# The purpose of advertising for Pepsi

What is the purpose of advertising for companies like Pepsi who advertise the same product and every person in the modern world knows about it? Why waste money?

Advertising is hard to understand if you take classroom economics models too literally. I highly recommend diving into the literature on behavioural economics if you are truly interested. But for the purposes of your question, Pepsi runs advertising because it operates in a market in which consumer choice is primarily driven by two sources of cognitive bias: the anchoring and the availability heuristic.

On the one hand, new customers are born every day, and if Pepsi doesn't run advertising then those new customers will see a Coke ad first. On the other, since existing customers don't actually make purchasing decisions based on a careful weighting of product merit, they need to be reminded that Pepsi exists and that there are warm, fuzzy feelings associated with the brand. This way, when they find themselves craving something to drink, Pepsi might be the brand that comes most readily to mind, because it's the last soft drink ad they saw.

This is just my opinion (built on some of the theory, but by no means do I claim it is the Complete Truth), but the anchoring heuristic in particular seems to explain brand loyalty in the cola market. I grew up in the era of the "blind taste test" and my takeaway from those social experiments is that when the most significant product differentiation is along branding lines, consumers will tend to just stick with whatever product they encounter first, because absent labeling and the social utility that comes from a trite form of tribalism, the consumer is indifferent to the choice.

My three ideas:

Industrial organization theory would suggest that a Pepsi or Coca-Cola (selling rather high quality "top shelf" cola drink) would want to "signal" that fact to others. This is sometimes referred to as "money burning" effort. The idea is "because we sell high quality product, we can afford to advertise SO MUCH - once consumers buy our product, they will realize that it is, in fact, high quality and will buy more in the future". Companies selling "lower quality" colas cannot afford to spend that much - therefore, advertising expenditures may be used to signal product quality. If consumers value quality, then no advertising might be worse than advertising, even considering the savings in expenditures. In general, the equilibrium with more advertising might be more efficient than the equilibrium without advertising.

Next, from the Dorfman-Steiner theorem, you get that advertising($$A$$) to revenue($$R$$) ratio should be: $$\frac{A}{R}=\frac{p-MC}{p}\eta_A=\frac{\eta_A}{-\eta_p}$$ where $$\eta_A$$ is demand elasticity with respect to advertising expenditure (it basically measures how much % quantity demanded increases when advertising expenditures increase by 1%), and $$\eta_p$$ is just price elasticity of demand.

Hence, the greater the consumers responsiveness to advertising and the lower the responsiveness to price, the larger will be the optimal level of advertising relative to sales. Soft drink markets are considered to be rather ad-elastic and price elastic. BUT at the same time, brands like Pepsi or Coca-Cola have relatively stronger consumer loyalty than other brands. Meaning that, if the price will increase by too much, consumers might buy less but not necessarily will switch to other cola brands. Thus, it might be a case that the demand is actually (pretty) inelastic that then makes advertising relatively profitable.

For yet another argument we would have to think what kind of market Pepsi is operating on. I am not an expert on cola drinks market but I would assume that it is something in between oligopoly (with two leaders, the only ones I can name from the top of my head: Pepsi and Coca-Cola) and monopolistic competition as the number of participants increase. According to Dixit and Norman (1978) output on markets defined that way is "the output is initially inefficiently low". They also show that profit maximization leads to an excessive level of advertising. The things is that when the firms maximize profits, they do not take into account the fact that the consumer will end up paying a higher price to cover the cost of the advertising: a small decrease in advertising from the profit maximizing level would benefit the consumer more than it would hurt the firms.

Dixit, A. and Norman, V., (1978), Advertising and Welfare, Bell Journal of Economics, 9, issue 1, p. 1-17.

As an economist, I think, Pepsi Co would want their product to have inelastic demand.

• This does not provide an answer to the question. To critique or request clarification from an author, leave a comment below their post. - From Review – Giskard Jul 21 '19 at 22:30
• Don't you let the author decide on the satisfactory answer? – london Jul 22 '19 at 22:10
• Thought police! – Giskard Jul 23 '19 at 2:01
• If this the first time you see a review action, reading the site (or network) faq may be useful. – Giskard Jul 23 '19 at 2:04
• Poor answer m8 ngl – user29463 Jul 27 '19 at 14:39