A Theory of Combative Advertising

<p>In mature markets with competing firms, a common role for advertising is to shift consumer preferences towards the advertiser in a tug-of-war, with no effect on category demand. In this paper, we analyze the effect of such "combative" advertising on market power. We show that, depending on the nature of consumer response, combative advertising can reduce price competition to benefit competing firms. However, it can also lead to a procompetitive outcome where individual firms advertise to increase their own profitability, but collectively become worse off. This is because combative advertising can intensify price competition such that an "advertising war" leads to a "price war." Similar to price competition, advertising competition can result in a prisoner's dilemma where all competing firms make less profit even when the effect of each firm's advertising is to enhance consumer preferences in its favor. Given such procompetitive effects, we further show that cost of combative advertising could be a blessing in disguise—higher unit cost of advertising resulting in lower equilibrium levels of advertising, leading to higher prices and profits. We conduct a laboratory experiment to investigate how combative advertising by competing brands influences consumer preferences. Our experimental analysis offers strong support for our conclusions.</p>