Advertising Rivalry in the U.S. Automobile Industry: A Test of Bain's Hypothesis

Article excerpt

Introduction

Working within Chamberlin's(13) theory that predicts a firm's market behavior from its market structure, Joe Bain(6) classified the U. S. Automobile industry as an oligopoly with high product differentiation. He predicted "effective collusion on price" combined with "rivalry in sales promotion" for that industry(6), p. 311. For the 1957-1971 period, Boyle and Hogarty(12) found that U. S. auto firms colluded in their price behavior, explained by indexes of comfort and performance and a dummy variable for power steering and brakes. Ramrattan(40) expanded that study for the 1972-1987 period, and reached the same conclusion. By failing to falsify Bain's price collusion hypothesis, those studies have opened the door to advertising expenditure as a positive performance indicator. Bain actually listed physical design, product reputation, conspicuous-consumption motives, and dealership systems beside advertising,(6) p. 300, as bases for firms to differentiate their products. Studying that array of non-price weapons, including R & D expenditures, Ramrattan(39) has argued that advertising is the preferred rivalry weapon for the auto firms. A good advertising copy shelters a firm from the rain of competition for about a year before rivals start imitating. Other non-price weapons do not have that trigger-power, and in some cases are dependent on advertising for their bang. A validation of Bain's Advertising hypothesis would enhance our understanding of product differentiation within the Bain-Chamberlin's paradigm that predicts a firm's market performance from the industry's market structure.

In this paper, we set price collusion and advertising rivalry within the ring of international changes that may have impacted domestic firms advertising policies. The U. S. Automobile firms suffered great instability in the post OPEC cartel era. On October 20, 1973, OPEC increased oil prices by 70 percent, and instituted an oil embargo on the U. S. By the end of that year, oil prices nearly quadrupled from $3.01 to $11.65 a barrel. Again in December 1978, oil prices increased by 14.5 percent consequent to the Iranian revolution, cutting supplies by 5 million barrels a day. March, 1979 saw another 9 percent increase by the OPEC, with agreement for members to add surcharges. Domestic oil prices were decontrolled in January 1981. By then, the double digits inflation rate was foiled with double digits interest rate. Early attempts by the Carter administration to curb inflation by credit restraint had an unintended effect on auto consumption, which was exempted from the restraint. Meanwhile, General Motors' stock price moved cyclically in all the recessions following the OPEC cartel in 1974.

We find the U. S. Firms exploring newer and better ways, globally and domestically, to confront foreign competition. Small firms particularly experienced cashflow setbacks, making advertising less affordable and probably more dependent on sales. Lending credence to Chrysler's new ad to the effect that firms either lead, follow, or stay out of the competition, American Motors strategically merged with Chrysler Corporation in 1987, while foreign firms continued to make steady inroads into domestic firms' market share. This paper appraises Bain's advertising hypothesis in those domains of competitive activities. After adjusting some auxiliary assumptions to accommodate the global competitive environment, we argue for postponing a falsification of Bain's advertising hypothesis.

The Model

Game Theory represents a progressive research program in modeling price collusion and advertising rivalry. While Cournot(14) and Bertrand(9) allowed only quantity and price adjustments respectively in modeling oligopolistic behavior, John Nash(35) allowed adjustment through anything and everything, including advertising. We seek an advertising game with at least two firms, N, as players, with similar strategies, S, a payoff function, II, and an information set, I. …