Investigating the Relationship Between Advertising and Pricing in a Channel with Private Label Offering: A Theoretic Model

Abstract

We study the relationship between pricing and advertising decisions in a distribution channel where national brands are competing with a private label. We solve a three-stage game-theoretic model where the national brands compete on advertising and prices, and the retailer is investing in umbrella advertising for the store and is selling a private label. The obtained equilibrium strategies highlight the importance of determining the complementary or competitive roles of advertising to better understand the relationship between advertising and prices, and to better adjust strategies to varying competition levels in the marketplace. In particular, we find that advertising that expands the national brands' sales gives pricing power to manufacturers. However, persuasive advertising can create different effects on prices depending on the strength of the advertising effect and on the price competition level between the national and the store brands. For highly competitive advertising effects, the retailer should charge lower prices for the private label when it carries highly advertised national brands, increase the national brand's price that is being advertised and decrease the price of the competing national brand. The retailer's advertising leads to higher prices for the national and private labels. We consider several extensions of the base model (retail competition, asymmetric manufacturers and dynamic effects of advertising) and show that our results still hold in such settings. Marketing implications and comparative statistics are also discussed.