, TW 0 b b for (0.4,1 ]. 16 It s obvous that for the hgher values of b the postve effect of profts due to the lower frms nvestments n advertsng domnates the negatve effect of the lower net consumers surplus. However, n absolute values the total welfare tend to decrease and thus, the proportonal decrease on the total welfare due to the ncreased competton domnates. We summarze our fndngs n the follow proposton: Proposton 4: In eulbrum, net consumers surplus s decreasng n both the degree of substtutablty between products γ and n the advertsng effectveness parameter b whle, the socal welfare s decreasng n γ and n the lower values of b (that s, when [0,0.4] ) but s ncreasng for the hgher values of b (that s, when (0.4,1] ) 5. The case of mere nformatve advertsng. In ths secton we consder the comparson between the case where frms nvest n both types of advertsng and the case where frms nvest only n nformatve advertsng. The latter case has been motvated by two alternatve facts. Frst, even f the countres legslaton framework does not prohbt the use of comparatve advertsng, frms tend to avod ths aggressve marketng practce because of the hgh rsk to be accused for an attempt to mslead consumers and be prosecuted by the rval to the court 17 [see for detals, Bargozz and Petz (006); Bargozz, et al. (006)]. Second, the fact that consumers may perceve a frm s comparatve advertsng campagn as manpulatve and thus, as a non trustworthy source of nformaton [see for detals, Wlke and Farrs (1975); Barone and Mnard (1999)]. In the mere nformatve case we assume that κ =κ =0, therefore frm s nverse demand s gven now by: p IN. Hence, n the fnal market 16 After some mathematcal manpulaton one can easly observe that, 3 TW 3 b( ){8 b ( ) ( ) ( 4) b[3 (4 3 ( ))]} b( ) ( ) 4[ ( 4) 8] ( b( )( ) ) b ( b( )( ) ) TW 17 In 000 Papa John s was forced by the court to pay over $ n damages to Pzza Hut due to the advertsng campagn Better ngredents. Better pzza that has been udged as msleadng snce, such clams can not be proved.

19 competton stage, where frms compete by settng ther outputs, frm solves the maxmzaton program, IN max ( ) c b (0) The best reply functon of frm s IN ( c ) R ( ) (1) Therefore by solvng the system of foc, we obtan eulbrum output of the second stage, gven by: ( )( c) 4 IN () Note that eulbrum output n the case where frms nvest only n nformatve advertsng s decreasng as the rval s nvestment n advertsng ncreases and products tend to be close substtutes. In the frst stage of the game, the maxmzaton program of the frm s gven by: max IN [( )( c) μ ] (4 ) b (3) Applyng frst order condtons we have that the best reply functon n nformatve advertsng s gven by: IN IN [( )(α - c) ] ( ) (4) b( 4) 4 Explotng symmetry we have that eulbrum level of nvestment n nformatve advertsng, IN* (α - c) 0 (5) b( ) 1 By comparng the eulbrum nvestment n nformatve advertsng n the case were frms nvest solely n nformatve advertsng, wth the correspondng values n the case where frms nvest n both nformatve and comparatve advertsng the followng Proposton derves For the proof see n the appendx.

20 Proposton 5: Frms expendtures level on nformatve advertsng under the mx advertsng case euals that of the mere nformatve case when the products are ndependent (γ=0), whle t s always hgher for all the other gven values of γ. The ntuton behnd ths result s that the use of comparatve advertsng augments market competton whch n turn, leads frms to overnvest also n nformatve advertsng. Note that n contrast to the analyss regardng Lemma 1 where, the expendture levels n nformatve advertsng was negatvely connected to the degree of competton for (0,0.66], n the case of mere nformatve advertsng we have that IN* b( ) 0 hold for all the gven values of γ. The reason for the [ b( ) 1] latter s that snce frms do not have any more the comparatve advertsng n ther set of strateges and thus, they are not threaten by the comparatve advertsng of the rval, they choose to nvest less n advertsng when the market competton augments,.e for the hgher values of γ, n order to avod the negatve conseuences of IN * ( ) advertsng cost. Moreover, 0. Ths replcates our b [ b( ) 1] arguments consderng Lemma 1. By substtutng (5) to (), (0), (18) and (16) the eulbrum values for output, profts net consumers surplus and total welfare respectvely are gven by: b(α - c)( ) b( ) 1 * IN, IN* b(α - c) b( ) 1 S IN net b (1 )(α - c) ( ) [ b( ) 1] b[ b( ) (3 ) ](α - c) TW IN (6) [ b( ) 1], Further, comparng the eulbrum values of output, profts, consumers surplus and total welfare n the case when frms nvest only n nformatve advertsng, wth the ones obtaned n the case where the frms nvest only n nformatve advertsng and the benchmark the followng Proposton derves

21 Proposton 6: If frms nvest only n nformatve advertsng, eulbrum output and net consumers surplus are lower than f frms nvest n both nformatve and comparatve advertsng but hgher than the benchmark. Profts and total welfare are hgher than f frms nvest n both nformatve and comparatve advertsng and the benchmark. Hence, the followng neualtes hold: IN, IN for γ = 0 IN S S S IN, IN S S for γ = 0 IN TW TW and IN TW TW whle, TW TW, for [0,0.4] and TW TW, for (0.4,1] The followng observatons are n order. Frst, regardng output, gven the strategc complementarty between the level of advertsng and output along wth the results presented n proposton 5, t s clear that the hgher levels of advertsng nvestment when frms nvest n both types of advertsng lead to hgher levels of output comparng to those obtaned n all the other cases. Second, consderng the eulbrum profts, t s obvous that when frms nvest n both nformatve and comparatve advertsng they conclude to be worst off. The explanaton behnd the latter s that the use of comparatve advertsng leads to ntensfed competton both n advertsng and output level and thus, leads to overnvestment n advertsng, hgher total producton and lower profts. On the contrary, when the frms nvest solely n nformatve advertsng, the benefcal effect of the ncreased frms demand due to the advertsng expendtures domnates the dmnshng effects of the advertsng costs and the fercer competton. Hence, frms conclude to be better off. From all the above t s clear that frms optmal choce to nvest both n nformatve and comparatve advertsng leads them to a prsoner s dlemma stuaton where they obtan the lower profts. ontnung our analyss, consderng consumers surplus, we have from the analyss after (18) that t s postvely related to the output level. Further snce IN always holds S S S IN holds also. Thus, the frms nvestment n advertsng (nformatve and comparatve) acts benefcal to consumers

22 snce t provde more nformaton and leads to hgher total producton. Fnally, regardng total welfare t s obvous that the effect of the hgher frms proftablty when they nvest only n nformatve advertsng domnates the effect of the hgher consumers surplus when frms nvest n a combnaton of nformatve and comparatve advertsng and the benchmark. 6. Extensons 6.1 Bertrand ompetton. In ths secton we consder the case where frms n the last stage of the game compete by choosng ther prces. In ths case each frm faces the lnear demand functon (1 ) a (1 )( ) p p (1 ), 0 1. Keepng all the other modelng specfcatons fxed, we observe that all of our man results stll hold under Bertrand market competton and the ntutve arguments are n lne wth the respectve ones n the ournot case. In partcular, we show that frms n the eulbrum have always strong ncentves to nvest n both nformatve and comparatve advertsng for all the gven values of the substtutablty parameter γ. However, we observe that the assumpton over the advertsng effectveness parameter b, changes from 4 8 b under ournot competton to ( 4) b under ( 4) ( 1) Bertrand competton. 19 Thus, our model possesses a prce settng eulbrum only f the cost of advertsng s sgnfcantly hgher than that of ournot. The ntuton behnd ths result s derved drectly by the fact that the Bertrand competton s harder than ournot. Thus, as the advertsng tends to be neffectve frms tend to nvest less n advertsng whch protects them by the mpacts of the exstng prsoners dlemma. 7. onclusons In ths paper, we have endogenously nvestgate the frms ncentves to nvest n nformatve and comparatve advertsng n an olgopolstc market wth horzontal and vertcal product dfferentaton, takng as basc premse, that nformatve 19 One can easly observe after some manpulatons that the assumpton over the effectveness parameter b under Bertrand competton s strcter than that under ournot competton.

23 advertsng s used by frms as a mean to transmt nformaton to consumers whle, comparatve advertsng s manly used n order present the advertsed product as superor to the rval s one. We argue that n the eulbrum frms optmal decson s to nvest n both nformatve and comparatve advertsng. Further, we show that whle the frms expendtures on comparatve advertsng are postvely connected to the degree of product substtutablty, the frms expendtures on nformatve advertsng tend to decrease when the products are not close substtutes and they tend to ncrease as the products tend to be perfect substtutes. Our man fndngs also hold under Bertrand competton f the advertsng effectveness parameter b s suffcently hgh. Moreover, by comparng the eulbrum outcomes when frms nvest n a combnaton of nformatve and comparatve advertsng wth those obtaned at the benchmark case wthout advertsng actvtes and those of the mere nformatve advertsng case, we show that frms endogenous choce to nvest n both types of advertsng always leads them to hgher output producton and lower proftablty. Thus, frms fnd themselves n a prsoner s dlemma stuaton where they conclude to be worst off. Hence, comparatve advertsng can be characterzed as wasteful advertsng snce both of the frms would be better off, f ths aggressve form of advertsng has been prohbted. On the contrary, our analyss reveals that the use of both nformatve and comparatve advertsng s benefcal to consumers, snce t leads to hgher net consumers surplus due to the hgher output and the mproved nformaton that consumers possess. Throughout the paper we have restrcted our attenton to a duopolstc market. Therefore, t would be challengng to extend our analyss by examne how the eulbrum results may change when there exst more than two competng frms n the market snce, n a stuaton lke that the use of comparatve advertsng may emerge a free-rder problem. Further, t would be nterestng enough to relax our mantan assumpton about frms symmetry and to nvestgate how the sze of a frm could alter ts ncentves to nvest n comparatve and nformatve advertsng. Snce both of the scenaros descrbed above are not easy tasks, ther analyss awats for further work.

24 8. Appendx 8.1 Proof of Proposton Output: Takng the frm s reacton curve when the frms nvest n both nformatve and comparatve advertsng we have that, R ( c ) omparng R ) wth the reacton functon of the benchmark case wthout ( advertsng actvtes R ), n whch only the left term of above euaton appears, ( and due to the symmetry of the game that mples that at the eulbrum the optmal expendture on comparatve advertsng s eual for both frms, κ * = κ * = κ *, (the effect of each frm s nvestment n comparatve advertsng neutralze one another), t s obvous that > always holds snce at the eulbrum, only the benefcal effect of nformatve advertsng over the output exsts. Profts: By evaluatng the dfference between the eulbrum profts of the case where frms nvest both n comparatve and nformatve advertsng gven n (15) and the profts of the benchmark case gven n (5) we have that, ( c) [ b ( ) (8 ) 4] 0 ( ) [ b( )( ) ] learly from the above euaton, snce both the nomnator and the denomnator are postve for all the gven values of the parameters b and γ, > always holds. 8. Proof of Proposton 3 onsumers Surplus: By euaton (6) we have that (18) we have thats net (1 )[ ] S. Therefore, snce net (1 )[ ] whle by the > always holds, t can be easly checked that S S for all the gven values of the parameters γ and b. net net Total Welfare: Takng the dfference between the socal welfare when frms nvest n both nformatve and comparatve advertsng gven n (19) and that of the benchmark case gven n (6) we have that,

25 TW TW 4(3 ) b( ) (3 6 4) ( ) [ b( )( ) ] From the above euaton t can be easly testfed, after some manpulatons, that for [0,0.4] TW TW holds whle, for (0.4,1] TW TW. 8.3 Proof of Proposton 5 Takng the dfference between the eulbrum expendture level n nformatve advertsng when frms nvest solely n nformatve advertsng and the correspondng value obtaned when the frms nvest both n nformatve and comparatve advertsng we have that, * IN* b ( ) ( c) [ b( ) 1][ b( ) ( ) ] The above euaton turn to be postve for all the (0,1] whle t s zero for γ=0. * IN * Thus, wth eualty when γ=0 8.4 Proof of Proposton 6 Output: Usng (14) and (6) we have that * IN* b ( )( c) [ b( ) 1][ b( ) ( ) ] The above euaton s always postve for (0,1] whle, t s eual to zero when γ=0. Therefore, * IN* wth eualty when γ=0. Further from Proposton we have that > always hold. Thus, IN, IN for γ = 0. Profts: Gven euatons (15),(6) we have that, IN b{( ) [b( ) ]}(α - c) [ b( ) 1][ b( )( ) ] The above euaton always exceed zero, thus IN of parameters γ and b. Further, from Proposton we have that IN holds. Therefore,. >Π holds for all the gven values > always

26 onsumer Surplus: onsumer Surplus can be expressed as S net ( 1 )[ * ] n addton we have show that IN, IN for γ = 0. Hence, t s obvous that S IN S S, IN S S for γ = 0. Socal Welfare: Usng euatons (19), (6) we have that, TW IN TW ( a c) b( ) [ b( 16 (1 (3 )) b( )(4 ( ))] [ b( ) 1] [ b( )( ) ] The above exceeds zero for the gven values of γ and b. Thus, IN TW TW Further, usng (6) and (6) we have that, TW IN TW 3 ( a c) [b( ) 3][ b( 16 (1 (3 )) b( )(4 ( ))] ( ) [ b( ) 1] The above euaton s always postve for all the gven values of γ and b. Thus, we IN conclude that TW TW always hold.

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