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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 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.

Suggested Citation

  • Alvin J. Silk & Ernst R. Berndt, 1994. "Costs, Institutional Mobility Barriers, and Market Structure: Advertising Agencies as Multiproduct Firms," NBER Working Papers 4826, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:4826
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    References listed on IDEAS

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    1. Alvin J. Silk & Ernst R. Berndt, 1993. "Scale and Scope Effects on Advertising Agency Costs," Marketing Science, INFORMS, vol. 12(1), pages 53-72.
    2. Porter, Michael E, 1976. "Interbrand Choice, Media Mix and Market Performance," American Economic Review, American Economic Association, vol. 66(2), pages 398-406, May.
    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. MacDonald, Glenn M & Slivinski, Alan, 1987. "The Simple Analytics of Competitive Equilibrium with Multiproduct Firms," American Economic Review, American Economic Association, vol. 77(5), pages 941-953, December.
    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. Caves, Richard E, 1986. "Information Structures of Product Markets," Economic Inquiry, Western Economic Association International, vol. 24(2), pages 195-212, April.
    7. Bailey, Elizabeth E & Friedlaender, Ann F, 1982. "Market Structure and Multiproduct Industries," Journal of Economic Literature, American Economic Association, vol. 20(3), pages 1024-1048, September.
    8. Gollop, Frank M & Monahan, James L, 1991. "A Generalized Index of Diversification: Trends in U.S. Manufacturing," The Review of Economics and Statistics, MIT Press, vol. 73(2), pages 318-330, May.
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    Cited by:

    1. Mohammad Arzaghi & Ernst R. Berndt & James C. Davis & Alvin J. Silk, 2008. "Economic Factors Underlying the Unbundling of Advertising Agency Services," NBER Working Papers 14345, National Bureau of Economic Research, Inc.
    2. 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.
    3. Sharon Horsky, 2006. "The Changing Architecture of Advertising Agencies," Marketing Science, INFORMS, vol. 25(4), pages 367-383, 07-08.
    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.
    5. 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.

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    More about this item

    JEL classification:

    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • L84 - Industrial Organization - - Industry Studies: Services - - - Personal, Professional, and Business Services

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