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Advertising as an Entry Deterrent:

Evidence from UK firms
David Paton
Published online: 07 Feb 2008.

To cite this article: David Paton (2008) Advertising as an Entry Deterrent: Evidence from UK firms,
International Journal of the Economics of Business, 15:1, 63-83, DOI: 10.1080/13571510701830507
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Int. J. of the Economics of Business,

Vol. 15, No. 1, February 2008, pp. 6383

Advertising as an Entry Deterrent: Evidence from

UK firms

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DAVID PATON
David.Paton@nottingham.ac.uk
International
1357-1516
Original
Taylor
102008
15
Professor
00000April
&
Article
Francis
DavidPaton
(print)/1466-1829
Journal
2008 Ltd
of the Economics
(online) of Business
10.1080/13571510701830507
CIJB_A_283172.sgm
and
Francis

ABSTRACT Advertising is widely considered to be an important isolating mechanism

through which firms may defend an established competitive advantage. However, there is
relatively little empirical evidence on the extent of the strategic use of advertising either to
deter or in response to entry. In this paper, I report on a study of the advertising practices
of 843 medium-sized and large UK-based firms. Nearly one-quarter of all the advertisers
surveyed state that they attribute importance to entry deterrence as an aim of their
advertising. Further, one in five managers of advertising firms state that they would
increase advertising expenditure if a new rival company appeared in their market. It is
also apparent that there is a strong correlation between the perceived importance of
advertising as an entry-deterring tool and the intensity of advertising spending. Multivariate modelling provides confirmation that the existence of a sheltered market position,
and the profitability that typically accompanies this, provides a statistically significant
determinant of the decision to use advertising as a strategic entry-deterring weapon.
Key Words: Advertising; Survey Data; Entry.
JEL Classifications: L10; M37.

1. Introduction
A central concern of research in corporate strategy concerns the ability of firms to
sustain a competitive advantage in the face of competition from actual or potential rivals (see Besanko et al., 2003). Following Rumelt (1984), the term isolating
mechanisms has been applied to those strategic devices that firms can deploy to
inhibit others from duplicating and thus neutralising the source of any competitive advantage. The list of such isolating mechanisms, from legal restrictions
through cost superiority to early-mover advantages, etc., is extensive (see
I would like to thank Neil Conant for his help and expertise with data management. Thanks are also
due to participants at the 2004 EARIE Conference in Berlin. Finally, I would also like to thank Steve
Thompson for numerous comments and suggestions that have improved this paper immeasurably.
David Paton, Nottingham University Business School, Nottingham University, Jubilee Campus, Wollaton
Road, Nottingham NG8 1BB, UK; email: David.Paton@nottingham.ac.uk
1357-1516 Print/1466-1829 Online/08/01006321
2008 International Journal of the Economics of Business
DOI: 10.1080/13571510701830507

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64

D. Paton

Mahoney and Panadian, 1992). Many of these, however, are applicable only to the
circumstances of specific industries.1 Advertising, by contrast, might be considered to be a generic strategy to defend and (attack) entrenched positions.
The lack of good quality primary data on the advertising practices of firms
has restricted empirical research on advertising (Rogers and Tokle, 1996; Paton,
1998). In this paper, I use information from the 1999 Advertising and Industry
Survey (AIS), a significant source of data on advertising by UK-based firms.2 The
AIS was a postal questionnaire survey of the advertising managers of UK firms,
funded by the Economic and Social Research Council, which yielded information
on the advertising practices of 843 companies. Unlike previous work that has
used attitudinal data collected from managers to explore firms strategic behaviour in this context, for example, Singh et al. (1998), Smiley (1988), this research is
not restricted in having to use a small number of advertising-related questions
from a wider survey.
There is an extensive body of theoretical work in economics and strategy that
has explored the issue of how advertising by incumbent firms affects entry into
markets. However, theoretical models have suggested alternative ways whereby
advertising can act both to raise and lower entry barriers. For example, if advertising builds up a stock of goodwill for a firm which lowers the returns to advertising of potential rivals, then entry is less likely. On the other hand, if advertising
builds brand loyalty by customers, then an incumbent firm will be less likely to
lower the post-entry price and entry becomes more attractive.3 A large body of
empirical work in economics has tried to examine the outcome of such processes,
but its findings are somewhat ambiguous;4 in part because of the difficulties in
identifying causation in complex simultaneous relationships.5 Similarly, attempts
to quantify the advertising response to entry are flawed if deterrence has been
successful and hence entry is unobservable.
This paper adopts the alternative approach of asking managers directly about
the relationship between advertising and entry and about their conjectured
advertising response to realised entry. Clearly any subjective approach has limitations: respondents may be untruthful, particularly if they consider their conduct
is in any sense anticompetitive; while advertising may impede or facilitate entry
even if managers do not realise it is doing so. However, it is difficult to justify
ignoring the perceptions of managers altogether. Here I use data from an anonymous survey of more than 800 advertising managers of UK-based firms to help
answer two questions: first, to what extent do managers perceive that entry,
whether actual or potential, plays an important role in their advertising
decisions? And second, are there systematic differences in the role played by the
threat of entry in advertising decisions across firms and industries?
In the next section of the paper, I discuss existing work on advertising and
entry in more detail. In section 3 I examine the methodology of the survey on
which the empirical work is based. In section, 4, I describe and discuss survey
responses on advertising and entry. In section 5, I report results of multivariate
models of the responses. Some concluding remarks are made in section 6.
2. Using Advertising to Sustain a Competitive Advantage
The resource-based view of the firm (Barney, 1991, 2001; Lockett and Thompson,
2001) holds that a firms competitive advantage occurs as a result of differences
between the set of resources and capabilities controlled by its managers and those

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Advertising as an Entry Deterrent 65

under the control of rivals. It is thus the result of rents generated by an inherent
short-run inelasticity of supply of such resources. In the longer term, most
resources and capabilities can be replicated by rivals, and hence successful
products can be imitated and the competitive advantage neutralised. Where a
competitive advantage is sustained over a longer period, it is seen to be the result
of some isolating mechanism that inhibits actual or potential rivals in the
generation of suitable resources. Besanko et al. (2003) suggest that such isolating
mechanisms either result from structural impediments to imitation, such as
patents, or from early mover advantages, such as reputation or buyer switching
costs. However, a variety of strategic actions are available to managers to defend
or attack established positions. For example, incumbents can commit to excess
capacity to deter entry (Lieberman, 1987) whilst entrants can use irrecoverable
investments to signal their intention to remain and hence influence incumbents to
reach an accommodation.
Advertising is perhaps the most straightforward strategic act in this vein. In
terms of the dichotomy suggested by Besanko et al. (2003), advertising enhances
the effectiveness of structural impediments, such as economies of scale and scope,
by raising incumbent sales. At the same time, advertising can reinforce earlymover advantages, such as the possession of a market reputation. While there are
examples of new entrants that have supplanted dominant firms using advertising-intensive methods, advertising is normally considered as a defensive strategy
in as much as it is likely to be more cost-effective when deployed by firms with an
existing competitive advantage:
For example, as advertising a form of investment in goodwill, new entrants
must spend in excess of current levels to match incumbents. By inflating the entry
costs of would-be rivals, advertising blunts the threat from one of the major forces
(see Porter, 1980) shaping rivalry. In addition, whilst advertising can be used by
new entrants to establish a presence, the returns to advertising by incumbents are
generally larger.6 Finally, even among existing rivals, economies of scale and
scope in the effectiveness of advertising typically benefit the larger rival. For
example, where firm A has more outlets than firm B in a given region, local TV
viewers seeing an advert from each are more likely to encounter, and hence enter,
an A outlet than a B outlet. Similarly, more diversified (generally larger) firms
may use umbrella branding (Besanko et al., 2003) across a range of products such
that advertising one product potentially benefits the rest, generating economies of
scope.
More sophisticated modelling, which allows for strategic interaction between
incumbent and (potential) entrant, produces a more ambiguous picture. While
high sunk costs of advertising leave the newcomer vulnerable to post-entry price
competition and thus generally deter entry in such models, the opposite effect can
also be generated. Thus Schmalensee (1983) and others show that lower incumbent advertising could be an effective entry barrier if it increased the credibility of
a post-entry price war. The difficulty with this literature is that, once entry occurs,
it is generally rational for the incumbent to preserve what remains of its competitive advantage by accommodating behaviour. However, to forestall entry it is
necessary to commit to post-entry non-accommodation. As noted above, incumbent advertising typically raises the sunk cost requirements of potential entrants
(see also Sutton, 1991) thus discouraging entry, but it simultaneously raises the
stock of goodwill of the incumbent and so discourages an aggressive post-entry
response. Despite the apparent ambiguities in the theoretical literature, there is

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66

D. Paton

general presumption that advertising largely works to sustain a competitive

advantage.
An important point largely ignored in the strategy and economics literature is
that the threat to a firms competitive position is unlikely to be constant over time.
Managers should be aware of any increase in this threat, particularly that posed
by new entrants, new products from existing rivals or aggressive competitive
behaviour from the latter, and respond accordingly. The thrust of the arguments
raised in this section suggests that managers perceiving any enhanced threat to
the firms market position will typically increase advertising levels. The extent to
which this response is observed, however, is likely to depend on the specific
competitive environment within which the firm is operating.
3. Data
The lack of good quality primary data on the advertising practices of firms is an
ongoing issue of concern to researchers and has placed severe restrictions on the
empirical analysis of advertising (see Rogers and Tokle, 1996). In this paper, I use
information from the 1999 Advertising and Industry Survey (AIS), a significant
source of data on advertising by UK-based firms. The AIS was a postal questionnaire survey of the advertising managers of UK firms, funded by the Economic
and Social Research Council and which yielded information on the advertising
practices of 843 companies.
The use of this data set raises important issues as to the usefulness of survey
data in general. I believe that surveys provide a useful and valuable source of
data for several reasons. Firstly, the approach of questioning managers, whilst not
without its own set of problems, is very direct and provides perhaps the only way
of examining overall firm strategy regarding advertising. Specifically, as argued
by Singh et al. (1998), questionnaires have the advantage that they can capture
actions which result in things not happening (p. 231). Secondly, and related to
this, managerial responses are valuable in their own right as they (ideally) reflect
what managers actually think about their advertising behaviour. Lastly, respondents are much more likely to answer specific questions about commercially
sensitive topics under the guarantee of anonymity that surveys can provide. In
any case, in the empirical work below, I complement the survey data with
information gained from company accounts.
3.1 Sampling Frame
The AIS was a postal questionnaire survey of the advertising managers of 5234
UK-based firms. The target population comprised mainly public companies (both
quoted and unquoted) but also included larger private companies, including
subsidiaries of overseas firms.7
The core unit of analysis in this paper is at the level of the firm and, indeed,
the Survey was directed to the Advertising Manager of each firm. Although much
work on advertising has been undertaken at firm level (for example, Ailawadi
et al., 1994; Cubbin and Domberger, 1988), the issue of the appropriate unit of
analysis is not an easy one to resolve. The advertising decisions of large firms may
be devolved to different business units further down the hierarchical scale and
some previous work has used either line of business (Singh et al., 1998) or the
product (Lilien and Weinstein, 1984) data. One practical disadvantage of using

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Advertising as an Entry Deterrent 67

more disaggregated units of analysis is the consequent difficulty of matching the
data collected with company accounts data.8 More fundamentally, this research
was concerned to examine the strategic use of advertising, that is in deterring and
responding to the threat of entry, rather than routine investment in brand maintenance. Accordingly, whilst I could not be sure of the location of the key decision
taker, a firm-level approach appeared most appropriate. Furthermore, I would
anticipate that even in multi-product firms there is typically some central co-ordination of advertising because of shared brand names, logos, etc. For these
reasons, the firm was used as the initial unit of analysis in the AIS, but, for particular questions, managers were asked to answer in relation to the companys
main product line or service.
Responses from and discussions with managers of firms in the design and
pilot stages suggest that the choice to use the firm as the level of analysis was
probably optimal. However, it must be noted that this does not mean it was
appropriate for every sector covered by the survey. Similarly, managers understanding of concepts such as the main product line or service may also vary
across companies.
3.2 Survey Design and Process
The questionnaire was designed to obtain both quantitative and qualitative information about a range of advertising issues as well as some background information about the company itself and its competitive environment. Of particular
relevance to this paper is that a number of questions were aimed specifically at
eliciting information on managers attitudes to entry by new companies and any
deterring action they may consider.
Full details of the survey design and process are contained in Conant and
Paton (2001). Following consultation with academic and government sources and
a pilot study of 154 randomly selected firms, the final version of the questionnaire
was sent to The Advertising Manager of a further 5222 firms. Those not responding were sent a second copy of the questionnaire about six weeks later. As the
original sample had been selected with the intention of excluding holding companies, responses in which the manager had classified the firm as such along with a
handful of others in which the responses were contradictory or difficult to
interpret were dropped from the sample. This left a total 843 valid responses,
16.00% of all firms in the survey. The breakdown by sector is given in Table 1. The
response rate is similar to that obtained in other firm-level postal surveys such as
those reported in Love and Roper (2004) and Cosh et al. (2005).
Each company surveyed was matched with accounts data from FAME.9 At
least some data were available for virtually all companies. These data were used
to conduct numerous tests for sample selection bias. These tests suggest that the
companies who responded are generally a fair representation of the population
sampled (see Conant and Paton, 2001).
I was also concerned that the data used in this paper (which depend on
managers answering particular questions) could be subject to intra-sample
response bias. Thus, I undertook chi-square and t-tests of the null hypothesis that
the sub-set of firms which answered at least one question related to entry had the
same distribution as all those responding. The test results are reported in Table 2.
The chi-square tests are of the null hypotheses that the distributions of company
type (public quoted, public unquoted or private) and industrial sector (as given in

68

D. Paton
Table 1. Respondents by industrial sector

Sector

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Consumer manufacturing
Producer manufacturing
Distribution
Retailing
Consumer services
Producer services
All

Responses

123
218
81
69
120
231
843

14.6
25.9
9.6
8.2
14.2
27.4
100.00

Source: 1999 Advertising and Industry Survey, Question 13.

Note: Firms classified as others or that did not respond to this question were grouped into one of the
above categories according to their primary SIC code and other available company information.

Table 1) are the same for respondents and non-respondents. In neither case can
the null hypothesis be rejected at any conventional significance level. The t-tests
are of the null hypotheses that the sample means of particular variables are equal
for all respondents and non-respondents. Tests are reported for turnover, number
employees, exports, pre-tax profits and value of fixed tangible assets, the last
three all as a proportion of turnover. In every case, the t-statistic is insignificantly
different to zero at the 1% level and only for profits is the statistic significant at
the 5% level. Taken together these tests provide little evidence of bias from within
the sample.
Despite these checks, the reliability of the results based on these data
naturally depend on whether the survey managed successfully to elicit honest
replies that accurately reflect the perceptions of key decision-makers within the
firm. Although responses from the pilot stage as well as informal discussions
with managers from firms in the sample who contacted the research team suggest
that those responding took the survey seriously, the reliability of the data gained
from the survey can never be known with certainty. This caveat emphasises the
need for the empirical results reported below to be interpreted with care.
Table 2. Tests for response bias
Respondents vs. nonrespondents
Variable
Company type
Ownership
Turnover
Employees
Export rate
Profit rate
Assets rate
Sector
A/S ratio

Entry respondents vs.

others

Distribution

Test statistic

p-value

Test statistic

p-value

2
2
t
t
t
t
t
2
t

2.15
2.80
1.50
1.36
1.62
0.54
0.52

0.54
0.25
0.13
0.17
0.10
0.59
0.61

15.18
2.47
0.98
0.99
0.22
2.08
0.22
4.67
1.18

0.002
0.29
0.33
0.32
0.83
0.04
0.83
0.32
0.24

Source: Financial Analysis Made Easy (FAME) and 1999 Advertising and Industry Survey.
Note: Figures are based on 1998/9 financial year.

Advertising as an Entry Deterrent 69

4. Managers Attitudes to Advertising and Entry

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4.1 Entry Deterrence as an Aim of Advertising

I report summary information on managers attitudes to advertising and entry in
Tables 3 and 4. In Table 3a I summarise answers to the question which asked
managers to indicate the degree of importance that they place on entry deterrence
as an aim of their companys advertising.10 Out of 696 managers who answered
this question, over half stated that entry deterrence was either not at all
important or quite unimportant. This is not unexpected, since routine brand
maintenance might be expected to dominate advertising policy. However, a
significant minority of managers (22.3%) indicated that entry deterrence was
either important or very important.
There is a good deal of evidence suggesting that advertising is more likely to
be used strategically in the case of consumer goods (see, for example, Buxton et al.,
1984; Schmalensee, 1989; Paton and Vaughan Williams, 1999). Consequently, in
Table 3b, I report the breakdown of responses by the firms main industrial sector,
as identified by the manager. Retailers are less likely to have entry deterrence as
an important aim, but there is little evidence of any difference in the pattern of
responses either between producer- or consumer-orientated firms or between
manufacturers and service firms. Formally, Pearson and likelihood ratio chi-square
tests cannot reject the null hypothesis that the pattern of responses is the same across
sectors and these results provide support for the strategy of surveying firms from
all sectors of the economy, rather than just, for example, consumer-orientated firms.
One issue hidden by the raw responses is the intensity of advertising undertaken by each group. In Table 3a I summarise the reported advertising to sales
ratios for each response to the advertising and entry question. There is strong
evidence that advertising levels are higher when entry deterrence is stated to be
more important. For example, managers for whom entry deterrence is a very
important aim report a mean advertising to sales ratio of 3.28%, compared to a
mean for all other firms of 2.18%. This result is consistent with entry deterrence
requiring additional advertising spend above the level necessary for simple brand
maintenance. A simple matched t-test confirms that this difference is strongly
significant. I explore this issue in more detail in the multivariate work below.
4.2 Managers Advertising Response to Entry
I next consider the conjectured advertising responses of managers to potential
entry. The AIS asked managers whether and how they would change their
Table 3a. Entry deterrence as important aim of firms advertising
Degree of importance
1
2
3
4
5
Total answering question

Number

Percentage

Mean A/S ratio

246
114
181
95
60
696

35.34
16.38
26.01
13.65
8.62
100.0

1.59
2.38
2.63
3.04
3.28
2.32

Source: 1999 Advertising and Industry Survey, Question 7.

Note: A response of 5 indicates that deterring entry is a very important aim of the firms advertising.

70

D. Paton
Table 3b. Entry deterrence as aim of firms advertising by industrial sector
Degree of importance
1

Total

13.41
24.39
10.57
6.10
16.26
29.27
100.00

14.04
25.44
10.53
10.53
15.79
23.68
100.00

17.13
27.62
5.52
13.81
13.81
22.10
100.00

15.79
25.26
15.79
3.16
16.84
23.16
100.00

16.67
20.00
8.33
10.00
13.33
31.67
100.00

15.09
25.14
9.77
8.76
15.37
25.86
100.00

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Sector
Consumer manufacturing
Producer manufacturing
Distribution
Retailing
Consumer services
Producer services
All

Source: 1999 Advertising and Industry Survey, Question 7 and Question 13.
Note: A response of 5 indicates that deterring entry is a very important aim of the firms advertising.

advertising levels in response to the introduction of new products or new firms.

Responses to this question are summarised in Table 4a. In both cases, the dominant answer is that of no advertising response with over 70% of managers indicating they would not change advertising in response to either new products or new
firms. Of the remainder, the dominant proposed reaction is aggression (that is, to
increase advertising) rather than accommodation. In the case of new products,
78.0% of managers indicating at least some response stated that they would
increase their advertising. For new firms, 82.3% of managers stated that they
would respond by increasing their advertising.
In principle, the fact that a manager states that entry deterrence is an important aim of advertising does not imply a particular response to the conjectural
questions. For example, a firm that uses advertising to deter potential entry may
still find it optimal not to respond if actual entry occurs. Similarly, the optimal
level of advertising for other firms may change post-entry. That said, it is notable
that that relatively high percentage of managers who indicated that entry
deterrence was quite or very important also stated that they would change their
advertising in response to new entry.
The breakdown of the conjectured responses to new products and new firms
is given by sector in Tables 4b and 4c, respectively. The Pearson and likelihood
ratio tests do not suggest systematic differences in the response to new products
Table 4a. Reaction of firm to new rival product or company entering market
New rival product
Change in % of sales
spent on advertising
Increase
Decrease
No change
Total

New rival company

Number

Mean A/S

Number

Mean A/S

117
33
523
673

17.38
4.90
77.71
100.0

3.61
1.94
2.02
2.27

139
30
504
673

20.65
4.46
74.89
100.0

3.20
1.86
2.05
2.27

Source: 1999 Advertising and Industry Survey, Question 12

Note: Advertising to sales ratio figures are restricted to the 616 firms reporting these data.

Advertising as an Entry Deterrent 71

Table 4b. Reaction of firm to new rival product by industrial sector

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Sector
Consumer manufacturing
Producer manufacturing
Distribution
Retailing
Consumer services
Producer services
All

Increase

Decrease

No change

Total

14.53
24.79
8.55
6.84
17.95
27.35
100.00

15.15
24.24
12.12
12.12
6.06
30.30
100.00

15.87
25.62
10.33
9.18
13.38
25.62
100.00

15.60
25.41
10.10
8.92
13.82
26.15
100.00

Source: 1999 Advertising and Industry Survey, Question 12 and Question 13.

across sectors. However, for the case of new firms, there is some evidence that
managers of service- and retail-based firms are more likely than those in other
sectors to indicate that they would respond by increasing their advertising. From
a corporate strategy perspective, this weakness of evidence of inter-sectoral
differences is not surprising. Intra-industry differences in firm profitability tend
to dominate inter-industry effects (McGahan and Porter, 1997), whilst the latter
are probably important for strategic groups of firms in particular sub-markets.
There is also evidence that managers who state that they would respond
actively to new entry tend to report higher advertising intensity than others. For
example, the mean advertising to sales ratio when no response to new firms is
indicated is 2.04%, whereas the figure for those managers who indicate an
increase in advertising is 2.94%, a difference that is statistically significant.
In summary, the evidence from the Survey suggests that the advertising
managers of a significant minority of UK firms perceive advertising either as a
way of deterring entry or as a strategic tool to use in response to entry. Furthermore, advertising is much more intensively used in these firms. However, there is
very little difference in attitudes to advertising and entry across different sectors
of the economy. In the light of these preliminary results, I now go on to examine
whether multivariate analysis can reveal systematic differences in managers
attitudes to advertising and entry deterrence.
Table 4c. Reaction of firm to new rival company by industrial sector

Sector
Consumer manufacturing
Producer manufacturing
Distribution
Retailing
Consumer services
Producer services
All

Increase

Decrease

No change

Total

9.35
20.14
8.63
14.39
23.02
24.46
100.00

20.00
30.00
6.67
10.00
10.00
23.33
100.00

17.06
26.59
10.71
7.34
11.51
26.79
100.00

15.60
25.41
10.10
8.92
13.82
26.15
100.00

Source: 1999 Advertising and Industry Survey, Question 12 and Question 13.

72

D. Paton

5. Multivariate Models of Advertising and Entry

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Since the primary purpose of our research was to investigate the strategic use of
advertising in discouraging and responding to entry, I used multivariate models
to analyse the responses to the relevant questions. Since the questionnaire
produced discontinuous data, I employed limited dependent variable models.
These were: first, an ordered probit to analyse the factors determining the importance of entry limitation to the advertising decision; and second, multinomial
logit models to explore the response to entry.

5.1 Advertising to Deter Entry

I initially explore the determinants of the importance of entry deterrence to the
advertising managers. Although it would be expected that the underlying importance of entry deterrence would be some continuous variable, the questionnaire
responses generate an ordinal measure divided into five ordered categories. We
denote this dependent variable as IMPORTANCE. In such a situation, ordered
probit is an appropriate estimation procedure. I relate this latent variable to a
variety of firm and industry level factors. Specifically, I hypothesise that defending a competitive advantage by limiting entry will be a more important motivation both for firms that are operating in markets with a high degree of market
power and for firms that are dominant in those markets. Firms within monopolised markets are likely to have most to lose from entry and the dominant firms
are the ones most likely to have the ability to influence the decisions of potential
rivals. It is common to use proxy measures of market power based on artificial
delineation such as the standard industrial classification. These measures suffer
from the disadvantage that industry definitions employed in the classification
frequently show a poor correspondence with actual market boundaries and my
preference is to use survey information provided by the managers on the market
conditions of their main product line or service. I use this information to construct
dummy variables for firms that are dominant advertisers in the market for their
main product line or service (DOM) and also for firms indicating that they face 5
or fewer competitors (MONOP) and more than 10 competitors (COMPET).11 I
also include the profit rate of the firm, lagged by one year as an alternative
measure of market power of the firm (PROFLAG).
The descriptive statistics in section four suggested there is little difference in
the importance of entry between consumer- and producer-orientated firms. An
alternative approach is to distinguish markets in which media advertising is an
important form of competition. These markets are likely to include some
producer-based markets (for example, that for office computers) as well as to
exclude some consumer-based markets. I construct such a variable using survey
information on the relative importance of advertising compared to other competitive tools such as price, quality and customer services. Specifically I define a
dummy variable (MEDIA) to equal one if media advertising is ranked as the first
or second most important form of competition in the firms market.
I am also interested in examining whether entry deterrence is more important
for different sorts of media. The survey provides us with information on the most
important (in terms of expenditure) advertising media for each firm and I use this
to construct dummy variables equalling one if the media in question is one of the
two most important for the firm. The media I consider are television (TV), radio

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Advertising as an Entry Deterrent 73

(RADIO), poster (POSTER), trade press (TRADE), national newspaper (NEWS),
national magazine (MAG), local press (LOCAL) and the Internet (INTERNET).
Given the nature of specific advertising media, it is important to control for
the geographical nature of the firms market. For example, a substantial proportion of advertising media in the UK are targeted at the national or international
(as opposed to the regional) level. Examples include national and satellite TV,
radio, newspapers and specialist magazines and the Internet. Thus, I include a
dummy variable (REG) for firms that indicate that market for their main produce
line is regional rather than UK, EU or International and I expect that entry
deterrence will be a much less important motivation for the advertising of these
firms. A description of each variable, along with summary statistics, is provided
in the Appendix.
The structure of the questions in the AIS means that the econometric model is
comprised almost entirely of discrete variables (the exception being lagged profitability which is continuous). Although unavoidable in this case, it is important to
bear in mind that the emphasis on discrete variables both here and in the multinomial model below, means that quite complex influences on advertising strategies
are being modelled using a somewhat simplistic functional form.
Results of the ordered probit estimates are reported in Table 5. In column 1, I
report a general model, whilst in column 2 I report a more parsimonious model in
which variables that are insignificant at the 10% level are dropped sequentially. At
each stage of this process, I re-check the significance or otherwise of variables that
were dropped at earlier stages. It is well known that limited dependent models can
be quite sensitive to violations of standard assumptions regarding the error term
(see, for example, Greene, 2000). For example, probit estimates are likely to be
inconsistent in the presence of either heteroscedasticity or non-normality. For this
reason, I report a range of diagnostic statistics both specifications. I find no
evidence of significant mis-specification.12
We find that, as expected, firms within monopolised markets and firms that
are dominant within these markets are significantly more likely to indicate that
entry deterrence is important. Similarly, high (lagged) profit rates are positively
associated with the importance of entry deterrence. The control variables for
markets within which media advertising is an important form of competition and
for firms whose market is regional both perform as expected. Looking at the
dummies for different forms of media, we find that firms for which radio advertising is important also tend to be ones for which entry deterrence is an important
motivation for advertising. Interestingly, none of the other media dummies,
including that for television, attract significant coefficients.
5.2 Determinants of the Advertising Response to Entry
In analysing the managers response to new entry to their core market we have
three alternative actions to consider. The most obvious approach is to relate the
advertising responses to firm characteristics using multinomial logit. However,
with multinomial logit we have to assume the independence of irrelevant alternatives (IIA) (see Greene, 2000). In other words, the relative probabilities of the decision to choose, say, alternative A rather than alternative B should be constant
irrespective of whether alternative C is included in the model. To explore the
validity of the multinomial model here, I use a Hausman test for the IIA assumption (see Greene, 2000). The Hausman test statistics (reported in Table 6) are all

74

D. Paton

Table 5. Ordered probit estimates of the determinants of the importance of entry

deterrence in advertising

DOM

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MONOP
COMPET
PROFLAG
MEDIA
TV
RADIO
POSTER
NEWS
MAG
LOCAL
TRADE
INTERNET
REG
N
Log likelihood
Wald test
Diagnostic tests:
Functional form
Heteroscedasticity
Normality

(1)

(2)

General model

Parsimonious model

0.223**
(0.094)
0.171
(0.130)
0.031
(0.108)
0.488**
(0.246)
0.253**
(0.123)
0.003
(0.209)
0.413**
(0.165)
0.067
(0.207)
0.098
(0.125)
0.021
(0.102)
0.008
(0.125)
0.052
(0.095)
0.123
(0.136)
0.424***
(0.153)
645
944.86
43.04***

0.209**
(0.090)
0.185*
(0.106)

0.388***
(0.141)
657
969.08
30.63

2.357
5.747
1.522

3.442
2.351
0.262

0.473**
(0.242)
0.278**
(0.117)

0.383**
(0.157)

Notes:
(i) The dependent variable is IMPORTANCE as described in the text.
(ii) Coefficients (as opposed to marginal effects) are reported. Robust standard errors in brackets.
(iii) * Significant at 10%; ** significant at 5%; *** significant at 1%.
(iv) The Wald test of the joint significance of all variables in the model.
(v) The diagnostic tests are as described in the text.

insignificant. In other words, there is no evidence, at least from these statistical

tests, to suggest that the multinomial logit model has violated the IIA assumption.
Our dependent variable (REACT) is trichotomous and defined as category 1 if
the manager indicates an increase in advertising in response to entry, category 2 if
a decrease and category 3 if no response. The latter category is used as the

Advertising as an Entry Deterrent 75

Table 6. Multinomial logit estimates of the determinants of the advertising
response to entry
(1a)

(1b)
General model

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Aggressive
response (increase
advertising)
DOM
MONOP
COMPET
PROFLAG
MEDIA
TV
RADIO
POSTER
NEWS
MAG
LOCAL
TRADE
INTERNET
REG
ASRATIO
ENTRY
Sectors:
Producer
manufacturing
Distribution
Retailing
Consumer
services
Producer
services
Constant

0.192
(0.238)
0.865***
(0.329)
0.310
(0.321)
0.568
(0.527)
0.326
(0.297)
0.469
(0.480)
1.124**
(0.472)
0.105
(0.578)
0.341
(0.346)
0.107
(0.275)
0.235
(0.329)
0.176
(0.289)
0.149
(0.336)
0.223
(0.361)
0.038
(0.032)
0.659**
(0.263)
1.038**
(0.434)
0.856*
(0.518)
1.759***
(0.477)
1.645***
(0.438)
1.320***
(0.414)
3.003***
(0.487)

(2a)

(2b)

Parsimonious model

Accommodating
response (decrease
advertising)

Aggressive
response (increase
advertising)

Accommodating
response (decrease
advertising)

0.443
(0.501)
0.484
(0.646)
0.006
(0.561)
0.223
(0.600)
0.655
(0.501)
33.77***
(0.580)
0.029
(1.146)
0.209
(1.193)
0.059
(0.672)
0.475
(0.478)
0.586
(0.610)
0.134
(0.504)
0.291
(0.594)
0.596
(0.742)
0.038
(0.084)
0.546
(0.506)

0.074
(0.729)
0.450
(0.920)
0.162
(0.979)
0.036
(0.820)
0.064
(0.734)
3.130***
(1.030)

1.0392***
(0.249

0.288
(0.521)

0.582
(0.456)
1.182***
(0.444)

32.125***
(0.409)
0.045
(1.141)

0.056*
(0.031)
0.677***
(0.259)

0.020
(0.087)
0.545
(0.480)

0.891**
(0.423)
0.749
(0.512)
1.780***
(0.457)
1.614***
(0.431)
1.151***
(0.406)
3.027***
(0.373)

0.081
(0.678)
0.081
(0.678)
0.647
(0.891)
0.069
(0.888)
0.069
(0.788)
2.699***
(0.634)

76

D. Paton
Table 6. Continued.
(1a)

(1b)

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General model

(2a)

(2b)

Parsimonious model

Aggressive
response (increase
advertising)

Accommodating
response (decrease
advertising)

Aggressive
response (increase
advertising)

0.000

0.799

0.00

IIA test
N
Log likelihood
Wald test

561
345.23
13672.0***

Accommodating
response (decrease
advertising)
1.372

561
350.98
12702.5

Notes:
(i) The dependent variable is REACT as described in the text. The reference category is no response.
(ii) Reference category for the sector dummies is consumer manufacturing.
(iii) See also Table 5, notes (ii) - (iv).

reference group.13 We include a vector of independent variables, similar to that

above but add a set of dummy variables for the sector of the firms main product
line or service (ASRATIO). We also include the reported advertising to sales ratio
of the firm and a dummy variable for the firms indicating that entry was a quite
or very important aim of their advertising (ENTRY).
Results are reported in Table 6. As before, the general models are reported in
columns 1a and 1b and the more parsimonious in columns 2a and 2b. Model
selection for the parsimonious model is similar to that for the probit model with
the exception that I retain any variable that is significant at the 10% level in either
equation. Perhaps unsurprisingly given the small sample size, the equation for an
accommodating response (decreasing advertising) appears to be less well specified than that for the aggressive response (increasing advertising). The results for
the positive advertising response suggest some important differences with the
ordered probit model above. An aggressive response seems much more likely for
products within producer manufacturing, retailing and services. Lagged profitability and being a dominant firm with respect to advertising have very little
impact on the probability of a positive or negative advertising response to the
entry of a new firm. However, firms operating within a highly monopolised
market for their main product line appear to be significantly more likely than
others to increase their advertising in response to entry of a new firm. Managers
for whom entry is an important aim of advertising are significantly more likely to
conjecture an aggressive advertising response. Once again radio advertisers are
more likely to indicate an aggressive response.
6. Conclusions
Advertising is widely considered to be an important isolating mechanism through
which firms may defend an established competitive advantage. However, there is
relatively little empirical evidence on the extent of the strategic use of advertising.
This apparent anomaly is most likely to be due to a lack of firm-level advertising
data. This paper has reported on a large-scale study of the advertising practices of
medium-sized and large UK-based firms. Nearly one-quarter of all the advertisers

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Advertising as an Entry Deterrent 77

surveyed state that they attribute importance to entry deterrence as an aim of their
advertising. Further, one in five managers of advertising firms, state that they
would increase advertising expenditure if a new rival company appeared in their
market. It is also apparent that there is a strong correlation between the perceived
importance of advertising as an entry-deterring tool and the intensity of advertising spending. Our multivariate modelling provides confirmation that the existence of a sheltered market position and the profitability that typically accompanies
this provides a statistically significant determinant of the decision to use advertising as a strategic entry-deterring weapon.
The reliance which can be placed on these results depends in part on the
extent to which managers provided honest and truthful responses. It is impossible to resolve this question definitively, but the anonymity provided by the
survey and the fact that the vast majority of managers were prepared to provide
answers to the relevant questions suggest that some confidence can be placed on
the results. Furthermore, the positive results obtained when objective accounting information was used in conjunction with the more subjective questionnaire
data adds credence to the findings.
The finding that a significant proportion of managers claim that entry
deterrence is an important reason for advertising emphasises how important it is
for potential entrants to assess carefully whether incumbent firms are likely to
respond to entry by aggressively by increasing their advertising beyond current
levels. Specifically, firms in services, producer manufacturing and those operating in highly monopolised markets appear to be much more likely to respond
aggressively than others.
Notes
1. Thus, patenting is important in R&D-intensive industries, such as pharmaceuticals, but largely
irrelevant to consumer goods such as food, drink and tobacco, while early-mover advantages are
manifest in high-tech industries where network externalities, switching costs and strong learning
economies are present.
2. A copy of the data is available from the ESRC Databank, study number 4209.
3. Much of this work has used a game theory approach. Examples include Schmalensee (1983) and
Fudenberg and Tirole (1984) who present models in which entry is deterred by under-advertising.
In contrast, in the more recent model of Doraszelski and Markovich (2007), over-advertising
deters entry.
4. See Kessides (1986), Robinson and Chang (1996) and Sass and Saurman (1995) for examples of
alternative findings on the advertising-entry-concentration relationship.
5. There is generally a correlation between industry profitability and advertising intensity. However,
distinguishing the effects of advertising in raising profits, perhaps by keeping out rivals, from the
effects of higher profits encouraging greater advertising spend and from more complex causal
routes altogether remain difficult.
6. The incumbent, who typically has in place sales networks etc., is generally better placed to meet
increases in demand. Rizzo and Zeckhauser (1990) provide an interesting example of new
entrant physicians using advertising to establish themselves in local US markets, but they also
find the returns to defensive advertising by established physicians in those markets to be higher.
Greuner et al. (2000) conclude that advertising does not increase barriers to entry in the new car
industry.
7. Full details of the selection criteria can be found in Conant and Paton (2001).
8. The Annual Business Inquiry Respondents Database provides accounts data at plant level for the
UK. It is not possible to identify individual firms in this database. Further, plant level is probably
too disaggregated for the purposes of this survey.
9. FAME is a database of accounts of some 130,000 UK-based firms covering all sectors of the
economy operated by Bureau van Dijk. It includes both UK- and foreign-owned companies as

78

10.
11.

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12.

13.

D. Paton
well as subsidiaries. Accounts data were subjected to various checks for consistency including
comparisons with other sources such as Datastream and Company Analysis.
The text of all relevant questions is provided in the Appendix.
We also considered more traditional measures of market concentration such as the Herfindahl
index and market share at 3- and 4-digit SIC levels. In fact, in every case, the survey variables
performed better and we do not report results for these other variables here.
These tests are adapted from those described in Machin and Stewart (1990) for the ordered probit
model and are distributed as follows. The test for functional form tests for the inclusion of powers
to the second, third and fourth degree and is distributed as 2 (3). The test for heteroscedasticity
tests the null hypothesis that the error variance = 1 and is distributed as 2 (k) where k is the
number of explanatory variables in the model. That for non-normality is a test for skewness and
kurtosis in the error term and is distributed as 2 (2).
Multinomial logit with k alternatives generates k 1 sets of coefficients since together these imply
the marginal probabilities for the remaining (reference) category.

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Ordinal variable ranking the importance of entry deterrence to advertising on a scale of 1 to 5

Trichotomous variable equalling 1 if the manager indicates that advertising would increase in response to entry, 2 if the
manager indicates a decrease and 3 for no change

Definition

Table A1. Variable definitions and descriptive statistics

Independent variables
DOM
Dummy variable equalling one if the manager indicates that it is one of the dominant advertisers in the market for their main
product line
MONOP
Dummy variable equalling one if the manager indicates that 5 or fewer rivals compete in the market for its main product or
service
COMPET
Dummy variable equalling one if the manager indicates that more than 10 rivals compete in the market for its main product or
service
PROFLAG
The mean rate of pre-tax profits as a proportion of sales reported by the firm over the previous three financial years (source:
FAME)
MEDIA
Dummy variable equalling one if the manager ranks media advertising as one of the two most important forms of competition
in the firms main market
TV
Dummy variable equalling one if the manager indicates that TV advertising is one of the two most important media
RADIO
Dummy variable equalling one if the manager indicates that radio advertising is one of the two most important media
POSTER
Dummy variable equalling one if the manager indicates that poster advertising is one of the two most important media
NEWS
Dummy variable equalling one if the manager indicates that national newspaper advertising is one of the two most important
media
MAG
Dummy variable equalling one if the manager indicates that magazine advertising is one of the two most important media
LOCAL
Dummy variable equalling one if the manager indicates that local newspaper advertising is one of the two most important
media

Dependent variables:
IMPORTANCE
REACT

Appendix

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0.487
0.417
0.497
0.178
0.346
0.233
0.238
0.217
0.361
0.427
0.384

0.224
0.560
0.038
0.139
0.058
0.060
0.049
0.153
0.239
0.180

SD

0.384

Mean

80
D. Paton

Dummy variable equalling one if the manager states that entry is a quite or very important aim of advertising
Proportion of total advertising to sales reported by the manager

ENTRY
AS RATIO

Note:
Summary statistics refer to all firms in the survey for which data are available.

Dummy variable equalling one if the manager indicates that the trade press is one of the two most important advertising media
Dummy variable equalling one if the manager indicates that the Internet is one of the two most important advertising media
Dummy variable equalling one if the manager indicates that the market for its main product or service is regional as opposed to
national or international

TRADE
INTERNET
REG

Definition

Table A1. (Continued).

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0.222
2.268

0.501
0.129
0.117

Mean

0.416
3.681

0.500
0.335
0.321

SD

Advertising as an Entry Deterrent 81

82

D. Paton

Survey Questions Used in the Study

All Managers were asked:
Yes* No

Q1. Does your firm advertise?

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(Take advertising to include sponsorship (e.g. sports) and direct mail, but not
product packaging or other forms of sales promotion)
Q13. In which sector is your companys main product line/service (Tick one
only)?
Manufacturing (consumer goods) Manufacturing (producer goods) Distribution
Holding company Retail Services Other, please specify:____________
Q15. At which of these markets is your companys main product line/service
aimed?
(Tick all that apply):
Regional market

UK market

EU market

International market

Q17. How many other firms compete in the market for your main product
line/service?
0-1

2-5

6-10

more than 10

Managers whose company did not advertise were asked:

Q5. Which of the following factors would make you likely to advertise in the
future?
(Tick any that apply)
(a) Your company introduces a new product/brand

(b) A rival company introduces a new product/brand

(c) Rival companies start to advertise/increase advertising activities

(d) Rival companies stop advertising/decrease advertising activities

(e) Trading conditions improve

(f) Trading conditions worsen

(g) A new company enters the market

(h) New opportunities on the Internet

(i) Other, please specify: ______________________________________________

Advertising as an Entry Deterrent 83

Managers whose company did advertise were asked:
Q7. To what extent are the following important aims of your advertising?
1 Not at all important 2 Quite unimportant 3 Neither important nor unimportant
4 Quite important 5 Very important

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1 2 3 4 5
(a) To provide customers with practical product information
e.g. prices etc.
(b) To inform customers about the merits of the product

(c) To raise awareness of your products/brands

(d) To raise awareness of your company

(e) To launch new products or brands

(f) To increase market share

(g) To increase the size of the whole market

(h) To make it difficult for other companies to enter the market

Q12. In each of the following situations, do you think the percentage of sales
that you spend on advertising for your main product line would increase,
decrease or not change?
1 Increase

2 Decrease

3 No change
1

(a) Trading conditions worsen throughout the whole economy.

(b) Trading conditions improve throughout the whole economy.

(c) Trading conditions worsen just within your main market(s).

(d) Trading conditions improve just within your main market(s).

(e) Your main rivals increase their advertising.

(f) Your main rivals decrease their advertising.

(g) Your company introduces a new product/brand.

(h) A rival company introduces a new product/brand.

(i) A new company enters your market.