When Good News is Bad
A WAVE OF POSITIVE PRESS, FIVE-STAR consumer reviews, and a drop in fixed costs sound like a dream come true for marketers and managers alike. Surprisingly, external positive shocks like these don’t always lead to an increase in profits according to research by Olin’s Baojun Jiang and Carnegie Mellon’s Kannan Srinivasan. The researchers use game theory to analyze the effects of positive consumer reviews, demand, and production costs on pricing and advertising strategies. Their findings provide some unexpected advice for managers.
KEY TAKEAWAYS for Managers
Take into consideration how competitors will react.
Avoid, in some situations, broadcasting positive changes to prevent triggering a competitor’s large strategic response.
Strengthen, when the competitor’s ability to respond is limited, the competitive advantages through strategic actions such as advertising.
Let’s look at two scenarios where Jiang and Srinivasan predict the impact of positive external shocks (good news) combined with different advertising strategies on the bottom line.
It may seem like common sense that if you get a barrage of positive news coverage for your product, your best bet would be to reduce your advertising spending, because you don’t really need it. However, Jiang found that assumption may be incorrect. If there’s a positive external shock AND advertising is costly or inefficient, it is in a firm’s best interest to increase its advertising spending. The reason? In this case, the firm’s competitor will see a huge barrier to increase its advertising, and it turns out to be even more profitable for the firm to further increase its competitive advantage by increasing advertising.
Same situation as scenario 1, except this time, advertising is relatively inexpensive, i.e., it can effectively change the consumer’s valuation or product preferences. In this case, Jiang argues that the firm with the good press should actually decrease its advertising spending in order to avoid an advertising spending war. The reasoning is that the firm’s competitor will significantly ramp up its advertising spending to compensate for the less favorable external news from the competitor’s perspective. In fact, the firm that got the seemingly favorable changes (e.g., positive press and consumer reviews) may see a decrease in profits because its competitors can fire back with dramatically increased advertising, thereby negating any of the original firm’s potential gains from the positive external news.
Jiang takes his findings on external shocks and advertising strategies a step further and predicts that the combination of:
- increased customer perception of the value of a product due to positive reviews/news, and
- efficient advertising spending on behalf of the firm with the positive news
will lead to an industry-wide increase in advertising spending.
So what impact, if any, do these scenarios have on pricing? Jiang discovered that if one firm has a positive external shock, and advertising throughout the industry is efficient, it can actually lead to a decrease in the price differences throughout the industry.
There are several applicable lessons in this research for managers. While certain external factors like supply costs and consumer reviews are beyond a manager’s control, mangers do have control over their reactions to external factors through advertising and pricing.
Mathematical analysis modeling or game theory used in this research provides useful insights about consumer and firm behavior in a controlled setting. The unexpected finding that good news could backfire on a firm if its competitors have effective marketing tactics leads Professor Jiang to offer this simple warning to managers when it comes to favorable external news for your company: “Be careful what you wish for.”
"Pricing and Persuasive Advertising in a Differentiated Market"
Authors: Baojun Jiang
, Assistant Professor of Marketing, Olin Business School, Washington University in St. Louis
Kannan Srinivasan, Carnegie Mellon University
Under journal review