J Optim Theory Appl (2008) 137: 465–483

DOI 10.1007/s10957-007-9340-8

Pricing and Advertising of Private and National Brands

in a Dynamic Marketing Channel

N. Amrouche · G. Martín-Herrán · G. Zaccour

Published online: 5 January 2008

© Springer Science+Business Media, LLC 2008

Abstract We consider a marketing channel where a retailer sells, along the manufac-
turer’s brand, its own store brand. We assume that each player invests in advertising
in order to build the brand’s goodwill. One distinctive feature of this paper is the in-
troduction of the negative effect of own advertising on other player’s goodwill stock
evolution. We characterize feedback-Nash pricing and advertising strategies and as-
sess the impact of the store brand and national brand’s goodwill stocks on these strate-
gies in different settings. The main findings suggest first that investing in building up
some equity for each brand reduces the price competition between them and propels
the market power for both. Second, the retailer will pass to consumer an increase in
its purchasing cost of the national brand in all situations as no coordination is taken
into account to counter the double marginalization problem. Finally, the higher the
brand equity of the store brand, the more the retailer invests in advertising.

Keywords Marketing channels · Private label · Advertising · Pricing · Differential

games · Feedback-Nash equilibrium

1 Introduction

We consider a marketing channel where a retailer offers to consumers its private la-
bel, or store brand, as well as a national manufacturer’s brand. The manufacturer

N. Amrouche
Long Island University, New York, USA

G. Martín-Herrán
Departamento de Economía Aplicada (Matemáticas), Universidad de Valladolid, Valladolid, Spain

G. Zaccour ()
Chair in Game Theory and Management, GERAD, HEC Montréal, Montréal, Canada
e-mail: georges.zaccour@gerad.ca
466 J Optim Theory Appl (2008) 137: 465–483

controls the wholesale price of its brand to retailer, and invests in advertising in or-
der to build up the brand equity (reputation or goodwill). The retailer decides on
the price-to-consumer of the two brands and invests also in advertising to raise its
private label equity. We are interested in investigating noncooperative pricing and ad-
vertising equilibrium strategies in the context where each player can affect, through
advertising, also the other player’s brand equity.
Store brands are by no means a marginal phenomenon. Indeed, according to the
Private Label Manufacturers Association,1 one in five products sold in U.S. super-
markets in 2004 was a private label. One major determinant of this success is the
improved quality of these labels (see e.g. [1–3]). Hoch and Banerji [2] note that this
success is however less likely to occur in product categories where the manufactur-
ers have made substantial advertising commitments to brand equity. Although it has
been generally the case that retailers spend their communication budgets mainly on
features rather than on unaffordable advertising campaigns, some major retailers do
advertise their private labels nationally (see e.g. [4] and [5]). We are interested in
such context where, indeed, each player’s advertising effort has two effects, i.e., rais-
ing its own brand equity and decreasing the other’s brand one. Intuitively, this context
is of interest when the store brand is positioned as one of high quality and actually
perceived by consumers as a possible substitute to the manufacturer’s brand.2
In this context of a retailer competing against a manufacturer, we wish to answer
the following questions:
• Assuming that there is a cross-price effect between the two brands, and that each
player takes into account the goodwill’s dynamics of both brands, how the goodwill
stocks affect the players’ strategies?
• Assuming that there is no cross-price effect, what is the impact the goodwill stocks
on players’ strategies?
• Assuming that each player is partially myopic, i.e., takes into account only the
goodwill’s dynamics of its brand, to what extent do the result may change from the
previous situations?
• Is it a good weapon for the retailer to invest as the manufacturer in advertising its
brand?
This paper differs from published contributions in many respects. The game the-
oretic literature on private labels is mainly static. By adopting a differential game
framework, our model captures clearly the differences between the advertising in-
vestments (flows) and their results in terms of brand equity (stock). The model allows
also to analyze the impact of brand equity on strategies. Moreover, the consideration
of a store brand building such stock has not been analyzed in the marketing litera-
ture, where the assumption has been typically that a store brand derives its revenues
by attracting price-sensitive market segments. Finally, it has been seldom the case to
fully include in a differential game of marketing channels, as it is done here, both
advertising and pricing strategies (see e.g. [6–12]).

1 See http://www.plma.com/.
2 For instance, jeans labels as Arizona (J.C. Penney), Canyon River Blues (Sears, Roebuck) and Badge
(Federated Department Stores) have become not only acceptable to consumers but even trendy thanks to
clever advertising of the product image (apart from the store’s image).
J Optim Theory Appl (2008) 137: 465–483 467

The rest of the paper is structured as follows. In Sect. 2, we develop a model for
the channel under study. In Sect. 3, we derive the Feedback-Nash Equilibrium and
interpret the results. In Sect. 4, we conclude.

2 Model

Consider a marketing channel formed of a manufacturer (player M) of a national

brand and a retailer (player R). The retailer offers the national manufacturer’s brand
(NB) as well as its own store brand (SB) or private label in its outlet. The SB is sup-
plied to the retailer at a constant wholesale price ws by another manufacturer who
does not play any strategic role in our setting (as in e.g. [13]). Denote by pn (t) the
price-to-consumer of the national brand at time t ∈ [0, ∞) and by ps (t) the retail
price of the SB. Both prices are controlled by the retailer. Denote by wn (t) the man-
ufacturer NB’s wholesale price to the retailer.
Each player advertises its brand in order to increase its brand equity (or market
potential). Let Ai (t) represent the advertising investment at time t for brand i, i ∈
{n, s}, where n stands for national brand and s for store brand. The advertising cost
Ci (Ai ) is assumed convex increasing and taken, for tractability, quadratic as follows:
ci2 2
Ci (Ai ) = ci1 Ai + A , i ∈ {n, s}, (1)
2 i
where ci1 and ci2 are positive constants.
Denote by Gi (t) brand i’s market potential whose evolution is governed by the
following differential equation:

Ġi (t) = Ai (t) − δGi (t) − ki Aj (t), Gi (0) = Gi0 ≥ 0, i, j ∈ {n, s}, i = j,
(2)
where δ > 0 is the decay rate. The above specification modifies the classical Nerlove-
Arrow dynamics by adding the term −ki Aj (t), where ki ≥ 0, i ∈ {n, s}. This means
that there are two sources of depreciation of brand i’s equity; the standard one, given
by δGi (t) which captures the idea that consumers forget to some extent the brand,
and the one due to the advertising by the other brand. Thus, the parameter ki repre-
sents the vulnerability of brand i to the advertising made by brand j . We suppose that
own advertising effect on brand equity is higher, in absolute terms, to the advertising
made by the other brand and hence ki < 1. Reference [14] explained that persuasive
advertising, that are more popular in competitive arena, aims to target selective de-
mand for the product. Comparative advertising is one possible format of persuasion.
Using these ads, firms try to change the preferences of consumers by increasing their
willingness to pay for the sponsoring brand and reducing the one for the comparison
brand. Some authors have modeled the spillover effect of advertising assuming either
a negative impact of advertising on the competing brand’s goodwill ([15] and [16])
or a positive external effects on the market size of all rivals [17].
Following [18], each brand demand depends on its equity and on both prices as
follows:

Di (t) = αi Gi (t) − pi (t) + ψi pj (t), i, j ∈ {n, s}, i = j, (3)

468 J Optim Theory Appl (2008) 137: 465–483

where ψi , i ∈ {n, s}, is a positive parameter capturing the cross-price effect on de-
mand. This specification deserves some comments. First, it is linear in prices which
is a popular assumption in the economics literature, with however a difference that
the maximal demand, i.e., the level of demand when the prices are zero, is not a given
constant but depends on the brand equity. For simplicity, we set αi = 1, i ∈ {n, s}.
Second, we normalize in (3) the direct-price effect to 1. Given that the direct-price
effect is larger than the cross-price one, see e.g. [19] and [20], we suppose that ψi < 1,
i ∈ {n, s}. From now on, we assume Gn − pn + ψn ps > 0 and Gs − ps + ψs pn > 0
in order to have a positive demand for the national and the store brands.
Assuming that both players are profit maximizers, their optimization problems
read as follows:
 ∞
max πM = e−ρt {(wn (t) − dn )Dn (t) − Cn (An (t))} dt, (4)
wn ,An 0
 ∞
max πR = e−ρt {(pn (t) − wn (t))Dn (t) + (ps (t) − ws )Ds (t)
As, pn ,ps 0
− Cs (As (t))} dt, (5)

where ρ is the common discount rate and dn is the constant unit production cost of
the NB.
By (1)–(5) we have defined a two-player, non-zero sum, infinite-horizon differen-
tial game with two state variables (Gn , Gs ) and five control variables (wn , An , As , pn , ps ).
We shall from now on eliminate the time argument when no confusion may arise.

3 Feedback Nash Equilibrium

We assume that the manufacturer and the retailer play à la Nash and thus decide
simultaneously their investments in advertising and the prices. Recall that the manu-
facturer controls An and wn , and the retailer As , ps and pn . As usual in autonomous
differential games played over an infinite time horizon, we consider that channel
members’s strategies are stationary feedback (see, for example, [21]), which means
that pricing and advertising strategies as well as value functions are time-independent
and only depend on the current levels of the state variables Gn and Gs . The next
proposition characterizes the Nash equilibrium and the equilibrium outcomes.

Proposition 3.1 Let denote by VR (Gs , Gn ) and VM (Gs , Gn ) the retailer’s and the
manufacturer’s value functions. Let assume that the transfer price is upper bounded
by w̄n .
(i) The following expressions satisfy the Hamilton-Jacobi-Bellman equations asso-
ciated with the retailer’s and manufacturer’s problems:
R1 2 R2 2
VR (Gs , Gn ) = G + G + R3 Gn Gs + R4 Gs + R5 Gn + R6 , (6)
2 s 2 n
VM (Gs , Gn ) = M1 Gn + M2 Gs + M3 . (7)
J Optim Theory Appl (2008) 137: 465–483 469

(ii) The retailer’s and the manufacturer’s optimal strategies are given by:

w̄n (ψn ψs + ψn2 − 2) − [2Gn + Gs (ψn + ψs )] − ws (ψn − ψs )

pn∗ (Gs , Gn ) = ,
(ψn + ψs − 2)(ψn + ψs + 2)
(8)
w̄n (ψn − ψs ) − [2Gs + Gn (ψn + ψs )] − ws [2 + (ψn + ψs )ψs ]
ps∗ (Gs , Gn ) = ,
(ψn + ψs − 2)(ψn + ψs + 2)
(9)
1
A∗s (Gs , Gn ) = [(R1 − kn R3 )Gs + (R3 − kn R2 )Gn + R4 − kn R5 − cs1 ],(10)
cs2
wn∗ (Gs , Gn ) = w̄n , (11)
1
A∗n (Gs , Gn ) = (M1 − ks M2 − cn1 ), (12)
cn2
if there are positive expressions and zero otherwise. The coefficients Ri , Mj , i =
1, . . . , 6, j = 1, 2, 3 are given in the Appendix.
Furthermore, R1 ≥ 0, R2 ≥ 0 and R3 has the same sign as the following expres-
sion:
kn + (ρ + 2δ)(−2kn + ψn + ψs )R1 . (13)
Moreover,
a.1 If R1 is chosen, then R1 − kn R3 > 0.
a.2 If R1 is chosen, then

R1 − kn R3 > 0 ⇔ 1 + kn2 − kn (ψn + ψs ) > 0,

where R1 , R1 are given in the Appendix.

The sign of R3 − kn R2 characterizes as follows:
b.1 If 1 + kn2 − kn (ψn + ψs ) < 0, then
b.1.1 If R1 is chosen, then R3 − kn R2 < 0.
b.1.2 If R1 is chosen, then R3 − kn R2 > 0.
b.2 If 2kn − ψn − ψs > 0, then

R3 − kn R2 < 0 ⇔ 4(1 + kn2 − kn (ψn + ψs )) + a1 cs2 (2δ + ρ)2 > 0.

b.3 If 2kn − ψn − ψs < 0 < 1 + kn2 − kn (ψn + ψs ), then

R3 − kn R2 > 0 ⇔ 4(1 + kn2 − kn (ψn + ψs )) + a1 cs2 (2δ + ρ)2 > 0.

Proof See the Appendix. 

Item (i) in the above proposition establishes that the retailer’s value function is
quadratic in the goodwill levels of the national and store brands, while the manu-
facturer’s value function is linear in these stocks. This is expected given the linear-
quadratic structure of the retailer’s problem and the linear-state structure of the man-
ufacturer’s problem. As a consequence, item (ii) shows that the retailer’s advertising
470 J Optim Theory Appl (2008) 137: 465–483

strategy is linear in the goodwill levels, while that of the manufacturer is feedback
degenerate (i.e., does not depend on the state).
The results in item (ii) allow the following remarks. Each pricing strategy depends
on both goodwill stocks. Further, the transfer price is set at its upper bound in equi-
librium. Note that the higher the latter, the higher is the retail price of the national
brand. Indeed,

∂pn∗ ψn ψs + ψn2 − 2
(Gs , Gn ) = > 0,
∂ w̄n (ψn + ψs + 2)(ψn + ψs − 2)

by the assumption 0 ≤ ψi < 1, i ∈ {n, s}. Therefore, the retail and transfer prices are
strategic complements. Put differently, the retailer will pass to consumer an increase
in its purchasing cost of the NB. This is the classical double marginalization problem
due to the absence of coordination. The relationship between the retail price of the
SB and this same transfer price is given by

∂ps∗ ψn − ψs
(Gs , Gn ) = ≥ 0 ⇔ ψn ≤ ψs .
∂ w̄n (ψn + ψs + 2)(ψn + ψs − 2)

The sign of this derivative depends on the relative magnitude of the cross-price effects
∂p ∗
ψn and ψs . If ψn > ψs , then ∂ w̄sn (Gs , Gn ) < 0 and the two variables are strategic
substitutes (when the wholesale price increases, the SB’s price decreases). If ψn <
ψs , then we have strategic complementarity (when the wholesale price increases, the
SB’s price increases too). Ultimately, the actual values of ψn and ψs is an empirical
matter. The results mean that the retailer will not decrease the SB’s price to try to
compete against the NB that disfavored it by increasing the wholesale price, unless
the cross-price effect of the SB (ψn ) is high compared the NB’s one (ψs ).
Furthermore, the advertising parameters, kn and ks , do not affect the pricing strate-
gies. Indeed,
∂pi∗
(Gi , Gj ) = 0, for i, j = n, s.
∂kj
This result is, most probably, a by-product of the model structure, i.e., the prices
do not affect the dynamics of the goodwill stocks.
To characterize the relationships between the retailer’s pricing strategies and the
goodwill stocks, we compute the following derivatives:

∂pn∗ ∂ps∗ 2
(Gs , Gn ) = (Gs , Gn ) = − > 0,
∂Gn ∂Gs (ψn + ψs + 2)(ψn + ψs − 2)
∂pn∗ ∂ps∗ ψn + ψs
(Gs , Gn ) = (Gs , Gn ) = − > 0.
∂Gs ∂Gn (ψn + ψs + 2)(ψn + ψs − 2)

Thus, increasing any goodwill’s level increases both retail prices. An interpretation
is that investing in brand equity for any brand enhances their differentiation and re-
duces the price competition between them, which leads to increase each brand market
power. Note also that own goodwill has a higher impact on own price than competing
J Optim Theory Appl (2008) 137: 465–483 471

brand goodwill, i.e.,

∂pi∗ ∂pi∗
(Gi , Gj ) > (Gi , Gj ), i, j = s, n, i = j.
∂Gi ∂Gj

With respect to the relationships between the retailer’s and manufacturer’s adver-
tising strategies and the goodwill stocks, the following results can be derived from
item (ii). If R1 − kn R3 is positive (always if R1 is chosen and if R1 is chosen and
condition (3.1) is fulfilled), the retailer’s advertising strategy depends positively on
the goodwill level of its own brand. This result has been obtained in some papers
dealing with advertising competition in horizontal (oligopoly) models (see e.g. [11]
and [23–26]).
To interpret further the advertising strategies in (10) and (12), we rewrite them as
follows:
∂VR ∂VR
cs1 + cs2 A∗s (Gs , Gn ) = (Gs , Gn ) − kn (Gs , Gn ),
∂Gs ∂Gn
∂VM ∂VM
cn1 + cn2 A∗n (Gs , Gn ) = (Gs , Gn ) − ks (Gs , Gn ).
∂Gn ∂Gs

Thus, in equilibrium, each brand sets the advertising level such that the marginal cost
(left-hand side) is equal to the marginal revenue. The latter is made of the difference
between the marginal contributions of own and competitor’s stock on value function.
Further, from the above expressions we see that the firms’ advertising decisions inter-
act through the goodwill stocks. Put differently, each advertising strategy cannot be
written as function of the other one. In that sense, they are neither strategic substitutes
nor complements, but independent.
The retailer’s reaction to a goodwill variation of the national brand depends on
the sign of R3 − kn R2 . If it is positive, then Gn has a positive impact on As . In the
literature on advertising expenditures in dynamic oligopolies, this result is reached
when the advertising is of the informative type (see e.g. [22] and [25]). If R3 − kn R2
is negative, then the retailer’s advertising is negatively related to her rival’s goodwill
stock. In the above references, this case is referred to as predatory advertising.
A sufficient condition guaranteeing that the expressions in (6), (7), (10), (12)
are retailer’s and manufacturer’s value functions and advertising strategies is
given by

lim e−ρt VR (Gs (t), Gn (t)) = 0, lim e−ρt VM (Gs (t), Gn (t)) = 0, (14)
t→∞ t→∞

where (Gs (t), Gn (t)) is the solution of the closed-loop dynamics obtained after sub-
stitution of the advertising strategies (10) and (12) into the goodwill dynamics given
by (2). This solution can be written as

Gn (t) = X1n eλ1 t + X2n eλ2 t + Gss

n , (15)
Gs (t) = X1s eλ1 t + X2s eλ2 t + Gss
s , (16)
472 J Optim Theory Appl (2008) 137: 465–483

where X1i , X2i , i = n, s, are constants, Gss ss

n and Gs refer to the steady states of the
goodwill variables and λi , i = 1, 2, are the real eigenvalues of the matrix associated
to the system of linear differential equations given in (39).
The steady-state levels of the goodwill stocks, Gss ss
n , Gs are given by

(cn1 − M1 + ks M2 )[(R1 − kn R3 )(kn ks − 1) + cs2 δ] − cn2 kn (cs1 − R4 + kn R5 )δ

n =
Gss ,
cn2 δ(R1 + kn2 R2 − 2kn R3 − cs2 δ)
(cn1 − M1 + ks M2 )[(kn R2 − R3 )(kn ks − 1) − cs2 ks δ] + cn2 (cs1 − R4 + kn R5 )δ
s =
Gss .
cn2 δ(R1 + kn2 R2 − 2kn R3 − cs2 δ)

The values of the goodwill stock at the steady state, (Gss ss

n , Gs ), are obtained after
replacing the equilibrium strategies in (2), and solving for Gn and Gs when Ġn (t) =
0, Ġs (t) = 0.
The computation of the state variable trajectories allows the identification of the
paths for the pricing and advertising strategies, and for the evolution of the demand
function for both brands. The results can be obtained after replacing Gn (t) and Gs (t)
by their respective values from (15) and (16) into (8), (9), (10) and (12).
The quadratic functional specification in (6) and (7) allows condition (14) to be
satisfied whenever the goodwill stocks are bounded. The next proposition states the
conditions for Gn , Gs to be bounded.

Proposition 3.2 The goodwill stocks are bounded if the conditions listed below ap-
ply:
1. R1 + kn2 R2 − 2kn R3 − cs2 δ is positive and the initial goodwill stocks are related
according to the following expression:
2δcs2 kn (kn R2 − R3 )
Gs0 = (Gn0 − Gss
n ) + Gs ,
ss
(17)
kn (kn R3 − R1 )

2. R1 + kn2 R2 − 2kn R3 − cs2 δ is negative.

Proof See the Appendix. 

Item 1 characterizes the situation where the steady state is stable in the saddle point
sense. The saddle point property means that given the initial goodwill level Gn0 , we
can find values of Gs0 (that satisfy (17)) such that the closed-loop system converges
to the steady state (Gss ss
n , Gs ) as time approaches infinity.
Item 2 guarantees a globally asymptotically stable equilibrium. In this case, any
initial level of the goodwill stocks converges to the steady-state as time approaches
infinity and leads to a bounded time path.
It is well known that, in infinite-horizon linear-quadratic optimization models, the
time paths of the states (goodwills) and of the controls are exponential functions of
time that converge towards the steady state, either from above or below depending
on whether the initial condition is higher or lower than the steady state. The initial
conditions for the goodwill stocks, and the relationship between the initial values for
the state and costate variables, that are required to have a trajectory that converges
J Optim Theory Appl (2008) 137: 465–483 473

towards the steady state, give us the initial conditions for the firms’ control variables:
advertising investments and prices.
To gain some additional qualitative insight into the advertising strategies, we focus
on two particular cases. Firstly, we consider that the cross-price effect on demands
is zero, that is, ψn = ψs = 0 (see (3)). Secondly, we consider a situation of partial
myopia which means that each player takes into account only the dynamics of its
own brand’s goodwill when maximizing its profits.

3.1 Zero Cross-Price Effect on Demand

When the demand function of each brand is independent of the price of its competitor,
the coefficients of the manufacturer’s and retailer’s value functions particularize as
follows:
w̄n − dn
M1 = > 0, M2 = 0,
2(δ + ρ)
R3 (R1 − kn R3 − cs2 (2δ + ρ)) kn (1 − 2R1 (2δ + ρ))
R2 = > 0, R3 = ,
kn (R1 − kn R3 ) 2(2δ + ρ)

kn2 (1 + kn2 ) + cs2 (2δ + ρ)2 ± (2δ + ρ) cs2 (cs2 (2δ + ρ)2 − 2(1 + kn2 ))
R1 = 2
> 0.
2(2δ + ρ)(1 + kn2 )
The manufacturer’s advertising is constant and independent of the advertising pa-
rameters kn , ks .
Some easy algebra allows us to show that for both roots of R1 , expression
R1 − kn R3 is always positive, while expression R3 − kn R2 is always negative. Since
R1 − kn R3 is always positive, the retailer’s advertising strategy depends positively
on the goodwill level of its own brand. Since R3 − kn R2 is always negative, then
the retailer’s advertising is negatively related to its rival’s goodwill stock. Using the
terminology previously stated, the retailer’s advertising is predatory.

3.2 Partially Myopic Players

By partially myopic behavior we mean that each player knows the value of the good-
will stocks for both brands, but it takes into account only the time evolution of its
own brand’s goodwill and disregards that of its competitor. Such assumption has been
made in, e.g. [11] and [22]. The justification of such assumption is that observing the
time evolution of the other brand goodwill is costly.
Since the price variables do not affect the dynamics of the brands’ goodwill stocks,
the equilibrium pricing strategies remain unchanged under this hypothesis and are
given by (8), (9) and (11). Therefore, we compute the advertising equilibrium strate-
gies under the partially myopic behavior.
Each channel member decides its advertising investment in order to maximize its
profits subject to the dynamics of its own goodwill stock. The manufacturer’s and
retailer’s advertising problems read:
 ∞
max πM = e−ρt {(wn − dn )Dn − Cn (An )} dt,
An 0
474 J Optim Theory Appl (2008) 137: 465–483

s.t. Ġn = An − δGn − kn As , Gn (0) = Gn0 ;

 ∞
max πR = e−ρt {(pn − wn )Dn + (ps − ws )Ds − Cs (As )} dt,
As 0

s.t. Ġs = As − δGs − ks An , Gs (0) = Gs0 .

The next proposition fully determines the advertising strategies as well as the equi-
librium outcomes when the channel members behave partially myopic.
pm pm
Proposition 3.3 Let denote by VR (Gs , Gn ) and VM (Gs , Gn ) the retailer’s and
the manufacturer’s value functions where the superscript pm stands for partial my-
opia.
(i) The following expressions satisfy the Hamilton-Jacobi-Bellman equations asso-
ciated with partially myopic retailer’s and manufacturer’s problems:

pm R̃1 2 R̃2 2
VR (Gn , Gs ) = G + G + R̃3 Gn Gs + R̃4 Gs + R̃5 Gn + R̃6 ,
2 s 2 n
pm
VM (Gn , Gs ) = M̃1 Gn + M̃2 Gs + M̃3 .

(ii) Assuming interior solutions, retailer’s and manufacturer’s advertising strategies

at the equilibrium are given by

∗pm 1
As (Gs , Gn ) = (R̃1 Gs + R̃3 Gn + R̃4 − cs1 ),
cs2
∗pm 1
An (Gs , Gn ) = (M̃1 − cn1 ),
cn2

where coefficients R̃i , M̃j , i = 1, . . . , 6, j = 1, 2, 3 are given in the Appendix.

Furthermore, R̃1 ≥ 0 and
1. If R̃1 is chosen, then R̃3 has the same sign as the following expression:

δ(ρ + δ)cs2 (−2 + ψn + ψs )(2 + ψn + ψs ) + 2. (18)

2. If R̃1 is chosen, then R̃3 ≥ 0,

where R̃1 , R̃1 are given in the Appendix.

Proof See the Appendix. 

Since R̃1 is always positive, the retailer’s advertising strategy depends positively
on the goodwill level of its own brand.
The retailer’s reaction to a goodwill variation of the national brand depends on
the sign of R̃3 . If it is positive (which is always true if R̃1 is chosen and if R̃1 is
chosen and the expression in (18) is positive), then Gn has a positive impact on As .
The advertising is informative. If R̃3 is negative (which happens when the root R̃1
is chosen and the expression in (18) is negative), then the retailer’s advertising is
negatively related to its rival’s goodwill stock. In this case the advertising is predatory.
J Optim Theory Appl (2008) 137: 465–483 475

4 Conclusions

We considered a marketing channel where the manufacturer and the retailer invest in
advertising in order to increase own brand equity and reduce competitor’s one. The
main findings are the following:
• First, investing in building up some equity for each brand reduces the price compe-
tition between them and enhances their differentiation which allows more market
power for both. Hence, the advertising’s option for the SB instead of other usual
strategies (features, promotions, etc.) seems to be an interesting weapon to con-
sider.
• Second, when there is no cross-effect or the players are partially myopic, the higher
the brand equity of the SB, the more the retailer invests in advertising. However,
the result is ambiguous in the general case.
• Third, assuming no coordination between both channel’s members, the double
marginalization problem could not be removed (whatever is the case) and the re-
tailer will pass to consumer an increase in its purchasing cost of the NB.
• Finally, if we consider that the price of each brand does not have any impact on
the demand of the competing brand, then our findings suggest that the retailer will
increase its advertising whenever the goodwill of its own brand increases and will
decrease it if the goodwill of the NB increases.
We made the assumption, as it is generally the case in the literature, that the retail
prices do not affect the evolution of the goodwill stocks. It is also of interest to attempt
integrating these prices in the dynamics and analyze the interplay between pricing
and advertising. This will come, however, at the cost of being able of characterizing
the equilibrium only numerically. Finally, we have assumed that the two players are
symmetric (information-wise) and implement a Nash equilibrium. Given a certain
tradition in marketing channels in assuming a leader-follower information structure,
it is relevant to study the resulting Stackelberg equilibrium in this case where the two
players invest in advertising.

Appendix

Proof of Proposition 3.1 The Hamilton-Jacobi-Bellman (HJB) equation associated

with the retailer’s optimization problem is as follows:

ρVR (Gs , Gn ) = max (pn − wn )[Gn − pn + ψn ps ]
pn ,ps ,As

+ (ps − ws )[Gs − ps + ψs pn ]
 
cs2 ∂VR
− cs1 + As As + (Gs , Gn )(As − δGs − ks An )
2 ∂Gs

∂VR
+ (Gs , Gn )(An − δGn − kn As ) . (19)
∂Gn
476 J Optim Theory Appl (2008) 137: 465–483

From the necessary conditions for optimality taking the partial derivatives of the
RHS in (19) with respect to pn , ps and As and equating to zero, we obtain

Gn − 2pn + (ψn + ψs )ps + wn − ws ψs = 0, (20)

Gs − 2ps + (ψn + ψs )pn − wn ψn + ws = 0, (21)
∂VR ∂VR
−cs1 − cs2 As + (Gs , Gn ) − kn (Gs , Gn ) = 0. (22)
∂Gs ∂Gn
The HJB equation associated with the manufacturer’s optimization problem is as
follows:
  
cn2
ρVM (Gs , Gn ) = max (wn − dn )[Gn − pn + ψn ps ] − cn1 + An An
dn ≤wn ≤w̄n ,An 2
∂VM
+ (Gs , Gn )(As − δGs − ks An )
∂Gs

∂VM
+ (Gs , Gn )(An − δGn − kn As ) . (23)
∂Gn

Note that the manufacturer’s optimization problem is linear in wn . Therefore, since

we assume Gn − pn + ψn ps > 0 in order to have a positive demand for the national
brand, the optimal solution for the transfer price is its upper bound, w̄n .
From the necessary condition for optimality, taking the partial derivative of the
RHS of (23) with respect to An and equating to zero, we obtain

∂VM ∂VM
−cn1 − cn2 An + (Gs , Gn ) − ks (Gs , Gn ) = 0. (24)
∂Gn ∂Gs
Solving (20) and (21), conditional on the value of wn which is set to w̄n , the
retailer’s optimal pricing strategies are obtained. Moreover, from (22) and (24), the
manufacturer’s and retailer’s optimal advertising strategies are derived as functions
of the partial derivatives of the value functions,
 
∗ 1 ∂VR ∂VR
As (Gs , Gn ) = (Gs , Gn ) − kn (Gs , Gn ) − cs1 , (25)
cs2 ∂Gs ∂Gn
 
∗ 1 ∂VM R ∂VM
An (Gs , Gn ) = (Gs , Gn ) − ks (Gs , Gn ) − cn1 . (26)
cn2 ∂Gn ∂Gs

Inserting the retailer’s optimal strategies, (8), (9), (25), and the manufacturer’s
optimal strategies, (11) and (26) in (19) and (23), the coefficients of the value func-
tions Ri , Mj , i = 1, . . . , 6, j = 1, 2, 3, are determined by identification and solve
the following nine algebraic Riccati equations (the first six correspond to the retailer,
whereas the second three correspond to the manufacturer):

−a1 (R1 − kn R3 )2 + cs2 (2 + (2δ + ρ)a1 R1 ) = 0, (27)

−a1 (R3 − kn R2 )2 + cs2 (2 + (2δ + ρ)a1 R2 ) = 0, (28)
J Optim Theory Appl (2008) 137: 465–483 477

kn a1 (R1 R2 + R32 ) − a1 R3 (R1 + kn2 R2 − (2δ + ρ)cs2 ) + a6 cs2 = 0, (29)

a1 cs2 [cn2 (δ + ρ)R5 + (cn1 − M1 + ks M2 )(R2 − ks R3 )]
+ cn2 [a1 (cs1 + kn R5 − R4 )(R3 − kn R2 ) + cs2 (a2 ws + a3 w̄n )] = 0, (30)
cn2 [a1 (R1 − kn R3 )(cs1 + kn R5 − R4 ) + cs2 (a7 ws − a2 w̄n )]
− a1 cs2 [(cn1 + ks M2 − M1 )(ks R1 − R3 ) − cn2 (δ + ρ)R4 ] = 0, (31)
−2a12 cs2 [(cn1 − M1 + ks M2 )(ks R4 − R5 ) − cn2 ρR6 ] − cn2 {a12 (cs1 + kn R5 − R4 )2
− 2cs2 [a1 a4 w̄n2 + ws2 (a1 a5 − 2ψs (ψn3 − 2ψs3 − ψn (4 + 3ψs2 )))
− ws w̄n a1 a6 a4 ]} = 0, (32)
−a1 (kn M1 − M2 )(kn R2 − R3 ) + cs2 (a3 (dn − w̄n ) + a1 (δ + ρ)M1 ) = 0, (33)
−a1 (kn M1 − M2 )(R1 − kn R3 ) + cs2 (a2 (dn − w̄n ) − a1 (δ + ρ)M2 ) = 0, (34)
a1 {cs2 (cn1 − M1 + ks M2 ) + 2cn2 [(kn M1 − M2 )(kn R5 − R4 + cs1 ) − cs2 ρM3 ]}
2

+ 2cn2 cs2 (2w̄n a4 − ws a6 a5 )(w̄n − dn ) = 0, (35)

where

a1 = (ψn + ψs + 2)(ψn + ψs − 2), a2 = ψ n − ψ s ,

a3 = −2 + ψs (ψn + ψs ), a4 = 1 − ψ n ψs , a5 = 1 + ψn ψs ,
a6 = ψ n + ψ s , a7 = −2 + ψn (ψn + ψs ).

From (49), we can obtain R6 as function of the coefficients R4 , R5 , M1 , M2 :

1
R6 = {a12 (2cs2 1 (M1 , M2 )(ks R4 − R5 ) + cn2 (cs1 − R4 + kn R5 )2 )
2a12 cn2 cs2 ρ
− cn2 cs2 [2a1 (a5 ws2 + a4 w̄n (w̄n − a6 ws )) − 4ws2 ψs (ψn3 − 2ψs3
− ψn (4 + 3ψs2 ))]},

where
1 (M1 , M2 ) = cn1 − M1 + ks M2 .
From (47), we can derive R5 as function of the coefficients R1 , R2 , R3 , R4 ,
M1 , M 2 ,
cn2 cs2 (a2 ws + a3 w̄n ) + a1 [cs2 (R2 − ks R3 ) 1 (M1 , M2 ) − cn2 (kn R2 − R3 )(cs1 − R4 )]
R5 = .
a1 cn2 (kn2 R2 − kn R3 − cs2 (δ + ρ))

Replacing this expression in (48), we obtain R4 as a function of R1 , R2 , R3 ,

M1 , M 2 ,
1
R4 = {a1 1 (M1 , M2 )(kn (kn ks − 1)(R1 R2 − R32 )
a1 cn2 2 (R1 , R2 , R3 )
478 J Optim Theory Appl (2008) 137: 465–483

− cs2 (ks R1 − R3 )(δ + ρ)) − (R1 − kn R3 )(cn2 kn (a2 ws + a3 w̄n )

− a1 cn2 cs1 (δ + ρ)) + cn2 (a2 w̄n − a7 ws )(kn (kn R2 − R3 ) − cs2 (δ + ρ))},

where

2 (R1 , R2 , R3 ) = (δ + ρ)(R1 + kn (kn R2 − 2R3 ) − cs2 (δ + ρ)).

From (52), we can obtain M3 as function of the coefficients R4 , R5 , M1 , M2 ,

1
M3 = {a1 [cs2 21 (M1 , M2 ) + 2cn2 (kn M1 − M2 )(cs1 − R4 + kn R5 )]
2a1 cn2 cs2 ρ
+ 2cn2 cs2 (dn − w̄n )(a5 a6 ws − 2a4 w̄n )}.

Solving simultaneously (50) and (51), we derive M1 and M2 as functions of the

coefficients R1 , R2 , R3 ,
a2 (R3 − kn R2 ) + a3 (R1 − kn R3 − cs2 (δ + ρ))
M1 = (w̄n − dn ) ,
a1 2 (R1 , R2 , R3 )
a3 kn (R1 − kn R3 ) + a2 (kn (R3 − kn R2 ) + cs2 (δ + ρ))
M2 = (w̄n − dn ) .
a1 2 (R1 , R2 , R3 )
From (46), we can obtain R2 as a function of R1 and R3 ,
a1 R3 (R1 − kn R3 − cs2 (2δ + ρ)) − cs2 a6
R2 = , (36)
a1 kn (R1 − kn R3 )

where kn is assumed to be different from zero.3

Replacing the expression of R2 in (36) into (45), we can derive R3 as a function
of R1 ,
kn + (2δ + ρ)(ψn + ψs − 2kn )R1
R3 = . (37)
(2δ + ρ)(2 − kn (ψn + ψs ))
The factor 2 − kn (ψn + ψs ) is positive, because 0 ≤ kn < 1, 0 < ψi < 1, i ∈ {n, s}.
Therefore, the sign of R3 coincides with the sign of its numerator and condition (55)
is derived.
Finally, replacing R3 given in (54) into (44) we obtain a quadratic equation for
coefficient R1 that allows us to obtain R1 as function of the model parameters,
√
a1 [4kn2 (1 − a6 kn + kn2 ) + cs2 [(2δ + ρ)(a6 kn − 2)]2 ] ±

R1 = 2
, (38)
8a1 (2δ + ρ)(1 − a6 kn + kn2 )
where
2

= a1 [a1 (4kn2 (1 − a6 kn + kn2 ) + cs2 [(2δ + ρ)(a6 kn − 2)]2 )

3 If k = 0, from (46), we can obtain R as a function of R and R . Replacing this expression of R

n 1 2 3 1
into (44), we can derive R3 as a function of R2 . Finally, replacing this expression of R3 into (45) we obtain
a quadratic equation for coefficient R2 that allows us to obtain R2 as function of the model parameters.
J Optim Theory Appl (2008) 137: 465–483 479

2
+ 16(1 − a6 kn + kn2 ) (2cs2 [(2δ + ρ)(a6 kn − 2)]2 − a1 kn4 )].

is assumed to be positive in order to have real solutions of (44).

Let R1 be the root with the positive sign affecting the square root, and R1 the root
with the negative sign.
Taking into account that a1 < 0, (44) and (45) can only be satisfied if R1 and
R2 are positive. From the quadratic equation characterizing coefficient R1 is easy to
conclude that R1 is positive if and only the following inequality applies:

4(1 + kn2 − kn a6 ) + cs2 [(2δ + ρ)(a6 − 2kn )]2 > 0.

In order to determine the dependency of the retailer’s advertising investment on its

own goodwill stock and on the national brand goodwill stock we have to characterize
the sign of the following expressions: R1 − kn R3 and R3 − kn R2 . After some algebra,
these expressions read as follows:

kn2 − 2(2δ + ρ)(1 + kn2 − kn (ψn + ψs ))R1

R1 − k n R 3 = ,
(2δ + ρ)(kn (ψn + ψs ) − 2)
cs2 (a1 (2δ + ρ)R3 + ψn + ψs )
R3 − kn R2 =
a1 (R1 − kn R3 )
cs2 (2kn − ψn − ψs )(2 + a1 (2δ + ρ)R1 )
= .
a1 (R1 − kn R3 )(kn (ψn + ψs ) − 2)
Easy but tedious computations allow us to establish the different possibilities on
the sign of R1 − kn R3 and R3 − kn R2 as shown in the statement of the proposition. 

Proof of Proposition 3.2 The eigenvalues λ1 and λ2 of the matrix associated to the
closed-loop dynamics are

R1 + kn2 R2 − 2kn R3 − cs2 δ

λ1 = −δ, λ2 = . (39)
cs2

Therefore, if R1 +kn2 R2 −2kn R3 −cs2 δ is positive, then one eigenvalue is negative,

while the other one is positive. Under this assumption, the steady state (Gss ss
n , Gs ) is
a saddle point. The initial conditions on the goodwill lying on the stable subspace
associated to the negative eigenvalue λ1 , given by (17), allow the system to converge
to the steady state as time approaches infinity.
If R1 + kn2 R2 − 2kn R3 − cs2 δ is negative, then both eigenvalues λ1 and λ2 are neg-
ative. Under this assumption, the steady state (Gss ss
n , Gs ) is globally asymptotically
stable. 

Proof of Proposition 3.3 The Hamilton-Jacobi-Bellman (HJB) equation associated

with the retailer’s optimization problem when it takes into account the dynamics of
its own goodwill stock but not that of its competitor, is as follows:

pm
ρVR (Gs , Gn ) = max (pn − w)[Gn − pn + ψn ps ] + (ps − ws )[Gs − ps + ψs pn ]
As
480 J Optim Theory Appl (2008) 137: 465–483
  pm 
cs2 ∂VR
− cs1 + As As + (As − δGs − ks An ) . (40)
2 ∂Gs

The HJB equation associated with the partial myopic manufacturer’s optimization
problem is as follows:
  
pm cn2
ρVM (Gn , Gs ) = max (wn − dn )[Gn − pn + ψn ps ] − cn1 + An An
An 2
pm 
∂VM
+ (Gn , Gs )(An − δGn − kn As ) · · · . (41)
∂Gn

From the optimality conditions, the retailer’s and the manufacturer’s optimal
strategies are given by
 pm 
∗pm 1 ∂VR
As (Gs , Gn ) = (Gs , Gn ) − cs1 , (42)
cs2 ∂Gs
 pm 
∗pm 1 ∂VM
An (Gs , Gn ) = (Gs , Gn ) − cn1 , (43)
cn2 ∂Gn

if there are positive expressions, and zero otherwise.

Inserting the retailer’s optimal strategies, (8), (9), (42), and the manufacturer’s
optimal strategies, (11) and (43) in (40) and (41), the coefficients of the value func-
tions R̃i , M̃j , i = 1, . . . , 6, j = 1, 2, 3, are determined by identification and solve
the following nine algebraic Riccati equations (the first six correspond to the retailer,
whereas the second three correspond to the manufacturer):

a1 R̃1 (−R̃1 + 2cs2 (2δ + ρ)) + 2cs2 = 0, (44)

a1 (−R̃32 + ρcs2 R̃2 ) + 2cs2 = 0, (45)
a1 R̃3 (−R̃1 + (δ + ρ)cs2 ) + (ψn + ψs )cs2 = 0, (46)
a1 [R̃3 (cn2 (cs1 − R̃4 ) − cs2 ks (cn1 − M̃1 )) + cn2 cs2 ρ R̃5 ]
+ cn2 cs2 (ws a2 + w̄n a3 ) = 0, (47)
a1 [R̃1 (cn2 (cs1 − R̃4 ) − cs2 ks (cn1 − M̃1 )) + cn2 cs2 (δ + ρ)R̃4 ]
+ cn2 cs2 (ws a7 − w̄n a2 ) = 0, (48)
2
a12 (−2cs2 ks (cn1 − M̃1 )R̃4 − cn2 (cs1 − R̃4 ) + 2cn2 cs2 ρ R̃6 ) + 2cn2 cs2 a1 a4 w̄n2
− 2cn2 cs2 ws [ws (−a1 a5 + 2ψs (ψn3 − 2ψs3 − ψn (4 + 3ψs2 )))
+ w̄n a4 a6 a1 ] = 0, (49)
a1 M̃1 (kn R̃3 + cs2 (δ + ρ)) + cs2 a3 (dn − w̄n ) = 0, (50)
a1 (kn M̃1 R̃1 + cs2 M̃2 ρ) + cs2 a2 (w̄n − dn ) = 0, (51)
2
a1 [−cs2 (cn1 − M̃1 ) + 2cn2 M̃1 (kn R̃4 − cs1 ) + 2cn2 cs2 ρ M̃3 ]
J Optim Theory Appl (2008) 137: 465–483 481

+ 2cn2 cs2 (w̄n − dn )(−2w̄n a4 + ws a5 a6 ) = 0. (52)

From (44), we can obtain R̃1 as function of the model parameters,


−(2δ + ρ)a1 cs2 ± ((2δ + ρ)a1 cs2 )2 + 8cs2 a1
R̃1 = , (53)
−2a1
where the following condition is assumed to be satisfied in order to have real solutions
of (44):
cs2 a1 (2δ + ρ)2 + 8 < 0.
Note that a1 is negative and therefore, both roots in (53) are positive. Let R̃1 be the
root with the positive sign affecting the square root, and R̃1 the root with the negative
sign.
From (46), we can derive R̃3 as a function of R̃1 ,
cs2 (ψn + ψs )
R̃3 = . (54)
(R̃1 − (δ + ρ)cs2 )a1

The sign of R̃3 is the opposite of the sign of the expression

R̃1 − (δ + ρ)cs2 . (55)

It can be easily shown that R̃3 is positive if R̃1 is chosen. If R̃1 is selected, the
expression (18) is negative (and therefore, R̃3 is positive) if and only if

δ(ρ + δ)cs2 a1 + 2 > 0.

From (45), we can obtain R̃2 as a function of R̃3 ,

a1 R̃32 − 2cs2
R̃2 = .
a1 ρcs2
R2 takes always a positive value.
Equation (50) allows us to write M̃1 as a function of R̃3 ,
a3 cs2 (w̄n − dn )
M̃1 = .
a1 (kn R̃3 + cs2 (δ + ρ))

The sign of M̃1 coincides with the sign of kn R̃3 + cs2 (δ + ρ). Therefore, if R̃3 is
positive, then M̃1 is also positive.
From (48) and (51) we can express the coefficients R̃4 and M̃2 in terms of the
coefficients M̃1 , the R̃1 ,

−cs2 ks (cn1 − M̃1 )R̃1 a1 + cn2 [cs1 R̃1 a1 + cs2 (ws a7 − a2 w̄n )]
R̃4 = ,
cn2 a1 (R̃1 − cs2 (δ + ρ))
cs2 (w̄n − dn )a2 + a1 kn M̃1 R̃1
M̃2 = − .
cs2 ρa1
482 J Optim Theory Appl (2008) 137: 465–483

From (47) we get R̃5 as a function of the coefficients R̃3 , M̃1 , R̃4 ,

a1 R̃3 [cs2 ks (cn1 − M̃1 ) − cn2 (cs1 − R̃4 )] − cn2 cs2 (ws a2 + w̄n a3 )
R̃5 = .
cn2 cs2 a1 ρ

Finally, from (49) and (52) we obtain the expressions of coefficients R̃6 and M̃3
in terms of coefficients M̃1 and R̃4 ,
1 2
R̃6 = {a 2 [cn2 (cs1 − R̃4 ) + 2cs2 ks (cn1 − M̃1 )R̃4 ]
2cn2 cs2 ρa1 1
+ 2cn2 cs2 [−w̄n a4 a1 (w̄n + a6 ws ) + ws2 (−a5 + 2ψs (ψn3 − 2ψs3
− ψn (4 + 3ψs2 )))]},
1
M̃3 = {2cn2 [kn M̃1 a1 (cs1 − R̃4 ) + cs2 (dn − w̄n )(ws a5 a6 − 2w̄n a4 )]
2cn2 cs2 ρa1
2
+ cs2 a1 (cn1 − M̃1 ) } · · · . 

Acknowledgements We wish to thank the six anonymous Reviewers for their constructive com-
ments. The second author’s research is partially supported by MEC and JCYL under projects SEJ2005-
03858/ECON and VA045A06, co-financed by FEDER funds. The third author’s research is supported by
NSERC, Canada.

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