Effect of Brand Loyalty on Advertising and Trade Promotions: A Game Theoretic Analysis

with Empirical Evidence

Author(s): Deepak Agrawal
Source: Marketing Science, Vol. 15, No. 1 (1996), pp. 86-108
Published by: INFORMS
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 Effect of Brand Loyalty
Trade Promotions: A
Analysis with Empirical
Deepak Agrawal
Purdue University
Abstract
In this paper we examine the issue of balancing media adver-
tising (pull strategy) and trade promotions (push strategy) for
manufacturers of consumer packaged goods utilizing a three-
stage game theoretic analysis and test model's implications
with scanner panel data.
We develop a model of two competing manufacturers who
distribute their brand to consumers through a common re-
tailer. In the model the manufacturers directly advertise their
brand to consumers and also provide trade deals to the re-
tailer. Each manufacturer's brand has a loyal segment of con-
sumers who buy their favorite brand unless the competing
brand is offered at a much lower price by the retailer. The
number of loyal consumers is different for the two brands and
so is the strength of their loyalty to their favorite brand. The
loyal consumers of the brand with stronger loyalty require a
larger price differential in favor of the rival brand before they
will switch away from their favorite brand.
The manufacturers first decide advertising spending level,
and then the wholesale price of their respective brands. The
two manufacturers do not observe each other's decisions
while making these decisions, however they do take into ac-
count how the other firm is likely to react as a function of their
own decisions. Advertising directly affects the strength of loy-
alty a consumer has for the favorite brand. If the favorite brand
advertises, the loyalty strength increases but if the rival brand
advertises, it decreases. The marginal effect of own versus
competing brand advertising is different in magnitude.
The two manufacturers provide trade deals to the retailer
by discounting the brand from a regular wholesale price. The
trade discounts are partially passed on to the consumers by
the retailer who sets the retail prices of the two brands after
observing the wholesale prices. The retail shelf price discounts
make the promoted brand more attractive to the consumers
due to the reduced price differential between their favorite
brand and the promoted brand, thus affecting their switching
behavior.
The model and its analysis shed light on the role of brand
loyalty in the optimal advertising and trade promotion poli-
MARKETINGSCIENCE/Vol. 15, No. 1, 1996
pp. 86h108
on Advertising and
Game Theoretic
Evidence
cies for the two manufacturers. The analysis indicates that, if
one brand is sufficiently stronger than the other and if adver-
tising is cost effective, then the stronger brand loyalty requires
less advertising than weaker brand loyalty, but a larger loyal
segment requires more advertising than a smaller loyal seg-
ment. Moreover, stronger brand loyalty requires more trade
promotion spending under these conditions. The analysis also
indicates that the retailer promotes the stronger loyalty brand
more often but provides a smaller price discount for it com-
pared to the weaker loyalty brand.
These analytical results can be understood better if we view
advertising as a "defensive" strategy used to build brand loy-
alty which helps in retaining the loyal consumers, and price
promotions as an "offensive" strategy used to attract the loyal
consumers away from the rival brand. For example, the result
that the stronger brand invests less in advertising than the
weaker brand can be explained as follows. The stronger loy-
alty brand does not find use of advertising attractive because
it faces little threat from the weaker brand due to its suffi-
ciently stronger loyalty. Instead it spends more on promotions
(provided advertising is cost effective) to attract away the
weaker brand's loyal consumers. The weaker brand, on the
other hand, finds it optimal to defend its loyal franchise by
spending more on advertising, as promotions do not help
much due to the difficulty in attracting away the stronger
brand's loyal consumers. In this sense, the stronger brand
plays "offensive" by using more trade promotions, and the
weaker brand plays "defensive" by emphasizing advertising.
We also conduct an empirical analysis of the model's prop-
ositions using scanner panel data on seven frequently pur-
chased nondurable product categories. In a sample of 38 na-
tional brands from the seven categories we find that weaker
loyalty brands spend more on advertising; brands with larger
loyal segment spend more on advertising; and the retailer pro-
motes stronger loyalty brands more often but provides a
smaller price discount on average for them compared to
weaker loyalty brands. These findings are consistent with the
model.
(Advertising;BrandLoyalty;GameTheory;PromotionalMix)
0732-2399/96/1501 /0086$01.25
Copyright ? 1996, Institute for Operations Research
and the Management Sciences
 EFFECT OF BRAND LOYALTY ON ADVERTISING AND TRADE PROMOTIONS:
A GAME THEORETIC ANALYSIS WITH EMPIRICAL EVIDENCE
1. Introduction
There has been a recent revival of interest, among both
practitioners and academics, in the issue of advertising
versus trade promotions (see Low and Mohr 1992; Nes-
lin et al. 1994a;Neslin et al. 1994b). Consumer packaged
goods manufacturers are taking a hard look at their pro-
motional mix, particularly trade promotional spending.
One estimate is that 33% of the trade promotion dollars
is used up in the administrative aspects of trade pro-
motions (a major part of which goes toward the time
spent by salesforce in settling retailer claims), another
33% goes directly toward retailer's revenue, and only
the remaining 33% ultimately reaches the consumer in
the form of a shelf price reduction (Ernst and Young
Report 1993). These estimates corroborate the concerns
of manufacturers that trade promotional spending is
not getting the desired results, and there is a need to get
out of the vicious circle of heavy trade dealing in favor
of more effective activities, particularly advertising
which helps build brand equity. However, it appears
that some amount of trade dealing inevitably will be
desirable because trade deals are used not only to in-
duce shelf price reductions but also to secure shelf
space, wider distribution, and retailer cooperation (Nar-
asimhan 1990). So the real issue facing manufacturers
is to achieve a balance between trade dealing and ad-
vertising.
In this paper we address this issue by developing a
three-stage game theoretic model of two competing
manufacturers selling their respective brands through
a common retailer. Our approach is to study adver-
tising and trade promotions simultaneously in a com-
petitive setting. This is consistent with the Neslin et
al. (1994a, p. 405) call for research addressing both
advertising and promotions together and not sepa-
rately. Our primary objective is to understand the role
of brand loyalty in the optimal promotional mix for
manufacturers. The game theoretic approach here is
not intended to explain observed phenomena but is
intended to understand and prescribe optimal pro-
motional policy.
In the paper we distinguish between the strength and
size of brand loyalty. Strength of brand loyalty is con-
ceptualized as the intensity of customer loyalty toward
the brand, whereas size of brand loyalty is conceptual-
ized as the proportion of consumers in the market loyal
MARKETING SCIENCE/Vol. 15, No. 1, 1996
to the brand.1 In our model one brand enjoys strong
loyalty among its loyal customers (named as stronger
brand), whereas the rival brand enjoys relatively less
loyalty among its loyal customers (named as weaker
brand). Each manufacturer is assumed to decide adver-
tising level and wholesale price for its brand, taking into
account possible actions of the competing brand man-
ufacturer; and the retailer sets retail prices after observ-
ing the wholesale prices of the two brands.
The analysis points to the differing roles of the
strength and size of brand loyalty in the promotional
mix. It indicates that stronger brand loyalty requires less
advertising than weaker brand loyalty but a larger loyal
segment requires more advertising than a smaller loyal
segment. Thus it indicates that the weaker brand would
spend more advertising dollars, and the brand with
larger loyal segment size would spend more on adver-
tising. Also, the weaker brand would promote to the
trade more often than the stronger brand.
In addition we find that trade promotional spending
is dependent on cost effectiveness of advertising. If ad-
vertising is cost effective, then the weaker brand would
spend fewer trade promotional dollars than the stronger
brand. And if advertising is costly, then the weaker
brand would spend more trade promotional dollars
than the stronger brand. At the retail level, however, we
find that the retailer would promote the stronger brand
more often but provide a smaller price discount on av-
erage for it than the weaker brand. We provide intuition
for these findings and relate them to previous findings
in the literature.
These analytical results can be understood better if
we view advertising as a "defensive" strategy used to
build brand loyalty which helps in retaining the loyal
customers, and price promotions as an "offensive"
strategy used to attract the customers away from the
rival brand. For example, one result is that the stronger
brand invests less in advertising than the weaker brand.
The intuition behind this result is that the stronger
brand does not find use of advertising attractive because
' In the theoretical model strength of brand loyalty is defined as the
price differential needed before the consumer will switch away to the
less favored brand (Pessemier 1959). It is noteworthy here that brand
loyalty strength was operationalized differently in the empirical anal-
ysis.
87
 AGRAWAL
BrandLoyaltyon Advertisingand TradePromotions
it already enjoys sufficiently stronger loyalty and there-
fore faces little threat from the weaker brand. Instead it
finds it optimal to spend more on promotions (when
advertising is cost effective) in order to attract away the
weaker brand's customers. The weaker brand, on the
other hand, finds it optimal to defend its loyal franchise
by spending more on advertising, as the promotions do
not help much because it is difficult to attract away the
stronger brand's loyal customers. In this sense, the
stronger brand plays "offensive" by using more trade
promotions, and the weaker brand plays "defensive"
by emphasizing advertising.
We also conduct an empirical analysis of the model's
propositions using scannerpanel data on seven frequently
purchased nondurable product categories. In a sample of
38 national brands from the seven categories,we find that
weaker loyalty brands spend more on advertising;brands
with larger loyal segment spend more on advertising;and
the retailer promotes stronger loyalty brands more often
but provides a smaller price discount on average for them
compared to weaker loyalty brands. These findings are
consistent with the model, thereby indicating support for
it. We next provide a brief review of the relevant literature
and point out main contributionsof this researchover pre-
vious research.
2. Literature Review
Advertising and trade promotions differ significantly in
several respects, including their effect on consumers'
purchase behavior, time frame within which effects take
place, and the processes by which the effects take place.
For example, in the context of frequently purchased
goods, the main effects of advertising are considered to
be brand positioning, category expansion, brand rein-
forcement (repeat purchase), and brand switching
(Deighton et al. 1990), whereas the main effects of sales
promotions are considered to be brand switching, pur-
chase acceleration, stockpiling, and repeat purchase
(Blattberg and Neslin 1990). Advertising is commonly
believed to positively affect brand loyalty, whereas pro-
motions may either have a negative effect or not have
any effect (Neslin and Shoemaker 1989, Davis et al.
1992). Advertising is considered to have long-lasting ef-
fects with possible delayed response and slow decay
(Little 1979). Promotions, on the other hand, are consid-
88
ered to have more immediate and short-term effects on
purchase behavior (Rossiter and Percy 1987). And there
is evidence that advertising effects follow a hierarchical
process (AIDA model, Strong 1925), whereas sales pro-
motion effects do not (reference price theory, Helson
1964; prospect theory, Kahneman and Tversky 1979).
Given these differences and the fact that both advertis-
ing and price promotions commonly are used in the
promotional mix of a brand, it becomes important to
model them differently yet simultaneously in a single
framework so that their opposing effects can be studied.
On the analytical side, Raju et al. (1990) examined two
competing manufacturers' pricing policies as a function
of brand loyalty. They define a stronger and a weaker
brand in terms of strength of brand loyalty and examine
how the degree of brand loyalty determines the optimal
frequency and depth of price promotions. Their analysis
indicates that the weaker brand promotes more often
than the stronger brand (this is shown to hold empiri-
cally as well) and offers smaller price discount when it
is sufficiently weaker, but offers greater discount when
it is only moderately weaker, than the stronger brand.
We build on this framework by incorporating manufac-
turer advertising and retailer pricing decisions in ad-
dition to manufacturer pricing, thereby allowing us to
study advertising and trade promotion tradeoffs and
retail promotion activities.
Other research which examines pricing policies of
competing manufacturers includes Narasimhan (1988),
Rao (1991), and Lal (1990a, b). Narasimhan defines
brand power in terms of proportion of customers loyal
to the brand and predicts that the average price will be
higher and the frequency of promotion lower for the
stronger brand. Rao examines competition between a
national brand and a private label and shows that only
the national brand promotes to attract the private label
customers (if they are sufficient in number). The private
label does not promote because its promotions only in-
crease the frequency of promotions by the national
brand. Lal addresses the issue of why retail promotions
occur and argues that national brand manufacturers al-
ternate promotions in order to keep the private label
brand from encroaching upon their market share.
One interesting finding in this paper is that at the man-
ufacturerlevel weaker loyalty brand promotes more often
than the stronger loyalty brand (consistent with Rajuet al.
MARKETINGSCIENCE/Vol. 15, No. 1, 1996
 AGRAWAL
BrandLoyaltyon Advertisingand TradePromotions
1990), and at the retail level, the retailer promotes the
weaker brand less often than the stronger brand (consis-
tent with Rao 1991). Rajuet al. consider only manufactur-
ers, whereas Rao considers retail price competition be-
tween a national brand and a private label. Thus our find-
ing helps to reconcile the results of Raju et al. and Rao.
Neslin et al. (1994b) model a monopolist manufac-
turer's optimal promotional mix policy as a dynamic
econometric model. They examine promotional mix
policy as a function of retailer carrying costs, retail pass
through, consumers' response to advertising, and con-
sumers' response to retail price promotions. Their sim-
ulations demonstrate a tradeoff effect between advertis-
ing and trade promotions consistent with our finding
(when advertising is cost effective). Also, they find that
as retail pass through increases (either in terms of fre-
quency or depth), frequency of trade promotions de-
creases, depth of trade discounts increases, total expen-
ditures on promotions increase, and advertising expen-
ditures decrease for the monopolist. We also find this
in our analysis for the stronger brand, which enjoys
higher retail pass through in terms of frequency. Se-
thuraman and Tellis (1991) also develop a monopoly
model to investigate the impact of the ratio of price to
advertising elasticity on the tradeoff between advertis-
ing and trade promotions. We add to this literature by
incorporating competition in the analysis.
In summary, the main contributions of this research
over previous research are in studying advertising and
trade promotions simultaneously in a competitive setting,
in developing an integrated analytic framework to ex-
amine the tradeoffs between the two, in incorporatingthe
role of the retailer,and in empirically investigating the role
of brand loyalty in promotional policies using scanner
panel data from several product categories. In the next
section, we describe the model in detail and present anal-
ysis of manufacturer advertising and price promotional
policies and of retail pricing. Then we present details of
empirical investigation, and finally summarize the discus-
sion and conclude with directions for further research.
3. Model
In our model, there are two national brands s and w
offered through a common retailer to a group of con-
sumers. Each consumer is loyal to a brand, but he/she
MARKETING SCIENCE/VOL 15, No. 1, 1996
can be induced to switch away if there is sufficient price
differential between the favorite brand and the less pre-
ferred brand. In other words, both brands are in each
consumer's consideration set, with one brand being the
favorite. We define the extent of favoriteness by the
price differential needed before the consumer will
switch away to the less favored brand (Pessemier 1959).
We assume that it takes a larger price differential to
make a consumer who prefers brand s to switch to
brand w than what it takes a consumer who prefers
brand w to switch to brand s. This implies that brand s
commands stronger preference among its loyal consum-
ers compared to what brand w commands among its
loyal consumers. Let the loyalty among loyal consumers
to brand s be Is,,and the loyalty among loyal consumers
to brand w be lw, such that Is, > Iw,.
The number of loyal consumers to each brand may dif-
fer such that a brand may have a very few but strongly
loyal consumers, many but only mildly loyal, or any other
combination. Without loss of generality we normalize the
total number of consumers to equal one and assume that
a proportion ms of consumers prefer brand s and propor-
tion mwprefer brand w, where ms + mw= 1. We further
assume that a consumer loyal to brand s has a reservation
price r for brand s and a lower reservation price (r - Is)
for brand w, whereas a consumer loyal to brand w has a
reservation price r for brand w and a lower reservation
price (r - iw) for brand s. Each consumer is assumed to
buy a brand and buy one unit of the chosen brand such
that surplus is maximized. Thus the demand function at
the retail level for brand i (where i = s, w; i * j) can be
written as (see Figure 1):
[1 if pi < pj - Ij,
Di(pi,pj) = jmiif pi - li c pj c pi + Ij,
tO if pj < pi - Ii.
The manufacturers are assumed to advertise their
brands directly to the consumers. They simultaneously
Figure1 Consumer
DemandFunction
Consumers Consumerw
wouldn'tbuy s wouldn'tbuy w
PS-IS PI PJ+ IW _ PW
89
 AGRAWAL
BrandLoyaltyon Advertisingand TradePromotions
decide advertising levels (i.e., without knowing the ad-
vertising level for the rival brand) a, and a,,, for their
respective brands such that own advertising positively
affects and competing brand's advertising adversely af-
fects the strength of brand loyalty. Furthermore the ef-
fect of own advertising is assumed to differ from that
of competing brand's advertising through a parameter,
y. A high y means that the effect of own advertising is
higher than competitor's advertising, whereas a low y
means that the effect of competitor advertising is higher
than that of own advertising. In other words, a high y
means advertising works more on brand's own loyal
customers than on potential brand switchers (similar to
the idea that advertising affects loyals differently than
switchers as in Tellis 1988 and Deighton et al. 1994).2
Finally, to incorporate diminishing returns to advertis-
ing, we assume that advertising effects have a square
root formulation and that advertising costs are linear,
i.e., it costs aa, and aa?.,to advertise for manufacturers
s and w, respectively, where a captures the cost effect-
iveness of advertising. A small a implies advertising is
relatively cost effective, and a large a implies advertis-
ing is relatively costly. This parameter captures market-
wide advertising effectiveness and is assumed to be the
same for both brands. It reflects the notion that in some
markets advertising may be relatively cost effective in
reaching target consumers, such as when target audi-
ence is geographically concentrated, or when a cam-
paign has higher effectiveness because of the nature of
the clientele. These assumptions translate into the fol-
lowing asymmetric effects formulation for the post-
advertising loyalties:
Is = + yFas- (1 - y)aF,
ISO
IW= lu.o + -y a5 - (1 - -y)a,
where 0 < y < 1 captures the effectiveness of own ad-
vertising.
After deciding advertising levels, the manufactur-
ers simultaneously declarewholesale prices wsand ww
2 Many of the results in this paper are based on y > 0.5, which implies
own advertising is more effective than competitor advertising in af-
fecting brand loyalty.
90
for their respective brands to the retailer. As part of
their promotional mix, manufacturers offer trade
deals to the retailer with the intention of reducing the
selling price of the brand making it more attractive to
loyal and nonloyal consumers alike. The trade pro-
motional spending is defined as the total discount
given to retailers over all purchases; where discount
is the difference between the regular price (i.e., the
highest wholesale price) and the actual wholesale
price in equilibrium. After observing the wholesale
prices, the retailer is assumed to set retail prices p, and
p, for the two brands, respectively, so as to maximize
expected profits. The marginal costs of production
and distribution for the two manufacturers, and the
marginal cost of retailing are assumed to be zero.
In this three-stage model the manufacturers are as-
sumed to decide advertising levels first for their re-
spective brands without knowing the advertising
level for the rival brand. Next they are assumed to
decide the wholesale prices for their respective
brands without knowing the wholesale price of the
rival brand but knowing the advertising levels of both
brands. These assumptions imply that (1) in any
given planning horizon advertising decision precedes
pricing decision, (2) pricing is changeable more easily
than advertising, and (3) once advertising is under-
taken it becomes a sunk investment. Lastly, the re-
tailer is assumed to decide the retail prices for the
brands it offers to consumers after observing the
wholesale prices of the two brands. There is support
for this stagewise decision making in the literature
(Quelch and Farris 1983, Shapiro 1987).
Now we solve this three-stage game for the equilib-
rium advertising and pricing strategies beginning with
the third stage retail pricing strategy.
Retail Pricing Strategy
The retailer's profit function is:
(P if Ps < Pw -
s-W) I,
ms(ps - ws) + mw(pzv - wW)
if Ps1 is pw c Ps + Iw,
(PW- wu,) if PZw
< PS - is.
The retailer would maximize profits by charging the
highest price that the consumers will pay. Intuitively,
MARKETINGSCIENCE/VOL.15, No. 1, 1996
 AGRAWAL
BrandLoyaltyon Advertisingand TradePromotions
there are three possibilities for the retailer as indicated
by the retail demand function: (1) if the stronger brand
is sufficiently cheaper than the weaker brand, promote
the stronger brand and sell it to both consumer seg-
ments; (2) if the weaker brand is sufficiently cheaper
than the stronger brand, promote the weaker brand and
sell it to both consumer segments; and (3) if the two
brands are not sufficiently different in wholesale prices
then do not promote either brand, and sell each to its
loyal segment. Consistent with these possibilities, we
obtain the following retail pricing strategy in equilib-
rium:
PROPOSITION1. The optimal pricing strategy of the re-
tailer is to chargep, = r - 1w- E,pw = r if ww > w, + (1 /
mW,)lw;chargeps = r, pu' = r if w, (1/ms)l C< ww s Ws
+ ( /m)1,)l1,; and charge, ps = r, pw = r - - e if w > ww
+ (//ms)i.
PROOF. See Appendix.
To understand this equilibrium note that the retailer
can always sell a brand to its loyal segment at regular
price. It promotes a brand only if the margin obtained
on selling the promoted brand to all of the market is
higher than selling it only to the loyal segment at regular
price. The equilibrium indicates that the retailer pro-
motes a brand if its wholesale price is sufficiently lower
and that he/she promotes only one brand at a time, if
at all. Moreover, when the retailer promotes a brand,
he/she does not buy the nonpromoted brand from the
manufacturer.
1.1. Thepricediscountofferedby the retailer
COROLLARY
on the weakerbrandis largerthan thatofferedon the stronger
brand.
PROOF. See Appendix.
This result follows from the retail price equilibrium
above. The retailer offers a larger discount 1I on the
weaker brand compared to lw on the stronger brand.
Note that because the regular price is the same (=r) for
both brands, this result holds for percentage discounts
as well. In other words, the retailer offers a higher per-
centage price discount on the weaker brand than the
stronger brand.
COROLLARY1.2. The retailer promotes the stronger
brandmorefrequentlythan the weakerbrand.
MARKETINGSCIENCE/Vol. 15, No. 1, 1996
PROOF. See Appendix.
This result suggests that at the retail level, we would
expect to see more frequent promotions but lower dis-
counts on the stronger brand. This finding is consistent
with Rao (1991), whose model corresponds to a retailer
setting the price of its own private label and retail price
of the competing national brand. He finds that the
weaker brand is promoted less often than the stronger
brand. This result is interesting also because at the man-
ufacturer level, it is reversed. We describe manufacturer
results next.
Manufacturer Pricing Strategy
We solve for the second-stage manufacturer pricing
equilibrium treating advertising spending in the first
stage of the game as a sunk investment. The post-
advertising profit function for manufacturer i (i = s, w;
I # j) is:
[wi if wj > w, +(1 /mj)1j,
ni = jmiwi if wi- (1/rmi)n w? c< WI.+ (1/m)nJ),
to if wi > wi + (1/mi)Ii.
It can be shown that a mixed strategy equilibrium in
prices exists for the above game when l. m2 r and Is
c
2 mj(r - lW)/(1 + msmw)(see Raju et al. 1990). We in-
terpret the mixed strategy equilibrium as a promotional
equilibrium in which the reservation price r is the reg-
ular price and a promotional price is any price below r.
We obtain the following results:
PROPOSITION2. The weakerbrandmanufacturer
pro-
motes more often but providessmaller discount on average
than the strongerbrandmanufacturer.
PROOF. See Appendix.
This manufacturer level finding is consistent with the
manufacturer pricing equilibrium in Raju et al. (1990);
and the retail level findings (Corollaries 1.1 and 1.2) are
consistent with retail pricing model of Rao (1991). A
reason for this reversal of findings at the manufacturer
and retail level is essentially that the retailer cares about
category profit, whereas manufacturers care about their
respective brand profit. The retailer realizes that the
stronger brand does not have to be promoted as steeply
as the weaker brand because it commands a price pre-
mium with consumers. Thus promoting the stronger
91
 AGRAWAL
BrandLoyaltyon Advertisingand TradePromotions
brand more steeply would only erode retailer's profit
margin on stronger brand and forego profits it makes
on the weaker brand.
However, at the manufacturer level, the brands are in
a market share game. The stronger brand increases its
profits only by attracting weaker brand's customers.
Therefore it keeps trying to induce the retailer to pro-
mote its brand more steeply by offering steeper trade
deals. Moreover, the stronger brand, in order to be pro-
moted at the retail level, not only has to overcome the
loyalty of the weaker brand but also has to provide at-
tractive enough margin to the retailer to entice the re-
tailer into promoting the brand. This aggressive strategy
on part of the stronger brand necessitates higher trade
discounts on average compared to the weaker brand,
which is only trying to keep its loyal customers from
switching to the stronger brand.
But the frequency with which the stronger brand pro-
vides a trade discount is lower than the weaker brand
because to induce the retailer to discount stronger brand
to attract weaker brand's loyal customers, the stronger
brand has to offer a lower price on all its sales to the
retailer, including those that ultimately result from its
own loyal customers. Therefore, it provides trade dis-
counts relatively less often. The retailer, on the other
hand, enjoys a higher margin on the stronger brand
even after promotion (the stronger brand is discounted
by 4, compared to a discount of 1 on the weaker brand);
therefore the retailer promotes the stronger brand more
often.
Thus adding a retailer to the model provides new im-
plications and also helps in understanding the differ-
ences in the results of Raju et al. and Rao. Another in-
teresting implication from the above results is with re-
spect to retail pass through, stated formally next.
COROLLARY 2.1. Comparedto the weaker brand, the
strongerbrandenjoys higher retail pass throughin termsof
frequencybut lowerpass throughin termsof size of discount.
PROOF. See Appendix.
Conceptually retail pass thorough (RPT, for short) is
defined as the fraction of trade deal that is passed on to
the consumers in the form of a retail promotion (Che-
valier and Curhan 1976). Because there are two dimen-
sions to a retail promotion, the size and frequency of
discount, there are at least three ways to look at RPT:
92
(1) the ratio of total retail spending over total trade pro-
motional spending on the brand during the year; (2) the
ratio of price discount in retail promotion over price
discount in trade promotion for the brand in a particular
promotion; and (3) the ratio of frequency of retail pro-
motions over frequency of trade promotions in a year.
It turns out that the ratio of expected retail spending
over expected trade promotional spending on the brand
is higher for the stronger brand consistent with Bucklin
(1988), Curhan and Kopp (1986), Blattberg and Neslin
(1990), and Tellis and Zufryden (1994). More interest-
ingly, however, it turns out that retail pass through is
higher for the stronger brand in terms of frequency but
lower in terms of size of discount.
This result is interesting because it shows that the two
measures of pass through can go in different directions,
and that the retailer may follow this strategy to suc-
cessfully maximize its profits and yet appease both the
stronger and weaker brand manufacturers with respect
to compliance with the terms of the trade deals.3
COROLLARY 2.2. As the size of its loyal segment in-
creases,the weakerbrandmanufacturerpromotesmoreoften
and providesa largerdiscount on average, but the stronger
brandpromotesless oftenand providesa smallerdiscounton
average.
PROOF. See Appendix.
This result is interesting because it indicates that the
two brands follow different strategies as the size of their
own loyal segment changes. Unlike the stronger brand
the weaker brand manufacturer prefers to rely more on
promotions as its own loyal segment size increases. The
intuition behind this result is that consumers are only
weakly loyal to brand w, and as more consumers be-
come loyal to the weaker brand it uses promotions to
keep them from switching to the rival brand. The
stronger brand, on the other hand, does not need
promotions to keep the strongly loyal consumers from
switching.
PROPOSITION 3. The stronger brand manufacturer
spendsmoretradepromotionaldollarsthan the weakerbrand
3In practice, however, manufacturers may favor frequency aspect of
pass through as a monitoring device because it is easier to observe and
is more comparable across retailers than size of discount pass through.
This issue needs to be researched further.
MARKETINGSCIENCE/Vol. 15, No. 1, 1996
 AGRAWAL
BrandLoyaltyon Advertisingand TradePromotions

manufacturer, if advertising is cost effective, specifically Iwi - aai ifwj> wi+ (1/m1)1
when a* < a < a**; and spends less tradepromotionaldol-
miw, - aa,
lars than the weakerbrand manufacturer,if advertising is
costly, specificallywhen a > a**. if wi - (1/m.)l C wj C w. + (1/m )1,

-aa, if wi > w + (1/mi)li,

PROOF. See Appendix.
The intuition behind this result is that if advertising where a captures the cost effectiveness of advertising such
is cost effective, the weaker brand is able to defend its that a lower a implies more cost-effectiveadvertising, and
loyal franchise by spending on advertising, and the advertising affects initial loyalties such that (for i = s, w;
stronger brand has to spend more trade promotion dol- i * j), li = li, + yva7 - (1 - y)Fa1. We obtain the following
lars to attract the rival's loyal consumers. But if adver- Nash equilibrium:
tising is costly, then the weaker brand is not able to
defend its franchise very well, and the stronger brand PROPOSITION 4. 'Whenthe stronger brand is suffi-
does not have to spend more trade promotion dollars ciently stronger, specificallywhen l, 2 1b0;l( -,- mu,r; and
to attract the rival's loyal consumers. when own advertisinghas greatereffecton own loyalties (y
> 2), the optimal advertising levels are such that: a* = 0;
COROLLARY3.1. As the size of its loyal segment in- - ((m2,r - Iwo) )/y)2 when a c a*; and a* = 0; a*U
creases, the weakerbrandmanufacturerspends moredollars = ((lv - lzvo)/y)2 when a > a*, wherea* = mz,,r(1 + m?,
on promotions,but the stronger brandspends fewer dollars - m,)y2/(mzi,r - lu,o)2;and 1*,= l (lzLo,
ISOr, a, m,L,);and
on promotions. /so = msr(1 + mw)/(l + mwms) + (1 - )/(m ,r -Iz,,)
if m2(1 + mZ)/(1 + mSmZV) ? m2,; and
PROOF. See Appendix.
This result is consistent with Corollary 2.2, as ex-
I (1 - ) M2r(1 + mw)
pected.

3.2. As the relativeeffectivenessof own ad-

COROLLARY ?m,~ if1 mz(1mS) O

2(1 +m,,)
vertising, y, in affecting loyalty strength increases, both
brandsspend less on promotions.

PROOF. See Appendix. PROOF. See Appendix.

This result indicates that promotions become less at-
tractive for the manufacturers as advertising becomes
more effective in reinforcing brand loyalty among loyal
consumers.
COROLLARY 3.3. As loyaltystrengthof the weakerbrand
increases,both brandsspend less on promotions.
PROOF. See Appendix.
Consistent with Corollary 3.2, this result indicates
that both brands decrease promotional spending as
their ability to keep loyal consumers increases.
Next we examine manufacturer advertising equilib-
rium.
Manufacturer Advertising Strategy
The preadvertising profits for manufacturer i (i = s, w;
I f j) are:
This equilibrium suggests that if the stronger brand
is sufficiently stronger than the weaker brand, then the
stronger brand would not invest in advertising for the
purpose of building loyalty4 because it already enjoys
sufficiently stronger loyalty. The weaker brand, on the
other hand, invests in advertising to build loyalty be-
cause it pays to invest in advertising to defend its loyal
franchise from switching to the stronger brand. More-
over, if advertising is highly cost effective (a c a*),
then the weaker brand spends more on advertising
(= ((mwr - I,/ )2) compared to when advertising is
not so cost effective.
4Note that advertising levels (aS,a,,) represent advertising used for
building brand loyalty; these levels are over and above the minimum
amount of advertising the two manufacturers may undertake to main-
tain their brand in consumers' consideration set.

MARKETING SCIENCE/VOl. 15, No. 1, 1996 93

 AGRAWAL
BrandLoyaltyon Advertisingand TradePromotions
COROLLARY 4.1. As the size of own loyal segment in-
creases, the advertisingspendingalso increases.
PROOF. See Appendix.
This result indicates that as more consumers become
loyal to a brand, the brand invests more in advertising.
This is consistent with the loyalty reinforcing role of
advertising in the model.
COROLLARY 4.2. As the relativeeffectivenessof own ad-
vertising, y, in affecting loyalty strength increases, the ad-
vertising spendingdecreases.
PROOF. See Appendix.
Corollaries 3.2 and 4.2 provide an interesting result
on the effect of y on promotional spending (i.e., adver-
tising and trade promotional spending) by the two
brands. Note that as y increases, the advertising by a
brand plays a more defensive role as it reinforces own
brand loyalty. Thus both brands are better able to keep
their loyal customers and hence find it less attractive to
spend on promotional activities. This reasoning is also
consistent with Corollary 3.3, which says that trade pro-
motional spending would decrease for both brands as
the two brands develop their own strong loyal fran-
chises. One reason for these results put together may be
that as both brands develop their own strong loyal fran-
chises, perhaps the competitive backlash is reduced,
which in turn reduces the need for promotional
spending.
Finally we substitute the manufacturer pricing equi-
librium into the advertising equilibrium to get the over-
all manufacturer equilibrium as a function of exogenous
initial brand loyalties.
Overall Manufacturer Equilibrium
We obtain the following results on overall manufacturer
equilibrium:
RESULT 1. When the stronger brand is sufficiently
stronger, specifically when lSOand lwosatisfy conditions
as in Proposition 4, and when advertising is very cost
effective, specifically when a c a*, the stronger brand
does not advertise (a* = 0); the weaker brand advertises
(a* = ((m 2r - lwo)/y)2); and both brands do not pro-
mote in equilibrium.
PROOF. See Appendix.
The intuition behind this result is that if the stronger
brand is sufficiently stronger and advertising is cost ef-
94
fective; the stronger brand would not invest in adver-
tising for the purpose of building loyalty because it al-
ready enjoys sufficiently higher loyalty. It also would
not spend any money on promotions because the threat
from weaker brand promotions is minimal. The weaker
brand, on the other hand, would invest in advertising
to build loyalty because advertising is cost effective and
it pays to invest in advertising to defend its loyal fran-
chise from switching to the stronger brand. Also, the
two brands would not spend any money on promotions
because advertising is very cost effective in keeping the
loyal consumers. Thus in this situation the weaker
brand would worry about defending its loyal franchise,
and the stronger brand would be content with its loyal
franchise.
RESULT2. When the stronger brand is sufficiently
stronger, specifically when i,o and l,o satisfy conditions
as in Proposition 4, and when advertising is cost effec-
tive, specifically when a* < a < a**, the stronger brand
does not advertise (a* = 0); the weaker brand advertises
(a* = ((lw - lzo)/y)2); both brands promote and the
weaker brand spends less trade promotional dollars
than the stronger brand in equilibrium.
PROOF. See Appendix.
RESULT3. When the stronger brand is sufficiently
stronger, specifically when Is, and lwo satisfy conditions
as in Proposition 4, and when advertising is costly, spe-
cifically when a > a**, the stronger brand does not ad-
vertise (a* = 0); the weaker brand advertises (a*
= - Iwo)/ y)2); both brands promote and the weaker
brand spends more trade promotional dollars than the
stronger brand in equilibrium.
PROOF. See Appendix.
We first note that these results apply to a situation
where the two brands sufficiently differ with respect to
strength of brand loyalty. In other situations, such as
when both brands command strong loyalties, both
brands do not advertise or promote in equilibrium (re-
fer to Lemma 2 in the appendix). Still other cases, such
as when both brands have weak loyalties or when loy-
alties are not sufficiently different, we leave for future
research.
The results indicate that given sufficient difference in
loyalty strength, the weaker brand would spend rela-
tively more on advertising than the stronger brand.
Intuitively, the stronger brand does not invest in
MARKETING SCIENCE/VOl. 15, No. 1, 1996
 AGRAWAL
BrandLoyaltyon Advertisingand TradePromotions

Figure2A AdvertisingExpenditures

Size of loyal segment Ad spending

Adsenig
a w
Small
Large .~~~~~~~~~~ 'ge aI

Strong a aS w Sm
> aS
Strengthof
Loyalty l A A __ oy lty
Weak
Weak a
aS
as Weaker
> ~~~~~~~~~~~~~
Stronger
w w

Ad spending al

as

> Loyalty
Weaker Stronger Strength

advertising to build loyalty because it already enjoys
sufficiently stronger loyalty to begin with. The weaker
brand, on the other hand, invests in advertising to build
loyalty so that it is better able to defend its loyal fran-
chise. In contrast to relative advertising spending, the
relative trade promotional spending is affected by the
cost effectiveness of advertising. The results suggest
that manufacturers would price promote only if adver-
tising is not very cost effective, i.e., if they believe that
consumer pull is sufficient for their category, they will
not price promote for the push effect. If advertising is
only moderately cost effective (a* < a < a**), the
weaker brand is moderately able to defend its loyal
franchise by spending on advertising and the stronger
brand needs to outspend the rival on trade promotions
to attract the rival's loyal consumers. And if advertising
is costly (a > a**), then the weaker brand is not able to
defend its franchise very well, and therefore, the
stronger brand does not need to outspend the rival on
trade promotions to attract the rival's loyal consumers.

Figure2B TradePromotionalExpendituresWhenAdvertisingIs Cost Effective

Size of loyal segment Promotional

Large Small Spending
s MEP~~~~~~~~~~~~~~~
Strong MEPs MEP MEPX 1
Lav%o ~~~~~~~MEPS
Strengthof | VLv v
Loyalty 1
Weak MEP > MEP
PW
~ Loyalty
Weaker Stronger Stength

MARKETING SCIENCE/VOL 15, No. 1, 1996 95

 AGRAWAL
BrandLoyaltyon Advertisingand TradePromotions
Figure2C TradePromotionalExpendituresWhenAdvertisingIs Costly
Size of loyal segment
Large Small
Strong MEPs < MEPs5
Strength of A
Loyalty
EWeakP
Weak
MEPw >w
These results are summarized graphically in Figures 2
(a), (b), and (c).
The results can be further illustrated with the help of
an example. Consider two real but disguised brands X
and Y in a food category. Brand X is a strong national
brand (loyalty estimate = 0.66) competing with a
weaker national brand Y (loyalty estimate = 0.52). The
model suggests that since the loyalty to X is already very
strong, it only needs to do minimal advertising to main-
tain its brand in consumers' consideration set. Brand Y,
on the other hand, needs to invest in advertising to build
brand loyalty; otherwise, it may lose its loyal consumers
to X. Indeed, the market share adjusted advertising
spending for brand X is almost half that of brand Y. In
addition if advertising is costly (such as when there are
no significant economies of scale of advertising; perhaps
because consumers are spread all over the market), X
needs to spend fewer dollars on promotions also, be-
cause given costly advertising Y is not able to increase
its loyalty strength much, and with fewer trade pro-
motional dollars X is able to attract Y's loyal customers.
Indeed, the trade promotional spending of X is less than
30% of spending of Y. If advertising is cost effective
(such as when customers are geographically concen-
trated and easy to reach), the model suggests that X
would need to spend relatively more trade promotional
dollars to make the rival's loyal customers switch.
The main results from the theoretical analysis relating
strength of brand loyalty and size of loyal segment to
advertising and pricing policies are summarized in Fig-
ure 3. Note that the retailer provides a discount of ls on
the weaker brand and a discount of l,7,on the stronger
96
Promotional
Spending
MIEPW
srn~~~~~~~~~
X
MEPW
MEPS
I I > Loyalty
Weaker Stronger Strength
brand, thus the average retail price discount is indepen-
dent of the segment size. Given this we do not derive
the comparative statics results of retail promotions as a
function of segment size. We empirically examine four
of these results. The empirical analysis is presented
next.
4. Empirical Analysis
In this section we attempt an empirical analysis of the
model by examining data, to see if the patterns in data
are consistent with the model's implications. To the ex-
tent the data patterns are consistent, it increases our
confidence in the underlying assumptions and structure
of the model.
Hypotheses Development
An ideal method for examining model's propositions
would be to identify pairs of strong and weak loyalty
brands which compete with each other and compare
their promotional activities. In reality, however, several
brands compete with one another, making it difficult to
unambiguously identify two brands which compete
with only each other. Therefore we develop an across
category framework in which we obtain brand loyalty
estimates for brands in several product categories and
relate these estimates to measures of their promotional
activities using regression analysis.5 Furthermore, since
'We use the terms manufacturer advertising/ promotions and brand
advertising / promotions interchangeably in this section even though
the same manufacturer may offer multiple brands in a category.
MARKETING SCIENCE/VOl. 15, No. 1, 1996
 AGRAWAL
BrandLoyaltyon Advertisingand TradePromotions

Figure3 MainTheoreticalResults

Manufacturer Trade Promotion Average Price Discount Frequency of Promotions

Advertising Expenditures
Expenditures
Manufacturer Retailer Manufacturer Retailer
Strength of Brand as < aw MEPs>MEPw if x*<anx** ADS > ADw RADS < RADw MPS< MPw RPS> RPw
Loyalty (Proposition4) MEPs<MEPw if >(Xa** (Proposition 2) (Corollary 1.1) (Proposition2) (Corollary 1.2)
(main effects) (Proposition 3)
Size of Loyal (,aI/n,)> ? (dMEPI/dm,)< 0 (dAD /dd)< 0 (dMP / dm)< 0
Segment (da&/Idm.)> | (dMEPI/d w,)>0 (ADA./do )> - (dMFP/dm)>O -

(comparative statics) (Corollary4.1) (Corollary 3.1) (Corollary 2.2)_ (Corollary2.2)

Notation:
aj : Manufactureradvertisingexpenditures for brandi (i=s,w)
MEPi : Trade promotionexpenditures for brandi (i=s,w)
ADi : Average price discount offered by manufacturerof brandi (i=s,w)
RADi : Average price discount offered by retailerfor brandi (i=s,w)
MPi : Frequency of trade promotions for brandi (i=s,w)
RPj : Frequencyof retail promotions for brandi (i=s,w)
mi : Size of loyal segment of brandi (i=s,w)
a : Cost effectiveness parameterof advertising(a higher a implies costlier advertising)

not all data are accessible to us (for example, wholesale
prices and corresponding retail prices), we focus on
only those propositions for which we are either able to
obtain data or construct proxy measures. Thus we do
not test hypotheses concerning trade promotion expen-
ditures.
H3. The averageprice discount at the retail level is neg-
atively relatedto the strengthof brandloyalty.
H4. Thefrequencyof price promotionsat the retail level
is positively relatedto the strength of brandloyalty.
Construct Measurement

Manufacturer Advertising BrandLoyalty(LOYALTYi,SIZEi). In the theoretical

Results 1-3 imply that the weaker brand manufacturer
spends more advertising dollars than the stronger
brand, and Corollary 4.1 implies that advertising spend-
ing is higher for the larger loyal segment size, thus in-
dicating following expected patterns in the data:
H1. Themanufactureradvertisingspendingis negatively
relatedto the strength of brandloyalty.
H2. The manufactureradvertisingspending is positively
relatedto the size of loyal segment.
Retail Promotions
Corollaries 1.1 and 1.2 imply the following patterns
in the data:
model, the strength of brand loyalty is defined as the
relative price differential needed to switch given that
the two competing brands have same regular price. In
reality, however, it is difficult to estimate such a price
differential because, first, unambiguously identifying a
competing pair of brands in a category with several
competing brands is not possible, and second, brands
have different regular prices. Even if such price differ-
entials were available, how to relate them to measures
of brand advertising and promotional activities is not
clear. Therefore we focus our efforts on developing an
interval scaled estimate of brand loyalty which reflects
relative strength of loyalty among consumers in the
market and which could be related to the interval scaled

MARKETINGSCIENCE/VOL 15, No. 1, 1996 97

 AGRAWAL
BrandLoyaltyon Advertisingand TradePromotions

estimates of brand advertising and promotional activi- the similarities of our brand loyalty measure with these
ties. approaches later in this section (after Equation 5).
In the literature brand loyalty has been measured in We next describe the method for estimating strength
several different ways. Raj (1982) defines highly loyal of brand loyalty (LOYALTYi) and size of brand loyal
customers as those who devote more than 50% of their segment (SIZEi)using scanner panel data which contain
product class purchases to the brand. Krishnamurthi purchase histories of several households over several
and Raj (1991) use the proportion of times each brand weeks.
is bought on all preceding purchase occasions, updating We estimate the following logit model:
it as each purchase occurs, as a measure of brand loy-
h-exp(uZ)i
alty. These share of purchase driven measures do not it
exp ( uhj)(1)
capture the effect of marketing mix. For example, a
brand may have high share of purchases just because it uh= ai + y propen, + , fkXk,I where (2)
is heavily price promoted. Guadagni and Little (1983) k

use an exponential smoothing formulation for brand h purchases

loyalty which incorporates the effect of past purchases
(including past marketing mix activity) on the current
purchases. Fader and Lattin (1993) develop an alterna-
tive measure assuming choice probabilities are distrib-
uted according to a Dirichlet distribution which also in-
corporates the effect of past purchases. Allenby and
Rossi (1991), on the other hand, define brand loyalty as
the residual of the predicted probability of choice from
the choice indicator averaged over all occasions. This
measure filters out the effect of past marketing mix ac-
tivities in computing brand loyalty. All these measures
capture the heterogeneity across households in propen-
sity to purchase different brands quite well, and treat
this heterogeneity as a direct measure of brand loyalty.
Chintagunta et al. (1991) and Gonul and Srinivasan
(1993) conceptually distinguish between household het-
erogeneity and intrinsic brand preference. These au-
thors use the intercept term in the brand utility model
as a measure of intrinsic brand preference and use semi-
parametric methods for estimation.
It can easily be shown that the intercept term in the
utility model is perfectly able to capture the rank order
information in the relative price differentials needed to
make a consumer switch away from one brand to the
other. In other words, the relative price differentials (the
definition of brand loyalty used in this paper) and the
intercept values have a perfect rank order correlation.
Therefore we develop a measure of brand loyalty here
along the lines of Chintagunta et al. (1991) and Gonul
and Srinivasan (1993) which is based on the intercept
term in the brand utility model and which also incor-
porates heterogeneity across households. We discuss
Pith the probability that household
brand i at purchase occasion t,
the utility to household h of purchasing
i=
brand i at purchase occasion t,
propeni = a measure of household h's propensity to-
ward brand i based on purchase behavior
before time t,
t = the level of marketing mix variable k for
brand i at purchase occasion t, and
a i, y, fk = model parameters.
Households are heterogeneous in their propensity to
purchase different brands. To capture this heterogeneity
in preferences across households we use the measure
propenh (Srinivasan and Kibarian 1989). To compute
this measure, we first estimate (using maximum likeli-
hood estimation procedure) the above logit model with-
out the propenh term on first half of the data, which we
call calibration period data. Next we use the estimated
parameters to compute predicted probability of choice,
qt over the calibration period. The heterogeneity mea-
sure is then computed as:
propenh = 6 propenh
+ (1i- tq)(y i_-q_i) where (3)
I 1 if i chosen at t -1,
=0 otherwise.
Here Yi propenh =0, and 0 < 6 < 1 is a smoothing
parameter, usually in the range of 0.70 to 0.85. The
propenh measure was initialized as 0.0 for all brands.
Note that propenhincreases if the brand is chosen on

98 MARKETING SCIENCE/VOl. 15, No. 1, 1996


BrandLoyaltyon Advertisingand TradePromotions
previous occasion and decreases if it is not. If the brand
is not chosen on previous occasion then yh _I = 0, which
will have a negative effect on propenh. And if the brand
is chosen on previous occasion then y- = 1, which will
have a positive effect on propenZh, as desired. The
propenh estimates were found not to be significantly
sensitive to different values of 6, therefore we use a
value of 0.75 in all our estimations. Finally, the
propenh vector for household h on the last purchase oc-
casion T in the calibration period is used as a measure
of household heterogeneity as it represents the most sta-
ble vector in the calibration period of household pro-
pensities towards different brands.
Next, we estimate the logit model in Equation (1)
with the marketing mix variables X"'s and the
propenh term on the second half of data, which we call
estimation period data, using maximum likelihood es-
timation procedure. This provides us with the estimates
of model parameters a's, ', and, 's. Next we estimate
the household level predicted probability of choice of
each brand on each occasion at equal marketing mix
activity on the estimation period data using the follow-
ing model:
mht
- where
=j exp(&,+ 5y IPP
propen h )
i= predicted probability of choice of brand i for
household h at purchase occasion t keeping the mar-
keting mix activity constant across brands.
This step (Equation 4) in effect gives the brand spe-
cific preference (relative to other brands in the category)
for each household when all brands have equal mar-
keting mix support, akin to a measure of intercept term
(incorporating household heterogeneity) in the utility
function.
Next, we classify each household into a loyal segment
based on the predicted probability vector on the last
purchase occasion T in the estimation period, Mh, for
that household. We assume that the household is loyal
to that brand which has the highest predicted probabil-
ity of choice (i.e., h E segment1 s.t. mih > mh- Vi * j).
We use the last purchase occasion here because it rep-
resents the most stable probability vector given the pur-
chase history of the household. Lastly, we compute the
interval scaled loyalty measure for each brand by av-
eraging the predicted probabilities of choice of the
MARKETING SCIENCE/Vol. 15, No. 1, 1996
AGRAWAL
brand over the households in its loyal segment reflect-
ing the strength of loyalty among its loyal consumers:
>hm
LOYALTYi
= , where (5)
Nh
LOYALTYi= estimated brand loyalty6 for brand i,
Nh =number of households in the segment loyal to
brand i.
The size of loyal segment, SIZE,, is computed as the
percentage of households that belong to the loyal seg-
ment of brand i.
We note that our brand loyalty measure is similar to
the two approaches available in the literature. One ap-
proach is to use a measure of household heterogeneity
similar to propenh measure to capture brand loyalty
(Allenby and Rossi 1991, Fader and Lattin 1993, and
Guadagni and Little 1983), and the other approach is to
use the intercept term in the utility model in Equation
(2) to capture the intrinsic brand preference (Chinta-
gunta et al. 1991, Gonul and Srinivasan 1993). The dif-
ference in our method is that instead of using only the
intercept term or the household heterogeneity, we com-
bine the effects of both to capture brand loyalty and use
a computationally easier estimation procedure com-
(4) pared to the semiparametric procedures. Also, our
method guarantees a loyalty and segment size estimate
for each brand in the category unlike semi-parametric
methods. We need these estimates for each brand to test
the hypotheses.
ManufacturerAdvertisingExpenditures(EXPENADV.).
We note that our interest is in examining the effect of
exogenously specified initial brand loyalties on manu-
facturer advertising and retail price promotion policies.
Accordingly, we use advertising data from a period
subsequent to the time period of scanner panel data to
account for this direction of causality.7 The data on
6A simple share of purchases measure has a correlation of 0.51 (p
= 0.0003) with LOYALTY,,indicating that as intended LOYALTYiis
not simply capturing share of purchases.
7Note that as with advertising, the causality in the empirical data may
work in reverse with price promotions also, i.e., price promotions may
affect brand loyalty rather than brand loyalty affecting price promo-
tions. Thus to test the model it would also be desirable to ensure loy-
alty estimates precede price promotion estimates in time. The inability
to do this is a limitation of our empirical analysis.
99
 AGRAWAL
BrandLoyaltyon Advertisingand TradePromotions

brand advertising were obtained from Arbitron's ad- Table 1 Descriptionof Data
vertising dollar summary published yearly. This pub-
Category # Purchases# Brands # Households#Stores #Weeks
lication reports dollar advertising expenditures in nine
media for most national brands. The measure of adver- OrangeJuice* 2958 6 115
tising expenditures is computed as the brand advertis- Crackers* 3159 6 252 15 104
ing expenditure expressed as a percentage of the total Coffee* 4946 4 398 6 108
advertising expenditures for all brands analyzed in the Laundry
Detergent* 2275 7 300 13 52
category.
Catsup* 4502 4 333 5 161
AveragePrice Discount Offeredby the Retailer(PRICED- PeanutButter* 8465 6 404 5 161
ISi). We operationalize this construct by the percentage Dishwashing
reduction in the average price when the brand goes on Liquid* 5356 13 256 5 161
promotion (i.e., feature and/or display), where price
FromI.R.I.,Inc.
reduction is the difference between the estimated reg- ** FromA.C.Nielsen, Inc.
ular price and the posted price. The regular price is es-
timated by the average price when the brand was not
featured or displayed. To examine the data patterns implied by H1 - H4, we
Frequencyof RetailPromotions(FREQPROMi). We op- begin by noting that the theoretical analysis assumes a
erationalize the frequency of retailer promotions by the sequential decision making process in which retail pro-
frequency of price cuts observed in the scanner panel, motion frequency and average price discount decisions
defined as the number of occasions on which the esti- are dependent on manufacturer advertising expendi-
mated regular price exceeds the actual price posted in tures decided earlier on in the first stage. To incorporate
the store, expressed as a percentage of the total number this dependence among decisions in the model, we in-
of occasions on which the brand could have been avail- clude EXPENADVi as an explanatory variable in retail
able. This proxy measure captures the relativefrequency promotion equations. We estimated the following three
of retailer promotions across brands. linear statistical models to derive the data patterns:

Data Description EXPENADVi = a0 + ajLOYALTYj

We estimated brand loyalties, loyal segment sizes, retail + a2SIZEj+ (6)
E ajDj+ (,
promotion frequencies, retail average price discounts,
and brand advertising expenditures for seven product
PRICEDISi = jo + j3LOYALTYi
categories: orange juice, crackers, coffee, laundry deter-
gent, catsup, peanut butter, and dishwashing liquid. A + j32EXPENADVi+ ,lfjDj + 2, (7)
brief description of the datasets is provided in Table 1.
There are 46 brands in these seven categories, of FREQPROMi= yo + yjLOYALTYj
which eight are private labels. We include the private
labels in the estimation of brand loyalties and segment + y2EXPENADV-+ E 71D1+ i, (8)
sizes, but exclude them in further analysis because theo-
retical analysis concerns brands which may promote to where subscript i (i = 1 to 38) refers to a national brand
the trade. Private labels do not promote to the trade as and D1s(j = 1 to 7) are the 0-1 category specific dummy
they are owned by the trade itself. This implies a sample variables included to capture any category specific dif-
size of 38 national brands for examining the data pat- ferences on variables not included in the above equa-
terns. We present the estimates of the various measures tions.
in Table 2 for all the brands in the seven categories. Note It is hypothesized that a1 < 0 (H1), a2 > 0 (H2), 81
that all measures within a category are defined in rela- < 0 (H3), and yi > 0 (H4).
tive terms rather than absolute terms thus making We estimated the above three equations using Joint
across category comparisons possible. Generalized Least Squares (SUR) estimator which

100 MARKETING SCIENCE/VOl. 15, No. 1, 1996

 AGRAWAL
BrandLoyaltyon Advertisingand TradePromotions

Table2 MeasurementEstimateson Seven ProductCategories

Category Brand Loyalty Size EXPENADV PRICEDIS FREQPROM

OrangeJuice 1 0.6077 0.1910 0.1544 0.1379 0.1105

2 0.4373 0.4494 0.4859 0.1254 0.1579
3 0.4828 0.2584 0.2917 0.1705 0.1870
4* 0.4897 0.0112 0.0852 0.0352
5* 0.3424 0.0377 0.1700 0.3110
6 0.4774 0.0562 0.0436 0.1381 0.1024
Crackers 7* 0.5039 0.1382 0.0244 0.0603
8* 0.5693 0.4431 0.0396 0.0615
9 0.5698 0.0203 0.1685 0.2403 0.3237
10 0.5763 0.0610 0.1774 0.0702 0.3212
11 0.7204 0.0285 0.2957 0.1682 0.3051
12 0.6012 0.3089 0.3548 0.1345 0.3103
Coffee 13 0.4439 0.0244 0.0251 0.1753 0.6929
14 0.6071 0.2774 0.4948 0.1587 0.6821
15 0.5712 0.5488 0.4730 0.0164 0.6543
16 0.6140 0.1494 0.0070 0.0991 0.6435
Laundry 17 0.5668 0.3808 0.4188 0.1222 0.6561
Detergent 18 0.5263 0.1967 0.1204 0.0875 0.6617
19 0.5544 0.1715 0.0868 0.1190 0.5683
20 0.4633 0.1130 0.1195 0.1022 0.6496
21 0.5482 0.0502 0.0455 0.0656 0.5389
22 0.5633 0.0586 0.1517 0.0938 0.4399
23 0.5566 0.0293 0.0572 0.0649 0.3360
Catsup 24 0.0000 0.0000 0.3561 0.4320 0.2820
25 0.8022 0.9153 0.4307 0.0189 0.5019
26 0.5633 0.0780 0.1983 0.0577 0.4870
27* 0.7046 0.0068 0.0126 0.4919
PeanutButter 28 0.6594 0.3137 0.3742 0.0214 0.5764
29 0.6097 0.3217 0.2111 0.0405 0.5602
30 0.4072 0.0054 0.1571 0.0197 0.5180
31 0.5246 0.0563 0.2212 0.0872 0.5180
32 0.2979 0.0027 0.0299 0.0545 0.5764
33* 0.6631 0.2949 0.0943 0.6286
Dishwashing 34 0.5303 0.0241 0.0413 0.0785 0.5640
Liquid 35 0.4635 0.1124 0.1107 0.0602 0.4634
36 0.4182 0.0120 0.0250 0.0011 0.4410
37 0.5160 0.0161 0.1306 0.0677 0.4484
38 0.0000 0.0000 0.0670 0.0894 0.0882
39 0.3935 0.0723 0.0900 0.1532 0.5093
40 0.0000 0.0000 0.0167 0.0102 0.0882
41 0.3091 0.0040 0.0255 0.0106 0.3056
42 0.5573 0.2731 0.1498 0.0398 0.5851
43 0.4989 0.2289 0.2595 0.0279 0.5528
44 0.5293 0.2169 0.0720 0.0591 0.5540
45* 0.5722 0.0361 0.2456 0.3540
46* 0.7041 0.0040 0.0013 0.1441

Privatelabel brand.
***** Datanot available.

MARKETING SCIENCE/VOl. 15, NO. 1, 1996 101

 AGRAWAL
BrandLoyaltyon Advertisingand TradePromotions

resulted in more efficient (but qualitatively identical) Table3 EstimationResults

estimates compared to OLS and 2SLS estimators, as this variable
Dependent
estimator takes into account the correlations in error variables
Independent EXPENADV PRICEDIS FREOPROM
terms across the equations. We checked for multicolli-
nearity and model misspecification problems by esti- 0.107C2 0.135a2 0.231a2
CONSTANT* (1.963) (4.112) (4.957)
mating various specifications including SIZE, and the
-0.1 83' - 0.1 98a 0.477al
LOYALTYi*SIZEi interaction terms in all three equa- LOYALTY (1.422) (2.82) (4.768)
tions but found no difference in qualitative results. 0.607a1
SIZE (5.364)
-0.05 0.049
EXPENADV (0.591) (0.397)
5. Empirical Results 0.084 0.120a2 _0.343a2
The results of the SUR estimation presented in Table 3 Dl** (1.348) (2.973) (5.969)
indicate that the equations fit the data reasonably well, 0.191a2 0.153a2 -0.222a2
with the system weighted R2 being 0.743. D2 (2.869) (3.627) (3.696)
With respect to advertising expenditures, the data 0.093 0.101 b2 0.158b2
support the patterns hypothesized in H1 and H2. The D3 (1.4575) (2.451) (2.702)
0.048 0.073b2 0.055
stronger brands spend less on advertising (p < 0.10),
D4 (0.907) (2.198) (1.157)
and brands with larger loyal segments spend more on 0.104 0.141a2 -0.04
advertising (p < 0.0001). D5 (1.456) (3.037) (0.609)
With respect to retail promotions, the data support 0.098c2 0.109 0.071
the patterns postulated in H3 and H4. The retailer pro- D6 (1.712) (0.514) (1.358)
vides higher price discount on average for the weaker SYSTEMWTDR2 0.743
n 38
loyalty brands (p < 0.01) and promotes the weaker loy-
alty brands less often as compared to stronger brands tvalues in parentheseswith each estimate.
(p < 0.0001). We note that this particular empirical re- * The Divariablescapturecategoryspecific effects.
al significantat 0.01 level using one-tailedtest.
sult supports the analytical finding of the retail pricing
a2
model in Rao (1991). significantat 0.01 level using two-tailedtest.
bl significantat 0.05 levelusingone-tailed test.
We also estimated the three equation system with the b2 test.
at 0.05 levelusingtwo-tailed
significant
advertising expenditure variable adjusted for market cl significantat 0.10 level using one-tailedtest.
share points. In other words, we divided the EXPEN- c2
significantat 0.10 level using two-tailedtest.
ADV by the market share (in %) to take into account Note:Alldirectionalhypothesesare tested using a one-tailedtest.
the possibility that a large share brand may spend more
just because of its greater size. The market share
measure was computed as a share of purchases in the 6. Conclusions and Future Research
panel. The results with respect to H1(p < 0.01), The theoretical analysis presented here provides implica-
H3(p < 0.05), and H4(p < 0.05) did not change. But be- tions for the optimal advertising and price promotion
cause the correlation between SIZE and market share is policies for competing manufacturers selling through a
high (=0.91, p < 0.01), the pattern hypothesized in H2(p common retailer.For example, the analysis indicates that
> 0.35) was significant only at the 0.35 level. if the stronger loyalty brand is sufficiently stronger than
Overall the data seem to be consistent with the pat- the weaker loyalty brand and if advertising is cost effec-
terns implied by the model. This is by no means a con- tive, then stronger brand loyalty requires less advertising
clusive test of model's validity; however, we believe than weaker brand loyalty, but a larger loyal segment re-
that good regression fits combined with strong signifi- quires more advertising than a smaller loyal segment.
cance of the results is encouraging. We also believe that Moreover,strongerbrand loyalty requiresmore trade pro-
the testing methodology presented here is useful and motion spending under these conditions. In addition, the
that efforts should continue to further test the theory. retailer should promote the stronger loyalty brand more

102 MARKETING SCIENCE/Vol. 15, No. 1, 1996

 AGRAWAL
BrandLoyaltyon Advertisingand TradePromotions
often but provide a smaller price discount for it compared
to the weaker loyalty brand. The empirical analysis, based
on scanner panel data on seven product categories, pro-
vides encouraging evidence for the model. However, there
are several caveats associated with these analyses in ad-
dition to their strengths.
The results with respect to brand loyalty strength may
at first seem counter-intuitive. For example, recently the
consumer packaged goods company, Proctor and Gam-
ble, announced a strategy to move away from trade
dealing in favor of advertising. P&G is widely regarded
as a strong national brand manufacturer. One way to
interpret P&G's actions in the model's context would be
that P&G is trying to build brand loyalty so that it be-
comes unquestionably a stronger brand. Once the
brands are sufficiently stronger, P&G wouldn't need to
invest further in advertising. In a way, the model im-
plies that P&G's brands are not "sufficiently" stronger
in loyalty strength yet.
The model and its analysis in this paper has the ad-
vantage of parsimony. It integrates the advertising and
pricing decisions in a very parsimonious way through
the construct of brand loyalty in a three-stage formula-
tion. It incorporates main effects of advertising-
namely, brand reinforcement-and of promotions-
namely, brand switching and repeat purchase in a com-
petitive setting in the context of established product cat-
egories. The model also considers the role of the retailer,
thus capable of providing implications for retail pass
through. The analyses highlight the distinction between
the strength and size of brand loyalty, which is appeal-
ing theoretically and also useful practically. For exam-
ple, marketers may benefit directly from knowing the
composition of their category franchise; specifically,
how many loyal customers there are for each brand, and
how loyal they are to each brand.
The main caveats associated with the model relate to
the absence of (1) dynamic effects of advertising and
promotions; (2) of repeated interactions among the
manufacturers, retailers, and consumers; and (3) retail
competition. Retail competition, for example, plays a
significant role in the retailer pricing strategy as the re-
tailers continuously monitor competitors' pricing and
promotional activities for designing their own strate-
gies. Moreover, retailer's primary objectives, to maxi-
mize store traffic and shelf turnover, do not necessarily
MARKETING SCIENCE/Vol. 15, No. 1, 1996
coincide with the objectives of the manufacturers. In
future, extensions of the model to incorporate these
features would be desirable. Another limitation is the
linear additive form used for the effect of advertising
on brand loyalty. Although it helps to keep the model
tractable, this functional form does not capture the
possible advertising threshold effects. Lastly the as-
sumption that the size of loyal segment remains un-
changed after advertising takes place is a limitation. In
reality, advertising may induce changes in the size of
loyal franchise.
In addition to advertising and trade dealing,
manufacturers also use consumer promotions in the
promotional mix to attract customers such as cents-
off coupons, sampling, and contests. It will be desir-
able to consider consumer promotions also in the
model.
In the empirical investigation, the most limiting fac-
tor is the unavailability of trade promotions data,
which precluded us from investigating propositions
regarding trade promotion spending. Also the defi-
nition of strength of brand loyalty does not exactly
match in the theoretical and empirical analysis. More-
over, in the theoretical model we analyze a suffi-
ciently stronger brand competing with a weaker
brand; however, it is difficult to identify empirically
if the stronger brand is indeed sufficiently stronger
than the weaker brand. This is a limitation of our em-
pirical analysis. Another limitation is the assumption
that each consumer is loyal to some brand as each
household is classified as a loyal household (to some
brand). In reality a consumer may not be loyal to any
one brand but may regularly switch among a subset
of brands. Inclusion of a switching segment in the
analysis will enrich the framework.
In summary we develop a parsimonious analytic
framework to examine the tradeoffs between advertis-
ing and trade promotion strategies. Extensions of this
framework to incorporate dynamic and repeated inter-
action effects and retail competition should prove fruit-
ful in enhancing our understanding of the promotional
mix. In addition we develop a methodology for esti-
mating the size and intensity dimensions of brand loy-
alty using readily available scanner panel data. Further
work on refining this methodology should also prove
fruitful because these estimates (of size and intensity of
103
 AGRAWAL
BrandLoyaltyon Advertisingand TradePromotions

brand loyalty) are of direct and significant relevance in

optimal brand strategy.8
s.t. p",< p -1I, (A5)

? C p7V C r, Oc p5 C-- r. (A6)

Appendix
Since this is symmetric in lv, 1, to Action 1, the retailer will pick pS
PROOF OF PROPOSITION 1. The retailer's profit function is: =rand pUI= r - - E, and earn profits
15 of I = [r - 15 - E - w].

mi(ps-ws)+ ( if p < p-1, Now, the retailer will follow Action 1 only if fl > fl, fl1. Now,
PS
rl > [lr if
rlr ms(ps
- Ws) + mW(pU1,
-
W70) if p5
-
Is C:- p7V CpS + IlV,/
(r - - e - w5) > r - mvwv - mSwS,
(Pw -ww) if p7,, < pS-Is
1
or if, w7, > ws +-IW, (A7)
Given the reservation prices, (r, r - IS) for the customer loyal to
brand s, and (r - I,. r) for the customer loyal to brand w, for brands
and,flr > rlr if (r - lw- e - w5)
s and w, respectively, the retailer does not charge a price above r.
There are three possible actions for the retailer: > (r - 1, - E - w5), or if, ww > w5 + (lw - Is).
Action 1: Sell only brand s to the whole market.
Action 2: Sell each brand to their own loyal segments. Since mwlu,> (17?.- IS),therefore condition (A7) is sufficient. Thus,
Action 3: Sell only brand w to the whole market. when W7., > Ws + m7V17V, retailer follows action 1. By symmetry, when
Retailer's optimization problem under Action 1 is: wI > w7, + m5sl,retailer follows Action 3. And for all intermediate
prices, wI - mI" c W7Vc wI + mWl17Vretailer follows Action 2.
max = (ps - Ws) The pricing strategy of the retailer is therefore:

chargep, = r - 17V- C; p7V = r if W7v> wI + (1/mW)lW

s.t. Ps < pw -w, (Al)
chargep, = r; pw= r if w5- (1/m5)1 C W7V C wI + (1/mW)lW
O -p-7V - r, Oc ps C r. (A2)
charge p5 = r; p7V = r - 1- e if wS > wW+ (1 /m5)lI. L
/lips > 0, retailer will choose the maximum p. that satisfies
Since lO1H1r
PROOF OF COROLLARY1.1. This result directly follows from the
constraints (Al) and (A2). Also, since flr is independent of Pw,retailer
retail price equilibrium above. The weaker brand has to offer a larger
can pick any Pwthat satisfies (Al) and (A2). Therefore, the retailer will
discount Is in order to attract the stronger brand loyal consumers,
pick pw= r and ps = pw - l7 - e r--l0v - , where eis an infinitesimal
whereas the stronger brand has to offer 17V to attract weaker brand loyal
number. The profits will be flr = [r - 17- e - wS.
consumers, where 1I > lw in equilibrium (shown later in Proposition
Retailer's optimization problem under Action 2 is:
4). 0
max flr = mS(ps - Ws) + mw(pw - ww) PROOF OF COROLLARY1.2. Retailer promotes the stronger brand
with a probability, Prob.[ww > ws + (1/mW)17V], and promotes the
s.t. WA) weaker brand with probability, Prob.[ws > ww + (1 /ms)Isj. As shown
PS -IS pw PS+1w,
in Raju et al. (1990), the asymmetry in loyalties (lw c m2%r and 15 2 ms(r
0 ' pwc r, 0 p5 C r. (A4) - lIj)/(1 + msmj)) ensures that the probability with which the weaker
brand is able to attract stronger brand's loyal consumers is zero, i.e.,
Condition (A3) represents all possible pairs of prices (ps, pw) for
Prob.[ws > W71, + (1 /mS)1J] = 0. Thus at the retail level, weaker brand's
which each brand retains its loyal customer. The retailer can maximize
promotion frequency is lower than that of the stronger brand. As
profits by charging the highest price for each brand, because 19H/2
shown later the asymmetry in post-advertising loyalties is preserved
ps > 0 and OHr/Opw > 0. The optimal prices, therefore, are ps = r and
in equilibrium. O
pw = r. Retailer will earn profits of H-2 = r - msws- MWwU PROOFOF PROPOSITION2. The mixed strategy pricing equilibrium
Retailer's optimization problem under Action 3 is:
for 0 c lw c m%2 r and 15 2 ms(r lW)/(1 + mSmW) - available from Raju
et al. (1990) is:

8 author thanks Rajiv Lal, V. Srinivasan, James Lattin, Scott Neslin 0 if 0 _ w5 < msr,
(area editor), and two anonymous reviewers for several useful sug-
mW(msmwr + l1V) . mw
gestions and Faruk Gul, Richard Staelin, Allen Weiss, Brian Gibbs,
+ Iw)2 if mr
(mwWs ? w, r--
Daniel Putler, and Peter Reiss for helping to improve this paper. The
f *(Ws) = O if fr - c-ws < r,
author also wishes to acknowledge James Lattin, Randolph Bucklin,
Peter Fader, A. C. Neilsen Inc., and Information Resources Inc. for mSm7vr + l17 if w, =

making the scanner datasets available, and the Marketing Science In-
stitute for financial support. 10 if w>r.

104 MARKETING SCIENCE/VOl. 15, No. 1, 1996

 AGRAWAL
BrandLoyaltyon Advertisingand TradePromotions

-'7V MEPW = m% r-l, + - mlog).

p0 if O c W7,, < m,r + m, 7V MV, M7,,,r- 17,,

if m,r+ - cw7,_ <r,

- 1- We plot the trade promotion expenditures as a function of 17., for
g*(w7,,) MSZV w)
=,2 w various values of M7n0in Figure 4.
IZV
m7J,m7,,r 17
The plot shows that at 17V = mVr, MEP.= MEP,,= 0; for 17 < 17.
O if
W7V>irf <Wm,r, MEP, > MEP,,; at 17. = 171MEI. = MEP,; and for 0 l,7

where f*, g* represent probability distribution functions of wholesale < w, MEP, < MEP7.

prices for brands s and w, respectively. For 0 ? l7. - m2r and Isv 2ll, the equilibrium advertising levels
Probability of a promotion by manufacturer i, (MP), is the cumu- (derived in the proof of Proposition 4) suggest that 4,.will be > lu
lative probability of charging a price below r. The equilibrium pricing provided advertising is cost effective; specifically, when a* < a < a**
strategy implies: where a* solves OEHU'[l, = mWr]/017 = 0, and a** solves OEFw[l.,
= l]w/Ol,, = 0; and, 1,, will be < Iu,when a > a**. Therefore, MEP,

MP,=
ZV 7V
MP7,, = > MEPW when a* < a < a** (advertising is cost effective); and MEP,
m7vr - Izv)
m7,(m7,,r < MEPl,,when a > a** (advertising is costly). O
If 17 c m7,r,then mW,r- lw < r, therefore, MP,, > MPs. As shown PROOF OF COROLLARY 3.1. The two derivatives,

later (proof of Proposition 4), the post-advertising loyalties satisfy 17V

OMEPs 212 _ w
m 2 r. +7V
c5
W__ _ log m, +
The average trade discount offered by manufacturer i, (AD), is reg- 9mw m7Vr\m7V U

ular price minus average price when on promotion, i.e., AD, = r

and
- fti<r wif(wl/w; < r)dw,, implying

OMEP7v 21w 21lVm7vr- 1,lr- mr2vr2 r m 7,,rl- lu,

(m3U,r2 +
- .12- 1,,m5m7,,r + l,,)m7r log s 7 3- + 2+ -log
(mIm7vr
U)
OmW mw m%(m,,r- Ij) mz, \ msmz,.r
ADS= m70(m72r
-4IW)
are both 2 0 for lw m 2r. O
PROOF OF COROLLARIES 3.2 AND 3.3. The two derivatives
lr - ) (m r - W.+mSmwr log( ' 1))

AD.,, = mW(mWr- lw) MEP,

1 - 2u, +1 + 17V
logM
mw mi, MV
Using numerical enumeration, it can be shown that ADs > AD7,,
when 17Vc Wr. 0 and
PROOF OF COROLLARY 2.1. In equilibrium, the weaker brand pro-
aMEPw (m%2r - lW)
motes to the trade more often but the retailer promotes the stronger
'91w m 2,(mwr -1,,)
brand to consumers more often, implying that retail pass through in
terms of frequency is lower for the weaker brand. Similarly, the
stronger brand provides a larger price discount on average to the trade
but the retailer offers a larger price discount on the weaker brand, Figure4 TradePromotionalExpenditures
implying that retail pass through in terms of depth of discount is lower
for the stronger brand.
0.9
PROOF OF COROLLARY 2.2. The first-order derivatives,
0.8U
aMP, 17V ad MPW, mwlwr(2-
aMW,. m7vr DmiV mv(mw,r- 0.7

are both positive when 17, c mZ2 r. Similarly, it can be shown that 0.6

0. 5
OAD,
< 0 and >ADw- 0. D
am,i aMDV 0.4 <
PROOF OF PROPOSITION 3. The expected promotional expenditure 0.3
MEP, for brand i is Li (r - wj)f(wj)dw,: 0.2 -
(mwr+ lw)(m2,r - 17,) 0.1 s
MEPV- zin -.P

0o
- M2 r + lW) 1 + 0 I- OL cc
c
(M7,,r m(imnwr 1)7 o 6 6 6 6 6 6 6 6
MW, M7vr mw

MARKETINGSCIENCE/Vol. 15, No. 1, 1996 105

 AGRAWAL
BrandLoyaltyon Advertisingand TradePromotions

are both c 0 for lV, m' r. Since I,V= 1,, + ya1,,- (1 - y)a,, therefore,
c and
OMEP,/ &y < 0; OMEP,O /&y < 0; OMEPI/ Ml,T,, < 0; and OMEP,V/ aOl710
<0. EL
01.-X
= (l-
1 m)fmr(1+ mV) -1ITOV + 7,r
(1 + M,m) W if (,SMs___+ M
,
<7 <i2
m70'
PROOFOF PROPOSITION 4. We first show that given a* = 0 and a 2 <

< a*, it is optimal for firm w to have a* = ((m%,r - 17,,0)/Y)2. Next we

show that given a* = ((m%2r- l700)/y)2and a - a*, it is optimal for Expected profits to firm w now are:
firm s to have a = 0.
Let a* = 0. The initial loyalties are asymmetric (i.e., la,. mz2r and c
V
Er7"(a=V(a'l=' , = )) = m,,r - aa,
is, 2 Is,); the stronger brand enjoys sufficiently stronger loyalty such
that the retailer promotes only the stronger brand). If post advertising
which are lower than what the firm earns at au,.
loyalties are also asymmetric then firm w solves the following problem
If a7, is increased even further, the regime continues to remain asym-
to choose a,v:
metric and expected profits to firm w continue to decrease. Therefore,
max EHl'1(a*= 0, a71,) given a* = 0, it is optimal for firm w to have a* = ((m%2 r - 1",O)/Y)2
provided a ? a*.
Now let a* = ((m%2r _l,,")/y)2 and a - a*. The loyalties are asym-
s.t. Il7, = 17?O0+ Ya7 mWr, (A9) metric. If firm s advertises, the loyalties continue to remain asymmet-
ric. Firm s solves:

IS= I,, - (1- y) A;2 m(r - (A10) max Efls(as, a*)

1 + mSm1,,
MM7
a,

From Lemma 1 (proved below), OEH?7/O1l1.> 0. Therefore firm w

chooses aw such that 17vis at its maximum and constraints (A9) and lvt)
st. I 17VI+ Y(m,r-
-
(1 - Y)v?a m2r, (A1)
(A10) are satisfied. a* = ((m2r - lw")/Y)2 is the optimal level at which
constraint (A9) is binding and constraint (A10) is satisfied because
a
m 2r(l + mJU (l -
Y) M2
/S = +~ 4-(1
I't,+
?St1 y - )(m7wr
Y) 17) 21+
m*(r-IW
msmzv
A 2
IS 2: + (m,r
l
- 17t(1)
0 i7(1+rM:S) y (
From Lemma 1, OEHs/Olu, > 0. Therefore firm s will choose as such
The expected profits to firm w are:
that 1,,is at its maximum and constraints (All) and (A12) are satisfied.
a = 0 is the optimal level at which constraint (All) is binding and
EHlw= =0O, a7t= =m1,r-aa1*. constraint (A12) is satisfied because Is, to. The expected profits to
firm s are:
If a7Vis chosen at a level beyond a*, the post advertising loyalties
now fall in the pure strategy regime wherem2r < 17,,< 1. From Lemma EHs(aa = 0, a*, = (m,r l)2) =mSr-aa, = mr.
2 (also proved below), under pure strategy, expected profits to firm w
are: If a, is increased beyond a*, i.e., if as > 0, the post advertising
loyalties continue to remain asymmetric and the expected profits
EHw(a* = 0, >a) = m7vr-aa7V,
a,v EflW(as,a*) = mr - aa, are lower than what the firm earns at a*.
which are lower than what the firm earns at a*l,. Therefore, given aT* ((mT2r-
= /Y)2 and a _ a*, it is optimal for
1ot)

If aw is increased further, 15 continues to decrease and 14,continues firm s to have a* = 0. Hence, a* = 0; a*, = ((m2,r - Ir)/y)2 is a Nash
to increase. At aZV = ((IS( - mwr)/( 1 - ))2, the competition moves equilibrium when l (- mzvrtl'; i1S0/ and a 2 a*.
from pure strategy to asymmetric regime where the weaker brand is Now, we show that for a > a*; a* = 0 and a* = ((I* - 17.,.>)/Y)2.
now asymmetrically stronger. The loyalties now are: When the cost effectiveness of advertising is such that a > a*, firm
w wishes to increase its loyalty only upto l/*, because beyond l* the
expected profits decrease. The level l* can be computed by solving
l = Is, + Y7a- (1 - y)f a= 1s0+ 0 - (1 - y) (h. - mM%Vr) r
aEnI[17,, = *Ia,I/Ol,= O.
Therefore, for a > a*, the optimal advertising levels are:a* = 0 and
' a*,= ((MZ1 - 17,, /y)2; where
'IV=17Wo + Ya7 -(1-) = IV + - m7,r)
ly
M,,,r(l + 9El17[V = Wrl2,
Asymmetry conditions < m 2r and 174 15 ms(r -1s)(1 + m,mw,) are
a* = 2 M7,-ml,,)y solves [ =0;
satisfied for ISO 150 where
and l* = I*(1l,,o,1,,,,r, a) solves &En1vilw = l*vllV = 0. ?I
-
Ms r(l + mw) (l y) (m2 fMs2(
. + M71) m2
M PROOFOF LEMMA 1. To show: aEUsI/Dali > 0 and aETw/Oalw > 0.
mS( (1 + m'M') (1y Umr-l1V,)if m M(1+mm70,)
The expected profits of manufacturer i are given by:

106 MARKETING SCIENCE/VOL 15, No. 1, 1996

 AGRAWAL
BrandLoyaltyon Advertisingand TradePromotions

the two brands to respective loyal segments at price r), and earn ex-
EHl =jI (wi - aaj)g(wj)f(wj)dwjdw, pected profits, net of advertising, equal to:
EHll = m,r - aa,; Ell" = m,0r - aa,,. O
+ f (mw - aaj)g(wj)f(wj)dwjdwj PROOF OF COROLLARIES 4.1 AND 4.2. In equilibrium, the optimal
advertising levels are a* = 0; a* = ((mX2r - 10W)/ ))2. The first deriva-
+f f
tives Oaa/&mzv> 0 and Na*/&Yy< 0 for brand w. Since the optimal
(-aaj)g(wj)f(wj)dwjdw.
advertising is a direct function of own segment size and y, the deriv-
atives will have the same signs for brand s. O
For loyalties satisfying 15 2 m,(mz,r - 21,,,/m?,,) and 1, < m2 r, the ex- PROOF OF RESULT 1. The condition a ? a* implies that the equi-
pected profits are:
librium advertising levels area* = 0 anda*, = ((mX2r - l0,)/y)2. At
these levels l, = m%2rwhich implies that the equilibrium promo-
(m%r2 + 172,+ m,,7vr(l - 3m7,))(m,r - aa)
Ens 2
mIVr(mvr - 1w)
tional frequencies (MP*, MPI*) are both zero. Similarly, the pro-
motional spending levels (MEP*, MEP*) are also both zero. El
EL =m(mmwr
+ I,, +m%Wr(m7,r- 214,,) PROOF OF RESULT 2. The condition a > a* ensures that the optimal
m.V mVr(mVr - 1V,) post-advertising loyalty 1X*,, is below m72r. Similarly, the condition a
<a** ensures that loyalty 1*is above i:. Thus when a* < a < a**,
mrmwr
+ m log ( m the equilibrium advertising levels areas = 0 anda* = ((I* - l",,)/ y)2.
At these levels, the equilibrium promotional frequencies are both non-
w + -
m7,,1,vr(m - )+mv
zero, and trade promotional expenditures are such that MEP*
- aa4lv mzlt,r(12 - 3m,,) + m > MEP*t(see Figure 4). El
PROOF OF RESULT 3. The condition a > a** ensures that the optimal
The derivatives with respect to 1t, are: post-advertising loyalty I* is below i: and equilibrium advertising lev-
els are a* = 0 and a* - ((jxt _ ) / y)2. At these levels, the equilibrium
EH'_ (m,r - aa,)(m%r2 - 3m73r2 + m72r2 + 2m,v1,vr - 12,)
promotional frequencies are both nonzero, and trade promotional ex-
m2r(m,Vr - 17V)2
penditures are such that MEP* < MEP* (see Figure 4). El
The second term in the numerator is always positive (for mw,< 1);
therefore the derivative is positive if m,r > aa,, i.e., when the expected
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