Shifting or Rotating Demand?

7 September 2006 at 4:10 am Lasse Leave a comment

| Lasse Lien |

For O&M readers interested in competitive strategy, I would like to recommend a recent paper in AER by Johnson and Myatt: “On the Simple Economics of Advertising, Marketing, and Product Design” (vol 96, no. 3). The authors analyze a weirdly understudied topic in economics, namely rotations of the demand curve. This means that firms by their choice of advertsing, marketing and product design can influence the dispersion of customers valuations for a product. Take for instance product design. A universally attractive new feature will simply shift the demand curve outward, while a new feature that pleases some customers and displeases others will lead to an increased dispersion of customers valuation, that is, to a rotation of the demand curve.

Of course, differentiation and niche tactics are well known in competitive strategy, but Johnson and Myatt are able to be precise about the conditions under which firms will prefer actions that increases the dispersion of consumers valuations, and when firms will prefer minimizing the dispersion of consumer valuations (going for volume). What they find is that under a remarkably wide variety of conditions profits are U-shaped in demand dispersion, meaning that firms either maximize or minimize dispersion. Michael Porter will probably appriciate this result. But the paper has a number of other interesting applications and ideas, one is for example the distinction between advertzing that is pure hype and informational. Pure hype advertizing shifts the demand curve outward, while informational advertizing rotates the demand curve.