STRUCTURE OF THE MARKET

The advertising industry operates in what should be termed a monopolistic competition. There are many firms but they differ in terms of reputation, service levels, location, capabilities, and size. There are some price differ- ences as well, although the price structure is relatively common throughout the industry when specific services are compared. Unlike many businesses, the most common price structure for the advertising industry was one based upon a commission system where the client paid a (usual) 15% commission on all media buys. Hence, the larger the client and the more ambi- tious the advertising plan and placements, the greater the money that was paid. In recent years, there has been much criticism of this historical prac- tice due to the very real possibility that the agency might choose the most expensive medium—typically prime time television—whether it was war- ranted for the strategy of the campaign and the target audience to be reached. As a result, many agencies converted to a negotiated flat price based on the actual work entailed by the job. For some jobs and in some agencies the fee basis is combined with some sort of commission for media placements, but this is becoming less common throughout the industry.

Because monopolistic competition means that the optimal price comes when product quantity yields a margin cost and when the firms involved sell products that may be differentiated from one another in several ways, the advertising industry fits best under this umbrella. However, unlike manufacturing firms, the clients or buyers of the agency production may differ from year to year as manufacturers tire of the product (the advertising) and switch to a different vendor (agency). This situation is different for firms that have their own in-house agency and for individuals who pur- chase advertising time and space for themselves (the latter is often classi- fied advertising). The advertising industry fulfills the other qualifications for monopolistic competition as well: There are a large number of firms involved, entry into the business is relatively easy (although it may not be possible to compete at the highest levels due to the necessary cost and ex- pertise demanded), and the other firms are unlikely to make retaliatory moves. The exception to this last is when a client asks several agencies to bid on a contract, but in this case, it is the client and not the competing agency that makes the initial move. The industry is competitive in the ways in which it seeks new accounts.

12. ECONOMICS OF ADVERTISING

253

SHAVER

A tangential and important point related to the advertising industry is that outside manufacturing and service firms spend large amounts on advertising, particularly in the categories of consumer products and low-price convenience foods. It is assumed that the amount of advertising expenditure by firms is related to units sold and at what price. There are also assumed to be diminishing marginal returns on excess advertising expenditure. The problem facing those firms paying for the advertising is that it is often difficult to measure sales gains and returns directly from advertising expenditure. Advertising is essentially an information conveying business. In some cases, advertising may fail to deliver the messages in an efficient manner or to provide a return on the product (advertising messages) in the most profitable way. Some goods and services can operate without advertising (or without much advertising) because there is little to differentiate the basic consumer goods among brands. Sugar would be an example. However, low-cost and easily substitutable products tend to do a great deal of advertising in some categories. Backman (1967) pointed out that products of low cost and low risk must continually advertise to keep customers loyal. He found that soft drinks, soaps, candy, gum, and other low-financial and low-social risk products spend a greater percentage of their budgets on advertising than do more easily differentiated products.

Given similar products (the soft drink market could be an example), firms tend to advertise at a level that approximates their close competitors. When it comes to decisions regarding media buys, both the client and the agency must make decisions as to expenditure before the actual audience reach or composition can be known. In recent years, agencies have asked broadcasters for a guarantee as to audience size—and have received money back if the audience does not meet the predicted level.

STRUCTURE OF THE MARKET