Competition as a Moderator of the Effect of Advertising on Sales

The author investigates the impact of competition on the sales response function. In particular, the influence of advertising on consumers’ price sensitivity (elasticity) is explored. Two opposing schools of thought, information theory and market power theory, explain how advertising changes consumer price elasticity. These two theories provide conflicting predictions of the direction of change in price sensitivity. The author proposes and estimates a model specifying conditions under which one of the two theories would apply. The impact of advertising on other parameters of the sales response function also is examined. The crucial determinant of the sign of these coefficients is competitive reactivity. An operational definition of this construct is proposed, and the hypotheses are tested empirically by an analysis of airline industry data.