Sunday, August 16, 2009

Is Marketing Expense Wasteful?

In the health care debate, many have noted the high level of administration expense, as there's the idea that without marketing expense, public healthcare will be cheaper.

Marketing has always seemed wasteful to those who are optimistic about government solutions, and indeed a big theme of John Kenneth Galbraith's oeuvre was that businesses waste money advertising. It seem that many think advertizements merely reallocate our expenditures in a zero-sum game of moving from Coke to Pepsi, Bud to Coors, without any real effects.

In 1972 Lee Benham presented what I think is one of the greatest empirical economic articles of all time (The Effect of Advertising on the Price of Eyeglasses). Optometrists give eye exams, and provide prescription glasses. Some states regulated optometry such that they could not advertise, others did not. The result? Those states with advertising had lower prices. This table basically says it all.



It seems that without advertising, firms don't compete as much, leading to higher prices.

10 comments:

Anonymous said...

Very interesting historical reference. I think your conclusion is a reasonable belief. But one could have had the belief with or without Benham's research. No matter how well researched Benham's piece might have been it is quite a stretch to say that "It seems that without advertising, firms don't compete as much, leading to higher prices. ". Plausible, yes. A reasonable belief, yes. But a "seeming" conclusion?

Anonymous said...

That's a good point. But I've always wondered about drugs advertised that require a prescription. These products cannot be selected/purchased directly by the targeted audience. How does this lower costs?

Anonymous said...

Froot Loops aren't purchased directly by their "target audience", but rather by their parents. So why does Kellogg's run Saturday morning TV ads?

Anonymous said...

"Is Marketing Expenses Wasteful?" Hope your book is better written than that headline.

Pete S said...

Eric, Excellent reference and excellent point.
I will point out that -- in the eye exam and glasses category -- it's quite easy to shop and compare. When shopping for health insurance the firms have an incentive to obfuscate through complicated contracts and conditions ... because it makes it difficult for the consumer to compare.
That's why ATT and MCI used to charge a different per-minute rate for each possible area code and exchange combination; it made it impossible to compare prices unless you only called one long distance number. When Sprint introduced $.10 per minute, all of a sudden it became easy to compare and the industry was turned upside down. Which happened again and again to that industry due to technology, but the example still holds. .

John said...

You're really comparing apples to oranges here in some cases. Not all drugs compete against each, unless in the "me too" category. Also, there's real demand for drugs, whereas people can live without Coke or Tide.

E_of_Scale said...

But how many glasses were sold in total in each area? I remember Galbraith's criticism of marketing being that it created artificial demand, not that it was a waste of money. I can't accept the lower margin at face value until the possibility that advertising created greater total demand is ruled out.

Anonymous said...

It all depends on what is promoted and for what purpose. As a physician who inherits patients who saw something on TV, they definitely trust me more. And getting people on statins or SSRI's who ought to be on them is definitely not wasteful.

Palming off marginal and expensive medicines as better than they really are, suitable for widespread prescribing when they are really niche products is highly wasteful. It is not a reflection of the marketing process but on the accurate representation of what is being sold and the sophistication of the audience to evaluate the pitch properly.

Anonymous said...

This shouldn't be so counter-intitive, every junior college in the nation teaches price elasticity in microeconomics. Advertising, if it works as intended, ramps up the "want-it" side of the equation, which is why "Buy one get one free" is so often the rule for everything from eyeglasses to pizzas.

Now if you could bust their bubble on "Administrative Expense" that would be orginal...

Bruschettaboy said...

Galbraith didn't think that advertising spend was wasteful; as E_o_S above notes, he thought that is was an essential part of the process of managing demand which enabled large companies to make planning decisions.