Advertising (Cabral 13.7)
Your company sells expensive, branded fountain pens. There are 100,000 people aware of your pens. Each of these 100,000 peoples has his or her own willingness to pay for your pens. This willingness to pay numbers are uniformly distributed between $0 and $50. So your demand curve is given by Q= 100000 ? (1 - (P/500)) . Your marginal cost per pen is $100. Well versed in economics, you are pricing your pens at $300 each, and selling 40,000 pens, generating a profit of $8 million. You have just become brand manager for these fountain pens. The previous brand manager engaged very little in advertising, but you are considering running a major promotional campaign to build your brand image and visibility. You are considering two possible advertising campaigns; call them "Build Value" and "Expand Reach". You will run either one of these campaigns or none at all; you cannot run both.
The "Build Value" campaign will not reach any new potential customers, but it will increase the willingness to pay of each of your existing 100,000 customers by 25%. This campaign costs $2.5 million to run.
The "Expand Reach" campaign will expand the set of potential customers by 25%, from 100,000 to 125,000. The 25,000 new customers reached will have the same distribution of willingness to pay as the preexisting 100,000 potential customers (namely, uniformly distributed between $0 and $500). This campaign costs $1.8 million to run.
(a) If your choice is between running the "Build Value" campaign and running no campaign at all, would you choose to run the "Build Value" campaign? Show your calculations.
(b) If your choice is between running the "Expand Reach" campaign and running no campaign at all, would you choose to run the "Build Value" campaign? Show your calculations.
(c) What choice would you make in this situation: Run the "Build Value" campaign, run the "Expand Reach" campaign, or run neither?