Chocolate and Gold Coins

Thursday, October 20, 2005

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.

12 Comments:

  • Hi Michael,

    I think it would be interesting to come up with a list of companies with quality products who don't advertise. Off the top of my head, I can think of Google and Ben & Jerry's.

    Vikram

    By Blogger Vikram A., at 7:30 AM  

  • Gasoline is rarely advertised. Same goes for salt, sugar, pepper, and nails.

    By Blogger Vikrum, at 10:33 AM  

  • Vikrum, Gasoline, Salt, Sugar are now some of the more heavily advertised products in india.

    Michael, great post (par for the course though)
    David Ogilvy did say "Good advertising kills a bad product faster" and it is true.
    Some unconnected, random thoughts that your post sparked off - see if you can make sense of it...

    I would think that products would sort themselves out into two categories:
    I think there's the other category too: Moderate products / substitutes that have similar quality and advertise neither too heavily nor not at all...

    Most often, advertising is the only usp brands can claim (for example coke & pepsi, whose only difference is in the way they advertise) and therefore it is difficult to say which is the bad product.

    advertising a bad product / one of inferrior quality might get the product pull up its socks and start delivering/standing up to its image... but this is assuming that some sensible guy is handling the brand in an ideal world that is, but then in an ideal world, there wouldn't be a product of inferior quality

    By Blogger Ravages, at 11:34 AM  

  • Great post.

    However even if consumers are savy, do they always have time to do first hand research on all the products, everytime they use it? Many rely on opinions. Failing that, we fall for the associative power of advertising... the ad made me feel good, so I have positive feelings about the product too.

    About advertising only quality goods etc, there is the old argument of marginal cost and marginal revenue. Regardless of whether you have a quality product or not, if the marginal revenue from the dollar spent on your (either short or long term) ad campaign is more than the marginal cost of doing it, why not do it? That decision should have nothing to do with what I think the quality or perceived quality of my product is.

    AA

    By Anonymous AA, at 11:34 AM  

  • Michael.....both this and the previous posts were very good.

    But.....in both, you assume (or hope) that a product will want to be good in order to succeed, and the consumer will be smart, and try to make the best choice thats laid out to him.

    However.......more often than not, a consumer is going to go by what "intangible" need is satisfied (Maslow's needs). If a product is satisfying an emotional need......a consumer will take it, even if its quality is low.

    Hence.....if advertized right.....a crappy product like IIPM will find plenty of takers.

    By Blogger Sunil, at 5:49 PM  

  • Hi Vikram, Vikrum, Chandru, AA, and Sunil

    Vikram: For a very long time the famous example of a company that never advertised was Hershey's (from 1900 to 1970).

    Why would Google advertise? It sells itself.

    Vikrum: Actually Morton Salt has had a very famous advertisement that has run for years (when it rains - it pours). Their salt was special because apparently it didn't absorb moisture or something.

    But most common commodities don't need advertisement.

    Chandru: That's a good quote by Oglivy and I was trying to find a good example. The one I remember read was the Piel's Beer ads. Famous comedians Bob Elliot and Ray Goulding made a very memorable set of commercials for Piel's Beer but the beer Co. later went bankrupt. Apparently the beer was no good. But the problem with the story is the ads really did sell the beer while they ran. The decline happened when they stopped advertising. But I guess the ads would have been worth a lot more if the beer had been a good product.

    AA: It makes more sense to shop around for more expensive items. Therefore there may be some very overpriced toothpastes out there that advertise heavily but automobiles are a different story. I would think it was in the interest of each family the heavily investigate an institute of higher learning like an MBA school.

    As for the marginal cost, marginal revenue - yes exactly right. But I am saying that the marginal revenue from advertising is higher for a quality product because they are more likely to get long term customers. See my comment about Piels beer above. Obviously their ads didn't provide as much marginal revenue in the long run because Piels beer went bondi.

    Sunil: That was my point: a poor quality product can be successfully marketed with good advertising if people are lazy about investigating the quality of the product independent of the advertised claims. This is understandable for toothpaste but less so for a B-school.

    But in the long run, IIPM will find it hard to find new suckers. They will probably prove Oglivy's (see Ravages comment) dictum that "Good advertising kills a bad product faster." The IIPM was getting to be too well known not to suffer a lot of bad word of mouth.

    By Blogger Michael Higgins, at 6:31 PM  

  • Hmmm...interesting discussion. In the IIPM case (or any educational institution) the "product" is both the "curriculum" and the "students" who graduate. IF IIPM if builds just enough reputation (thru ads) to get slightly better students each year, their product (students) will get better each year (irrespective of curriculum). I think companies hiring the students have more importance in B-Schools than the degree itself, because students go there mainly to land high paying jobs. As the students get slightly better each year, better companies will hire them, further bolstering IIPM brand.

    In some other disciplines the actual knowledge imparted to the students may be more important than which companies hire them. In that case the first product i.e. the curriculum is more important in which case this brand building thru ads may fail, unless the quality of curriculum also goes up.

    By Blogger Transmogrifier, at 8:17 PM  

  • Michael,

    I would add that it pays to advertise if you are selling a product of ambiguous quality.

    There's an interesting paper by Hoch & Ha ("Consumer Learning: Advertising and the Ambiguity of Product Experience," Journal of Consumer Research, vol 13, 1986) which concludes that when the product quality is unambiguously good or bad, consumer learning is based on the quality of the product. But if product quality is ambiguous as with many products, advertising has dramatic effects on consumers perception of product quality - essentially consumers percpetion of quality is shaped by the advertising they receive.

    In another article by Braun ('Post Experience advertising effects on consumer Memory, JCR, Mar 1999), this impact of advertising can shape memory for the product even after the product has been experienced.

    n!

    By Blogger Neela, at 10:10 PM  

  • Michael, you seem to imply that the people who go to IIPM are too lazy to properly investigate the school.

    I would not agree - laziness could be true of some students & families. But I think that this is really a classic case of motivated reasoning (for an excellent discussion of motivated reasoning, see Kunda, The Case for Motivated Reasoning, Pyschological Bulletin, Nov 1990), in which people ar emotivated to search for evidence that confirms their conclusion.

    Its easy to see why people would engage in motivated reasoning with regard to business schools in India- the gold rush with an MBA. The question is: how do you debias people who will engage in motivated reasoning?

    Research shows one way to do this is to increase the accuracy-motivation of people, which is done by getting them, for example to justify their reasoning to others.

    Any other ideas?

    n!

    By Blogger Neela, at 10:29 PM  

  • Hi Transmogrifier and Neela
    Transmo: I tend to agree with Ravages, "Advertising kills a bad business faster." Too many people now know that the IIPM faculty is simply former IIPM students with no practical business experience. This knowledge will kill any positive "branding effect" that the IIPM ads might have had.

    Neela: I cannot know exactly what the students and parents of IIPM were thinking when they signed up. It does seem like PT Barnum's dictum "There's a sucker born every minute."

    Your idea of "Motivated Reasoning" sounds to me to be more or less a euphonism for intellectual laziness. The bottom line, if you didn't do sufficient homework on the B-school before attending, then you get an F.

    I will admit that when I went to college the first time, I was pretty lazy about it. I have no real good explanation for that except that I was only 17 and not very mature. My parents should have taken more interest in the subject but I guess they assumed I would go to the local state school (which I didn't) and it was not worth their while to investigate such an important choice. In retrospect, it is hard to rationalize. But, luckily, I did not go to a school like the IIPM.

    By Blogger Michael Higgins, at 12:19 PM  

  • Michael,

    I think you need to understand the context in which parents and kids make decisions to enter schools such as IIPM.

    First, in India, after doing just an undergrad degree (esp a non-engineering one) one can't hope to break into the management ranks at any halfway decent firm. Hence hte rush for a graduate degree.

    Second, the MBA is the quickest and surest way to enter corporate India as there is still little tradition to take grads in say, English literature in consulting firms or banks.

    Third, kids normally go to bschool right after undergrad, in which case, parents pick up the tab and have a lot ot say about education of the child. Parents are often desperate to have their children "settled" in a white collar job in a respected multinational. To do this, any management degree, even from a third-tier school is worth it.

    Fourth, all the media attention on IIM salaries tends to make everyone think they'll strike it big after entering a management institute.

    Obviously parents and kids take all this into account when faced with the question: IIPM or nothing (or a worse alternative).

    IIPM, at least till this controversy erupted was seen as a school of ambiguous quality. One read those haywire advertisements (bad) and one met students, some of whom seem to have done OK (good). This is where I believe the advertising played a role in giving this school respectability, which was aided by press coverage to the school and founder.

    So I would hesitate to simply call it intellectual laziness. I think it would be hard to reach any other conclusion, given motivated reasoning. There has not been, till Rashmi's article, any expose on this school and most word-of-mouth has been OK so what basis would there be for checking claims?

    And finally, it is a question of latitude. Parents and kids might know that 50% of the advertising is garbage, but as long as the school delivers on the other 50% (well as long as the school delivers a job!) they might still be fine with the trade-off.

    n!

    By Blogger Neela, at 10:11 AM  

  • Very good article! After reading it, I finally thought about what I really want to be in the future. Thank you so much!

    By Anonymous homework help, at 6:01 AM  

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