Endogeneity of marketing variables in multicategory choice models

Abstract

Abstract A regressor is endogenous if it is correlated with the unobserved residual of a model. Ignoring endogeneity may lead to biased coefficients. We deal with the omitted variable bias that arises if firms set marketing variables considering factors (demand shocks) that researchers do not observe. Whereas publications on sales response or brand choice models frequently take the potential endogeneity of marketing variables into account, multicategory choice models provide a different picture. To consider endogeneity in multicategory choice models, we follow a two-step Gaussian copula approach. The first step corresponds to an individual-level random coefficient version of the multivariate logit model. We analyze yearly shopping data for one specific grocery store, referring to 29 product categories. If the assumption of a Gaussian correlation structure is met, the copula approach indicates the endogeneity of a category-specific marketing variable in about 31% of the categories. The majority of marketing variables rated as endogenous are positively correlated with the omitted variable, implying that ignoring endogeneity leads to an overestimation of the coefficients of the respective marketing variable. Finally, we investigate whether taking endogeneity into account by the copula approach leads to different managerial implications. In this regard, we demonstrate that for our data ignoring endogeneity often suggests a level of marketing activity that is too high.