Wednesday, February 25, 2015

Denying Market Entry Through Advertising



 
Brick By Brick

          Robert Smile surveyed over three hundred companies on their use of entry-deterring strategies. His findings are reproduced in Besanko et al. (2013). Smile examined the use of these firms in terms of the learning curve, advertising, patent acquisition, limit pricing, and excess capacity. All of these were examined in terms of the use for new products and existing products. The data are pretty clear in that use of advertising is the predominate entry-deterring strategy used by companies in the sample. Companies use intensive advertising in 62% of cases with a new product and in 52% of cases with existing products (p. 219).
Use of entry barriers exist because there is a profit advantage in controlling market share. Entrants to a market move the supply curve to the left but do not necessarily move the demand curve. This means that ceteris paribus, the equilibrium price of the product under consideration will be lower than it was before a rival firm’s market entry, and the quantity demanded will be divided between the incumbent and the new entrant. This drives down both profit and revenue. A rational actor will work to limit entry to their market.
The main problem with some of the options in limiting market entry is that they do not necessarily work in a dynamic system. If a firm either tries to keep prices low to prevent entry or maintain excess capacity, they may seem to make sense in a toy model with two time periods, but the actual market is changing and exists in a world of infinite time periods. Over time, if a firm were exercising limit pricing as a monopoly with limit pricing, it would see zero economic profit. If it were instead willing to share the market, as an oligopoly, then they would be able to see some profit above zero (Besanko et al. pp. 208). The same applies for holding excess capacity. A firm cannot be expected to hold that capacity forever. And as the saying goes, what cannot go on forever, will not.  The fact that these options do not necessarily work ties in with the fact that in many countries such theoretically anti-competitive practices are illegal.
The other side is looking at what works and what is used. Firms predominately use advertising to create product differentiation and limit market entry. A look at the top advertisers will illustrate this. Of the top twenty-five advertisers, several industries stand out. The cell phone industry’s big four are all represented. The list also includes five automakers, three insurance companies, five large retailers, two fast food companies, and three tech companies. The only real surprise is that there is only one beer company (“America's 25 Biggest Advertisers”). The common feature is that these are some of the biggest companies in America, so they can afford to spend a lot on advertising, but they all compete in fairly concentrated markets. Advertising is not just a way to maintain and steal market share from competition firms, but it creates a barrier to entry. To be fair, some of these industries have high barriers to entry for a new firm, but it also impedes other nation’s companies from market entry because the brands are part of the environment in a way that a new entrant could only hope to be. In terms of protecting market-share, advertising and marketing is the smart move for any executive.



References
Advertising Age. (2013, July 8). Infographic: Meet America's 25 Biggest Advertisers. Advertising Age. Retrieved from http://adage.com/article/news/meet-america-s-25-biggest-advertisers/242969/
Appleby, J. (2014, May 2). New hepatitis C Drugs’ Price Prompts an Ethical Debate: Who Deserves to Get Them? Washington Post. Retrieved from http://www.washingtonpost.com/business/new-hepatitis-c-drugs-price-prompts-an-ethical-debate-who-deserves-to-get-them/2014/05/01/73582abc-cfac-11e3-937f-d3026234b51c_story.html

Besanko, D., Dranove, D., Shanley, M., & Schaefer, S. (2013). Economics of Strategy (6th ed.). New York: Wiley.