On Inter-Industry Variation in the Vertical Integration of Advertising Services

Abstract

We investigate inter-industry variation in the relative incidence of advertisers' utilization of in-house rather than independent advertising agencies. To account for this variability, we develop a set of hypotheses drawing on two perspectives that figure prominently in the literature on vertical integration. The first perspective emphasizes scale economies and double marginalization. The second perspective is that of transactions cost economics. The hypotheses are tested using a database consisting of a cross section of 70 two digit SIC industries measured at two points in time, 1991 and 1999. Confirming our first hypothesis, we found the tradeoff between the potential gains accompanying avoidance of double marginalization and the possible sacrifice of size-related scale economies tended to operate so as to decrease the likelihood of vertical integration as the size of advertising outlays increased. Consistent with three additional hypotheses suggested by transaction cost economics, we find that the likelihood of internalization of advertising services increases across industries as (i) advertising intensity increases and is greater for (ii) technological intensive and (iii) creative industries. The underlying rationale for (i) and (ii) emphasizes the role of human asset specificity while that for (iii) relates to transaction similarity and the opportunity to exploit scope economies. A fourth hypotheses suggested by transaction cost analysis, that predicted greater vertical integration of advertising services in the retailing due to temporal specificity, was rejected.