Working Paper: NBER ID: w4826
Authors: Alvin J Silk; Ernst R Berndt
Abstract: What accounts for the diversity and limited concentration that has long characterized the organization of the advertising agency industry? This question is addressed by treating an advertising agency as a multiproduct firm. The firm's product line or service mix is defined in terms of the set of different media categories where an agency places the advertising messages which it creates on behalf of its clients. Evidence is presented indicating that the structure of demand and costs in the advertising agency industry conforms to the conditions that MacDonald and Slivinski (1987) showed were required for an industry to sustain an equilibrium with diversified firms. Building on this framework, we formulate a set of three hypotheses relating to the realization of product-specific scale and scope economies. The first two hypotheses posit that given low fixed costs and minimal entry barriers, both media-specific scale and scope economies are available and can be exploited by relatively small-size agencies. The third hypothesis suggests that large agencies may experience diseconomies of scope as a consequence of excessive diversification induced by two pervasive industry institutional phenomena: (i) 'bundling' of agency services to match client demand for a mix of media advertising; and (ii) 'conflict policy' which prohibits an agency from serving competing accounts and operates as a mobility constraint. Utilizing a multiproduct cost function, we estimate media-specific scale and scope economies for a cross-section of 401 U.S. agencies in 1987. The results obtained support the set of three hypotheses outlined above.
Keywords: advertising agencies; market structure; multiproduct firms; scale economies; scope economies
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| advertising agency industry characteristics necessary for sustaining competitive equilibrium (M38) | competitive equilibrium with diversified firms (L19) |
| low fixed costs and minimal entry barriers (L11) | small agencies exploit media-specific scale and scope economies (L25) |
| excessive diversification driven by conflict policy and media bundling (G34) | large agencies face diseconomies of scope (L25) |
| agency size and product mix (L85) | realization of scale and scope economies (L25) |