8. Business cycle behaviour

Significance

Advertising is the paid communication of firms and other organizations directed towards consumers and the broad society.

TV and radio spots, billboards, paid spaces in the press and other means are used to vehicle key messages about products, brands, brand values, and identities. The typical expected effects are to raise sales, to maintain them over time, and to improve the general image of the firm.

Advertising follows logically after listening to consumer requirements, introducing productive conditions, distributing the goods. However, the actual sequence - and emphasis deriving from the diverse sub-cultures - can be quite differentiated.

Massive advertising is typical of big oligopolists operating in a large consumer market (e.g. Coca Cola and Pepsi Cola) and of multinationals entering new countries.

Impact on behaviours and outcomes

Micro level

By providing a mix of information and persuasion, advertising impacts almost all phases of the decision making process of the consumer.

It announces the existence of a new good, previously unknown and unnoticed by the general public. It raises awareness and conveys information about new, possibly imported, goods.

It provides an answer to a search phase by the consumer, either at the time of search, as it happens with Google Ads, or leaving a content to the memory, that will be retrieved at the time of serch.

Sometimes, it make easier to reach the good, e.g. by showing where it can be bought ("point of sales"). Usually a minority relegated to leaflets and billboards, certain advertising visual messages contain reference to the price of the good. Their presence is used to press for a reference price that the consumer will use to compare brands and retailers, if not even a immediate transaction (e.g. by mobile commerce).

More significantly, advertising connects a good to a need, suggesting that by consuming the good the need will be fulfilled. A common method is to link the good to the most fundamental and universal needs, most deeply felt, whereas - without advertising - the good would be considered as of a much narrower application and utility. Indeed many ads promise happiness to the buyer, much overstating the reasonable effect of the product.

More radically, it has been argued that advertising revives latent need or even creates new needs, which earlier were not felt. In so doing, advertising tend to raise an entire category of products to higher ranking in terms of perceived needs.

Consumer's bounded rationality usually restricts the number of brands that are remembered in association to a category. Advertising is here extremely important since it places a specific brand in the short list of consumer's mind. When asked to name brands of a certain category (e.g. soft drinks), the consumer will promptly answer with the most advertised "known" brands he is aware of.

Advertising may contain the reference only to the product of a given brand and variety or may explicitly or implicitly address competitors over which is given a negative and distantiating pitch, sometimes with brush irony.

Advertising can address specific segments by highlighting a connection between their identity to the product and the brand. Purchasing the goods becomes then a way to re-assure the consumer own aspirational ego (e.g. "I'm a stylish woman, so..."). If this connection is widely known, the good might become a "status symbol" used to send social messages (e.g. a very expensive item "talks" about the wealth of the owner or of the purchaser, a stylish new item "talks" about good taste and being in the highly connected social core, a counterculture item send a social message to the same community, etc.).

Advertising tries to set the "default value", the status quo, the reference point for the mechanism described by Prospect theory. It provides a shortcut, both mental and visual, to a decision, tempting the receiver into identifying himself in a condition in which he already owns the good (thus "not purchasing" becomes a sacrifice). This favours both the purchase and a higher acceptable price.

Visual advertising will tend to provoke "recognition" of the product when displayed in the shop, whereas word-based advertising will reinforce remembering the name of the brand, so that the consumer will explicitly request it to the seller. The latter, when choosing the structure of its supply, which is a cumulative bundle of all goods on the shelves, will tend to include all (or most) heavily advertised brands, feeling confident to suggest them to the doubtful client. In all this, advertising reduces the perceived risk for the buyer and for the seller.

In a more abstract direction, advertising does not only underline the benefits of a certain product but also enrich a brand with symbolic values (e.g. anti-conformism, community belonging, security, etc.), so that customers can enter in an empathic relationships with the brand, leading to positive attitudes for a wide variety of products across different categories.

In a more practical orientation, since the actual purchase requires a "triggering occasion", where attention is paid to satisfy a certain need or desire, advertising prompts first purchase by stimulating and creating occasions. It highlights that "time has come" or that "a deadline is approaching" or "last units are available", providing a stimulus for the purchase intention - an interior order to buy.

Advertising reveals the features of the good, on which the latter will be compared with other competing products. It usually points to a "unique selling proposition", a key wedge against all other competitors.

In this way, advertising educates the consumer to pay attention to certain features or performances. In particular, advertising tries to shift consumers' attention from weak to strong sides of the product and modify the weights that consumer attributes to their importance.

To the extent the consumer adjust expectations on product performance based on his or her current experience, she or he may well be "rather satisfied" of what routinely repurchase or what already belongs to his cumulative bundle; advertising tries to build a gap and justify bold new choices, raising the expectations for new goods. For instance, the purchase of a new car before what is currently owned entered into the last part of its useful and troublefree part of its life may be motivated by the appearance in the market of something new and highly desirable (e.g. electric car which are fun to drive). Please note that this awareness can be spread also without advertising, but rather with non-paid media coverage and word-of-mouth dynamics (with companies sometimes trying to mimick and participate to such dynamics - paid support to a media outlet in exchange for editorials not explicitly paid, facilitative platforms and gadgets for positive word-of-mouth, etc.)

For restyled and restaged existing products, advertising can lead to a new look at them, offering the opportunity to a change in opinion.

One can note - in the content of some advertising - the bold attempt to radically negate a possible objection to the product, exposing the exact opposite trait. Here the aim is to reduce psychological barriers to the purchase, winning the interior battle that takes place in the consumer's mind. For instance, an image of a very independent person could be used as testimonial for a product that creates dependency (e.g. cigarettes).

In another perspective, advertising can be a public commitment of a "known" firm assuring that, against its short-term interest, it uses the best ingredients, the most natural production processes, and so on.

More deeply, advertising can change the importance that consumer attaches to specific features of the good, raising the corresponding "parameters" of choice.

If the good hasn't been already personally consumed, advertising can improve the perceived performance of the good. It puts the product and its features in a better light, increasing the evaluation of the consumer.

Advertising suggests uses of the good and place it in a certain category, which is the frame for consumer choices and comparisons. A weak product in a category could be "diverted" into another, in which it has some comparative advantages. Advertising can suggest new uses for a product and new occasions when to consume it.

Although usually the experience in consumption is the moment where "truth" emerges and the consumer can express its highly personal judgement, advertising can prepare and "frame" the experience so that negative elements can be separated from the product and attributed to something else. In this way, it modifies the way the experience is remembered and retrieved when making a new choice and during further post purchase behaviours. Post-consumption exposure to advertising can introduce fragments to the memory of experience, since "memory rewrites the past with current information, updating your recollections with new experiences" [1].

To modify experience is a tough task for advertising, but some comprehensive strategies can be somewhat effective. It creates a social atmosphere that tend to block negative experience to be communicated and circulated to others. A lie repeated thousands of times by thousands of people will be considered as a truth.

More in general, advertising extends the social appreciation of the kind of behaviours related to the good. It is particularly effective for situations in which the purchase has a social meaning ("I buy it so to be praised and envied by others"), because it can act as a substitute for the "general opinion" of the others.

Advertising strives to produce a social standard and social norm, putting a higher bar to the individual that wants to be integrated and appreciated by society, thus adopts a certain good as a way to adhere to this norm. In this, advertising strives to enter into the sources of social norms, which traditionally are respected institutions, influencial individuals, scientists and opinionmakers, etc. There may be resistance from them (and from certain consumers) in accepting advertising as legitimate source of social norm. Conversely, the presence of testimonials within advertising is a way in which it tries to ingest and integrate them and gain respectability. To the extent that online social networks becomes reference for a larger number of individuals, who quickly compare themselves to other members of the network, influences (people with many followers, especially within the subset of the network with which the person is more in contact) become sources of proposed social norms (and they may be paid by brands to insert their products into what they consume, praise and support). What seemed to be a horizontal organization of society is quickly re-hierachised. Disintermediation of social knowledge is re-intermediated.

In other words, advertising can give rise to a wave of reactions in social networks, so that, for instance, friends who saw the advertising tend to suggest - when asked for advice - exactly that brand, thus inducing imitation not only of real choices by others but also of their intentions and attitudes.

In another vein, advertising reinforces a positive attitude and sustains habits in purchasing. Advertising reminds - to the already convinced consumer - the pleasure it brings, so stimulating re-purchasing. It also enlarges the kind of occasions for consuming the good. In so doing, massive advertising of already known firms is an entry barrier for new firms, even if they offer superior quality goods, which are simply disregarded by indifferent consumer.

For certain routine purchases, advertising can even short-circuit the decision process by triggering an automated response to the stimulus: the product is on the shelf, the consumer hand keeps it. The connection is offered by a "trustworthy" brand, whose (heavily advertised) logo is what reduces the complexity of multi-criteria choice to a simple gesture.

To be effective, advertising tend to be massively repeated over a number of media channels for certain periods and repeated again over the years. Some elements (e.g. the slogan) tend to be a unified theme across different versions of the ad spot.

Needless to say, some advertising can be so unskilful, badly carried out, and without enough budget, so to result largely ineffective. Advertising - especially of new products - can have unexpected consequences and many campaigns fail their targets.

Much depends on the very words, colours, emotions, and the media channels used in the advertising, what opens a large field for the creativity of its authors. In some cases, advertising can be considered as a new form of art.

Industry level

The main impact of advertising is on sale volumes. The second main aim of advertising is to differentiate the products from competitors, reducing the relative degree of substitution, so to sustain a premium-price over them, which in turn guarantee fairly high margins on costs, leading to high profits, provided the quantity sold is large enough to justify the fixed discretionary costs of advertising.

More specifically to the industry business cycle, advertising speeds up the diffusion of new goods. It prepares and accompanies the phase of take off, when "dominant design" defines the final form of a good, as pointed out by J. M. Utterback.

In other terms, advertising can trigger the passage from large competition of very similar unbranded products to a market where there is a clear leader (the top advertiser) and its imitators.

There may be a dynamic correlation between market shares and the "share of voice" (i.e. the share in advertising expenditure): when there is a large discrepancy between the two, the share of voice might lead to changes in market shares. This is appealing to challengers of current market leaders.

Large irreversible investments in plants couldn't be undertaken without the reasonable expectation of wide sales, so that advertising has the task, together with other elements of the marketing mix, to deliver them.

For mature products, advertising tries to stabilize sales at high values, counteracting seasonal falls and preparing seasonal peaks.

In some countries, certain professional services - where reputation is essential - exhibit zero or low advertising levels, because advertising is considered a cheap way to gain awareness and is condemned by the profession. Word-of-mouth circulation of reputation is considered a better way to choose e.g. a medical doctor or a lawyer. In this, there may be a hint that competition is not welcomed, either for ethical reasons or because of fear of price competition among advertised professionals. Some would say that the best advertising for a restaurant is the queue in front of it waiting to sit, not a billboard boasting "high quality" dishes.

If consumers are prone to adjust their judgements upwards because of advertising, the incentive to improve in-built quality is weakened and R&D will receive less budget.

Less real innovation can depend on an overemphasis on advertising, if the society is easily subjugated by paid persuasion. Innovation efforts are then directed towards minor changes aimed at perceived-only differentiation from the competitors.

If brand alone is the key of the decision, then the quality of the good is not important.

If, instead, people base their judgement on autonomous personal experience, advertising can trigger the first purchase, but not repurchasing. If they are influenced by group belonging and social networks, advertising and other's personal experience have a mixed role.

If consumers can judge inherent quality and if social networks effectively transmit these judgements, advertising will fail if attempts to promote bad quality goods. Next, only goods of sufficient quality will be advertised, mainly to activate first adoption, experience and the social networks. This, in turn, is conducive to trust by people who cannot judge autonomously ("They wouldn't spend so much for advertising, if they weren't sure of having a good product").

An effect of advertising, whose importance is growing, is on the trade channels. Producers of mass consumption goods usually do not sell directly the product to each consumer but relies on retailers, both small shops and large surfaces. With the latter raising in importance, the balance of power between manufacturers and distribution is shifting towards the distributors, who sometime labels with their own logo a vast array of goods, manufactured by now-anonymous firms. In so doing, retailers increase their margins and control over product features.

Thanks to advertising, big producers can reach directly the consumer, making them aware of their own brand, hoping that consumers will look for their products in the retailers POS (point of sales), badly reacting to the lack of them. This forces retailers to supply branded goods, to avoid losing consumers in favour to their competitors of other chains.

In short, advertising can strengthen the position of producers in front of retailers.

Conversely, large retailers can heavily advertise short periods of price cuts ("promotions"), leading to an increased number of customers in their big-boxes or premises. This can be combined with a wide presence of "private labels" where retailer's brand is put under a variety of items, in direct competition with industrial brands. Since private labels do not have large ad-hoc advertising budget, they are profitably sold by positioning them nearby the industrial national brands. For a spreadsheet model of customers' choices in these cases, see here.

In the classical case of a well established incumbent oligopoly core challenged by new entrants with radically different products, advertising can either be used by the former (to increase brand loyalty) or by the latter (to highlight the new opportunities). The latter, however, often have invested most of their discretionary spending in R&D to achieve the product innovation, so they are cash constraint and weak in advertising. Banks could be reluctant to finance costly advertising campaigns for new products of uncertain success (thus indeed reducing their chances of success). The weakness in advertising make the the challenger more subject to media scrutiny and possibly biased and erratic coverage, with myths and overexagerations. It reduces the companies voice in the narrative about itself.

This is particularly relevant in the fields where climate change is requiring a host of technological innovation but the structure of the sector hinders this "necessary" outcome. In this case,our book on "Innovative Economic Policies for Climate Change Mitigation" puts forth the proposal of giving free airtime to TV advertising of clean goods.

Conversely, when demands tends to flat out in aggregate terms, for having reached a certain "satiation" of the need in the willing population, which is compatible with a steady state and a reduced requirement of natural resources, advertising may try to stimulate an escape from sationation that, as positive for the industry as it is, may well be socially and environmentally undesirable.

The economics of advertising is a dynamic connection between reasons to advertise and to supply advertising. As an industry, advertising is a rich ecosystem of creative agencies, media centres and outlets, survey & research companies and consultants. It represents a major source of income for radio and television channels and the press, possibly making them more independent from government influence but aligning them to business interests.

Finally, it should also be noted that there exist advertising campaigns that deliberately remove a direct commercial aim, while rather improving the general image of a firm and its commitment to socially approved values.

A formal model capturing advertising roles

Some years ago, we released a model in which advertising is available to firms and it impacts on consumers' decision-making. You can experiment how the level of expenditure in advertising is linked to past and expected market conditions as well as to the competitor's choice, by playing yourself in this simulation. People observing you while playing could try to elicit some strategy and tactics you use in determine the level of advertising expenditure, possibly identifying replicable routines to feed into simulation models.

Neoclassical approach to advertising

Advertising in economics is a very interesting field because the neoclassical theory, with its assumption of rational consumer, who should not be influenced by what firms says but only by the utility in the good, is struggling to find out a rationale for the overwhelming empirical evidence of profit-oriented firms that spend for advertising.

The neoclassical (hyper)rational consumer bases its choices on his own subjective preferences, which are completely out of control for the seller. Indifference curves do not shift because of advertising. Consumer preferences are given; they are not manipulated by advertising. He is perfectly informed about the quality of the good and its decision-making process is based only on price and preferences.

Consumer sovereignty, which states that supply adapts to demand and never the reverse, is a key tenet for neoclassical economics.

Standard neoclassical condition of perfect competition is incompatible with advertising, which is a fixed cost generating no effects, since the rational consumer is completely uninfluenced by advertising. Profit-maximising advertising behavior for a company operating in a perfectly competitive market is not to advertise. Any firm paying for advertising would simply fail and shut down.

If all markets were perfectly competitive, no firm would ever pay for advertising. Advertising would be irrational.

Accordingly, if you see some advertising, either firms are irrational (do not maximise profits, waste money by pushing up costs purposeless,...) or that market isn't perfectly competitive. The same idea of promoted "brand" - distinguishing one's firm product from the competitors - breaks the condition of product homogeneity.

Once accepted that certain markets are not perfectly competitive, advertising can be justified, in a neoclassical environment, as a policy of a player in a game, e.g. as sunk cost that makes credible the commitment to stay on the market and not to leave if other firms enter. In this case, advertising can be justified even if it had completely no effects on sales and consumers' decisions.

But advertising does have these effects. And the failure of neoclassical theory to account for them makes advertising an anomaly for the neoclassical paradigm.

Consumers' heterogeneity in front of advertising

Not everybody reacts at the same way when exposed to advertising. There are people, who directly believe what is transmitted without any critical personal stance, retaining a more positive attitude towards the advertised product, with significant effects on sales in subsequent periods.

At the opposite side of the spectrum, there are those who do not buy what is advertised as a matter of principle ("it's mean and vulgar").

In the middle, there are those who select elements from advertising for real choices, adjusting to its messages, while retaining some degree of independent judgement.

The proportion in the population of these three basic types can widely fluctuates, depending on the general and specific cultural level, richness of social interaction and networking, difficulty of choice.

In terms of the media business (TV, press, websites as Facebook, etc.), between people that are prone to persuasion and others that resist, either because of high education or because of deep distrust, the media relying on advertisement for its funding will try to appeal with content and qualities the former, so that they will constitute the bulk of its audience. This tends to shape the content of non-paid programmes and articles, whose task is to attract an audience prone to be persuaded by advertising. In sharper terms, when you see a stupid program in TV, they claim that it's the average person that asks for it, in reality they are luring the below average person that will disproportionately be bamboozled by their true source of income. You are the product sold to industry.

The medium used and the authority of the testimonials have strong impact on the credibility of advertising. However, even the most absurd and surrealistic advertising can provoke significant changes in attitudes and behaviours.

Advertising and vertical differentiation

Until now, we did not distinguish the many kinds of advertising in terms of market segment. However, the vertical product differentiation plays a huge role in shaping the message, the style of the advertising, its main channels of reproduction and diffusion.

It's well beyond the aim of the present short introduction to provide full schemes of those relationships. However, as a first approximation, you might consider the following table:

It goes without saying that there are many counter-examples. Creativity is here the rule; the product, the consumer habits, the national communication infrastructure can be so diverse that any generalization misses important points. But next time you shall see an advertising, try to characterize its target, so to develop your own ability of interpretation.

In another vein, it is worth asking in which vertical market segments are the largest advertising budgets and whether advertising has an impact (and which) onthe price of the product advertised.

Determinants

As a discretionary fixed cost, advertising budget expresses the policy of the firm, in particular:

1. the sub-culture of the top management;
2. the perception and interpretation of the business phase (e.g. launch of a new product while strong general recovery is expected);
3. the past experience with advertising effectiveness;
4. how much the competitors are visible on media;
5. the current cash flow as well as profits.

In other words, high levels of advertising spending is usually linked to the following factors:

1. a market-oriented business culture, with top management raising from marketing department, not e.g. from R&D dept.;
2. the perceived need of providing the market with new information and more positive attitudes;
3. positive examples of advertising effectiveness in the firm's past;
4. high visibility of competitors in the media;
5. abundant cash flow and high profits.

Business cycle behaviour

During recession, most firms cut advertising expenditure. The first firms to exit from recession lead the productivity and profits increase, so they are usually the first to use (pro-actively) advertising; in so doing they are experiencing high "share of voice" (% of total adv. budget and visibility), so usually being effective in prompting sales, establishing a positive feedback between advertising, volumes of sales, consumption level, and profits. With more generalized recovery, their competitors imitate them, which boosts overall expenditure.

Since many more firms are now spending for advertising, their individual "share of voice" - thus to a large extend their effectiveness - is falling down. Prices - in particular media - can be very high (because of inelasticity of adv spaces and high demand), so that the recession finds unprepared firms with skyrocketed adv. budget and falling sales. This, in turn, justifies the following cuts.

In crisis times, certain services and products that usually don't need to be advertised (e.g. house sales in city centres) get promoted to stimulate any demand.

Long-term trends

Advertising is a part of the long term dynamics of Learning To Consume (Witt, 2001; Chai, 2016). Advertising is on the rise since several decades in almost all over the world, because of the mass market and globalization dynamics. Foreign producers in richer countries can afford TV advertising in developing countries, so to prepare the ground to their market positioning for the future.

Formal models

Dynamic competition with advertising, finance, and R&D

Consumer reaction to informative advertising

An agent-based model with advertising and social networks

Recognition process of advertising information: a multi-agent based approach

How effective is advertising in a duopoly?

Advertising in the U.S. Personal Computer Industry

Advertising in telecoms and media market: an agent-based model

Related papers

Critiques and proposals for advertising in the perspective of sustainability in developed and developing countries

Alcohol and advertising

Junk food in Asian countries: a comparative study of the influence of advertising

[1] D. J. Bridge, J. L. Voss. Hippocampal Binding of Novel Information with Dominant Memory Traces Can Support Both Memory Stability and Change. Journal of Neuroscience, 2014; 34 (6): 2203 DOI: 10.1523/JNEUROSCI.3819-13.2014

Wtt U., Learning To Consume - a theory of wants and the growth of demand, Journal of Evolutionary Economics, 11:23 - 36, 2001.

Chai A., Tackling Keynes' question: a look back on 15 years of Learning to Consumer, Journal of Evolutionary Economics, DOI: 10.1007/s00191-016-0455-7, 2016.

Data

Advertising expenditure in Japan by media and product: 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Advertising and consumption expenditure by product

Advertising Effectiveness in UK Film Distribution