Advertising, Product Differentiation and Cooperation

Collaboration among sizeable competitors is usually considered to be harmful to social welfare while competition among such competitors is perceived the better, or even best, mode of operation. We examine industries where the goods produced are homogeneous and producers employ advertising in order to artificially differentiate the products in the eyes of customers. Our two stage game models consider firms that advertise in the first stage and then compete, in the second stage, in the final products market. We explore the effects of either a no-advertising regime, a competition regime, or a cooperation regime in the advertising stage. We examine the consumer and producer welfare effects of the above regimes, and show that cooperative advertising dominates competitive advertising as both customers and producers would prefer cooperation over competition. Indeed, cooperative advertising yields higher profits, lower prices and less wasteful advertising. Hence, forbidding cooperation (cartel) in the advertising phase, as an antitrust violation, is erroneous, and the regulator should rather allow and even encourage such cooperation. Similarly, courts, while dealing with such advertising collaboration, should interpret the rule of reason in a manner that defines it within the legitimate range of economic behavior.