How Does Advertising Affect Price Elasticity?

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Abstract

The topic of the project is how advertising affects price elasticity. Key research questions are what factors determine the effect of advertising, how advertising character influences price elasticity, how promotion impacts the customer mindset in the long-term perspectives and what companies should consider when adjusting their price and marketing strategies. The findings are that various factors determine the effect of advertising on price elasticity.

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First, it is the type of customers; second, it is the character of advertising, whether it is informative or persuasive. Advertisement can increase and decrease price elasticity regarding the targeted buyers and features of particular markets. To achieve effectiveness in marketing campaigns, the companies should consider the prices of competing firms or change the demand for goods from all sellers in a given product group.

Introduction

The concept of price elasticity is fundamental when developing a complete pricing strategy in retail. According to it, the manufacturer can set optimal prices, win customer loyalty, and achieve its goals. The price elasticity of demand is necessary to indicate the correlation between changes in the required quantity of a product and changes in its price. When the price changes, the demand for a product remains at the same level, then the product is considered inelastic, and vice versa. Marketing specialists should pay attention to this aspect, analyzing to what extent the product is sensitive to fluctuations in price. Achieving an acceptable level of an advertising campaign, which can bring the success of a product intervention in the market, is possible only when considering all crucial variables. Therefore, it becomes vital when making certain decisions on pricing strategy.

Price elasticity and advertising are interconnected; the latter is a type of activity or product aimed at implementing tasks of various organizations by distributing information. This information should impact the mass or individual consciousness, causing a particular reaction in the targeted audience. Advertising’s purpose is to ensure the sale of goods and profit to the advertiser. The key research questions are what factors determine the effect of advertising and how advertising character influences price elasticity.

Moreover, it includes how promotion impacts the customer mindset in the long-term perspectives and what companies should consider when adjusting their price and marketing strategies. Overall, it is important to consider at the micro-level as almost any state of consumer demand can be altered by marketing activities, including targeted promotional activities. Thus, it should be consistent with the firm’s actual production capabilities or its sales policy.

Competing Perspectives

There are two principal approaches towards the character of the impact of advertising on price elasticity. The first one adheres to the idea that advertising results in product differentiation, contributing to customer loyalty. In the presence of more than one manufacturer, product differentiation arises since consumers can distinguish between goods produced by different firms (Chan et al., 2017).

Although the goods of various organizations are usually assumed to be substitutes, each of them gains almost monopoly power within certain limits determined by the price elasticity of demand for its goods. Product promotion enhances this differentiation and reduces the price elasticity of the advertised product, which further brings the firm’s behavior closer to monopoly (Chan et al., 2017). Therefore, price sensitivity decreases and raises prices for the targeting products.

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Another opinion is that advertising provides information on products and, consequently, develops people’s consideration set; as a result, there is high price elasticity. Brand advertising lacking price information had led to lowering price elasticity, while the ad with such information had caused opposite outcomes (Chan et al., 2017). Moreover, advertising attracts price-sensitive consumers, making the demand curve more elastic (Erdem et al., 2008).

The effect is determined mainly by the content of advertising, whether it is informative or persuasive. Price elasticity for different categories of goods will change in different ways according to the character of the target audience and methods used in promotion (Erdem et al., 2008). The price sensitivity for a product allows companies to determine whether consumers can be influenced by changing prices. The topic has been examined in multiple studies; however, there is no standard approach towards the question as results are mixed depending on the research area.

Information Sources

The information sources in the research paper can be considered reliable as most of them are peer-reviewed articles from scientific journals. The theory is presented in work by Helmond (2020); he provided comprehensive information on pricing strategies. It focuses on finding an optimum price for the products and services of the companies. Helmond (2020) also considered the problem of advertising as an essential part of pricing strategy. Several case studies were used in the paper; for instance, the survey conducted by Kianfar (2019) aimed at examining the effects of advertising on the price elasticity of demand in a three-level supply chain.

Kianfar (2019) applied a mathematical model of type mixed-integer quadratically, principles of harmony search, mathematical modeling to conduct research. Zhao et al. (2015) analyzed advertising effects on elasticity in a two-tier supply chain. A Stackelberg game model was used; the findings develop knowledge in advertising decisions within price-dependent demand (Zhao et al., 2015). These sources present the general approach towards advertising effects on price elasticity.

Regarding alternative opinions and in-depth analysis, several articles provide comprehensive research on the topic. Motta (2013) presents the assessment of price elasticity in different situations when there is an advertising and promotion ban. Ataman et al. (2016) conducted the most comprehensive study on advertising’s long-term impact on price elasticity across brands and categories. Chan et al. (2017) investigated the effect of advertising on a company’s goodwill and price sensitivity in the retail sector.

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Erdem et al. (2007) provided a study to examine how various marketing activities impact the demand curve. Nielsen scanner panel data on four consumer goods categories were applied (Erdem et al., 2007). The limitations of most studies are the lack of modeling relating to the situations. However, the reliability and validity of the sources are ensured by the clarity of methodological position and the use of a complex of modern theoretical methods.

Discussion and Analysis

In terms of present market circumstances, price elasticity reflects the relationship between adjustments in demand and price. If the market is considered elastic, a slight fluctuation in price results in a significant change in sales volume (Helmold, 2020). On the contrary, in case the market is inelastic, then even perceptible price modifications lead to only minor changes in sales (Helmold, 2020). Thus, pricing strategies should take into account the degree of elasticity; elastic markets require lower prices to increase profits; in inelastic categories, higher prices are needed to raise profits.

Types of Customers

The price sensitivity of consumer demand is also influenced by the specifics of purchasing behavior and purchasing decisions. There are several types of customers in terms of price sensitivity and perception of the product value. The first group is price-oriented buyers interested in low prices that provide a minimum level of quality (Helmold, 2020). It is almost unmanageable to persuade them to pay more for the extra qualities of the item. They tend to make choices according to their own experience; they know how much to pay for a particular product (Helmold, 2020). Such customers are not interested in information about the properties of the goods, and they make purchases in markets or stores with the lowest priced discounters.

Another group is customers valuing brand relationships; they have strong preferences for companies – both products and stores. Like price-driven purchasers, they are reluctant to consider alternatives. If the range of prices for the products in the chosen brand meets expectations, there will be no search for other options (Helmold, 2020). A change of preferences is possible only due to a loss of confidence in the brand (Helmold, 2020). These customers go shopping in the same stores, ignoring the advertisements. If they compare prices, it will be only to reaffirm their choice.

For value-oriented buyers, the product’s price is critical, but at the same time, they would like to get a specific product. They used to spend more time searching for particular goods compared to previous types of customers. They can make a high-value purchase if, as a result of market research, they find that some product qualities are worth the money (Helmold, 2020). Such customers receive information about a product from various sources to complete the assessment and find the best price-quality ratio (Helmold, 2020).

They are also called price-sensitive customers. Another group is people that choose convenience, being not interested in comparing prices and brands. They buy what is currently available to them without the effort of searching (Helmold, 2020). This is possible if the buyer values time or his/her spending on the product is insignificant, so there is no need to look for and analyze other options for quality and price.

Therefore, advertising may become a decisive factor in gaining profit; people buy and spend more on popular brands than on no-name ones. This means that specific pricing and non-pricing agents incentivize customers to pay more for certain products, even when cheaper alternatives are available (Zhao et al., 2015). Combining these factors is the price elasticity of demand; its precise calculation allows retailers to increase their revenue while maintaining high customer loyalty (Zhao et al., 2015). As a result, organizations face a common problem of how to increase prices, avoiding decreasing sales. Some manufacturers assume that raising prices would cause a drop in consumer demand; consequently, it leads to investing amounts in a marketing strategy contributing to increasing demand for the goods.

General Effects on the Market

Regarding the fundamentals, the price elasticity value for most kinds of goods is negative. Therefore, if the price is growing, the demand is decreasing (Kianfar, 2019). It does not concern luxury items as they have an opposite tendency regarding price elasticity (Kianfar, 2019). According to Chan et al. (2017), pricing and advertising complement each other as the latter affect the price elasticity of demand. For instance, marketing competition reinforces price competition while improving the companies’ profitability (Chan et al., 2017). Increased costs on advertising lead to mitigating the level of price competition.

Furthermore, in a manufacturer-retailer channel, additional advertising costs reduce the double marginalization issue (Chan et al., 2017). This problem affects the profit of firms negatively and brings adverse outcomes for consumers. According to Chan et al. (2017), the organizations’ and retailers’ profit margins are both decreased when they can compete in price and advertising. Chan et al. (2017) claim that, in this case, advertising serves as a strategy that makes retailers drop the price. With an enlarged share of marketing campaigns, it stimulates price elasticity.

Character of Advertising

The most fundamental difference concerning influence on consumer decision-making is between the informative and persuasive effects of advertising. Informative effects do not affect the structure of consumers’ preferences; they only inform them about the existence of a product or reduce uncertainty about its unknown characteristics (Ataman et al., 2016). Thus, consumers are initially unaware of the product; an example is launching a good of an entirely new type on the market.

Consequently, the only way for them to find out about it is through advertising. Contrariwise, persuasive advertising has the reverse effect as it directly changes sales rates and preferences in the target audience and population in general. Therefore, such a question can be assessed in terms of whether advertisements decrease price elasticity or increases.

Decreased Price Elasticity

The model of the influence of persuasive advertising on demand, in general, is also considered. It is based on the assumption that the willingness to pay for a product changes. The maximum sums customers are willing to spend for an item turns out to be higher than in the absence of advertising (Motta, 2013). In this case, the price elasticity of demand depends on the level of advertising: the more intensively a particular product is promoted, the less price elastic the demand for it becomes (Motta, 2013). A persuasive effect also leads to a decrease in the price elasticity of demand in the case of more than one product.

In some cases, advertising does not always increase the price elasticity of demand. For instance, according to Erdem et al. (2008), the demand is less elastic in the Ketchup market. It is because companies focus their advertising on the distinctive taste of their products (Erdem et al., 2008). The Heinz company focuses on a horizontal dimension, valued by consumers (Erdem et al., 2008). According to Erdem et al. (2008), “advertising that stresses horizontal characteristics in which a brand is perceived as having an advantage will increase willingness to pay for infra-marginal consumers (p. 140). Hence, the advertising effects depend on vertically or horizontally differentiation.

Regarding monopolies, a large firm is always interested in obtaining the image of a high-quality goods manufacturer, which creates price differentiation relative to the existing lesser-known brands. Corporations can count on top status because they have the necessary resources to provide the natural benefits of product differentiation. Advertising can increase monopoly power by creating and maintaining consumer preferences for a particular brand of product, thereby reducing the elasticity of demand for it (Kianfar, 2019). It allows them to charge high prices and retain a significant market share for a long time. Consequently, advertising contributes to forming a solid brand image and leads to monopoly power, diminishing price elasticity.

Increased Price Elasticity

Compared to advertising effects that decrease price elasticity, its influence on the curve of the substitute product is more complex. If advertising for one product is at the same time anti-advertising for another, then the increase in its intensity enhances the price elasticity of demand for the second product (Zhao et al., 2015). If advertising of a product is constructive and contributes to the attractiveness of both products for the consumer, its impact on the demand for the product is determined by the level of this constructiveness (Zhao et al., 2015). The price elasticity of demand for a product decreases with increasing advertising intensity; otherwise, it grows.

There are two ways how advertising can increase the price elasticity of demand. The first is that it impacts the particular factors of consumer’s demand functions, making the latter less or more price sensitive (Erdem et al., 2008). According to Erdem et al. (2008), another method is that advertising modifies the target audience and brings other groups of buyers. In particular, it draws the attention of price-sensitive consumers willing to pay for a brand (Erdem et al., 2008). Overall, these approaches stimulate increasing the price elasticity of demand.

Considering the second method, advertising may attract more price-sensitive customers; this results in increased elasticity. For instance, price promotions will influence sales rates in the retail sector (Chan et al., 2017). TV ads include images, sound, movement, and color and, hence, significantly influence the advertising audience than ads in other media. However, the disadvantage of TV advertising is that during its broadcast, the attention of a potential consumer should be focused on the screen, or the advertising message will not be perceived.

An example is TV advertising that is advantageous only if it was accompanied by in-store promotions (Erdem et al., 2008). Such a promotion increases customers’ awareness and raises their willingness to pay.

Price elasticity and advertising are interconnected in terms of the company’s reputation. According to Chan et al. (2017), a company’s goodwill presented through marketing campaigns also influences price elasticity. A brand’s reputation depends on advertising spendings; the demand becomes price elastic (Chan et al., 2017). Regarding price elasticity in supply chains, advertising directly affects the demand. For instance, the research conducted by Kianfar (2019) argues that one of the principal promotion tools is advertising as it influences the potential clients’ interests. It also raises brand awareness; hence, it affects companies as it stimulates the customers’ buying behavior (Kianfar, 2019). Therefore, advertising is recognized as a pull marketing instrument, being a strategic complement.

Long-term Effect of Advertising on Price Elasticity

With regard to the long-term perspective, advertising has a prolonged effect on price elasticity. According to Ataman et al. (2016), there is a positive trend in the consequences of marketing campaigns for this aspect.

For instance, lowering price elasticity is achievable for lower-quality and higher-priced brands through own and competitive advertising (Ataman et al., 2016). It is reliable for an average brand in an expensive segment of products as price elasticity will be more likely reduced in the long term compared to a less expensive category brand (Ataman et al., 2016). Highly concentrated and frequently used products are characterized by the beneficial effect of advertising on price elasticity (Ataman et al., 2016). It is a practical means to enhance “brand health in mature fast-moving goods markets” (Ataman et al., 2016, p. 20). Therefore, the effect of advertising relies on the product category, frequency of buying as the level of product maturity defines the level of price elasticity reduction.

In terms of reducing price sensitivity, promotion is more profitable for trademarks with a lower-than-average offer regarding quality and high price (Ataman et al., 2016). In this case, advertising stimulates clients to buy alternatives that are considered better for meeting their needs (Ataman et al., 2016). In addition, marketing campaigns diminish long-term price elasticity considerably in frequently purchased and highly concentrated goods categories with a moderate degree of maturity (Ataman et al., 2016). Advertising campaigns of competitive firms also change the average brand’s price elasticity. However, the long-term effects are weaker than an organization’s own promotion (Ataman et al., 2016). Therefore, all advertising for each brand category has a long-term impact on price elasticity in the particular industry.

Recommendations

Manufacturers and retailers spend significant amounts on promotions when this advertisement can bring no profit for the company. The activity aims to promote a product or service that affects the target audience; it is also divided into informative and persuasive. The first visually informs clients of a product or service, and the latter allows a free promoted product or gift when buying a particular product and discounts (Chan et al., 2017). Therefore, advertising is profitable if the organization takes into account the regular price of the product. If it is too low, then the promotion will undermine the brand’s margin; if it is too high, the buyer will deliberately wait for the stock, negatively affecting sales at the regular price.

One of the measurements of whether an advertising campaign is effective in increasing sales rate is advertising elasticity. As a result of good advertising, there is a positive impact on demand (Kianfar, 2019). The more organizations spend on promotion campaigns; the more customers will be attracted to the product (Kianfar, 2019). Therefore, there is an option when the benefits of advertising can counteract a price increase. Reflecting microeconomic theory, advertising a product with high price elasticity is not entirely efficient. Once a company starts offsetting advertising costs with the selling price, demand will decrease.

However, it is profitable to advertise goods with high elasticity of demand in terms of advertising. It should never be overlooked because the elasticity of demand for advertising for almost any product changes at different periods of its presence on the market.

It is necessary to know the price elasticity to determine regular and promotional prices. There are four options for product price elasticity, and each requires a different marketing approach. For low elasticity of advertising and regular prices, it is recommended to reduce discounts or raise regular prices to increase profits. These measures are appropriate for niche and seldom-bought products with little competition between manufacturers and strong customer brand loyalty (Kianfar, 2019). If the elasticity of promotions is low and the regular price’s high, the company should invest less in advertising and support the latter; this mainly concerns essential goods.

In the opposite situation, when the elasticity of the promotion is high and the regular price is low, the advertisements will help increase sales, and the subsequent rise in the regular price will consolidate the effect of the shares. It is helpful for products with above-average brand loyalty. Finally, with high promotional and regular price elasticities, the approach is to vary the full price and run promotions based on the retailer’s specific short-term goals (Kianfar, 2019). This is for products with intense competition between manufacturers and with a low level of brand loyalty. Therefore, from the definition of the product category and the type of elasticity, it is possible to regulate the product’s position on the market.

In addition, the elasticity of the product depends not only on the category but on the particular retailer. For example, a large impulse bakery manufacturer decided to raise the price of its most popular product (Ataman et al., 2016). Moreover, preliminary calculations based on national sales data showed that the price increase should not affect sales (Ataman et al., 2016). However, when marketers began to make predictions for each trade channel, it turned out that sales of some retailers would decrease because shoppers in supermarkets are less sensitive to price changes than in hypermarkets.

Moreover, price sensitivity even depends on the packaging format and market competition. Therefore, the manufacturer needs to calculate, in addition to its elasticity, the so-called cross-elasticity (Ataman et al., 2016). Intrinsic elasticity shows the change in sales if the product’s original price is adjusted, but competitors’ prices remain unchanged (Ataman et al., 2016). Cross-elasticity measures how much sales will be lost if competitors’ prices change (Ataman et al., 2016). Thus, each promotion should be planned individually; no approach gives the same results for all products.

At the overall market level, price elasticity is related to market share. Brands with a small market share are more sensitive to price changes than brands with a large market share within a single product (Erdem et al., 2008). Consumers are willing to pay a slightly higher price for a genuine brand with real benefits. This is due to the influence of brand strength; customers are more likely to purchase products of well-known brands and will more quickly come to terms with an increase in the price of a favorite product (Erdem et al., 2008). Consequently, they will not accept an increase in the price of products that have not yet gained such popularity.

The price should be within certain limits; in a mature market, the range or levels of prices for goods or services are established. If the product’s price is out of bounds, the customers’ willingness to pay will be less than it could be. Thus, by reducing the price without understanding and taking into account the price elasticity of demand when calculating the size of the discount, the company risks losing profitability even with a tangible increase in turnover.

Conclusion

From a firm’s perspective, advertising plays a vital role in pushing products in an imperfectly competitive environment. Advertising tries to adapt consumer demand to a new product; due to it, the firm hopes to increase its market share and increase consumer loyalty in relation to its differentiated product – shifting the demand curve for the firm’s product to the right and reducing its price elasticity. There are four types of customers: price-driven buyers, customers valuing brand relationships, value-oriented buyers, and those who choose convenience. Based on this assumption, the effect of advertising may differ whether it increases price elasticity or decreases it.

Concerning general advertisement effects on the market, it is beneficial for reducing double-marginalization problems and stimulates marketing and price competition within the industry, improving the companies’ profitability. Moreover, another factor that determines the effect of promotion is the character of marketing campaigns. The informative advertising does not lead to any curve adjustments; however, persuasive one can significantly change the situation. The latter depends on vertically or horizontally differentiation; price elasticity decreases due to monopoly power stimulated by advertisement in some markets.

The opposite effect when price elasticity raises occurs due to changes in the target audience and increased share of price-sensitive buyers. The complexity of the analysis of this problem stems from the variety of structural and behavioral prerequisites. Moreover, advertising can change the cross-elasticity of demand for a product concerning the prices of competing firms or change the demand for goods from all sellers in a given product group. Thus, it is required to conduct marketing research using proper methods or use ready-made data to determine the sensitivity of consumers to price.

References

Ataman, B., Pauwels, K., Srinivasan, S., & Vanhuele, M. (2016). Advertising’s long-term impact on brand price elasticity across brands and categories. HEC Paris Research Paper No. MKG-2016-1153. Web.

Chan, T. Y., Narasimhan, C., & Yoon, Y. (2017). Advertising and price competition in a manufacturer-retailer channel. International Journal of Research in Marketing, 34(3), 694-716. Web.

Erdem, T., Keane, M. P., & Sun, B. (2008). The impact of advertising on consumer price sensitivity in experience goods markets. Quantitative Marketing and Economics, 6(2), 139-176. Web.

Helmold M. (2020) Total Revenue Management (TRM). Springer.

Kianfar, K. (2019). Maximizing profit in a supply chain by considering advertising and price elasticity of demand. Computers & Industrial Engineering, 135, 265-274. Web.

Motta, M. (2013). Advertising bans. SERIEs, 4(1), 61-81. Web.

Zhao, L., Zhang, J., & Xie, J. (2015). Impact of demand price elasticity on advantages of cooperative advertising in a two-tier supply chain. International Journal of Production Research, 54(9), 2541-2551. Web.

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