Conceptual Framework
It is often presumed that the average consumer is responsive to advertising and promotion. However, one of the key questions with respect to advertising by firms in markets for healthcare inputs is whether advertising raises ‘selective’ or brand-specific demand versus ‘primary’ or industry-wide demand (Borden, 1942). The answer to this question has normative implications and relevance for public health. For instance, is advertising by the cigarette industry combative and solely reflective of a market share transfer or does it also lead to an overall expansion of the market? This was one of the disputes that was central to the litigation initiated in 1999 by the US Department of Justice (DOJ) against cigarette manufacturers. As a starting point, it is helpful to draw upon three principal views that have emerged with respect to why consumers may respond to advertising: (1) persuasive, (2) informative, and (3) complementary.
Chamberlin (1933) integrates advertising into his theory of monopolistic competition, observing that advertising can help firms to differentiate their products and generate an outward shift in firm-level demand. According to Chamberlin, advertising impacts demand by altering consumers’ tastes and preferences . Under this ‘persuasion’ hypothesis, brandlevel demand would not only shift outward in response to advertising but also become relatively less elastic, possibly leading to higher prices. Advertising-induced product differentiation and creation of brand capital may deter entry and enhance the monopolistic power of incumbent firms, especially if these established firms also enjoy scale economies in advertising and production (Kaldor, 1950). Thus, under the persuasion view, advertising can have significant anticompetitive effects, a point that was also emphasized by Robinson (1933).
Chamberlin (1933) also pointed to the transfer of information to consumers as another explanation for why consumers respond to advertising. This informative view of advertising took on a formal expression in Ozga (1960) and Stigler (1961). In markets characterized by imperfect information, advertising can effectively reduce search costs by conveying direct or indirect information to consumers regarding the existence, quality, price, and other attributes of products. As Bagwell (2007) noted, in such markets, advertising emerges as an endogenous response and solution to the information asymmetry. In contrast to the persuasive view, advertising plays a more constructive role under the informative view, and may also have pro competitive effects. As consumers receive low-cost (relative to incurring search costs) information on products and brands, the firm’s demand becomes relatively more elastic and price dispersion in the market is reduced. Advertising can thus promote competition among incumbent firms and facilitate the entry of new firms as well as the introduction of new products.
Nelson (1974) contended that even when advertising does not hold direct information content, it may still signal indirect information regarding product quality and firm attributes. For instance, advertising can signal that a firm is an efficient producer because these firms would benefit the most from expanding demand. Advertising can also enhance the match between products and buyers in markets where consumers have heterogeneous valuations. And, advertising may help consumers recollect their previous experience with the product and lead to repeat-business. Because this effect is more valuable for firms producing high-quality products, advertising may thus indirectly signal quality even for new consumers.
Nelson (1970) distinguished between search goods, wherein the consumer can determine quality before purchase though perhaps after incurring some search costs, and experience goods, wherein the consumer can assess quality only after consumption. Advertising addresses an informational imbalance for experience goods by providing indirect information content regarding quality, and advertising intensity is thus predicted to be higher for experience goods. In contrast, advertising for search goods (for instance, eyeglasses, consumer electronics, or credit cards) would be focused on providing direct information regarding price, location, availability, and product attributes.
Darby and Karni (1973) also found it useful to distinguish a third category of goods that have ‘credence’ attributes, for which the consumer is unable to accurately evaluate quality even post consumption. This market failure of imperfect information for experience and credence goods also potentially gives firms an incentive to engage in misleading advertising claims (Darby and Karni, 1973; Nelson, 1974). Where market based mechanisms are unable to deter deceptive advertising, there is a role for government regulation and publicly funded dissipative counter-advertising.
Although the persuasive and informative views provide conflicting assessments of the role of advertising, the third view of advertising provides a framework under which advertising is complementary to the advertised product. That is, advertising does not need to exert any direct influence on consumer preferences , and it may or may not possess information content. Within a household production framework, Stigler and Becker (1977) modeled the advertised product with its associated advertising expenditures as inputs into the production function for each final commodity, implying a complementarity between the advertised product and its advertising. Under this framework, a higher level of advertising can raise demand because the consumer now believes that he can obtain a greater output of the final commodity from a given input of the advertised good. In a related but separate framework, Becker and Murphy (1993) directly modeled advertising as an input into the individual’s utility function. Advertising raises demand in this framework by increasing the marginal utility of the advertised good. Note that this complementarity follows from the fact that there does not exist a separate market for advertising messages – considerable transactions and monitoring costs make it infeasible to separately sell advertising to consumers.
Both of these paradigms, which impart a complementary role to advertising, also bridge back to the informative view. For instance, if advertising enables consumers to produce information at lower cost (Verma, 1980), then consumers can indeed more efficiently convert market goods into valued final commodities, as assumed by Stigler and Becker (1977). And, even if advertising in uninformative, it may still play a constructive role because consumers may value it directly, as assumed by Becker and Murphy (1993).
The upshot of this discussion is that no single view of advertising is applicable in every setting. Furthermore, from a public health standpoint, the debate centers around whether advertising reflects a brand-switching process or a market expansion process, especially in relation to the market for unhealthy inputs such as cigarettes, underage drinking, and junk food – or in different terms, whether advertising is combative (predatory) or cooperative. Because advertising can affect both selective (brand-centric) as well as primary (market) demand under all three views, the question cannot be resolved based on theory alone and empirical evidence needs to bear upon the specific demand effects of advertising in various markets. With that said, markets for most healthcare inputs have some predominant experience attributes – such as tobacco and alcohol products, over-the-counter (OTC) and prescription medications, and snacks and beverages. Thus, advertising intensity for many of these goods tends to be higher relative to the average industry (2.1%; see Table 1). These views of advertising also highlight potential effects on price, which depend on the extent to which advertising expenditures raise operating costs, affect price elasticity of demand, and allow firms to take advantage of scale economies. Finally, the concentration effects of advertising – that is, whether it facilitates entry or whether it augments the monopoly power of established firms – depends on whether advertising is purely persuasive in nature and leads to spurious brand differentiation or whether it redresses imperfect information and makes demand more elastic.