What, if any, is the relationship among prices, advertising expenditures, and return on investment? Prior research has yielded inconclusive answers to this question, but in analyzing data from 227 consumer businesses, the authors have found a consistent pattern. Companies with relatively high prices and high advertising expenditures, for instance, had higher profits than companies with relatively low prices and high advertising budgets. Such consistency remains important when one is considering the impact of factors like product quality, stages in the product life cycle, product risk, and market share on the price-advertising relationship. The authors also address the issue of whether advertising increases consumer prices.
A few years ago, a leading ketchup maker significantly increased its advertising and promotion expenditures and simultaneously lowered its prices. The company gained market share at the expense of the top ketchup manufacturer, Heinz, and other brands, but the victory was a hollow one. The combination of increased advertising expenditures and low prices caused its profits to suffer, and the company eventually abandoned this strategy.
Would the company eventually have improved its profit margins? Maybe, but waiting would have required a commitment of cash reserves and extreme patience on the part of its management and stockholders.
Beyond the implications for the ketchup maker seeking to improve its competitive position, the experience has relevance for other companies in consumer goods markets because many have tried the same strategy and had similar unsatisfactory results. The reason for the lack of success, we believe, lies in their failure to take seriously enough into account what we have discovered to be an extremely close relationship between advertising expenditures, prices, and profits. One outgrowth of the relationship is that companies doing the most relative advertising tend to command premium prices for their products and also to obtain the best margins.
Consumer goods marketers have long recognized a correlation between advertising and pricing strategies. When a product is successfully differentiated from competitive offerings, distribution in retail stores is almost ensured and premium prices can be commanded from retailers and consumers. Less well-known brands, on the other hand, struggle for distribution and consumer acceptance by positioning themselves as lower-priced alternatives of satisfactory quality; they cut factory prices and hope retailers will pass on some of their savings to consumers.
Examples of this phenomenon abound. Heinz ketchup usually sells at wholesale prices that are about 10% higher than Hunt’s or Del Monte’s and as much as 20% over private labels’. In the supermarket, the spread between Heinz’s prices and its competitors’ is somewhat less. (See the sidebar “Prices, Advertising, and Ketchup.”) Advertised aspirin brands command even larger wholesale and retail price premiums and hold 90% of the total market. (To appear price-competitive, most retailers mark up less advertised brands at a higher percentage than they do advertised brands and thus make the differential in retail prices between the two groups less than the spread in wholesale prices.)
Another example comes from the liquor industry, where a 1978 study showed fast-growing, premium-priced brands to be spending $7.26 per case on advertising. The industry average for all distilled spirits is only $1.75.1 Heavily advertised brands, as a rule, sell for more.
Although these examples illustrate that premium prices and high advertising expenditures can march hand in hand, this is not the only successful marketplace strategy, nor is such a strategy a guarantee of success. What is important to keep in mind is that consistency between the two is crucial for short-term and medium-term profitability. In most markets, consistency means that relative prices and relative advertising levels are coordinated. In other words, high relative advertising expenditures should accompany premium prices, and low relative advertising expenditures should be tailored to low prices.
Unfortunately, no hard quantitative evidence concerning the prevalence of the relationship between premium price and high advertising expenditures has previously been gathered. Nor has the degree to which premium prices stem from advertising as opposed to other differences among products such as product quality been ascertained. (For a discussion of previous research in this area, see the sidebar “Difficulties of Researching the Price-Advertising Relationship.”)
Analyzing the Price-Advertising Relationship
We set out to accumulate such evidence by analyzing price and advertising data for consumer goods manufacturers. Specifically, we wanted to answer three questions:
1. How strong is the association between price and advertising strategies among consumer goods businesses?
2. Does the strength of this association depend on certain characteristics of the business’s strategy and market, such as product quality, market share, and stage in the product life cycle?
3. Finally, do businesses that maintain consistent advertising and pricing strategies earn higher profits than those that fail to maintain some consistency between the two?
Our analysis shows that the general association between price and advertising strategies is strong and statistically significant. Our analysis also demonstrates that the strength of the relationship depends on some product and market factors and not on others. To the third and perhaps most important question, the answer is yes—that is, consistent strategies result in higher profits. Businesses with inconsistent pricing and advertising strategies earn lower profits than do businesses with consistent strategies.
These are strong statements that have broad and significant implications for marketing strategy formulation. They are not based solely on isolated examples. They are supported by what we believe is solid statistical analysis that is relevant to a large number of consumer goods marketers. Discussion of the more technical statistical safeguards of our research has been relegated to the Appendix; we will concentrate in this discussion on the most important aspects of the research techniques as well as on the results and implications of our findings.
Gathering the Data
To determine the general relationship between advertising and pricing strategies, we used information on 227 consumer businesses from the Profit Impact of Market Strategies (PIMS) project of the Strategic Planning Institute in Cambridge, Massachusetts.2 Our analyses were based on data covering the 1971–1977 period and included two variables that are central to the rest of this article:
- Relative advertising. We asked businesses to compare their own media advertising budgets, as a percentage of sales, with those of their leading competitors and to tell us whether they spent “much less,” “somewhat less,” “about the same,” “somewhat more,” or “much more” on advertising. Each business answered this question for each of four separate years, and we averaged the answers to avoid measuring temporary abnormalities in a given business’s strategy.
- Relative price. We also asked businesses to compare their average selling prices (factory prices) with the prices of leading competitors and to quantify the differences. For example, if a business reported +5%, its selling prices would average 5% higher than competitors’; a –3% would mean that selling prices average 3% less than competitors’. Each business answered this question for four separate years, and we averaged the answers over the four years.
Assessing the Results
How strong is the association between relative price and relative advertising? Our analysis of the data, which is shown in Exhibit I, indicates that brands with high relative advertising budgets are also charging premium prices, and vice versa. For example, the 58 businesses in the PIMS data base that spend “much less” on advertising than their competitors also charge prices that average almost 3% below the market average for their products. (Some businesses charge higher and some lower prices, but the average for the 58 businesses is clearly well below their respective market norms.)
Exhibit I Relative Advertising and Average Relative Price (Compared with Competition)
Contrast this finding with the average relative prices of the 23 businesses that have relative advertising budgets of “much more” than their competitors. These high advertisers command prices that average 7% above the competition. (Again, some businesses in this group have prices that are even higher and some have lower prices.)
The overall pattern is one of strong association between businesses that have high relative advertising budgets and businesses that charge high relative prices.
Of course, high-quality advertising is probably more effective than low-quality advertising. But measuring advertising quality is difficult enough for a single company, let alone for 227.
Two explanations can be offered for the association between price and advertising. First, retailers and consumers are willing to pay higher prices for known products than for unknown brands. Second, marketers are willing to advertise more when gross profit margins are high.
For the purposes of our research, it does not matter which of these explanations is most true. From the managers perspective, as we shall show later, the key is to keep advertising and pricing consistent—regardless of what is driving what. We shall return later to the question whether advertising increases the prices consumers pay, but first we wish to take a closer look at the basic advertising-price pattern.
Relating Advertising & Prices to Other Factors
If we look again at Exhibit I, a number of additional issues arise beyond the conclusion that relative prices commanded by high advertisers exceed those commanded by low advertisers. Don’t businesses with high advertising budgets and high relative prices also market products of high quality? Also, how accurate is an analysis that lumps together big-ticket durables with convenience goods? Is this relationship true for all stages of the product life cycle?
Effect of Product Quality
Marketers often argue that their products command higher prices not merely because they are advertised but also because they are of high quality. This is undoubtedly true in many cases but may or may not have an effect on the relationship between relative advertising and relative price. Even if one accepts the proposition that Anacin dissolves faster than private-label aspirin, the price differential between the two would probably not be as great as it is without advertising.
Exhibit II shows that businesses with high-quality products charge high relative prices for the extra quality but that businesses with high quality and high advertising levels obtain the highest prices. Conversely, businesses with low quality and low advertising charge the lowest prices. Businesses that consider their products of higher quality and that advertise at levels higher than competition charge prices that average 6.5% above competitors’. For high-quality producers with less relative advertising, this figure is –.1%. Thus quality alone does not enable the business to command the same price as quality that is communicated to consumers.
Exhibit II Effect of Product Quality on Relationship Between Relative Price and Relative Advertising
Marketers who tell consumers about quality differences in their products command higher prices than marketers who depend on high quality to communicate itself to consumers. For mass-produced items, advertising is the most efficient way of communicating superior quality—especially when consumers may not be able to judge quality differences from inspection or use. Protein content in food products is an example of a product feature that advertising can communicate to consumers.3 Even visible product attributes may require advertising to explain their value. Frank Perdue has “educated” his customers to appreciate his chickens’ yellow skins, and as a consequence, he has been able to charge premium prices.
Unfortunately, product quality is not easy to measure with any degree of precision. We have used management judgments about the quality of their products relative to their competition. One might expect managers to overrate their products. However, unless the degree of exaggeration is related to advertising expenditure levels, the pattern we show would remain unchanged. In other words, if all managers overrated their products by a factor of 20%, those with the highest product quality would still be highest, and those with the lowest product quality would still be lowest.
Effect of Product Life-Cycle Stages
Exhibit III illustrates differences between relative advertising and relative prices for businesses at various stages of the product life cycle. The exhibit shows a stronger relationship between relative advertising and relative price levels when products are in the late stage of the life cycle than when they are new to the market. In new product categories, a considerable amount of confusion with respect to price is likely to exist in the market. Also, prices are probably changing fairly frequently.
Exhibit III Effect of Product Life Cycle on Relationship Between Relative Pricing and Relative Advertising
The electronic calculator is an example of a product category that experienced considerable market turmoil before prices stabilized. During the early stages of the calculator’s life cycle, improvements and new features were added at a rate that may have left the trade and consumers alike somewhat confused about price-quality relationships. Options for programmable calculators, rechargeable batteries, memories, and many other functions were introduced over a relatively short period. Prices changed frequently as well (usually downward) in the early stages of the life cycle.
Also, when new brands are introduced in an established product category, marketers often use trade and consumer promotions to encourage distribution and trial. Advertising expenses during these periods are likely to be high and prices low. Competitors react with promotions of their own, and the resulting advertising-price relationships are usually ill-defined and unstable compared with periods when businesses have settled on long-term positioning strategies. Thus the earlier the stage in the life cycle, the more confused the relationship between relative advertising and relative pricing.
Effect of Product Risk
Exhibit IV suggests that the relationship between relative advertising and relative prices is somewhat weaker for products that cost more than $10. We believe consumers deem these products high-risk purchases. Thus for product purchases where risk is high, the relationship between advertising and price is not quite as strong.
Exhibit IV Effect of Price Risk on Relationship Between Relative Price and Relative Advertising
When consumers purchase big-ticket products such as appliances or automobiles, advertising alone is unlikely to convince them to pay substantial percentage price premiums. A small percentage difference in such cases may loom large in dollar terms. For small-ticket items such as beer and cigarettes, the relative percentage price differential between premium and nonpremium brands will naturally be greater.
This analysis reflects only the financial risk inherent in a purchase and not the other consequences of poor product performance. Drugs and personal-care products would probably show even stronger relationships between relative advertising and relative prices. Branded aspirin commands relatively large price premiums primarily because the consumer is willing to pay more to ensure good quality in a product that is ingested. Similarly, the consequences of poor product quality are different for canned green beans than for deodorants. (However, if botulism were more prevalent, advertised brands of canned vegetables might command greater price premiums.) Unfortunately, we have no measures of these other risks and cannot quantify their effect on the price-advertising relationship.
We emphasize, however, that even for big-ticket products, average relative prices are higher when businesses also have higher relative advertising budgets.
Effect of Market Share & Competition
Let us turn now to the question of the effect of a business’s market position and competitive environment on the price-advertising relationship.
As we can see in Exhibit V, businesses with high market shares show stronger relationships between relative advertising and relative price than businesses with low market shares, primarily, we believe, because consumers rely on a brand’s position in the market as a clue (often correctly so) to product quality.
Exhibit V Effect of Market Share on Relationship Between Relative Price and Relative Advertising
In addition to level of market share, the stability of the competitive relationship is important. Exhibit VI indicates that businesses in unstable competitive environments show stronger relationships between relative advertising and relative price than businesses in stable environments. (Market stability is measured by the amount of market share changes that occur from year to year.)
Exhibit VI Effect of Market Stability on Relationship Between Relative Price and Relative Advertising
Fashion goods and cosmetics are examples of businesses that experience relatively short life cycles. Because of the extra risk inherent in such businesses, marketers may adopt “fast payback strategies” and charge even higher prices to recoup advertising investments over a short time period.
In most types of consumer business, managers behave as if premium prices and high relative advertising strategies were related and therefore make them a consistent part of the marketing mix. This pattern holds true for products of both high and low quality.
Businesses that seem to be most consistent in their pricing and advertising strategies are those in the later stages of the life cycle and companies with few new products. Businesses with high market shares, businesses in unstable competitive environments, and businesses marketing low-dollar-value consumer products also show especially high correlations between relative price and relative advertising expenses.
What About Return on Investment?
The most important question for managers is, of course, whether companies with consistent pricing and advertising strategies produce higher returns on investment than companies with inconsistent strategies. To test this question, we devised a measure of the consistency between the two. We looked at the businesses’ relative advertising and price strategies and classified them as shown in Exhibit VII.
Exhibit VII Price-Advertising Consistency
The average value of ROI for businesses with various levels of consistency is shown in Exhibit VIII. The more inconsistent the pricing and advertising strategy is, the lower the average ROI. The differences are significant at almost all levels. Businesses that deviate from the general pattern of consistency between pricing and advertising strategies do not perform as well as those that follow the pattern. This finding holds regardless of whether the inconsistency results from the relative price exceeding the level of relative advertising or vice versa.
Exhibit VIII Relationship Between Price-Advertising Consistency and Return on Investment
Exhibit IX indicates that companies with high-quality products have higher ROIs in general than companies with low-quality products. However, of greatest importance to this study is that the companies with high-quality products appear to suffer most from inconsistent advertising and price strategies. Similarly, companies with products in the later stages of the product life cycle sacrifice substantial ROI by pursuing inconsistent advertising and price strategies.
Exhibit IX Factors Affecting Price-Advertising Consistency and Return on Investment
One Last Check
We performed a final test of the price-advertising relationship. For this test, we divided the sample of consumer businesses into three groups: low relative advertisers, medium relative advertisers, and high relative advertisers. For each of these subsamples, we explored the relationship between relative price and ROI with linear regression analysis.
The result suggests that for low relative advertisers, relative price is negatively associated with ROI. For high advertisers, the reverse is true. These regressions provide further support for the idea that advertising increases businesses’ need to charge high relative prices or vice versa. Also important to note is the fact that, while no single advertising or pricing strategy is right, some combinations are wrong.
Possible Reactions & Final Conclusions
At this point, we envision two possible reactions to our research findings. One may be that the findings are nothing but common sense and that managers should be aware of the need for consistency in advertising and pricing. But the fact that a substantial number of businesses are not pursuing consistent advertising and pricing strategies is what enabled us to uncover the relationship we found.
A second possible reaction could be that the profit impact of inconsistent pricing and advertising strategies is short-term—that businesses with low prices and high advertising expenditures are building market share, while businesses with high prices and low advertising budgets are milking their companies for profits. If the latter were true, then we should have observed higher ROIs for businesses with low advertising budgets and high prices. We found the opposite, however, and can only conclude that this sort of milking strategy does not usually succeed. The first possibility—market share building—is more difficult to evaluate. In that case, one would expect to find, as we did, lower ROIs from investment spending. Worth noting, however, is that our data and analyses are based on four-year averages, so the payout must be long-term indeed.
Baron Bich employed substantial advertising and low prices to dominate the markets for ballpoint pens in Europe and the United States. Isn’t this an example of an inconsistent strategy that was enormously successful, one might ask? Well, maybe, but Bich is also reputed to have spent millions of dollars and several years waiting for his U.S. acquisition to become profitable. Had the felt tip pen been introduced a few years earlier, we suspect, the whole strategy might have failed. The baron also had no stockholders to answer to at that time. And the Bic shaver and pantyhose market entries have not duplicated the results of the ballpoint pen.
What about L’eggs pantyhose and Timex watches? Compared with the total market, these brands were definitely highly advertised and relatively low priced. They also became profitable fairly quickly. Both of these products, however, were accompanied by major changes in the markets, shifts in distribution channels, product characteristics, and favorable socioeconomic trends. L’eggs and Timex helped create new markets and were not competing in established segments. (In fact, L’eggs came in at a price higher than other pantyhose brands being sold through supermarkets, even if lower than department store brands.)
A willingness to gamble that changes in product or production technology will not make manufacturing facilities obsolete4, considerable financial resources, and a tolerance for long payback periods seem to be prerequisites for the baron’s strategy. Our analysis suggests that the approach to strategy that uses high advertising budgets and low relative prices fails more often than it succeeds. Major market innovations may enable inconsistent strategies to end happily, but they appear to be a risky bet for most marketers.
We believe this research provides strong evidence that relative pricing and advertising strategies go together and that most businesses which deviate from this pattern suffer in terms of profitability. The patterns we found in the analysis of both management behavior and profitability are strong enough to suggest that businesses should have very good reasons for deviating from the rule of consistency before they do so.
1. “Liquor Imports Threaten to Drown U.S. Distillers,” Business Week, April 2, 1979, p. 92.
2. The PIMS program is a large-scale, ongoing statistical study of the market and the individual competitive characteristics, strategies, and financial performances of business units. For details on the data base, its advantages, and its limitations, see Robert D. Buzzell, Bradley T. Gale, and Ralph G. M. Sultan, “Market Share—A Key to Profitability,” HBR January–February 1975, p. 97.
3. Neil H. Borden, in The Economic Effects of Advertising (Chicago: Richard D. Irwin, 1942), describes such features as “hidden values.”
4. Michael E. Porter, “How Competitive Forces Shape Strategy,” HBR March–April 1979, p. 137. See, for example, his discussion of the experience curve as a barrier to entry.