Beruflich Dokumente
Kultur Dokumente
Communicated by G. Leitmann
1. Introduction
1 The authors thank the PhD seminar participants at the University of Texas at Dallas
for helpful comments.
2 Assistant Professor, School of Management, University of Texas at Dallas, Richardson,
Texas.
3 Ashbel Smith Professor, School of Management, University of Texas at Dallas,
Richardson, Texas.
163
0022-3239/04/1000-0163/0 © 2004 Plenum Publishing Corporation
164 JOTA: VOL. 123, NO. 1, OCTOBER 2004
2. Background
where x(t) and y(t) represent the market shares of the two firms, whose
parameters and decision variables are indexed 1 and 2 respectively. Note
that
x(t) + y(t) = 1.
with the stochastic, monopoly advertising model of Sethi (Ref. 15). The
Sethi model is given by the Itô equation
dx(t) = ρu(t) 1 − x(t) − δx(t) dt + σ (x)dw(t), x(0) = x0 , (4)
Chintagunta and Jain (Ref. 17) test this specification using data from
the pharmaceuticals, soft drinks, beer and detergent industries, and find
it to be appropriate. Sorger describes the appealing characteristics of the
specification, noting that it is compatible with word-of-mouth and nonlin-
ear effects. However, the decay constant δ is not included here and it is
assumed to be replaced totally by competitive effects.
On the other hand, we extend the Sethi model to allow for competi-
tion. We are able to do so, while retaining the decay constant. Note that a
stochastic version of the Sorger model is a special case of ours (specified
in the next section) when δ = 0. The decay constant, which goes back to
the Vidale-Wolfe formulation, is not solely replaced by competitive adver-
tising effects. Thus, in order to capture effects such as forgetting, the decay
parameter has been morphed into the churn parameter. We will discuss
how including the term affects the outcome.
3. Model
we have
Now that y(t) = 1 − x(t), we need use only the market share of firm
1 to completely describe the market dynamics. Thus, ui (x, y), i = 1, 2,
and σ (x, y) can be written as ui (x, 1 − x) and σ (x, 1 − x). With a slight
abuse of notation, we will use ui (x) and σ (x) in place of ui (x, 1 − x) and
σ (x, 1 − x), respectively. Thus,
√ √
dx = [ρ1 u1 (x) 1 − x − ρ2 u2 (x) x − δ(2x − 1)]dt+σ (x)dw,
x(0) = x0 , (9)
with 0 ≤ x0 ≤ 1.
As noted in Ref. 15, when choosing a formulation, an important con-
sideration is that the market share should remain bounded within [0, 1],
which can be problematic given stochastic disturbances. In our model, it is
easy to see that x ∈ [0, 1] almost surely for t > 0, as long as ui (x) and σ (x)
are continuous functions that satisfy the Lipschitz conditions on every
closed subinterval of (0, 1) and further that ui (x) ≥ 0, x ∈ [0, 1], and
σ (x) > 0, x ∈ (0, 1) and σ (0) = σ (1) = 0. (10)
168 JOTA: VOL. 123, NO. 1, OCTOBER 2004
Each firm seeks to maximize its expected, discounted profit stream subject
to the market share dynamics. Note that, when the advertising expenditure
enters linearly in the dynamic equation, its cost in the objective function
is assumed to be quadratic as in Ref. 15. Equivalently, one can take the
square root of the advertising expenditure in the dynamic equation and
subtract the advertising expenditure linearly in the objective function (e.g.,
Ref. 19). See Refs. 26–27 for a discussion.
4. Analysis
where Vi = dVi /dx, Vi = d 2 Vi /dx 2 and where u∗1 and u∗2 denote the com-
petitor’s advertising policies in (16) and (17), respectively. We obtain the
JOTA: VOL. 123, NO. 1, OCTOBER 2004 169
which hold as we shall see later. Substituting (19) in (16) and (17), we
obtain the Hamilton-Jacobi equations
Following Ref. 15, we obtain the following forms for the value functions:
V1 = α1 + β1 x, (22a)
V2 = α2 + β2 (1 − x). (22b)
These are inserted into (20) and (21) to determine the unknown coeffi-
cients α1 , β1 , α2 , β2 . Equating powers of x in Eq. (20) and powers of 1 − x
in Eq. (21), the following four equations emerge, which can be solved for
the unknown coefficients:
α = α 1 = α2 ,
β = β1 = β2 ,
m = m1 = m2 ,
c = c1 = c2 ,
ρ = ρ1 = ρ2 ,
r = r1 = r2 .
There are two solutions for β. One is negative, which clearly makes no
sense. Thus, the remaining positive solution is the correct one. This gives
also the corresponding α. The solution is
α = (r − δ)(W − W 2 + 12Rm) + 6Rm /18Rr, (28a)
β= W 2 + 12Rm − W /6R, (28b)
where
R = ρ 2 /4c, W = r + 2δ.
We can see now that, with the solution for the value function, the con-
trols specified in Eq. (18) reduce to (19). This validates our choice of (19)
in deriving the value function.
Table 1 provides the comparative static results for the parameters
(proofs with the authors).
When ρ increases or c decreases (i.e., there is a marginal increase in
the value of advertising or a reduction in its cost), then as one might
expect, the amount of advertising increases. However, contrary to what
one would expect to see in a monopoly model of advertising, the value
function decreases. This occurs because, in this market, all advertising
occurs from competitive motivations, since the optimal advertising expen-
diture would be zero if a single firm were to own both identical products.
Advertising does not increase the size of the marketing pie, but affects
only its allocation. Thus, the increase in advertising causes a decrease
in the value function. The same logic does not apply when m increases
JOTA: VOL. 123, NO. 1, OCTOBER 2004 171
α + − + + −
β + − + − −
u∗ − + + − −
V (x) + − + ? −
Legend: increase (+), decrease (−), ambiguous (?).
The reason is that, when a firm has a market share advantage over its
rival, δ helps the rival unequally by tending to equalize market shares.
where
Once we obtain the correct value of β1 out of the four solutions of the
quartic equation (29), the other coefficients can be obtained by solving for
α1 , β2 , and then α2 . The solution is given in Appendix A (Section 6).
We collect the main results of the analysis into Theorem 4.1.
αi ?, + ?, − +, − ? −, +
βi ?, + ?, − +, − − −, +
u∗i −, + +, − +, − − −, +
Vi (x) ?, + ?, − +, − ? −, +
Legend: increase (+), decrease (−), ambiguous (?).
JOTA: VOL. 123, NO. 1, OCTOBER 2004 173
Thus, the expected market shares converge to the form resembling the
attraction models commonly used in marketing. However, while an attrac-
tion model would rate the attractiveness of each firm based on its lower
cost, higher productivity of advertising, and higher advertising, it would
exclude exogenous market phenomena such as churn.
To further characterize the evolution path, we can calculate the vari-
ance of the market shares at each point in time. A specification of the dis-
turbance function that satisfies (10) is required for this purpose. We use
σ (x)dw = σ x(1 − x)dw,
E[x(0)2 ] = x02 .
The solution is
A1 (A1 + σ 2 /2)
E[x(t)2 ] = x02 e−2(A1 +A2 +σ
2 /2)t
+
(A1 + A2 + σ 2 /2)(A1 + A2 )
−2(A1 +A2 +σ 2 /2)t
×[1 − e ]
e−(A1 +A2 )t − e−2(A1 +A2 +σ /2)t
2
+
A1 + A 2 + σ 2
2 2A1 (A1 + σ 2 /2)
× 2(A1 + σ /2)x0 − . (42)
A 1 + A2
JOTA: VOL. 123, NO. 1, OCTOBER 2004 175
E[x(t)2 ] = (E[x(t)])2
holds for all t. For σ > 0, the variance is given by the formula E[x(t)2 ] −
(E[x(t)])2 , which allows us to find that, in the long run, the variance of
the market shares for both firms is given by
A1 A2 σ 2 /(2A1 + 2A2 + σ 2 )(A1 + A2 )2 . (44)
The procedure described in Zwillinger (Ref. 28, pp. 702, Eq. 182.3) is used;
i.e., for an SDE
can be used, where the {ς(t)} are i.i.d. standard normal random variables.
The time step = 0.01 is used.
Figure 1 shows a sample path. One can see that the path hovers
around the mean. It never stays on the mean as it is continuously dis-
rupted due to the Brownian motion. We can calculate a confidence inter-
val if the path is normally distributed around the mean. Then,
E[x(t)] ± 1.96 E[x(t)2 ] − (E[x(t)])2
176 JOTA: VOL. 123, NO. 1, OCTOBER 2004
provides the 95% confidence interval for the market share path. While we
know that the distribution is not normal, nevertheless, as Fig. 2 shows, the
proposed confidence interval does an adequate job of tracking the mar-
ket shares. Since the normal distribution is not bounded between zero and
one, the confidence interval may exceed the minimum or maximum mar-
ket share as happened in this case, In Section 4.5, we obtain the equi-
librium distribution of the market share, which enables us to provide the
exact confidence intervals for the equilibrium market shares.
This analysis has the value that it provides a diagnostic tool for man-
agement to handle market share fluctuations. Whereas minor fluctuations
within the confidence bands may call for cursory examination, overstep-
ping the bands indicates the need for a detailed review. It may be indica-
tive of a shift in the underlying market parameters and hence it requires
a reevaluation of the advertising spending policies. Also, the market share
fluctuations directly cause fluctuations in advertising spending according
to Theorem 4.1; hence, one can simulate the advertising budget as well.
Fig. 2. Market share for firm 1: Normal density 95% confidence interval (dashed lines), and
equilibrium market share 95% confidence interval (dotted lines).
For our problem, we shall obtain first and then attempt to solve the
Fokker-Planck equation. Firm 1’s stochastic differential equation from
(33) is
dx = (A1 − (A1 + A2 )x)dt + σ x(1 − x)dw, x(0) = x0 . (45)
which simplifies to
× C1 + C2 x −2A1 /σ (1 − x)−2A2 /σ dx .
2 2
(49)
5. Conclusions
where
Every quartic equation has four roots. Excluding the fortuitous cases,
where two or more roots are equal, the following results are easily
observed:
where
β1 (1) < 0, β1 (2) > 0, β1 (3) > β1 (2), β1 (4) > β1 (3)
F (β1 )|β1 =β1 (3) = (β1 (3) − β1 (1))(β1 (3) − β1 (2))(β1 (3) − β1 (4)),
is negative.
(A3) We can calculate the slope F (β1 ) directly from (52) and eval-
uate it at any positive real root. The result is
F (β1 )|β1 =F −1 (0) = 2 3R12 β14 + R1 (W1 + W2 )β13 + m1 W2 β1
+m1 (m1 − W1 β1 ) /β1 > 0. (54)
It follows from points (A2) and (A3) above that there is only
one real positive root and hence a unique solution to the
differential game. To obtain an explicit solution, we utilize the
182 JOTA: VOL. 123, NO. 1, OCTOBER 2004
We pick β1 as the only real positive solution out of the four roots, i.e.,
β1 = β1 (i ∗ ), where i ∗ = {i ∈ {1, 2, 3, 4}|β1 (i) > 0}. (61)
While i∗ may depend on the data, there will only be one i∗ in every case.
into (62)–(63) to obtain G1 (u∗1 , u∗2 ) and G2 (u∗1 , u∗2 ). Then, the
implicit function theorem can be written as
∂u∗1 /∂θ
= −(1/)
∂u∗2 /∂θ
2c2 u2 2c2 u1 ρ1 2c2 (r2 +2δ) 2c1 u1 ρ2
− + √ √ + √ √ √
x ρ2 1 − x x ρ2 x ρ1 1−x x
×
2c2 u2 ρ1
2c1 u1 2c u ρ2 2c (r +2δ)
√ √ − + √1 2 √ + 1 √1
ρ2 1−x x 1 − x ρ1 1−x x ρ1 1−x
× ∂G1 /∂θ
∂G
/∂θ ,
2
(65)
where it can be shown that > 0. The calculations for the
results reported in Table 2 follow in a straightforward manner.
(B3) For α1 , we note from Eq. (30) that, in many cases, α1 will have
the same comparative statics as β1 . These relationships are as
follows:
∂α1 /∂c2 > 0, ∂α1 /∂m1 > 0, ∂α1 /∂m2 < 0, ∂α1 /∂r1 < 0,
∂α1 /∂r2 > 0, ∂α1 /∂ρ2 < 0. (66)
184 JOTA: VOL. 123, NO. 1, OCTOBER 2004
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