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Costs, Institutional Mobility Barriers, and Market Structure: Advertising Agencies as Multiproduct Firms

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  • 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 that 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 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: (1) “bundling” of agency services to match client demand for a mix of media advertising, and (2) “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. The paper concludes with a discussion of the implications of these findings for the restructuring currently underway in this industry.

Suggested Citation

  • Alvin J. Silk & Ernst R. Berndt, 1994. "Costs, Institutional Mobility Barriers, and Market Structure: Advertising Agencies as Multiproduct Firms," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 3(3), pages 437-480, September.
  • Handle: RePEc:bla:jemstr:v:3:y:1994:i:3:p:437-480
    DOI: 10.1111/j.1430-9134.1994.00437.x
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    References listed on IDEAS

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    1. R. E. Caves & M. E. Porter, 1977. "From Entry Barriers to Mobility Barriers: Conjectural Decisions and Contrived Deterrence to New Competition," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 91(2), pages 241-261.
    2. Schmalensee, Richard & Silk, Alvin J & Bojanek, Robert, 1983. "The Impact of Scale and Media Mix on Advertising Agency Costs," The Journal of Business, University of Chicago Press, vol. 56(4), pages 453-475, October.
    3. Eaton, B Curtis & Lemche, S Q, 1991. "The Geometry of Supply, Demand, and Competitive Market Structure with Economies of Scope," American Economic Review, American Economic Association, vol. 81(4), pages 901-911, September.
    4. R. Schmalensee & R. Willig (ed.), 1989. "Handbook of Industrial Organization," Handbook of Industrial Organization, Elsevier, edition 1, volume 2, number 2.
    5. Silk, Alvin J. & Berndt, Ernst R., 1992. "Scale and scope effects on advertising agency costs," Working papers 3381-92., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    6. R. Schmalensee & R. Willig (ed.), 1989. "Handbook of Industrial Organization," Handbook of Industrial Organization, Elsevier, edition 1, volume 1, number 1.
    7. Wang Chiang, Judy S & Friedlaender, Ann F, 1985. "Truck Technology and Efficient Market Structure," The Review of Economics and Statistics, MIT Press, vol. 67(2), pages 250-258, May.
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    Cited by:

    1. Mohammad Arzaghi & J. Vernon Henderson, 2008. "Networking off Madison Avenue," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 75(4), pages 1011-1038.
    2. Sharon Horsky, 2006. "The Changing Architecture of Advertising Agencies," Marketing Science, INFORMS, vol. 25(4), pages 367-383, 07-08.
    3. Charles King & Alvin J. Silk & Niels Ketelhöhn, 2003. "Knowledge Spillovers and Growth in the Disagglomeration of the Us Advertising‐Agency Industry," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 12(3), pages 327-362, September.
    4. Mohammad Arzaghi, 2005. "Quality Sorting and Networking: Evidence from the Advertising Agency Industry," Working Papers 05-16, Center for Economic Studies, U.S. Census Bureau.

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