Comparative Advertising: The role of prices

This paper investigates some of the strategic aspects related to a firm's decision to engage in comparative advertising. Comparative advertising is where firms compare their good to a rival good in their advertising. There are a few papers on this in economics (and many more in marketing) that looked at comparative advertising as disclosing the attributes of goods as compared to the attributes of rival goods.

For instance one paper (Barigozzi et al. 2009) says that firms engage in comparative advertising in order to show that they are high quality. By comparing their good's quality to a rival good in their advertising, a firm opens itself up to litigation if the claims they make are unreasonable. This means that only a high quality firm would do this and hence comparative advertising allows firms with high quality goods to separate themselves from lower quality firms.

The other key paper in this field (Anderson & Renault 2009) thinks about comparative advertising as showing individual consumers what the best good is for them. By doing this a weaker firm may be able to ensure that some consumers come to them. This mechanism is probably clearer with a simple example. Consider that you know that 70% of people like coke more than pepsi and 30% of people like pepsi more. You do not know if you will like coke or pepsi more however. If you were to buy a good, you would pick coke because there is a 70% chance that you are one of the people that like coke more. This is bad for Pepsi because everyone that doesn't know what they like can reason with the same logic and buy coke so Pepsi makes no sales. But what if Pepsi could engage in comparative advertising which tells everyone all of the features of coke and pepsi. Then people would know whether they are a coke person or a pepsi person before they go to buy the good. This will mean that Pepsi will get 30% of the market which is much better than the 0% they could manage without comparative advertising[1].

To me however it seems like there was a significant amount of comparative advertising that could not be explained by these previous papers. There are certain examples of comparative advertising that contrasted a firm's price with an external firm's price for essentially the same (or very similar) goods. Here the focus is not on contrasting good characteristics because often no large difference exists.

Take for instance the advertisements of Progressive Direct, an American auto insurance company that gives prospective consumers the prices offered by competitors for comparable insurance plans. They air advertisements promising "we compare our direct rates side by side to find you a great deal, even if its not with us". Another example is provided by Amazon who allow competing firms to sell products on their site [2].

As a final example consider Skyscanner which allows searchers for flights to automatically get prices from competing services like Expedia. This behaviour seems counterintuitive. Considering that a consumer is currently on Skyscanner's webpage, why are they making it easier for that consumer to go to a rival website?

My explanation of this is built around the general tendency of consumers to judge quality by price. If a firm sets a high enough price for an item then a consumer can reason "If it were a low quality good that was cheap for the firm to produce then the firm would be want to sell it for a low price (with high sales quantity). The price is high though which must mean the good must cost alot to produce and it is a high quality good". Thus setting a high price can be a method through which a firm can show consumers that their good is high quality.

Often however the price that is required to communicate this high quality is so high that the firm is not making much money because the quantity they sell is so low. If the firm could communicate their high quality another way they would like to so they could drop their price to a lower level (with higher sales volume).

This is the basic insight through which I explain price comparative advertising. Firms sell the same goods as their rivals and consumers can realise that as the goods sold are identical, their quality must also be identical. Instead of charging a high price to signal high quality a firm can instead charge a lower price whilst engaging in price comparative advertising against a rival firm. The consumers can see the high price charged by the rival firm and realise that the good is high quality and buy from the advertising firm (which has the lower price).

The rest of this paper is comprised of analysing how this market will operate in equilibrium. Clearly if all firms were advertising like this there would not be any high pricing firms left to convince consumers the good was high quality. As it turns out advertising against rivals means that a firm can signal their high quality more efficiently than by setting a high price: the downside is that this firm faces greater price competition from the firm they advertise against. This means that in equilibrium there will be firms setting a high price and avoiding competition as well as firms that face greater price competition whilst advertising. This conforms to the intuition that the firms offering price checks tend to be the firms that are the lower pricing firms in the market.

There are other things I find that are less intuitive though. One is that firms do not earn any greater profit from advertising than from setting a high price. Whilst they do not need to set such a high price (with low sale quantity) and thus signal more efficiently, any extra profits from this are completely eroded from additional price competition. Thus in equilibrium, firm profit will be unchanged from the case where there is no advertising. The effect on consumers however is very positive as they benefit from lower prices both from firms not price signalling as much as well as from greater price competition in the market.

Whilst regulators in Europe and the United States have long allowed comparative advertising it is still banned in countries like Saudi Arabia and China. In Japan it is allowed but seldom used as it is considered impolite by consumers. The conclusion of this research is that market efficiency and prices for consumers could both be improved by more widespread comparative advertising. Thus the recommendation is that comparative advertising should be legalised and encouraged by legislators and regulators.


[1] Please note that in order to avoid maths this paragraph does simplify this paper considerably, particularly by avoiding talk about the strategic pricing choices of coke and pepsi.

[2] Amazon also receives a portion of the revenues from these external sellers on their website. Whilst these revenues no doubt play some role in Amazon's decision to operate this marketplace it is also true that this allows Amazon customers to compare Amazon's prices with other vendors.