Economic Analysis of Advertising Agency Services

Abstract

We address a longstanding puzzle surrounding the unbundling of services occurring over several decades in the US advertising agency industry: what accounts for the shift from bundling to unbundling of services and the slow pace of change? Using Evans and Salinger’s (2005, 2008) cost-based theory of bundling, we develop a simple model of an agency’s decision to unbundle as a tradeoff between the fixed cost to the advertiser of establishing a relationship with an agency and pecuniary economies of scale available from providing media services. The key predictions of the model are supported by an econometric analysis of cross-sectional and pooled data from the quinquennial US Censuses conducted between 1982 and 2007. Agencies are more likely to unbundle with increasing size and diversification, but are less likely to do so with increasing age. Longitudinal growth in unbundling is partially explained by increases in media prices overtime.