Products vs. Advertising: Media Competition and the Relative Source of Firm Profits∗

In this paper we ask when will a firm earn more profits from selling the attention of its customers to advertisers than from selling the underlying product itself. In other words, when will a firm become an advertising " medium " ? We investigate this decision as a function of the intensity and nature of competition. We show that regardless of inherent product value to customers, when the firm faces high within-industry competition it will always earn more profits from the product market; implying that firms cannot " advertise their way out " of intense competition. However, for products of moderate inherent value, we find that the product model is more attractive when competition is at either extreme (very high or low) but the advertising model is more attractive when competition is in the middle range. This results in an inverse-U pattern for relative source of profits as a function of within-industry competition. We also look at the level of competition between-media and identify conditions for firm profits in one industry to increase as a result of heightened competition with another industry. Moreover, we show that as two media are more substitutable (hence competing more head-to-head for advertising campaigns) their source of profits will diverge. In addition, the paper considers the impact of the disutility created by advertising for the product consumer. Interestingly, we find that low levels of consumer disutility may actually increase the proportion of profits from advertising as compared to products.