Rafi Mohammed

Does Advertising Increase or Decrease Retail Prices?

Posted on October 17th, 2007 (3 Comments)

During one of my first weeks as an economics graduate student, I asked my advisor Rob if I could read every pricing article that he had. Being a nice guy, Rob lent me his office key and I photocopied away over a long weekend. One of the articles that I’ve always remembered was “The Effects of Advertising on the Price of Eyeglasses” by Lee Benham. While it’s an oldie (published in 1972) using data from 1963, I find this paper’s results fascinating.

There are conflicting theories about the price effects of advertising. Some have argued that advertising is persuasive and differentiating. An advertiser can highlight its value (we have the best selection/service), differentiate its brand (we’re the premiere place to shop) – this would lead to higher prices. In addition, it is expensive to advertise so these costs have to be covered. Cartier and Polo advertise in this manner. In contrast, some advertisers focus on making it easier for customers to find the best deals (e.g., the Best Buy/Circuit City rivalry) by highlighting their low prices.

Lee investigated the question of whether advertising increased or decreased prices in the eyeglasses market. In the 1960’s, approximately 75% of states restricted advertising for eyeglasses and advertising was permitted in the remaining 25%. Great control and experimental markets.

So what states do you think had higher prices? Those that allowed advertising or those that didn’t? Several economics and marketing professors at the University of Chicago (arguably the best university in the world) were asked their opinions. 40% of the economists and 100% of the marketing faculty expected prices to be the same or lower in regulated states where advertising was not allowed.

Lee’s results are interesting. He found that in states with no advertising restrictions, the average price was $33.04…remember this was 1963. In states that allowed advertising, the average price was $26.34. Wow…eyeglasses were 20% cheaper in states that allowed advertising. And remember, it costs more to advertise – one chain claimed its advertising costs averaged $2.00 per eyeglass. Eyeglass companies in states that restrict advertising were making a killing!

It’s interesting that some industries restrain from advertising their prices. For example, buying a wedding ring is often a convoluted pricing exercise. You rarely see diamond prices advertised. As a result, it seems that my friends always get an outstanding deal from someone like their cousin’s best friend from high school. Do you really think all of these side deals result in the lowest prices being offered?

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Readers' Comments on This Blog Entry

From LarryBitner on October 17th, 2007
Let's not forget two important factors that every marketing strategy should reflect: that price is relative to quality and perceived value, but also that price drives our perception as consumers. With that in mind, price is more effective when used to "position" a product rather than to simply sell it. The role of advertising is not to sell, it is to create awareness, to educate the consumer, to communicate a need, a want a use that generates the opportunity to sell. If advertising "positions" a product effectively, it definitely can increase the perceived quality and value and thus increasing the price that I am willing to pay. Poorly composed advertising will do more harm than good but professionally designed ads will always provide ROI - "return on investment"...
From Leo Piccioli on October 20th, 2007
Very interesting. There might have also been an "economies of scale" effect; i.e. the states where advertising was allowed developed larger eyeglasses markets (through demand generation from advertising), and, due to competition, were able/forced to lower their prices. What do you think?
From Wilson Brumiller on December 28th, 2007
Benham's findings are very interesting, mainly to disprove those with "gut feeling". You mentioned that there is no advertising in some markets. In Brazil, where I live, restaurants do not advertise their prices, hotels only advertise, sometimes, their "regular" price, not the price charged. It is tacky to advertise low prices here.