Generic Advertising, Brand Advertising and Price Competition: An Analysis of Free-Riding Effects and Coordination Mechanisms

Abstract

The main purpose of generic advertising is to enlarge the total market demand rather than cap- turing further slices from competitors. Several studies point out emergence of free-riding behavior under independent contribution and suggest use of coordination mechanism. However, existing literature does not shed light on the conditions under which generic advertising can be detrimental (beneficial) to stronger firms weakening (strengthening) their competitive advantage. Also, under a setting including both price and brand advertising competition, coordination in generic advertising has not been unraveled. In order to deal with such issues, we consider a one-stage duopoly game in which two firms jointly spend in generic advertising and, simultaneously, compete by setting price and brand advertising. Under independent contribution, we show that when generic advertis- ing effectiveness is high or differences between firms are overall small, weaker firm’s free-riding lowers the profit difference between the two firms and, sometimes, leads the stronger firm to make even lower profit. On the other hand, in presence of low generic advertising effectiveness or high asymmetries between firms, the stronger firm takes more advantage from generic advertising and increases the profit gap. Under coordination we consider two commonly used mechanisms to share generic advertising expenditure, i.e. fixed percentage (FP) mechanism and sales-proportional (SP) mechanism. We discover that neither mechanism is always dominant in terms of industry profit. In fact, under symmetry, SP mechanism always drives firms to spend more in generic advertising. However, this will result in a higher industry profit if either price or brand advertising competition is fierce or generic advertising effectiveness is low. On the other hand, FP mechanism can guaran- tee a bigger pie when both price and brand advertising competition is mild and generic advertising is highly effective. Numerical analysis under asymmetry seems to confirm our findings.