When It Pays to Advertise

Some comments to my previous post got me thinking about advertising and whether the old saying, “It pays to advertise,” is really true in all cases. I would say that in general it only pays to advertise if you are selling a quality good or service. Advertisement costs money and this cost has to be made up in volume. This is easier to do if you can continue to sell the product in volume for years to come, even after you stop advertising. You want loyal customers who buy your product because they like it. This will only occur if you produce a product that has a very favorable cost and quality combination.

I would think that products would sort themselves out into two categories: ones that advertise regularly and cost a bit more and are premium quality and ones that cost less and don’t advertise and are of lesser quality. If I go to buy toothpaste, there may be 50 choices available. Maybe two-thirds of those are made by famous brands that advertise heavily. Then the remainder will be generic brands that never advertise and sell for less. If I think, “toothpaste is toothpaste,” then I would buy a generic brand and save a dollar. But most people would not risk getting an inferior product for the mere savings of one dollar so they choose a name brand.

Advertising has a lot to do with building a brand reputation. If you invest in the reputation of your product, you can reap a healthy stream of profits for years to come. But there’s a catch: if your product really isn’t so good, people will figure this out eventually and bad word-of-mouth will destroy your reputation. This is why I think it only pays to advertise a quality product.

But here is the interesting part: if only quality products advertise, people will assume that advertised products are quality products. A producer of an inferior product might seize this opportunity to free ride off of this perception and pass his inferior product as a quality product by merely advertising it heavily. If consumers are not savvy, this strategy might work for a small number of producers – especially ones with a lot of marketing skill. The market will be “polluted” by these inferior products passing themselves off as superior products. Over time, bad word-of-mouth may hurt these products but not before their producers pocket their millions.

There may be lots of strategies that take advantage of lazy consumers occasionally. For example, most gasoline stations charge almost the same price for gasoline because the market is very competitive. But some consumers become lazy and assume that the price of gasoline is the same everywhere. Therefore, a small number of stations in desirable locations will be able to charge several cents more than the average price knowing that many consumers never check the price and don’t realize that they are overspending. Obviously not many stations could successfully use this strategy but a few do.

The point is that the consumer has to take the job of being a consumer seriously. Just because markets tend to produce competitive prices everywhere, one cannot be lazy and just assume that these prices are the same everywhere, you need to shop around. Likewise we cannot assume that advertised products are quality products. We need to do are own research to see if the product is worth the money that the producer is charging.

When we buy a product or a service that is no good, we are likely to keep quiet about it because it is embarrassing to admit to a mistake. But this information is essential to an efficient economy. This information is the essential negative advertising that would counterbalance the producer’s misleading advertising. We each have a minor role in the general economy and we can help the economy along a little bit by taking that role seriously.