Evidence that advertising affects long-term price elasticity

By Nigel Hollis

A paper which starts with the statement, “Advertising often aims at creating and reinforcing brand differentiation, which should translate into reduced price competition,” is going to get my attention. The findings reported confirm that advertising does lower long-term price elasticity, but the role of differentiation is inferred not measured.

Advertising lowers price elasticity

The paper titled, Advertising’s long-term impact on brand price elasticity across brands and categories, is authored by M. Berk Ataman, Koen Pauwels, Shuba Srinivasan, and Marc Vanhuele. Their analysis explores 7 years of data from Kantar Worldpanel in France for 350 brands, in a variety of packaged goods categories. The results are summarized as follows:

“Our results indicate that both own and all competitive advertising in the category lower price elasticity of an average brand in the long run through their effects on intermediate customer mindset metrics.”

I am not qualified to comment on the Hierarchical Multivariate Dynamic Linear Transfer Function Model used, but the results align with my experience, and confirm that pricing power is one of the most important benefits of advertising. And that is important, particularly when too many marketers are focused on volume market share gains, trading higher sales for lower margins.

The authors report a simulation based on their model that shows for the average brand a 1% increase in advertising spending results in incremental returns to advertising of 11.7%. Given that the simulation assumes volume is constant, we might expect that all this gain would fall to the bottom line as additional profit. Further simulations suggest far stronger, positive gains for niche and premium brands but negative effects for economy and value brands.

Differentiation is inferred not measured

All well and good, but when it comes to how advertising influences price elasticity the explanation is theoretical, and I am not convinced that the primary mechanism by which advertising influences price elasticity is the creation and reinforcement of brand differentiation. This might seem strange coming from someone who, like the authors, believes differentiation is important, but I would like more proof than just references to past papers.

My main concern is that the role of differentiation is inferred not measured. The mindset metrics used in the model are advertising awareness, brand consideration, and brand liking. Of which, the effects on advertising awareness “consistently dominate.” This is exactly what I would expect having examined the response to advertising for thousands of brands, and it lends itself to an alternative explanation of how advertising could influence price elasticity.

While I believe it is reasonable for the authors to state that, “Our research suggests that consumers are willing to accept price increases for brands that invest more heavily in advertising…,” the rest of the statement, “…with a view toward differentiation (as is the case for most advertising in our data set),” is justified only based on inference and reference to other academic studies.

Does advertising need to differentiate to influence price elasticity?

While there plenty of evidence to suggest that perceived differentiation does encourage people to pay higher prices, does advertising have to create that differentiation? I suspect that depends on the brand and the category.

Advertising can amplify what is different about a brand – be it product, purpose, or price. And when there is little to differentiate between brands in a category, advertising alone can help a brand stand out from the crowd. But what all effective advertising does is make a brand more salient, which is why the analysis finds that advertising awareness consistently dominates the mindset metrics.

I do not believe it is necessary to invoke differentiation as the means by which advertising affects price elasticity. Given that the analysis is based on packaged goods, it seems far more likely that advertising improves brand salience, which has the effect of reinforcing habitual buying behavior among users and triggering impulse purchasing among non-users. The more instinctive that behavior, the less consideration will be given to the price asked.

Confusion not consideration

One of the findings from the paper is that in addition to its own advertising spend, competitive advertising spend also increases a brand’s ad awareness and decreases its price elasticity. The authors suggest that this is because competitive advertising heightens attention, helping people differentiate between brands, but I suspect the opposite is true.

People do not pay much attention to advertising, so even when the “message” is remembered, it often gets attributed to the wrong brand. So, it is not surprising that the model finds a cross-brand advertising effect, but I suspect that it is the result of misattribution, which helps reinforce existing purchase behavior. People are most likely to misattribute advertising to a brand they use, reinforcing its salience, and encouraging habitual purchase behavior.

Important findings, questionable interpretation

I believe the paper by M. Berk Ataman, Koen Pauwels, Shuba Srinivasan, and Marc Vanhuele is an important contribution to our learning about how advertising works. The paper clearly demonstrates that advertising can influence price elasticity over time, which ought to insulate volume sales from changes in the price asked.

However, I believe the references to differentiation as the mechanism by which advertising reduces price elasticity are a bit of a red herring. Far more likely to my mind, and consistent with the findings, is that awareness of advertising boosts salience and prompts more instinctive purchase decisions. This does not preclude advertising from amplifying a brand’s inherent differentiation, or creating it, but it does offer a broader mechanism by which advertising can affect price elasticity.