To be considered for the Young Economist Award: Advertising Restrictions and Competition in the Children’s Breakfast Cereal Industry C. Robert Clark∗ March 14, 2005 Abstract This paper takes advantage of the ban on advertising directed at children in the Canadian province of Quebec to examine the nature of advertising in the market for a particular children’s product, and to determine whether the advertising restriction differentially impacts certain varieties. Using a unique data set from the Print Mea- surement Bureau of Canada which surveys the purchasing behavior of some fifteen thousand Canadian households annually, as well as advertising and price data from AC Nielsen, I examine the children’s breakfast cereal market in Canada. If advertising in this market is informative, it should help to overcome perceived product differenti- ation, and so should lead to price competition and lower prices. If it is persuasive, it should generate the perception that there are fewer substitutes for promoted brands, and so should increase perceived differentiation and prices. I show that prices are higher in Quebec than in other Canadian regions, suggesting that the role of advertis- ing in this market is to inform consumers about existence. If advertising is informative, a ban on advertising should increase the market shares of older, better-known brands and decrease the market shares newer and/or less well-known brands. This predic- tion is confirmed in the data: established brands have higher market share in Quebec than in Canadian regions where advertising is permitted, and the opposite is true for non-established brands. JEL classification: L1, L5, M3 Keywords: Advertising restrictions, Competition ∗Institute of Applied Economics, HEC Montr´eal, Universit´ede Montr´eal, 3000 Cˆote-Sainte-Catherine, Montr´eal,QC, CANADA H3T 2A7 and CIRANO; [email protected] 1 1 Introduction Advertising has come to represent a critical element of firm strategy. In the United States, in the year 2000, the average advertising to sales ratio for the two hundred largest advertising spending industries was close to 5% (AdAge.com). However, for a variety of products in an increasing number of jurisdictions, advertising is restricted. Cigarette advertising is restricted to varying degrees, in a number of countries including all OECD countries. Alcohol advertising is also often heavily regulated. Sweden, Greece and the Canadian province of Quebec have enacted legislation prohibiting at least some forms of advertising directed at children. Restrictions on advetising directed at children are also being considered in the U.S. where the American Psychological Association recently came out in favor of a ban on advertising directed at children under the age of eight, and in the European Union where a ban on junk food advertising to children is being considered.1 Reducing total consumption would seem to be the main purpose of these advertising bans.2 However, in addition to affecting the overall level of sales, an advertising ban may have a differential impact on specific firms, advantaging some relative to others. Whether or not there is a differential impact and which firms are advantaged or disadvantaged depends on the role that advertising plays. If advertising’s role is largely to inform new consumers about a product’s existence and characteristics (see Stigler (1961), Butters (1977), and Grossman and Shapiro (1984)) then older, better known brands will benefit. Newer products cannot use advertising to generate awareness and so it now becomes more difficult to inform potential customers of their existence.3 Word-of-mouth becomes a potentially more important avenue of information and so established products are likely to be harmed relatively less than are new products or those of which few consumers are aware. 1McKay, Betsy, ”Study Tries to Link Obesity in Children with Food Marketing”, http://online.wsj.com, January 27, 2005. 2The European Union junk food advertising ban, for instance, is being considering in order to fight rising levels of obesity (http://news.bbc.co.uk/2/hi/business/4190313.stm). 3 These predictions are supported by theoretical work by Clark (2003), whose static model of informative advertising and brand awareness predicts greater market shares for recognized brands in regions where advertising is permitted and the opposite for non-established brands, and by Doraszelski and Markovich (2002), whose dynamic model of awareness advertising predicts that if there are existing asymmetries amongst firms, then banning advertising may increase the market shares of firms with higher levels of awareness. 2 Alternatively, persuasion, and not information transmission, may be the more im- portant function of advertising. Stigler and Becker (1977), and Becker and Murphy (1993) suggest that advertising affects the utility that consumers derive from consum- ing a product. Advertising creates prestige or image effects by acting as a complement to the consumption of the product. This type of advertising has also been referred to as goodwill advertising (Nerlove and Arrow (1962), Boyer (1974)). Advertising expendi- tures contribute to a stock of goodwill that depreciates over time. Without the ability to advertise, it is more difficult for brands to generate goodwill, and so if advertising is persuasive, then products with significant stocks of goodwill should benefit from the regulation (Doraszelski and Markovich (2003)). In addition to these effects on competition, the two theories of advertising yield differ- ent predictions of the impact of advertising on price. If advertising is informative, then it should help to overcome perceived product differentiation and so should lead to price competition and lower prices. On the other hand, if advertising is persuasive, then it generates the perception that there are fewer substitutes for promoted brands, and as a result increases perceived differentiation and prices. Therefore, if advertising is informa- tive and it is banned, prices should be higher, while if it is persuasive and it is banned, prices should be lower. In this paper I take advantage of the ban on advertising directed at children in Quebec to examine the nature of advertising in the market for a particular children’s product, and to determine whether the advertising restrictions differentially impact certain varieties. The Quebec Consumer Protection Act has outlawed commercial advertising directed at persons under the age of thirteen. This legislation went into effect in April of 1980. From that time forward, advertising directed at children was prohibited under sections 248 and 249 of the Act. The Act lists three criteria that must be considered in order to determine whether an advertisement is directed at children: i) the nature and intended purpose of the goods advertised, ii) the manner of presenting the advertisement, and iii) the time and place it is shown. If products are intended exclusively for the use of children or have a marked appeal for children, then they cannot be advertised at all on children’s programmes (programmes for which children make up at least 15% of the audience), and can only be advertised on other programmes if they are treated so as not to appeal to the 3 needs of children.4 Using a unique data set from the Print Measurement Bureau of Canada (PMB) which surveys the purchasing behavior of some fifteen thousand Canadian households annually, as well as advertising and price data from AC Nielsen, I examine the children’s breakfast cereal market in Canada. I first show that prices for children’s brands are higher in Quebec than in other Canadian regions; this finding suggests that the role of advertising in this market is to inform consumers about existence. Given this, I then test the prediction that a ban on advertising increases the mar- ket shares of older, better-known brands (established brands) and decreases the market shares of newer and/or less well-known brands (non-established brands). This predic- tion is confirmed in the data: established brands have higher market share in Quebec than in Canadian regions where advertising is permitted, and the opposite is true for non-established brands. These results are consistent with those from studies of the effect of advertising restric- tions on competition in different industries. Eckard (1991) studies the cigarette industry through an examination of the 1971 ban on television advertising in the United States. By comparing measures of competition in the cigarette industry in the ten years prior to the ban and in the ten years after, he finds that shares of leading brands were declining before the ban on advertising, but stable or increasing after its imposition. He also finds that the ban impedes the entry of new firms into the industry. Holak and Reddy (1986) report similar results. They find that the effect of past sales on current purchases is stronger after the ban on cigarette advertising. Sass and Saurman (1995) examine restrictions that vary by region. They analyse the malt beverages industry and find that advertising restrictions lead to increases in market concentration. The present study examines the reasons why brands are differentially affected by the advertising restrictions, whereas those mentioned above all focus on the effect of advertis- ing restrictions on large market-share brands without modeling what it is about having a large market share that allows these brands to grow in the absence of advertising. Holak and Reddy do point out that there is some evidence that being an early entrant could be important. They show for some cigarette categories that purchase inertia for earlier entrants is greater after the ban. Sass and Saurman discuss what it is about large- 4There are some minor exceptions. In particular, in-store displays are exempt from the legislation. 4 share brands that allows them to enjoy greater market share in states where advertising is restricted: big-share brands are produced by large national brewers, while small-share brands are produced by local brewers.