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Advertising as an Entry Deterrent:

Evidence from UK firmsDavid Paton

Published online: 07 Feb 2008.

To cite this article:David Paton (2008) Advertising as an Entry Deterrent: Evidence from UK firms,

International Journal of the Economics of Business, 15:1, 63-83, DOI: 10.1080/13571510701830507

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Int. J. of the Economics of Business,Vol. 15, No. 1, February 2008, pp. 6383

1357-1516 Print/1466-1829 Online/08/01006321 2008 International Journal of the Economics of Business

DOI: 10.1080/13571510701830507

Advertising as an Entry Deterrent: Evidence from

UK firms

DAVID PATONTaylorandFrancisLtdCIJB_A_283172.sgm10.1080/13571510701830507InternationalJournalof theEconomicsof Business1357-1516 (print)/1466-1829 (online)OriginalArticle2008Taylor&Francis151000000April2008Professor [email protected]

ABSTRACT Advertising is widely considered to be an important isolating mechanism

through which firms may defend an established competitive advantage. However, there isrelatively little empirical evidence on the extent of the strategic use of advertising either todeter or in response to entry. In this paper, I report on a study of the advertising practicesof 843 medium-sized and large UK-based firms. Nearly one-quarter of all the advertiserssurveyed state that they attribute importance to entry deterrence as an aim of theiradvertising. Further, one in five managers of advertising firms state that they wouldincrease advertising expenditure if a new rival company appeared in their market. It isalso apparent that there is a strong correlation between the perceived importance ofadvertising as an entry-deterring tool and the intensity of advertising spending. Multi-variate modelling provides confirmation that the existence of a sheltered market position,

and the profitability that typically accompanies this, provides a statistically significantdeterminant of the decision to use advertising as a strategic entry-deterring weapon.

Key Words: Advertising; Survey Data; Entry.

JEL Classifications: L10; M37.

1. Introduction

A central concern of research in corporate strategy concerns the ability of firms tosustain a competitive advantage in the face of competition from actual or poten-tial rivals (see Besanko et al., 2003). Following Rumelt (1984), the term isolatingmechanismshas been applied to those strategic devices that firms can deploy toinhibit others from duplicating and thus neutralising the source of any competi-tive advantage. The list of such isolating mechanisms, from legal restrictionsthrough cost superiority to early-mover advantages, etc., is extensive (see

I would like to thank Neil Conant for his help and expertise with data management. Thanks are alsodue to participants at the 2004 EARIE Conference in Berlin. Finally, I would also like to thank Steve

Thompson for numerous comments and suggestions that have improved this paper immeasurably.David Paton, Nottingham University Business School, Nottingham University, Jubilee Campus, WollatonRoad, Nottingham NG8 1BB, UK; email: [email protected]

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64 D. Paton

Mahoney and Panadian, 1992). Many of these, however, are applicable only to thecircumstances of specific industries.1Advertising, by contrast, might be consid-ered to be a generic strategy to defend and (attack) entrenched positions.

The lack of good quality primary data on the advertising practices of firmshas restricted empirical research on advertising (Rogers and Tokle, 1996; Paton,

1998). In this paper, I use information from the 1999 Advertising and IndustrySurvey (AIS), a significant source of data on advertising by UK-based firms.2TheAIS was a postal questionnaire survey of the advertising managers of UK firms,funded by the Economic and Social Research Council, which yielded informationon the advertising practices of 843 companies. Unlike previous work that hasused attitudinal data collected from managers to explore firms strategic behav-iour in this context, for example, Singh et al. (1998), Smiley (1988), this research isnot restricted in having to use a small number of advertising-related questionsfrom a wider survey.

There is an extensive body of theoretical work in economics and strategy that

has explored the issue of how advertising by incumbent firms affects entry intomarkets. However, theoretical models have suggested alternative ways wherebyadvertising can act both to raise and lower entry barriers. For example, if adver-tising builds up a stock of goodwill for a firm which lowers the returns to adver-tising of potential rivals, then entry is less likely. On the other hand, if advertising

builds brand loyalty by customers, then an incumbent firm will be less likely tolower the post-entry price and entry becomes more attractive.3A large body ofempirical work in economics has tried to examine the outcome of such processes,

but its findings are somewhat ambiguous;4 in part because of the difficulties inidentifying causation in complex simultaneous relationships.5Similarly, attemptsto quantify the advertising response to entry are flawed if deterrence has beensuccessful and hence entry is unobservable.

This paper adopts the alternative approach of asking managers directly aboutthe relationship between advertising and entry and about their conjecturedadvertising response to realised entry. Clearly any subjective approach has limita-tions: respondents may be untruthful, particularly if they consider their conductis in any sense anticompetitive; while advertising may impede or facilitate entryeven if managers do not realise it is doing so. However, it is difficult to justifyignoring the perceptions of managers altogether. Here I use data from an anony-mous survey of more than 800 advertising managers of UK-based firms to helpanswer two questions: first, to what extent do managers perceive that entry,

whether actual or potential, plays an important role in their advertisingdecisions? And second, are there systematic differences in the role played by thethreat of entry in advertising decisions across firms and industries?

In the next section of the paper, I discuss existing work on advertising andentry in more detail. In section 3 I examine the methodology of the survey onwhich the empirical work is based. In section, 4, I describe and discuss surveyresponses on advertising and entry. In section 5, I report results of multivariatemodels of the responses. Some concluding remarks are made in section 6.

2. Using Advertising to Sustain a Competitive Advantage

The resource-based view of the firm (Barney, 1991, 2001; Lockett and Thompson,2001) holds that a firms competitive advantage occurs as a result of differences

between the set of resources and capabilities controlled by its managers and those

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Advertising as an Entry Deterrent 65

under the control of rivals. It is thus the result of rents generated by an inherentshort-run inelasticity of supply of such resources. In the longer term, mostresources and capabilities can be replicated by rivals, and hence successfulproducts can be imitated and the competitive advantage neutralised. Where acompetitive advantage is sustained over a longer period, it is seen to be the result

of some isolating mechanism that inhibits actual or potential rivals in thegeneration of suitable resources. Besanko et al. (2003) suggest that such isolatingmechanisms either result from structural impediments to imitation, such aspatents, or from early mover advantages, such as reputation or buyer switchingcosts. However, a variety of strategic actions are available to managers to defendor attack established positions. For example, incumbents can commit to excesscapacity to deter entry (Lieberman, 1987) whilst entrants can use irrecoverableinvestments to signal their intention to remain and hence influence incumbents toreach an accommodation.

Advertising is perhaps the most straightforward strategic act in this vein. In

terms of the dichotomy suggested by Besanko et al. (2003), advertising enhancesthe effectiveness of structural impediments, such as economies of scale and scope,by raising incumbent sales. At the same time, advertising can reinforce early-mover advantages, such as the possession of a market reputation. While there areexamples of new entrants that have supplanted dominant firms using advertis-ing-intensive methods, advertising is normally considered as a defensive strategyin as much as it is likely to be more cost-effective when deployed by firms with anexisting competitive advantage:

For example, as advertising a form of investment in goodwill, new entrantsmust spend in excess of current levels to match incumbents. By inflating the entrycosts of would-be rivals, advertising blunts the threat from one of the major forces(see Porter, 1980) shaping rivalry. In addition, whilst advertising can be used bynew entrants to establish a presence, the returns to advertising by incumbents aregenerally larger.6 Finally, even among existing rivals, economies of scale andscope in the effectiveness of advertising typically benefit the larger rival. Forexample, where firm A has more outlets than firm B in a given region, local TVviewers seeing an advert from each are more likely to encounter, and hence enter,an A outlet than a B outlet. Similarly, more diversified (generally larger) firmsmay use umbrella branding (Besanko et al., 2003) across a range of products suchthat advertising one product potentially benefits the rest, generating economies ofscope.

More sophisticated modelling, which allows for strategic interaction betweenincumbent and (potential) entrant, produces a more ambiguous picture. Whilehigh sunk costs of advertising leave the newcomer vulnerable to post-entry pricecompetition and thus generally deter entry in such models, the opposite effect canalso be generated. Thus Schmalensee (1983) and others show that lower incum-

bent advertising could be an effective entry barrier if it increased the credibility ofa post-entry price war. The difficulty with this literature is that, once entry occurs,it is generally rational for the incumbent to preserve what remains of its competi-tive advantage by accommodating behaviour. However, to forestall entry it isnecessary to commit to post-entry non-accommodation. As noted above, incum-

bent advertising typically raises the sunk cost requirements of potential entrants(see also Sutton, 1991) thus discouraging entry, but it simultaneously raises thestock of goodwill of the incumbent and so discourages an aggressive post-entryresponse. Despite the apparent ambiguities in the theoretical literature, there is

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66 D. Paton

general presumption that advertising largely works to sustain a competitiveadvantage.

An important point largely ignored in the strategy and economics literature isthat the threat to a firms competitive position is unlikely to be constant over time.Managers should be aware of any increase in this threat, particularly that posed

by new entrants, new products from existing rivals or aggressive competitivebehaviour from the latter, and respond accordingly. The thrust of the argumentsraised in this section suggests that managers perceiving any enhanced threat tothe firms market position will typically increase advertising levels. The extent towhich this response is observed, however, is likely to depend on the specificcompetitive environment within which the firm is operating.

3. Data

The lack of good quality primary data on the advertising practices of firms is an

ongoing issue of concern to researchers and has placed severe restrictions on theempirical analysis of advertising (see Rogers and Tokle, 1996). In this paper, I useinformation from the 1999 Advertising and Industry Survey (AIS), a significantsource of data on advertising by UK-based firms. The AIS was a postal question-naire survey of the advertising managers of UK firms, funded by the Economicand Social Research Council and which yielded information on the advertisingpractices of 843 companies.

The use of this data set raises important issues as to the usefulness of surveydata in general. I believe that surveys provide a useful and valuable source ofdata for several reasons. Firstly, the approach of questioning managers, whilst notwithout its own set of problems, is very direct and provides perhaps the only wayof examining overall firm strategy regarding advertising. Specifically, as argued

by Singh et al. (1998), questionnaires have the advantage that they can captureactions which result in things not happening (p. 231). Secondly, and related tothis, managerial responses are valuable in their own right as they (ideally) reflectwhat managers actually think about their advertising behaviour. Lastly, respon-dents are much more likely to answer specific questions about commerciallysensitive topics under the guarantee of anonymity that surveys can provide. Inany case, in the empirical work below, I complement the survey data withinformation gained from company accounts.

3.1 Sampling Frame

The AIS was a postal questionnaire survey of the advertising managers of 5234UK-based firms. The target population comprised mainly public companies (bothquoted and unquoted) but also included larger private companies, includingsubsidiaries of overseas firms.7

The core unit of analysis in this paper is at the level of the firm and, indeed,the Survey was directed to the Advertising Manager of each firm. Although muchwork on advertising has been undertaken at firm level (for example, Ailawadiet al., 1994; Cubbin and Domberger, 1988), the issue of the appropriate unit of

analysis is not an easy one to resolve. The advertising decisions of large firms maybe devolved to different business units further down the hierarchical scale andsome previous work has used either line of business (Singh et al., 1998) or theproduct (Lilien and Weinstein, 1984) data. One practical disadvantage of using

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more disaggregated units of analysis is the consequent difficulty of matching thedata collected with company accounts data.8More fundamentally, this researchwas concerned to examine the strategic use of advertising, that is in deterring andresponding to the threat of entry, rather than routine investment in brand mainte-nance. Accordingly, whilst I could not be sure of the location of the key decision

taker, a firm-level approach appeared most appropriate. Furthermore, I wouldanticipate that even in multi-product firms there is typically some central co-ordi-nation of advertising because of shared brand names, logos, etc. For thesereasons, the firm was used as the initial unit of analysis in the AIS, but, for partic-ular questions, managers were asked to answer in relation to the companysmain product line or service.

Responses from and discussions with managers of firms in the design andpilot stages suggest that the choice to use the firm as the level of analysis wasprobably optimal. However, it must be noted that this does not mean it wasappropriate for every sector covered by the survey. Similarly, managers under-

standing of concepts such as the main product line or service may also varyacross companies.

3.2 Survey Design and Process

The questionnaire was designed to obtain both quantitative and qualitative infor-mation about a range of advertising issues as well as some background informa-tion about the company itself and its competitive environment. Of particularrelevance to this paper is that a number of questions were aimed specifically ateliciting information on managers attitudes to entry by new companies and anydeterring action they may consider.

Full details of the survey design and process are contained in Conant andPaton (2001). Following consultation with academic and government sources anda pilot study of 154 randomly selected firms, the final version of the questionnairewas sent to The Advertising Manager of a further 5222 firms. Those not respond-ing were sent a second copy of the questionnaire about six weeks later. As theoriginal sample had been selected with the intention of excluding holding compa-nies, responses in which the manager had classified the firm as such along with ahandful of others in which the responses were contradictory or difficult tointerpret were dropped from the sample. This left a total 843 valid responses,16.00% of all firms in the survey. The breakdown by sector is given in Table 1. The

response rate is similar to that obtained in other firm-level postal surveys such asthose reported in Love and Roper (2004) and Cosh et al. (2005).

Each company surveyed was matched with accounts data from FAME.9Atleast some data were available for virtually all companies. These data were usedto conduct numerous tests for sample selection bias. These tests suggest that thecompanies who responded are generally a fair representation of the populationsampled (see Conant and Paton, 2001).

I was also concerned that the data used in this paper (which depend onmanagers answering particular questions) could be subject to intra-sampleresponse bias. Thus, I undertook chi-square and t-tests of the null hypothesis that

the sub-set of firms which answered at least one question related to entry had thesame distribution as all those responding. The test results are reported in Table 2.The chi-square tests are of the null hypotheses that the distributions of companytype (public quoted, public unquoted or private) and industrial sector (as given in

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68 D. Paton

Table 1) are the same for respondents and non-respondents. In neither case canthe null hypothesis be rejected at any conventional significance level. The t-testsare of the null hypotheses that the sample means of particular variables are equalfor all respondents and non-respondents. Tests are reported for turnover, numberemployees, exports, pre-tax profits and value of fixed tangible assets, the lastthree all as a proportion of turnover. In every case, the t-statistic is insignificantlydifferent to zero at the 1% level and only for profits is the statistic significant atthe 5% level. Taken together these tests provide little evidence of bias from withinthe sample.

Despite these checks, the reliability of the results based on these datanaturally depend on whether the survey managed successfully to elicit honestreplies that accurately reflect the perceptions of key decision-makers within thefirm. Although responses from the pilot stage as well as informal discussionswith managers from firms in the sample who contacted the research team suggestthat those responding took the survey seriously, the reliability of the data gainedfrom the survey can never be known with certainty. This caveat emphasises theneed for the empirical results reported below to be interpreted with care.

Table 1. Respondents by industrial sector

Sector Responses %

Consumer manufacturing 123 14.6

Producer manufacturing 218 25.9

Distribution 81 9.6Retailing 69 8.2

Consumer services 120 14.2

Producer services 231 27.4

All 843 100.00

Source:1999 Advertising and Industry Survey, Question 13.Note:Firms classified as others or that did not respond to this question were grouped into one of theabove categories according to their primary SIC code and other available company information.

Table 2. Tests for response bias

Respondents vs. non-

respondents

Entry respondents vs.

others

Variable Distribution Test statistic p-value Test statistic p-value

Company type 2 2.15 0.54 15.18 0.002

Ownership 2 2.80 0.25 2.47 0.29

Turnover t 1.50 0.13 0.98 0.33

Employees t 1.36 0.17 0.99 0.32

Export rate t 1.62 0.10 0.22 0.83

Profit rate t 0.54 0.59 2.08 0.04

Assets rate t 0.52 0.61 0.22 0.83

Sector 2 4.67 0.32

A/S ratio t 1.18 0.24

Source:Financial Analysis Made Easy (FAME) and 1999 Advertising and Industry Survey.

Note:Figures are based on 1998/9 financial year.

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4. Managers Attitudes to Advertising and Entry

4.1 Entry Deterrence as an Aim of Advertising

I report summary information on managers attitudes to advertising and entry inTables 3 and 4. In Table 3a I summarise answers to the question which asked

managers to indicate the degree of importance that they place on entry deterrenceas an aim of their companys advertising.10Out of 696 managers who answeredthis question, over half stated that entry deterrence was either not at allimportant or quite unimportant. This is not unexpected, since routine brandmaintenance might be expected to dominate advertising policy. However, asignificant minority of managers (22.3%) indicated that entry deterrence waseither important or very important.

There is a good deal of evidence suggesting that advertising is more likely tobe used strategically in the case of consumer goods (see, for example, Buxton et al.,1984; Schmalensee, 1989; Paton and Vaughan Williams, 1999). Consequently, in

Table 3b, I report the breakdown of responses by the firms main industrial sector,as identified by the manager. Retailers are less likely to have entry deterrence asan important aim, but there is little evidence of any difference in the pattern ofresponses either between producer- or consumer-orientated firms or betweenmanufacturers and service firms. Formally, Pearson and likelihood ratio chi-squaretests cannot reject the null hypothesis that the pattern of responses is the same acrosssectors and these results provide support for the strategy of surveying firms fromall sectors of the economy, rather than just, for example, consumer-orientated firms.

One issue hidden by the raw responses is the intensity of advertising under-taken by each group. In Table 3a I summarise the reported advertising to salesratios for each response to the advertising and entry question. There is strongevidence that advertising levels are higher when entry deterrence is stated to bemore important. For example, managers for whom entry deterrence is a veryimportant aim report a mean advertising to sales ratio of 3.28%, compared to amean for all other firms of 2.18%. This result is consistent with entry deterrencerequiring additional advertising spend above the level necessary for simple brandmaintenance. A simple matched t-test confirms that this difference is stronglysignificant. I explore this issue in more detail in the multivariate work below.

4.2 Managers Advertising Response to Entry

I next consider the conjectured advertising responses of managers to potentialentry. The AIS asked managers whether and how they would change their

Table 3a. Entry deterrence as important aim of firms advertising

Degree of importance Number Percentage Mean A/S ratio

1 246 35.34 1.59

2 114 16.38 2.38

3 181 26.01 2.63

4 95 13.65 3.04

5 60 8.62 3.28

Total answering question 696 100.0 2.32

Source: 1999 Advertising and Industry Survey, Question 7.Note:A response of 5 indicates that deterring entry is a very important aim of the firms advertising.

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70 D. Paton

advertising levels in response to the introduction of new products or new firms.Responses to this question are summarised in Table 4a. In both cases, the domi-nant answer is that of no advertising response with over 70% of managers indicat-ing they would not change advertising in response to either new products or newfirms. Of the remainder, the dominant proposed reaction is aggression (that is, toincrease advertising) rather than accommodation. In the case of new products,78.0% of managers indicating at least some response stated that they wouldincrease their advertising. For new firms, 82.3% of managers stated that theywould respond by increasing their advertising.

In principle, the fact that a manager states that entry deterrence is an impor-tant aim of advertising does not imply a particular response to the conjecturalquestions. For example, a firm that uses advertising to deter potential entry maystill find it optimal not to respond if actual entry occurs. Similarly, the optimallevel of advertising for other firms may change post-entry. That said, it is notablethat that relatively high percentage of managers who indicated that entrydeterrence was quite or very important also stated that they would change theiradvertising in response to new entry.

The breakdown of the conjectured responses to new products and new firmsis given by sector in Tables 4b and 4c, respectively. The Pearson and likelihood

ratio tests do not suggest systematic differences in the response to new products

Table 3b. Entry deterrence as aim of firms advertising by industrial sector

Degree of importance

1 2 3 4 5 Total

Sector % % % % % %

Consumer manufacturing 13.41 14.04 17.13 15.79 16.67 15.09

Producer manufacturing 24.39 25.44 27.62 25.26 20.00 25.14

Distribution 10.57 10.53 5.52 15.79 8.33 9.77

Retailing 6.10 10.53 13.81 3.16 10.00 8.76

Consumer services 16.26 15.79 13.81 16.84 13.33 15.37

Producer services 29.27 23.68 22.10 23.16 31.67 25.86

All 100.00 100.00 100.00 100.00 100.00 100.00

Source:1999 Advertising and Industry Survey, Question 7 and Question 13.Note:A response of 5 indicates that deterring entry is a very important aim of the firms advertising.

Table 4a. Reaction of firm to new rival product or company entering market

New rival product New rival company

Change in % of salesspent on advertising Number % Mean A/S Number % Mean A/S

Increase 117 17.38 3.61 139 20.65 3.20

Decrease 33 4.90 1.94 30 4.46 1.86

No change 523 77.71 2.02 504 74.89 2.05

Total 673 100.0 2.27 673 100.0 2.27

Source:1999 Advertising and Industry Survey, Question 12

Note:Advertising to sales ratio figures are restricted to the 616 firms reporting these data.

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across sectors. However, for the case of new firms, there is some evidence thatmanagers of service- and retail-based firms are more likely than those in othersectors to indicate that they would respond by increasing their advertising. Froma corporate strategy perspective, this weakness of evidence of inter-sectoraldifferences is not surprising. Intra-industry differences in firm profitability tendto dominate inter-industry effects (McGahan and Porter, 1997), whilst the latterare probably important for strategic groups of firms in particular sub-markets.

There is also evidence that managers who state that they would respondactively to new entry tend to report higher advertising intensity than others. Forexample, the mean advertising to sales ratio when no response to new firms isindicated is 2.04%, whereas the figure for those managers who indicate anincrease in advertising is 2.94%, a difference that is statistically significant.

In summary, the evidence from the Survey suggests that the advertisingmanagers of a significant minority of UK firms perceive advertising either as away of deterring entry or as a strategic tool to use in response to entry. Further-more, advertising is much more intensively used in these firms. However, there isvery little difference in attitudes to advertising and entry across different sectorsof the economy. In the light of these preliminary results, I now go on to examinewhether multivariate analysis can reveal systematic differences in managersattitudes to advertising and entry deterrence.

Table 4b. Reaction of firm to new rival product by industrial sector

Increase Decrease No change Total

Sector % % % %

Consumer manufacturing 14.53 15.15 15.87 15.60Producer manufacturing 24.79 24.24 25.62 25.41

Distribution 8.55 12.12 10.33 10.10

Retailing 6.84 12.12 9.18 8.92

Consumer services 17.95 6.06 13.38 13.82

Producer services 27.35 30.30 25.62 26.15

All 100.00 100.00 100.00 100.00

Source:1999 Advertising and Industry Survey, Question 12 and Question 13.

Table 4c. Reaction of firm to new rival company by industrial sector

Increase Decrease No change Total

Sector % % % %

Consumer manufacturing 9.35 20.00 17.06 15.60

Producer manufacturing 20.14 30.00 26.59 25.41

Distribution 8.63 6.67 10.71 10.10

Retailing 14.39 10.00 7.34 8.92

Consumer services 23.02 10.00 11.51 13.82

Producer services 24.46 23.33 26.79 26.15

All 100.00 100.00 100.00 100.00

Source:1999 Advertising and Industry Survey, Question 12 and Question 13.

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72 D. Paton

5. Multivariate Models of Advertising and Entry

Since the primary purpose of our research was to investigate the strategic use ofadvertising in discouraging and responding to entry, I used multivariate modelsto analyse the responses to the relevant questions. Since the questionnaireproduced discontinuous data, I employed limited dependent variable models.These were: first, an ordered probit to analyse the factors determining the impor-tance of entry limitation to the advertising decision; and second, multinomiallogit models to explore the response to entry.

5.1 Advertising to Deter Entry

I initially explore the determinants of the importance of entry deterrence to theadvertising managers. Although it would be expected that the underlying impor-tance of entry deterrence would be some continuous variable, the questionnaire

responses generate an ordinal measure divided into five ordered categories. Wedenote this dependent variable as IMPORTANCE. In such a situation, orderedprobit is an appropriate estimation procedure. I relate this latent variable to avariety of firm and industry level factors. Specifically, I hypothesise that defend-ing a competitive advantage by limiting entry will be a more important motiva-tion both for firms that are operating in markets with a high degree of marketpower and for firms that are dominant in those markets. Firms within monopo-lised markets are likely to have most to lose from entry and the dominant firmsare the ones most likely to have the ability to influence the decisions of potentialrivals. It is common to use proxy measures of market power based on artificialdelineation such as the standard industrial classification. These measures sufferfrom the disadvantage that industry definitions employed in the classificationfrequently show a poor correspondence with actual market boundaries and mypreference is to use survey information provided by the managers on the marketconditions of their main product line or service. I use this information to constructdummy variables for firms that are dominant advertisers in the market for theirmain product line or service (DOM) and also for firms indicating that they face 5or fewer competitors (MONOP) and more than 10 competitors (COMPET).11 Ialso include the profit rate of the firm, lagged by one year as an alternativemeasure of market power of the firm (PROFLAG).

The descriptive statistics in section four suggested there is little difference in

the importance of entry between consumer- and producer-orientated firms. Analternative approach is to distinguish markets in which media advertising is animportant form of competition. These markets are likely to include someproducer-based markets (for example, that for office computers) as well as toexclude some consumer-based markets. I construct such a variable using surveyinformation on the relative importance of advertising compared to other competi-tive tools such as price, quality and customer services. Specifically I define adummy variable (MEDIA) to equal one if media advertising is ranked as the firstor second most important form of competition in the firms market.

I am also interested in examining whether entry deterrence is more important

for different sorts of media. The survey provides us with information on the mostimportant (in terms of expenditure) advertising media for each firm and I use thisto construct dummy variables equalling one if the media in question is one of thetwo most important for the firm. The media I consider are television (TV), radio

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(RADIO), poster (POSTER), trade press (TRADE), national newspaper (NEWS),national magazine (MAG), local press (LOCAL) and the Internet (INTERNET).

Given the nature of specific advertising media, it is important to control forthe geographical nature of the firms market. For example, a substantial propor-tion of advertising media in the UK are targeted at the national or international

(as opposed to the regional) level. Examples include national and satellite TV,radio, newspapers and specialist magazines and the Internet. Thus, I include adummy variable (REG) for firms that indicate that market for their main produceline is regional rather than UK, EU or International and I expect that entrydeterrence will be a much less important motivation for the advertising of thesefirms. A description of each variable, along with summary statistics, is providedin the Appendix.

The structure of the questions in the AIS means that the econometric model iscomprised almost entirely of discrete variables (the exception being lagged profit-ability which is continuous). Although unavoidable in this case, it is important to

bear in mind that the emphasis on discrete variables both here and in the multino-mial model below, means that quite complex influences on advertising strategiesare being modelled using a somewhat simplistic functional form.

Results of the ordered probit estimates are reported in Table 5. In column 1, Ireport a general model, whilst in column 2 I report a more parsimonious model inwhich variables that are insignificant at the 10% level are dropped sequentially. Ateach stage of this process, I re-check the significance or otherwise of variables thatwere dropped at earlier stages. It is well known that limited dependent models can

be quite sensitive to violations of standard assumptions regarding the error term(see, for example, Greene, 2000). For example, probit estimates are likely to beinconsistent in the presence of either heteroscedasticity or non-normality. For thisreason, I report a range of diagnostic statistics both specifications. I find noevidence of significant mis-specification.12

We find that, as expected, firms within monopolised markets and firms thatare dominant within these markets are significantly more likely to indicate thatentry deterrence is important. Similarly, high (lagged) profit rates are positivelyassociated with the importance of entry deterrence. The control variables formarkets within which media advertising is an important form of competition andfor firms whose market is regional both perform as expected. Looking at thedummies for different forms of media, we find that firms for which radio adver-tising is important also tend to be ones for which entry deterrence is an important

motivation for advertising. Interestingly, none of the other media dummies,including that for television, attract significant coefficients.

5.2 Determinants of the Advertising Response to Entry

In analysing the managers response to new entry to their core market we havethree alternative actions to consider. The most obvious approach is to relate theadvertising responses to firm characteristics using multinomial logit. However,with multinomial logit we have to assume the independence of irrelevant alterna-tives (IIA) (see Greene, 2000). In other words, the relative probabilities of the deci-

sion to choose, say, alternative A rather than alternative B should be constantirrespective of whether alternative C is included in the model. To explore thevalidity of the multinomial model here, I use a Hausman test for the IIA assump-tion (see Greene, 2000). The Hausman test statistics (reported in Table 6) are all

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74 D. Paton

insignificant. In other words, there is no evidence, at least from these statistical

tests, to suggest that the multinomial logit model has violated the IIA assumption.Our dependent variable (REACT) is trichotomous and defined as category 1 if

the manager indicates an increase in advertising in response to entry, category 2 ifa decrease and category 3 if no response. The latter category is used as the

Table 5. Ordered probit estimates of the determinants of the importance of entrydeterrence in advertising

(1) (2)

General model Parsimonious model

DOM 0.223**(0.094)

0.209**(0.090)

MONOP 0.171(0.130)

0.185*(0.106)

COMPET 0.031(0.108)

PROFLAG 0.488**(0.246)

0.473**(0.242)

MEDIA 0.253**(0.123)

0.278**(0.117)

TV 0.003(0.209)

RADIO 0.413**(0.165)

0.383**(0.157)

POSTER 0.067(0.207)

NEWS 0.098(0.125)

MAG 0.021(0.102)

LOCAL 0.008(0.125)

TRADE 0.052(0.095)

INTERNET 0.123(0.136)

REG 0.424***(0.153)

0.388***(0.141)

N 645 657

Log likelihood 944.86 969.08

Wald test 43.04*** 30.63

Diagnostic tests:

Functional form 2.357 3.442

Heteroscedasticity 5.747 2.351

Normality 1.522 0.262

Notes:(i) The dependent variable is IMPORTANCE as described in the text.(ii) Coefficients (as opposed to marginal effects) are reported. Robust standard errors in brackets.(iii) * Significant at 10%; ** significant at 5%; *** significant at 1%.(iv) The Wald test of the joint significance of all variables in the model.(v) The diagnostic tests are as described in the text.

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Table 6. Multinomial logit estimates of the determinants of the advertisingresponse to entry

(1a) (1b) (2a) (2b)


Aggressiveresponse (increase

advertising)

Accommodatingresponse (decrease

advertising)


advertising)


advertising)

DOM 0.192(0.238)

0.443(0.501)

MONOP 0.865***(0.329)

0.484(0.646)

1.0392***(0.249

0.288(0.521)

COMPET 0.310(0.321)

0.006(0.561)

PROFLAG 0.568

(0.527)

0.223

(0.600)

MEDIA 0.326(0.297)

0.655(0.501)

TV 0.469(0.480)

33.77***(0.580)

0.582(0.456)

32.125***(0.409)

RADIO 1.124**(0.472)

0.029(1.146)

1.182***(0.444)

0.045(1.141)

POSTER 0.105(0.578)

0.209(1.193)

NEWS 0.341(0.346)

0.059(0.672)

MAG 0.107(0.275)

0.475(0.478)

LOCAL 0.235(0.329)

0.586(0.610)

TRADE 0.176(0.289)

0.134(0.504)

INTERNET 0.149(0.336)

0.291(0.594)

REG 0.223(0.361)

0.596(0.742)

ASRATIO 0.038(0.032)

0.038(0.084)

0.056*(0.031)

0.020(0.087)

ENTRY 0.659**(0.263)

0.546(0.506)

0.677***(0.259)

0.545(0.480)

Sectors:

Producermanufacturing

1.038**(0.434)

0.074(0.729)

0.891**(0.423)

0.081(0.678)

Distribution 0.856*(0.518)

0.450(0.920)

0.749(0.512)

0.081(0.678)

Retailing 1.759***(0.477)

0.162(0.979)

1.780***(0.457)

0.647(0.891)

Consumerservices

1.645***(0.438)

0.036(0.820)

1.614***(0.431)

0.069(0.888)

Producer

services

1.320***

(0.414)

0.064

(0.734)

1.151***

(0.406)

0.069

(0.788)Constant 3.003***

(0.487)3.130***(1.030)

3.027***(0.373)

2.699***(0.634)

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76 D. Paton

reference group.13We include a vector of independent variables, similar to thatabove but add a set of dummy variables for the sector of the firms main productline or service (ASRATIO). We also include the reported advertising to sales ratioof the firm and a dummy variable for the firms indicating that entry was a quiteor very important aim of their advertising (ENTRY).

Results are reported in Table 6. As before, the general models are reported incolumns 1a and 1b and the more parsimonious in columns 2a and 2b. Modelselection for the parsimonious model is similar to that for the probit model withthe exception that I retain any variable that is significant at the 10% level in eitherequation. Perhaps unsurprisingly given the small sample size, the equation for anaccommodating response (decreasing advertising) appears to be less well speci-fied than that for the aggressive response (increasing advertising). The results forthe positive advertising response suggest some important differences with theordered probit model above. An aggressive response seems much more likely forproducts within producer manufacturing, retailing and services. Lagged profit-ability and being a dominant firm with respect to advertising have very littleimpact on the probability of a positive or negative advertising response to theentry of a new firm. However, firms operating within a highly monopolised

market for their main product line appear to be significantly more likely thanothers to increase their advertising in response to entry of a new firm. Managersfor whom entry is an important aim of advertising are significantly more likely toconjecture an aggressive advertising response. Once again radio advertisers aremore likely to indicate an aggressive response.

6. Conclusions

Advertising is widely considered to be an important isolating mechanism throughwhich firms may defend an established competitive advantage. However, there is

relatively little empirical evidence on the extent of the strategic use of advertising.This apparent anomaly is most likely to be due to a lack of firm-level advertisingdata. This paper has reported on a large-scale study of the advertising practices ofmedium-sized and large UK-based firms. Nearly one-quarter of all the advertisers

Table 6. Continued.

(1a) (1b) (2a) (2b)



advertising)


advertising)


advertising)


advertising)

IIA test 0.000 0.799 0.00 1.372

N 561 561

Log likelihood 345.23 350.98

Wald test 13672.0*** 12702.5

Notes:(i) The dependent variable is REACT as described in the text. The reference category is no response.(ii) Reference category for the sector dummies is consumer manufacturing.

(iii) See also Table 5, notes (ii) - (iv).

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surveyed state that they attribute importance to entry deterrence as an aim of theiradvertising. Further, one in five managers of advertising firms, state that theywould increase advertising expenditure if a new rival company appeared in theirmarket. It is also apparent that there is a strong correlation between the perceivedimportance of advertising as an entry-deterring tool and the intensity of advertis-

ing spending. Our multivariate modelling provides confirmation that the exist-ence of a sheltered market position and the profitability that typically accompaniesthis provides a statistically significant determinant of the decision to use advertis-ing as a strategic entry-deterring weapon.

The reliance which can be placed on these results depends in part on theextent to which managers provided honest and truthful responses. It is impossi-

ble to resolve this question definitively, but the anonymity provided by thesurvey and the fact that the vast majority of managers were prepared to provideanswers to the relevant questions suggest that some confidence can be placed onthe results. Furthermore, the positive results obtained when objective account-

ing information was used in conjunction with the more subjective questionnairedata adds credence to the findings.The finding that a significant proportion of managers claim that entry

deterrence is an important reason for advertising emphasises how important it isfor potential entrants to assess carefully whether incumbent firms are likely torespond to entry by aggressively by increasing their advertising beyond currentlevels. Specifically, firms in services, producer manufacturing and those operat-ing in highly monopolised markets appear to be much more likely to respondaggressively than others.

Notes

1. Thus, patenting is important in R&D-intensive industries, such as pharmaceuticals, but largelyirrelevant to consumer goods such as food, drink and tobacco, while early-mover advantages aremanifest in high-tech industries where network externalities, switching costs and strong learningeconomies are present.

2. A copy of the data is available from the ESRC Databank, study number 4209.3. Much of this work has used a game theory approach. Examples include Schmalensee (1983) and

Fudenberg and Tirole (1984) who present models in which entry is deterred by under-advertising.In contrast, in the more recent model of Doraszelski and Markovich (2007), over-advertisingdeters entry.

4. See Kessides (1986), Robinson and Chang (1996) and Sass and Saurman (1995) for examples of

alternative findings on the advertising-entry-concentration relationship.5. There is generally a correlation between industry profitability and advertising intensity. However,

distinguishing the effects of advertising in raising profits, perhaps by keeping out rivals, from theeffects of higher profits encouraging greater advertising spend and from more complex causalroutes altogether remain difficult.

6. The incumbent, who typically has in place sales networks etc., is generally better placed to meetincreases in demand. Rizzo and Zeckhauser (1990) provide an interesting example of newentrant physicians using advertising to establish themselves in local US markets, but they alsofind the returns to defensive advertising by established physicians in those markets to be higher.Greuner et al. (2000) conclude that advertising does not increase barriers to entry in the new carindustry.

7. Full details of the selection criteria can be found in Conant and Paton (2001).8. The Annual Business Inquiry Respondents Database provides accounts data at plant level for the

UK. It is not possible to identify individual firms in this database. Further, plant level is probablytoo disaggregated for the purposes of this survey.

9. FAME is a database of accounts of some 130,000 UK-based firms covering all sectors of theeconomy operated by Bureau van Dijk. It includes both UK- and foreign-owned companies as

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78 D. Paton

well as subsidiaries. Accounts data were subjected to various checks for consistency includingcomparisons with other sources such as Datastream and Company Analysis.

10. The text of all relevant questions is provided in the Appendix.11. We also considered more traditional measures of market concentration such as the Herfindahl

index and market share at 3- and 4-digit SIC levels. In fact, in every case, the survey variablesperformed better and we do not report results for these other variables here.

12. These tests are adapted from those described in Machin and Stewart (1990) for the ordered probitmodel and are distributed as follows. The test for functional form tests for the inclusion of powersto the second, third and fourth degree and is distributed as 2(3). The test for heteroscedasticitytests the null hypothesis that the error variance = 1 and is distributed as 2 (k) where k is thenumber of explanatory variables in the model. That for non-normality is a test for skewness andkurtosis in the error term and is distributed as 2(2).

13. Multinomial logit with k alternatives generates k1 sets of coefficients since together these implythe marginal probabilities for the remaining (reference) category.

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80 D. Paton

TableA1.

Variabledefin

itionsanddescriptivestatistics

Definition

Mean

SD

Dependent

variables:

IMPORTANCE

Ordinalvariablerank

ingtheimportanceofentrydeterre

ncetoadvertisingonascaleof1to

5

REACT

Trichotomousvariableequalling1ifthemanagerindicatesthatadvertisingwouldincrease

inresponsetoentry,2ifthe

managerindicatesad

ecreaseand3fornochange

Independentvariables

DOM

Dummyvariableequallingoneifthemanagerindicates

thatitisoneofthedominantadvertisersinthemarketfortheirmain

productline

0.384

0.487

MONOP


that5orfewerrivalscompeteinth

emarketforitsmainproductor

service

0.224

0.417

COMPET


thatmorethan10rivalscompetein

themarketforitsmainproductor

service

0.560

0.497

PROFLAG

Themeanrateofpre-

taxprofitsasaproportionofsalesreportedbythefirmoverthepreviousthreefinancialyears(source:

FAME)

0.038

0.178

MEDIA

Dummyvariableequallingoneifthemanagerranksmediaadvertisingasoneofthetwom

ostimportantformsofcompetition

inthefirmsmainma

rket

0.139

0.346

TV


thatTVadvertisingisoneofthetw

omostimportantmedia

0.058

0.233

RADIO


thatradioadvertisingisoneofthe

twomostimportantmedia

0.060

0.238

POSTER


thatposteradvertisingisoneofthetwomostimportantmedia

0.049

0.217

NEWS


thatnationalnewspaperadvertisin

gisoneofthetwomostimportant

media

0.153

0.361

MAG


thatmagazineadvertisingisoneofthetwomostimportantmedia

0.239

0.427

LOCAL


thatlocalnewspaperadvertisingis

oneofthetwomostimportant

media

0.180

0.384

Appendix

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TableA1.

(Continued).

Definition

Mean

SD

TRADE

Dummyvariableequallingoneifthemanagerindicatesthatthetradepressisoneofthetwomostimportantadvertisingmedia

0.501

0.500

INTERNET


thattheInternetisoneofthetwom

ostimportantadvertisingmedia

0.129

0.335

REG

Dummyvariableequallingoneifthemanagerindicatesthatthemarketforitsmainproductorserviceisregionalasopposedto

nationalorinternational

0.117

0.321

ENTRY

Dummyvariableequallingoneifthemanagerstatesthatentryisaquiteorveryimportant

aimofadvertising

0.222

0.416

ASRATIO

Proportionoftotalad

vertisingtosalesreportedbythem

anager

2.268

3.681

Note:

Summarys

tatisticsrefertoallfirmsinthesurveyforwhichdataareavailable.

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82 D. Paton

Survey Questions Used in the Study

All Managers were asked:

Q1. Does your firm advertise? Yes*No

(Take advertising to include sponsorship (e.g. sports) and direct mail, but notproduct packaging or other forms of sales promotion)

Q13. In which sector is your companys main product line/service (Tick oneonly)?

Manufacturing (consumer goods)Manufacturing (producer goods)Distribution

Holding companyRetailServicesOther, please specify:____________

Q15. At which of these markets is your companys main product line/serviceaimed?

(Tick allthat apply):

Regional market UK market EU market International market

Q17. How many other firms compete in the market for your main productline/service?

0-1 2-5 6-10 more than 10

Managers whose company did not advertise were asked:

Q5. Which of the following factors would make you likely to advertise in thefuture?

(Tick anythat apply)

(a) Your company introduces a new product/brand

(b) A rival company introduces a new product/brand

(c) Rival companies start to advertise/increase advertising activities

(d) Rival companies stop advertising/decrease advertising activities

(e) Trading conditions improve

(f) Trading conditions worsen

(g) A new company enters the market

(h) New opportunities on the Internet

(i) Other, please specify:______________________________________________

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Managers whose company did advertise were asked:

Q7. To what extent are the following important aims of your advertising?

1Not at all important2Quite unimportant3Neitherimportant nor unimportant

4Quite important5Very important1 2 3 4 5

(a) To provide customers with practical product informatione.g. prices etc.

(b) To inform customers about the merits of the product

(c) To raise awareness of your products/brands

(d) To raise awareness of your company

(e) To launch new products or brands

(f) To increase market share

(g) To increase the size of the whole market

(h) To make it difficult for other companies to enter the market

Q12. In each of the following situations, do you think the percentage of salesthat you spend on advertising for your main product line would increase,decrease or not change?

1Increase 2Decrease 3No change

1 2 3

(a) Trading conditions worsen throughout the whole economy.

(b) Trading conditions improve throughout the whole economy.

(c) Trading conditions worsen just within your main market(s).

(d) Trading conditions improve just within your main market(s).

(e) Your main rivals increase their advertising. (f) Your main rivals decrease their advertising.

(g) Your company introduces a new product/brand.

(h) A rival company introduces a new product/brand.

(i) A new company enters your market.

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