Thursday, July 12, 2012

TV and Advertising

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The Television Industry and Advertising

After a long day’s work or a hard day at the office, people come home, sit in the Laz-e-Boy recliner, and flip on the television. Watching a favorite TV show has become many people’s favorite way to relax or past the time. A wide variety of programming exists and most anyone will be able to watch something they can enjoy. The television industry is part of the entertainment business and has high entertainment value for viewers. In that respect, it is an important industry, for example in terms of the time people spend watching TV. At the same time, it is important as a means of transmitting advertising. Television therefore has a two-fold role, both as a provider of entertainment and a transmitter of advertising. This paper will discuss the relationship between the TV market and the product markets through the market for advertising. It will also examine the different types of advertising, advantages and disadvantages of TV advertising, and how the rivalry between TV channels and the profit potential in product markets affect TV channels’ prices on advertising slots, programming decisions, and the producers’ purchase of advertising on TV.

From the beginning of television, advertising and programming were connected through network personnel and sponsorship. At first, television programs were owned by advertisers, which based the content of the shows on the interests of the audiences they wished to reach (Folkerts 41). Today it is rare for an entire program to be sponsored by one advertiser. Rather, networks or stations sell time for ads during a show. A basic feature of the television industry is that viewers dislike commercials and are attracted to a channel that invests in its programming. However, a TV channel earns its revenues by selling advertising slots to producers in the product market and attracts viewers for this advertising by investing in programming. Producers in product markets increase sales by advertising. Since an increase in advertising tends to reduce the number of viewers, there are diminishing returns to television advertising. The law of diminishing returns states, “as successive units of a variable resource are added to a fixed resource, beyond some point the extra, or marginal, product that can be attributed to each additional unit of the variable resource will decline” (McConnell Brue 160). Thus, the more a producer advertises its products on a TV channel, fewer viewers are available there for other producers to advertise to.

There are several common types of television techniques and advertisements used by producers. The first is the straight announcement, which consists primarily of someone looking at the camera and delivering a sales talk. Demonstration is important in TV because viewers are interested in what the product will do for them. A testimonial by a famous person can draw attention to a product or idea. Testimonial commercials work best when the celebrity has credibility as a source (Dunn 4). In a dramatized commercial, the point is presented through a story that can be told very briefly. Dialogue is a commercial in which two or more people are talking. The basic advantage of the dialogue is its ability to involve the viewer and encourage them to participate in the dialogue.

The biggest advantage of television advertising, if used wisely, is the unbelievable impact on viewers. It is basically almost the same as a door-to-door sales staff that can make visits at a very inexpensive rate. And when the person presenting the sales pitch is a popular personality, the advertising can be extremely effective. Another benefit of TV advertising is that it impacts a large number of persons not reach by print media. If a person doesn’t want to read a newspaper or magazine to find out what’s going on, they will more than likely turn on the evening news. Constant repetition of a sales message helps make people feel that they know the product, whether or not they like it. Television makes it possible to repeat a message as often as an advertiser can afford. Commercials are extremely flexible and allow advertisers to demonstrate their product, create a mood, make a blockbusting announcement about the product, or try it out in certain areas. Advertisers can usually find some combination of TV presentations that will communicate the desired impression.

Television advertising also involves several unique problems. Advertising messages on TV come and go quickly. If people have their sets on, but are not watching or listening, they cannot return later. And when commercials are bunched together, a viewer might use the time to get a snack or see what else is on. Although some network shows reach viewers for a surprisingly low cost, certain minimum cost considerations can price the medium-sized advertiser out of the television field. Newspapers and other printed information carry a stamp of authenticity that television broadcasts don’t have. People tend to believe something more if they actually see it in print. Another disadvantage is that mass coverage creates the lack of selectivity for the audience. It is difficult to determine exactly the viewing audience and there by choosing which commercials to air at certain times.

Television is used to build and reinforce brand image and awareness. TV gets more than half of all national consumer-advertising dollars. Using the networks as a marketing strategy has become very popular. In the short run, television advertising can dramatically increase a producer’s share in a specific market. In a study done on dry cereal advertising, all brands except Ralston’s made heavy use of network television. The goal was to observe the effects mass-market advertising would have on Ralston’s market share. Ralston began using some network television advertising halfway through the 1-week study period. Ralston saw its market share go up from 4.8 in the pre-TV period to 5.% after utilizing the networks (Jones 7).

Company sponsorship of individual TV programs saw decline after the quiz show scandals of the 160s. Although one advertiser doesn’t sponsor an entire show today, the influence it has on programming still exists. Individual advertisers occasionally affect content, but advertising as a form of financing has a more pervasive impact. A decision a TV channel must make within its schedule is the amount of advertising to allow. Some programs that are very flexible, such as newscasts and sports events, permit channels to air large quantities of advertising time. When a channel only sells a small amount of advertising, it can fill in with advertising for its own programs. A TV station’s time scheduling will in many cases put restrictions on the quantity of advertising to allow. If, for example, a TV channel broadcasts a series of 5-minute sit-coms during an evening, there will only be time for 5 minutes of advertising per half hour. By considering the amount of advertising a channel allocates, a producer can speculate the audience size their commercials receive.

TV channels programming decisions, as well as advertising firms advertising decisions, are always made before TV viewers make their choices. At the same time, the effect of advertising on the product markets is only felt after the advertising has been actually aired and watched by the viewers. Thus, product-market competition takes place after the TV viewers decisions are made. Advertising firms make their decisions about how much to advertise on each channel only after the TV channels have committed, not only to their programming, but also to their quantities of advertising.

For discussion purposes, television advertising can be broken up into four stages. The first stage involves each TV channel choosing its quantity of advertising and a programming schedule. A TV channel’s profit is the difference between its revenue from advertising and costs of investments in programming. The goal is to maximize profits by determining how much advertising to allocate and which programs to broadcast. In the next stage, each producer determines how much to advertise on a specific TV channel. An advertising firm looks at viewer demographics and audience size when deciding which channel and commercial to use to realize the most benefits. The viewer then decides whether or not to watch TV and, if so, which TV channel to watch. They make their decision after the TV channel and producer have already completed their advertising decisions. Finally, the producers compete in the product market by advertising and differentiating their products. The goal is to distinguish their product from others. By making price less of a factor than product differences, producers participate in non-price competition (McConnell Brue 0).

We are now in a position to investigate how the equilibrium outcome detailed in

Section is affected by a change in the number of advertisers, n. This number may

increase, either through an increase in the number of firms in each market, i.e., a decrease

in market concentration throughout the economy, or through an increase in the number of

product markets. Total spending on advertising increases as a result of a reduction in the number of firms, keeping constant the number of product markets. A reduction in the number of firms makes each remaining firm more concerned about the fact that own advertising tends to reduce the number of viewers. This dampens the incentive for each firm to increase advertising and would, all else equal, result in a reduction in total advertising. On the other hand, fewer firms result in a higher price-cost margin. This encourages firms to advertise more. The latter effect turns out to dominate, and it is reinforced by the TV stations’ responses. They invest more in programming, thereby attracting more viewers and even more advertising. The result is that both total advertising and total investment in programming increase following a reduction in the number of firms.

Note also that the total number of viewers increases following a reduction in the number of firms. Since advertising increases as well, which tends to reduce the number of viewers, the driving force behind this result is the TV channel’s increased investment in programming. Finally, note that the price per advertising slot also increases. This follows directly from the fact each TV channel’s two choice variables mutually reinforce each other [see Nilssen and Sørgard (001) on this reinforcement property].

However, total spending on advertising can also increase as a result of an increase in the number of advertising firms, if this latter increase is solely due to an increase in the number of product markets. In such a case, price-cost margins are unaffected by a change in the number of firms. Now, an increase in the number of firms makes each firm less concerned about own advertising’s effect on the number of viewers. This spurs an increase in total advertising. Again, the TV channels’ response reinforces the initial effect. They invest more in programming, thereby increasing the total advertising even more.

The economic literature on advertising has been slow on modeling the market for

advertising. The present contribution aims at filling this gap, by presenting a model of the

market for advertising that incorporates some crucial features of the TV industry, the

main provider of advertising space.

Most importantly, we assume that viewers are attracted by TV channels’ investments in programming but dislike their advertising. Combining this model of the TV industry with a model of product-market competition with advertising, we are able to discuss how asymmetries between various product markets affect the equilibrium outcome. We find that even small asymmetries have dramatic effects. In the case of two product markets where one product market has more firms than the other, but where the markets otherwise are identical, the firms in the product market with many firms choose not to advertise. The crucial feature of our model producing this result is TV viewers’ dislike for advertising, entailing congestion among advertisers. At an increase in the price of advertising, the firms in the market with many firms would, as expected, reduce their demand for advertising. This would, in turn, reduce the congestion of advertising on TV and thereby attract more viewers. The firms in the market with few firms would respond to an increase in the number of viewers by increasing their demand for advertising, despite the price of advertising having increased. The TV stations exploit those firms’ ‘perverse’ demand by increasing their price so that, in equilibrium, the firms in the market with many firms decide not to advertise at all on TV.

The second issue is how product-market competition affects the equilibrium outcome. We found that the profit potential in the product market is of importance for the amount of programming investments as well as for the amount and price of advertising. The less intense product-market rivalry is, the larger is the potential revenue generated by advertising. A TV channel exploits this in two ways. First, it reduces its supply of advertising slots. Second, it invests more in programming to attract more viewers and thereby to encourage the producers to advertise more. As a result, a relaxation of price competition in the product markets results in higher prices of advertising, more advertising, and more investment in programming. This suggests that there are two successive battles over the profit potential in the product markets one among the producers and one among the TV channels. An escalation of advertising by the producers spurs more investment in programming, and vice versa. Product market competition may also be affected by a change in the number of firms. We found that the effect of increasing the number of advertising firms depends on whether the increase is by increasing the number of firms in each market, making the markets less concentrated, or by increasing the number of markets. The former way of increasing the number of advertising firms reduces the price-cost margin and thereby the profit potential in the product markets. Thus, while there now are more firms demanding advertising, they also earn less from advertising.

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