Assessing the profitability of cooperative advertising programs in competing channels

Abstract

A large literature studied the profitability (effectiveness) of cooperative advertising programs (CAPs) in distribution channels, but very few studies modeled pricing decisions in competitive markets under different channel structures. This paper fills this gap. We propose a game-theoretic model where two competing channels make pricing and promotional decisions. The effectiveness of CAPs is studied under different channel structures to examine how vertical and horizontal externalities can impact the effectiveness of CAPs. Each channel structure can be integrated or decentralized to account for different vertical interaction effects, resulting in three cases: (i) both channels are decentralized (DD), (ii) both are integrated (II), and (iii) a hybrid structure where one channel is decentralized and is competing with an integrated channel (DI). We solve six non-cooperative games: (1) both manufacturers offer CAPs under DD, (2) only one manufacturer offers a CAP under DD, (3) both manufacturers do not offer CAPs under DD, (4) the decentralized manufacturer offers a CAP under DI, (5) the decentralized manufacturer does not offer a CAP under DI, and (6) the channel problem under II. Then, we obtain and compare equilibrium profits and strategies across these games. The main results indicate that the profitability of CAPs depends on the levels of price competition and of the advertising effects. Also, while manufacturers benefit from CAPs, retailers may not find such programs profitable. Finally, the decentralized or integrated structure of the competing channel significantly impacts the effects of cooperative advertising. For example, CAPs can effectively coordinate the DD channel and even help it exceed profits earned by a vertically integrated channel. However, in the DI case, although CAPs can improve total channel profits, they do not fully coordinate the channel.