Advertising in a Distribution Channel

Conventional wisdom suggests that one of the goals of manufacturer advertising is to reduce the cross-price elasticity between products (make one's own and rivals' products appear to be less substitutable in the eyes of consumers). Conventional wisdom also suggests that, all else being equal, retailers will be able to obtain better terms of trade from manufacturers the more substitutable are the manufacturers' products. It follows that retailers should be opposed to advertising that has the effect of reducing cross-price elasticities and thus that manufacturer advertising can be a source of channel conflict. We show that these conventional wisdoms need not hold when only some consumers are exposed to the advertising messages. Using a Hotelling model of demand, we show that (1) manufacturers can be worse off from advertising that reduces the cross-price elasticities between their products, (2) channel conflict need not arise, even when the sole purpose of advertising is to affect cross-price elasticities, and (3) depending on its bargaining power, a retailer can be better off when the manufacturers' products are perceived to be less substitutable.