Economic Report
`
`February 1977
`
`SALES, PROMOTION,
`and PRODUCT DIFFERENTIATION
`in
`TWO PRESCRIPTION DRUG MARKETS
`
`by
`Ronald S. Bond
`and
`David F •. Lean
`
`=if
`]
`
`;
`
`"
`
`" ,
`\
`
`StatTReport to the FEDERAL TRADE COMMISSION
`
`

`
`11
`
`FEDERAL TRADE COMMISSION-Staff Report
`
`Federal Trade .Commission
`
`CALVIN COLLIER, Chairman
`PAUL RAND DIXON, Commissioner
`ELIZABETH HANFORD DOLE, Commissioner
`DAVID A. CLANTON, Commissioner
`
`DARIUS W. GASKINS, JR., Director, Bureau of Economics
`JAMES M. FOLSOM, Deputy Director
`EDWARD EITCHEs, Assistant to the Director
`SANFORD REDERER, Assistant to the Director
`P. DAVID QUALLS, Assistant Director for Industry Analysis
`WILLIAM H. SPRUNK, Assistant Director for Financial Statistics
`
`This is a staff report, prepared by the Conimission's Bureau of Economics.
`The Commission has not adopted the report in whole or in part. Hence, all
`statements, conclusions and recommendations contained herein are solely
`those of the staff responsible for its preparation.
`
`../
`
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`
`ORIGIN AND SCOPE. OF S1UDY
`
`iii
`
`PROLOGUE
`
`ORIGIN AND SCOPE OF STUDY
`
`When the B~eau of Economics fIrst undert~k a pre1iminary analysis of
`the prescription drug industry, a decision was made to focus upon aspects
`of the industry that had received little investigation. That fIrms in the
`industry generally experienced high accounting rates of return, that
`product prices were often substantially above production costs, and that
`industrywide promotion was very high has been widely documented in
`existing literature. Among the most interesting and seemingly Important
`questions that the preliminary analysis raised were those related to the
`brand-name pr~scribing habits of physicians. Accordingly, the Bureau .
`chose to focus the Prescription Drug Study upon the concept of product
`differentiation and its relationship to promotion and sales.
`Because a careful analysis of product differentiation requires a thorough
`understanding of potential· therapeutic substitutability among brands, a
`decision was made to limit the study to three well defmed markets having
`different structural characteristics: the market for metronidazole, a patent
`protected vaginal anti-infective for which therapeutic substitutes were
`relatively poor; the market for orally effective diuretics, a market in which
`patent protection allowed only a few fnmS to compete; and the market for
`antianginal drugs, a ma.rket with no important patents and a large number
`offmns.
`Collecting data from the participants in each market, the Bureau set out
`fU'St to confmn a hypothesis frequently found in the economic literature:
`that markets with only a few sellers of differentiated products will exhibit
`unusually high, possibly wasteful levels of promotional expenditures
`(Scherer 1970, pp. 334-337). Thus it was expected that total expenditures
`fot promotion in oral diuretics would account for a higher percentage of
`total sales than would expenditures for promotion in either the metronida(cid:173)
`zole or antianginal markets.
`Data collected via the Prescription Drug Survey did indeed reveal that
`sellers of oral diuretics spent a higher percentage of their sales on
`promotion than did the seller of metronidazole. But the data also revealed
`some other very interesting and unanticipated phenomena. First, although
`many ~o~e fmns competed in the market for antianginal agents than in the
`
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`FEDERAL TRADE COMMISSION-Staff Report
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`market for oral diuretics, concentration was higher in antianginals than in
`oral diuretics throughout most of the time period under study.! Second,
`sellers of antianginal drugs on average devoted a higher, rather than lower,
`percen tage of their sales dollar to promotion than did sellers of oral
`diuretic drugs. Finally, the disaggregated data r~vealed that ~he leading
`frrinS in both antianginals and oral diure.tics had promotion-to-sales ratios
`substantially lower than those of the nonleading fIrms: the high market
`ratios reflected primarily the promotion of nonleading fIrms.
`Subsequent analysis of the antianginal and oral diuretic markets led to
`what the Bureau .believes are important and signifIcant fmdings. This
`Economic Report focuses solely upon those two markets.
`1 Four-fum sales concentration in 1971 was 82 percent in the antianginal market and 67 percent in the oral diuretic market:
`eight-firm concentration was 91 and 82 percent, respectively.
`
`

`
`v
`
`ACKNOWLEDGEMENTS
`
`This is an Economic Report to the Federal Trade Commission by the
`Bureau of Economics, Darius W. Gaskins, Jr., Director. Ronald S. Bond
`and David F. Lean are the authors of the study .
`. The authors are grateful to the many persons who contributed to this
`work. Darius W. Gaskins, Jr., Frederic M. Scherer, former Director, James
`M. Folsom, Deputy Director, and Michael P. Lynch, former Assistant
`Director for Industry Analysis,_ read drafts of the Report, making valuable
`comments and suggestions.
`Special written contributions were made by Michael Lynch, who
`developed the dominant fum model presented in Appendix A, and by Ira
`Whitten, who authored Appendix B, as well as the oral diuretic section of
`AppendixC.
`Barbara Battle, Paulette Easter, Jammie McKay, and Ira Whitten
`provided valuable assistance with the collection and classification of the
`data used in the study. George Pascoe, assisted by Patricia Foster, was
`responsible for computer programming and data processing operations.
`Jammie McKay provided useful background research, analyzing a number
`of questions that developed as the study progressed. In addition, Barbara
`Battle provided statistical assistance and prepared a large number of tables
`and charts. Vera Chase typed successive drafts of the Report, and Bess
`Townsend provided editorial assistance.
`The staff of the Commission's Office of the General Counsel -deserve
`thanks for their help in drafting the questionnaire forms and for their legal
`assistance. John T. Fishbach and Jay C. Shaffer were especially helpful in
`this regard. The authors also wish to thank their colleagues, particularly
`Warren Greenberg, Michael Lynch, and P. David Qualls, for their
`numerous discussions about the meaning and significance of the fmdings
`of this Report.
`Finally, the authors are grateful to the pharmacologists who assisted
`with technical advice and to the. staff members of other government
`agencies who aided this work in various ways.
`
`

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`FEDERAL TRADE COMMISSION-Staff Report
`
`SUMMARY
`This report presents new evidence on the concept of product differentia(cid:173)
`tion and upon its relationship to brand promotion and brand sales. '
`Focusing upon two therapeutic markets for prescription drugs, the analysis
`presents a complex piCture, part of which supports and patt of which
`refutes the widely-held notion that leading brands gain and retain market
`dominance primarily as a result of promotional activity.
`In each of the markets here under study, the frrst frrm to offer and
`promote a new type of product received a substantial and enduring sales
`advantage. Moreover, although the promotional dollars spent by the frrst
`frrms were absolutely large, the frrst frrms nonetheless devoted a smaller
`percentage of their sales dollars to promotion than did their competitors.
`In each market the success of the first brand did stimulate other frrms to
`enter with therapeutically substitutable products. Yet such follo~-on
`brands failed to dislodge the early entrant from a dominant position.
`Neither heavy promotion nor low price appears to have been sufficient to
`persuade prescribing physicians to select in great volume the substitute
`brands oflate entrants.
`But late entrants were not universally unsuccessful. Follow-on firms that
`were frrst to offer and promote brands having some therapeutic novelty
`useful to at least a subset of patients did achieve substantial sales volumes.
`The large sales of novel brands were associated with heavy promotional
`expenditures.
`In general, then, the data appear to reveal that sales and promotional
`dominance do go hand-in-hand. Nonetheless, the data also show that the
`opportunities for gaining sales via promotion are decidedly limited.
`Qualitative characteristics such as the timing of entry ,and therapeutic
`novelty appear to determine both the profit-maximizing level 'of promotion
`and the _ sales associated with that promotion. Large-scale promotion of
`brands that offer nothing new is likely to go unrewarded.· When other
`things are equal, physicians appear to prefer the brands of existing sellers
`to those of new sellers.
`
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`TABLE OF CONTENTS
`
`vii
`
`Page
`Chapter
`I. INTRODUCTION ............................................................ 1
`The Markets ........................................ ' .................... , . . ... 2
`. The Data ...................................................................... 3
`Organization of the Report .......... :..................................... 4
`II. PRODUCT DIFFERENTIATION AND ADVERTISING .......... 5
`III. ORALLY EFFECTIVE DIURETICS ............................. ...... 11
`Historical Context ....................... ;.................................. 12
`Merck's Sales Advantage ................................................. 14
`A Closer Look at Merck's Advantage ................................... 18
`Exploring the Product Differentiation Advantage .................... 26
`IV. ANTIANGINALS .......................................................... 35
`Introduction ................................................................. 35
`The Treatment of Angina Pectoris .... ' ................................... 35
`The Rapid-Acting Agents: Drugs to Relieve Acute Anginal
`Pain ......................................................................... 38
`Long-Term Prophylactics: Drugs to Prevent Anginal Pain .......... 39
`Early Entry and the DominanCe ofPeritr.ate ........................... 42
`Overtaking Peritrate: The Experience of "Major" Rivals ............ 47
`V. SALES, PROMOTION, AN,D THE ADVANTAGE
`FROM BEING FIRST ...................................................... 57
`Explaining Sales and Promotion ......................................... 61
`Summary ......................•...................... '....................... 68
`Statistical Addendum. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . .. 69
`VI. CONCLUSIONS ............................................................ 75
`Generality of Results ...................................................... 77
`Policy Implications. .... .. . . . . . .. . .. . ... . . . .. . . . . .. . . . . . .. . .. . . .. . . . ...... .. 78
`Potential Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 79
`APPENDIX
`A. Technical Discussion ............................... " ...................... 82
`Previous Work .............................................................. 82 .
`A Course for Further Research ................................... :...... 86
`Conclusions ................................................................. 91
`B. Survey Scope and Process of Data Collection ......................... 92
`Survey Firms Providing Data Analyzed in this Report ............... 93
`Resolution ............... ~ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 94
`Order ................................................ , ........................ 96
`Special Report I .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 97
`Special Report II ................... : ..................................... 125
`C. Patents and Licenses .................................................... 145
`Oral Diuretic Drug Patents ........................... .................. 145
`
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`FEDERAL TRADE COMMISSION-Staff Report
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`Oral Diuretic Drug Licenses ....... ................................ ..... 148
`Oral Diuretic Drugs: Summary ........................................ 149
`Antianginal Drug Patents............................................... 158
`Antianginal Drug Licenses ................ .............. ............... 158
`REFERENCES ...................................................... -. . . . . . .. .. 162
`
`liST OF TABLES
`
`Page
`Table
`111.1 Diuretic Sales by Class: The Early Years, 1956-62 ........... ~ ~ ...... 12
`111.2 Share of Oral Diuretic Sales Accounted for by Market Segments .. 16
`111.3 Market Share of Merck and Co., by Submarket ....................... 19
`111.4 Size Distribution of Firms, Oral Diuretics ............................. 21
`111.5 Sales of Generically Identical Brands .............................. ~ . . .. 22
`111.6 Quantity Sold, Sales, and Average Prices of Generically Identical
`Brands, Oral Diuretic Drugs ............................................. 24
`111.7 Dollars of Promotion as a Percent of Sales ............................. 25
`111.8 Promotional and Sales Rankings of Orally Effective Diuretic
`Drugs: 1958-71 .......................................................•.... 27
`111.9 Orally Effective Diuretic and Antihypertensive Drugs Receiving
`Important or Modest Gain Classification from FDA ................ 29
`111.10 Brands of Oral Diuretic and. Combination Diuretic-Antihyper-
`tensive Drugs First to Offer New Therapeutic Advantages ........ 30
`111.11 Brands of Oral Diuretic Drugs ................................... :..... 31
`IV.l Antianginal Sales, Number of Firms and Brands, Sales Concen-
`tration, and Ratio of Promotion to Sales ............................... 36
`IV.2 Drug Appearances: The Nitrites ......................................... 37
`IV.3 Shares Held by Antianginal Chemicals, 1956-71 ..................... 41
`IV.4 Comparative Prices: Peritrate versus Other PETN Products,
`1968-71 ...................................................................... 43
`IV.5 Market Share, Promotion, and Promotion to Sales Ratios, (PIS)
`of 16 Anitanginals, 1956-71 .............................................. 48
`IV.6 Promotion as a Proportion of Sales: Peritrate Versus All Other
`An tianginals .............................. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 51
`V.l Sales and Promotion Equations: Oral Diuretic Drugs ................. 71
`V.2 Sales and Promotion Equations: Antianginal Drugs .................. 73
`C.l Oral Diuretic Patents and Licenses..................................... 150
`C.2 Firms Holding Patents or Licenses ..................................... 157
`C.3 Antianginal Patents.............. ....................... ............. ..... 160
`C.4 Antianginal Licenses ................ ....... .............. ....... ...... ... 161
`
`

`
`CHAPTER I
`
`INTRODUCfION
`
`Prior to World War II, drugs were sold primarily under generic names.
`The physician's prescription told the pharmacist which basic chemicals
`were to be used, and the pharmacist would combine those chemicals into
`dosage forms for the patient's consumption. The introduction of penicillin
`and other antibiotics, however, signaled the end of traditional practices.
`The phenomenal growth in demand for antibiotic drugs demonstrated the
`dramatic sales and profit potential from the development and introduction
`of new drugs. At the same time the rapid entry of firms into antibiotic
`production resulted in substantial price declines that also demonstrated
`how quickly prices and profits might be eroded by the entry of
`competition. Seeking to enhance and protect the market positions of their
`products, firms began to adopt strategies now institutionalized in the
`industry. Large sums of money were expended to develop patentable
`drugs. New drugs were assigned easy-to-remember trademarked brand
`names to supplement the generic or established :J;l.ames. Furthermore, firms
`devoted additional dollars to promote their trademarked brands, learning
`quickly of the willingness of physicians to prescribe by brand rather than
`by generic name.
`The substantial investment by pharmaceutical firms in promotion is by
`now a well-known phenomenon. In 1970, thirty of the largest marketers of
`prescription drugs spent $682 million on promotion of these drugs. That
`amount represented 21 percent of the frrms' total sales in the United States
`and amounted to an' outlay of more than $2,400 per employed physician.l
`Whether such intensive promotional activity enhances the welfare of
`consumers by better informing physicians or· lessens the welfare of
`consumers by wasting scarce resources, the promotional activity of drug
`frrms has been the subject of considerable public criticism. During
`hearings conducted by the late. Senator Estes Kefauver, drug promotion
`. was alleged not only to be wasteful, but also to be deficient in
`informational content, to perpetuate inflated prices, and to limit the ability
`of small firms to compete. More recently, testimony before a committee
`chaired by Senator Gaylord Nelson reiterated the concern of consumers,
`1 Dollar figures arc based upon data submitted to the Federal Trade Commission via the Prescription Drug Survey.
`PhysiciaD employment data were taken from the U.S. Faclbook (1975).
`
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`FEDERAL TRADE COMMISSION-Staff Report
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`politicians, social scientists, and physicians themselves. In its summary the
`Subcommittee on Monopoly noted (U.S. Senate 1972, p. 39):
`
`. " there seems little doubt that the current promotional practices
`contribute substantially to minimizing more ,intensive price competi(cid:173)
`tion in many retail prescription drug markets. The consumer is not
`only adversely affected by the absence of such competition, he is also
`asked to fmance-in the form of the prices he pays for drugs-the
`very barriers which may deny him lower drug costs.
`
`On the informational content of prescription drug promotion, the report
`adds (U.S. Senate 1972, p. 63):
`
`... the record suggests that drug advertising and detailing rarely
`provide prescribers with complete and balanced comparisons of the
`benefits and risks of competing drugs .... Manufacturers do not
`readily help physicians objectively reevaluate the proper uses of older
`agents in the light of new developments.
`
`Despite continued public criticism, there have been no economic
`analyses of prescription drug promotion at narrowly defmed market levels
`where promotion might be related to the success or failure of individual
`brands. Accordingly, the Bureau of Economics has used the data gathering
`powers of the Federal Trade Commission to obtain the information needed
`to analyze, on a level more detailed than has heretofore been possible,
`promotion, product differentiation, and sales in two markets for prescrip(cid:173)
`tiondrugs.
`
`The Markets
`
`Oral diuretics are drugs used in the treatment of edema and hyperten(cid:173)
`sion. For purposes of this study, the market for diuretic drugs dates back to
`the introduction of ·the ·benzothiadiazine chemicals (thiazides)·in 1957.
`Combining highly effective therapy with the ease of oral administration,
`introduction of these thiazide chemicals marked a turning point in diuretic
`and antihypertensive therapy, and drugs formerly used in the above
`indications were virtually abandoned in favor of the thiazides. New (non(cid:173)
`thiazide) chemicals appeared in later years and within classes of oral
`diuretics a high degree of therapeutic substitutability existed. Oral diuretics
`were offered by between IS and 20 frrms in the 1960's, a period of rapidly
`growing demand. The drugs have been sold primarily under brand rather
`than generic n~mes. Furthermore, virtually all the agents were sold under
`patent or patent licenses. Hence, oral diuretic drugs were selected as an
`example of patented drugs marketed by only a few sellers.
`
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`

`
`INTRODUCTION
`
`3
`
`Drugs classified as antianginal agents are indicated for the relief and
`prevention of angina pectoris, a severe pain in the vicinity of the heart. No
`important patents have protected antianginal products, and these drugs
`have been offered by over 100 sellers in the past 20 years. Since medical
`liteJ;a!ure suggested that, within classes, antianginal brands were. therapeu(cid:173)
`tically highly substitutable, antianginals were selected as an example of a
`class of unpatented drugs marketed by many sellers.
`
`The Data
`
`Annual sales, quantity sold, and dollar promotional data by type were
`requested from each firm that could be identified as having marketed a
`drug in one or more of the selected markets during the period 1956-71. In
`addition, the firms were asked to supply copies of patents, patent-license
`agreements, and marketing reports,' as well as information on sources of
`supply. Sales and quantity sold data are available for each dosage strength
`of each relevant brand, and promotional data are available for each brand.
`The data and materials obtained via the Survey are unusually detailed
`and provide a unique opportunity for testing certain hypotheses regarding
`economic behavior. Nevertheless, the data do have ~tations.
`First,. some observations are missing from the data. Since the study
`covers a time period extending back to 1956, it is inevitable that some drug
`products that should be in the markets were not identified. The extent of
`such exclusionary errors is unknown but is thought to be limited.
`Furthermore, among those drug products that were identified, data were
`frequently not retrieved. The reasons underlying the unavailability of data
`range from firm bankruptcies to the inadequacy of firm records. Such
`missing observations are typically for firms the sales of which are small
`relative to the market as a whole.
`Second, the data supplied by the frrms are subject to variation in
`accuracy. Estimates, particularly of promotional data, were common
`among smaller frrms, and the bases on which such estimates were made
`may vary substantially. Similarly, some large firms employed different
`estimating techniques with the potential for variation in accuracy probably
`less than that of the smallerTrrms, since the large frrms are more likely to be
`estimating from some recorded data set.
`Finally, when the study was first being formulated, a decision was made
`to focus upon only a few carefully delineated markets rather than upon a
`larger number of markets each of which would necessarily have been less
`carefully defmed. While the decision to limit the number of markets under
`study has enabled the staff to become quite familiar with the individual
`drug products involved, multivariate analysis across markets is obviously
`not possible.
`
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`Organization of the Report
`
`Chapter II presents an introductory theoretical discussion of product
`differentiation and its relationship to sales and promotion. Chapters III
`.ap.d IV then document with detailed data, the nature and meaning of
`product differentiation in the markets for oral diuretic and antianginal
`drugs. Chapter V integrates the observations in Chapters III and IV with a
`more generalized discussion of product differentiation theory. Chapter V
`also introduces multivariate analysis to identify systematically the determi(cid:173)
`nants of brand sales and promotion in both markets. Finally, Chapter VI
`offers conclusions and discusses policy implications of the fmdings.
`
`'(cid:173),
`
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`
`PRODUcr DIFFERENTIATION AND ADVERTISING
`
`5
`
`CHAPTER II
`
`PRODUcr DIFFERENTIATION
`AND ADVERTISING
`
`Economists have long speculated that fIrms considering entry into an
`existing market may face a disadvantage relative to fIrms already
`established in that market. Joe Bain wrote:
`
`... a general tendency of buyers to prefer established to new products may place
`potential entrants to a differentiated product industry at a disadvantage as compared to
`frrms already established in the industry (Bain 1956, p. 116)
`
`Bain noted that newly entering fIrms might have to accept a lower selling
`price and/or incur higher selling costs than existing fIrms to persuade
`buyers to accept their products. The total disadvantage due to product
`differentiation would depend upon the sum of the price and selling-cost
`disadvantages and upon the length of time that the entrant might expect
`the disadvantages to persist.
`In case studies of several manufacturing industries, Bain identilled
`numerous product differentiation characteristics that would probably
`disadvantage prospective entrants. The characteristics included product
`reputation, established dealer systems, brand allegiances, customer service,
`and advertising (Bain 1956, pp. 128-129). Hence, Bain's defInition of
`product differentiation was multi-faceted and decidedly qualitative.
`While subsequent students of the effects of product differentiation did
`not fail to recognize the complex nature of the subject, the search for an
`easily quantillable measure of product differentiation inevitably led to
`advertising. As Mann recently noted:
`
`. .. product differentiation is not a well-specified concept ... and ... a more
`manageable inquiry is to single out one way sellers try to exploit the differentiability of a
`product ... (Since) sufficient data are available on advertising ... the cross-sectional
`empirical investigations to date have been limited to the role of advertising (Mann 1974,
`pp.138-139).
`
`But advertising has been identilled as more than a proxy for the broader
`concept of product differentiation. Advertising by itself has been charac(cid:173)
`terized as a barrier to the entry of new competition. Comanor and Wilson
`state:
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`FEDERAL TRADE COMMISSION-Staff Report
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`... high prevailing levels of advertising create additional costs for new entrants which
`exist at all levels of output.· .. : In addition, the effect of advertising on fIrm revenues is
`subject to economies of scale which result from increasing effectiveness of advertising
`messages per unit of output as well as from decreasing costs for each advertising
`message purchased (Comanor and Wilson 1967, pp. 425-426).
`
`The Comanor and Wilson thesis "has two parts. First, Comanor and
`Wilson assume asymmetry over time in the effectiveness of a given level of
`advertising expenditure. To achieve a given sales volume in a given period
`of time while selling at a given price, a new entrant would have to advertise
`his product more than did an existing fIrm. Abstracting for the moment
`from the economies of scale argument, Comanor and Wilson's fIrst point
`may be shown diagrammatically as depicted in Figure 11.1. Holding all
`other factors constant every level of sales requires more advertising dollars
`Jor entering fIrms than for existing fIrms.
`
`Figure 0.1
`
`Sales
`
`Existing firm
`
`Entrant firm
`
`Promotion
`
`Strictly speaking, the. assumption of asymmetry over time in the sales
`effectiveness of advertising does not identify advertising as a barrier to
`entry. Instead, the assumption implies that consumers themselves create a
`barrier by responding to the promotion of early-to-enter brands more
`favorably than to the promotion of later-to-enter brands. In their recent
`book, Comanor and Wilson [1974] provide an explanation for such,
`consumer behavior. The authors suggest that consumer's experiences with '
`existing brands create a reservoir of consumer information about the
`qualities if those brands. Consumers have little or no information about
`
`

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`PRODUcr DIFFERENTIATION AND ADVERTISING
`
`7
`
`newly entering brands, and. entrant fIrms must advertise intensively to
`createa stock of such information. Comanor and Wilson further argue that
`fIrms entering an existing market may have to advertise more intensively
`than established fIrms did when they entered the market:
`
`. .. the effectiveness of advertising in a new product area may be greater than where
`products are well established and consumers have to come to rely on specific brands.
`Consumer attachments are often originally weak or absent, so that adveritising
`messages encounter relatively little resistance. [For fIrms entering an already-established
`market] consumer resistance may be encountered that requires a proportionately larger
`volume of advertising if a substantial market share is to be gained (Comanor and
`Wilson 1974, p. 46).
`
`Comanor and Wilson's analysis implies that the stock of consumer
`information created through experience with existing brands creates a
`disadvantage for newly entering brands. The disadvantage would exist
`even if established trademarked brands had never been advertised in the
`media at all. Hence, Comanor and Wilson's fIrst proposition does not
`really identify advertising as the cause of the barrier to entry. Instead,
`Comanor and Wilson have merely restated Bain's proposition that product
`differentiation implies that, when other things are equal, including
`advertising, consumers prefer existing brands to newly entering brands.
`The second part of the Comanor and Wilson thesis is the assumption of
`economies of scale to advertising. Comanor and Wilson assert that, up to
`some point, additional dollars spent on advertising yield increasing dollars
`of sales. They are not alone in believing that advertising is subject to
`economies of large scale. Numerous writers have argued that quantity
`discounts and increased message effectiveness may give large:sca1e
`advertisers a cost advantage over their smaller competitors (Simon 1970,
`pp. 3-8). Whatever the merit of the various arguments, however, direct
`empirical tests of the proposition have been few and have provided
`ambiguous results (Simon 1970, pp. 8-22). The assumption of economies to
`large-scale advertising changes the shape of the advertising-sales relation(cid:173)
`ship. Figure 11.2 depicts an advertising-sales relationship that is S-shaped ..
`The lower part of the S shows the area of increasing returns, and the upper
`part of the S illustrates the area of decreasing returns to increased
`advertising.
`Combined, the two Comanor and Wilson assumptions imply that the
`advertising-sales relationships faced by entrant and existing firms appear
`as shown in Figure 11.3 on the following page.
`Empirical tests of the proposition that product differentiation and/or
`advertising create barriers to entry have been rather indirect. Because
`sales, price and promotional data have seldom been available at the
`product or brand level, most studies have not been able to focus directly
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`FEDERAL TRADE COMMISSION-Staff Report
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`upon consumer preferences. for new vis-a-vis existing products, nor upon
`the relationship, if any, of qualitative characteristics and advertising to
`
`Figure D.2
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`Sales
`
`I , r "i
`I' >
`I
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`Promotion
`
`Figure D.3
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`Existing firm
`
`Entrant firm
`
`Sales
`
`Promotion
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`those preferences .. Although numerous variations exist, most empirical
`tests have followed a similar methodology. A sample of consumers goods
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`

`
`PRODUcr DIFFERENTIATION AND ADVERTISING
`
`9
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`markets has been selected, at.td advertising as a percentage of sales has then
`been related either to the size distribution of firms in the markets
`(concentration) or to a weighted average of the profitability of the firms in
`the markets. Where empirical analyses have revealed that markets with
`higher than average advertising-to-sales ratios, also exhibited higher than
`average concentration or firm profitability, the evidence has often been
`interpreted as confirming the hypothesis that product differentiation
`and/or advertising creates a barrier to entry.l
`But because the empirical tests have been indirect, the meaning of the
`empirical results has been subject to considerable dispute.2 Critics have
`noted that the direction of causality in any observed relationships between
`advertising and concentration or profitability is unclear. That is,high
`concentration or high profitability may cause high advertising rather than
`the high advertising causing high concentration or profitability (Schmalen(cid:173)
`see, 1972). If finns could increase their profitability merely by advertis4tg,
`one might logically wonder why all fmns do not promote their way to
`riches. The road to high profits undoubtedly involves more than the
`advertising budget.
`Other critics have noted that where industries with high advertising also
`have high profits, the relationship may merely reflect accounting inadequa(cid:173)
`cies. Firms treat advertising as a current expense, and all advertising
`expenditures made. in any giv