L15Nov09.306 - Lec 15 Demand Side Advertising Brand Names...

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Lec 15: Demand Side: Advertising, Brand Names; Strategic Behaviour FRE 306
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Lec 16: Advertising, Brand Name Investments, Strategic Behaviour 2 How Much Advertising is Optimal? Apply MR=MC rule: keep advertising more until the extra returns from a unit of advertising is just equal to the extra costs of that unit (e.g., one minute of TV ads) If incremental profit exceeds extra cost of increase in advertising, spend more on advertising budget i.e., advertise more if (P-MC) ( Q/ A) > k , where P-MC = marginal profit; Q/ A = increase in quantity demanded due to a “unit” increase in advertising (the “effectiveness” of the ads), and k = “unit” cost of advertising message
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Lec 16: Advertising, Brand Name Investments, Strategic Behaviour 3 What is Optimal Advertising Intensity? Eqm level of advertising reached when (P-MC) ( Q/ A) = k [Marginal gain=MC of advtg] Put differently, by reorganizing terms, The optimal advertising expenditure per extra dollar of sales, Ak/PQ, is equal to the gross margin {(P-MC)/P} times advertising elasticity of demand ( Q/ A)(A/Q), where P=market price, MC=marginal cost, P-MC=marginal profit, (P-MC)/P = gross margin, A=unit of extra advertising, k=cost of that extra unit A, PQ=total sales or revenue, ( Q/ A)(A/Q) is the percentage increase in quantity sold for 1% increase in advertising If gross margin (profits) high, and your advtg very effective, then you would spend a great deal on advtg
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Lec 16: Advertising, Brand Name Investments, Strategic Behaviour 4 Food Industry Example Fact: Ready-to-eat cereal industry is one of the most profitable of all food industries and has an unusually high spending rate on marketing/promotion (55% of sales revenue), of which 40% on advertising alone Kellogg’s has both high margins (70%) and very effective ads, so their cereal advertising expenditure is high…30% of sales Campbell Soups has a relatively high advertising elasticity of demand due substantially to its strong brand name, but they receive very low margins on canned goods (<5%).
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