Maryland Smith Research / September 3, 2020

Why Buzzworthy Companies Should Up Their Ad Budgets

Word-of-Mouth Isn’t Always Free Advertising. It Could be a Sign to Spend More

Why Buzzworthy Companies Should Up Their Ad Budgets

Companies have long welcomed the word-of-mouth spread between consumers about the quality of their products, seeing it as free advertising and thinking they can get away with spending less on paid advertising. But, according to new research from the University of Maryland’s Robert H. Smith School of Business, sometimes the exact opposite is true.

“If the role of advertising is to signal quality, then when you have learning about a product between consumers through observing or because of word of mouth, then it is a better idea to spend more on advertising,” says Maryland Smith’s Yogesh Joshi, an associate professor of marketing who co-authored the paper, forthcoming in Marketing Science.

And, says Joshi, companies shouldn’t be covert about it.

“What matters is that consumers should be aware that the company is spending a ton of money on advertising. That should be clear.”

Why the flashy show of expensive ads?

It’s called the money-burning effect, says Joshi, and, thanks to previous research, advertisers already know it works. When consumers see a company advertise during the Super Bowl, for example, they infer that company is so confident in the high quality of its products that it can sink huge sums into lavishly expensive TV ads just to communicate that.

“Advertisers already know the role of money-burning in signaling quality,” says Joshi, “but what they may not know is that this role of advertising as a tool to signal quality becomes even bigger when consumers are learning through word of mouth by talking to or observing other consumers.”

The research specifically looks at “experience goods” – products or services a consumer actually has to buy and experience for themself before passing judgment on, like movies, vacation resorts, haircuts or restaurant meals. Anything a consumer can learn about the quality of a good or service before buying is helpful in the decision-making process. That’s where learning from others, and also cues from ads, come in.

Consumers are more likely to learn about high-quality products from each other. Early consumers who try and like products will use them and tell others about them. Consumers who come to the market later infer that if a lot of people have already tried a product and are talking about it, then the product quality must be good. That makes it more attractive for firms with poor-quality products to try and imitate the actions of a firm high-quality product. That’s why, to really stand out, a high-quality firm actually has to make the bigger splash.

“To separate itself, the high-quality firm ends up having to spend more money on advertising than they normally would,” says Joshi.

Only a firm that actually makes a product of high quality will be able to credibly spend that kind of money on advertising, he says. Companies with low-quality products cannot afford to do the same thing.

To illustrate, Joshi uses an example of a consumer deciding between handbags from two companies, a high-quality one and a low-quality one. The shopper won’t know whether they like a particular handbag until they’ve bought and used it. The strategy for a high-quality firm is to spend a lot of money on advertising to show the consumer that it can afford to do so because it knows that once she buys its handbag, she’ll like it so much that she’ll become a repeat customer. A poor-quality firm can’t afford to sink that much in advertising because even if it fools a consumer into buying its handbag, the low quality will put her off from ever buying another one. And this effect becomes even stronger when later consumers learn from earlier buzz.

Low-quality firms can get away only with the earliest consumers, says Joshi. “Once consumers experience a low-quality good, they feel like they got duped.”

Joshi says high-quality companies that already have a lot of consumer buzz should take note of the research findings and may want to increase their advertising budgets.

“If the job is actually to convince consumers about quality, then this is the right recommendation for firms and managers.”

Read more: “When Consumers Learn, Money Burns: Signaling Quality via Advertising with Observational Learning and Word of Mouth,” by Yogesh Joshi and Andres Musalem of the University of Chile and Instituto Sistemas Complejos Ingenieriaand, is forthcoming in Marketing Science.

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