Why Companies Advertise

The economic reasons firms spend so much on advertising, from informing buyers to signalling quality and building brand loyalty.

Companies around the world spend hundreds of billions of dollars a year on advertising. Economists have long debated what all this spending achieves: does it help consumers or just manipulate them?

Informative advertising

Some advertising simply provides information: that a product exists, what it does, where to buy it and how much it costs. A supermarket flyer listing this week’s prices or an advert for a new bus route helps people make better choices. Economists call this informative advertising. By making it easier to compare, it can increase competition and lower prices.

Research by Lee Benham in 1972 found that in U.S. states that banned advertising for eyeglasses, prices were substantially higher than in states that allowed it. Advertising helped customers find cheaper sellers.

Persuasive advertising

Other advertising aims to change how people feel about a product, associating it with happiness, success or status, often with little real information. This is persuasive advertising. Critics argue it creates wants that people did not have, and makes products seem different when they are not, allowing higher prices.

Advertising as a signal

A third view comes from information economics. Expensive advertising can act as a signal of quality. A company only spends heavily on advertising if it expects customers to come back, which makes sense only if the product is good. Even an advert with no information may tell consumers: “we are confident enough to spend a lot to reach you.”

The new restaurant

A new restaurant opens and spends heavily on advertising. If the food is poor, people will try it once and not return, and the advertising money will be wasted. A restaurant confident in its food expects repeat customers who make the advertising pay off. So heavy advertising can hint that the owners believe in their product.

Advertising and competition

Advertising can lower barriers for new firms by helping them reach customers. But very large advertising budgets can also create barriers: newcomers may struggle to match an established brand’s spending. Whether advertising increases or reduces competition depends on the market.

Thinking all advertising is manipulation

Some advertising does try to manipulate, but much of it provides useful information about prices, products and new options. Banning advertising can actually raise prices by making comparison harder.

Key takeaways

Informative advertising helps consumers compare and can lower prices.
Persuasive advertising aims to change feelings and may support higher prices.
Heavy advertising can signal that a firm expects satisfied repeat customers.
Advertising can both help new firms enter and create barriers to entry.