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Using cointegration analysis for modeling marketing interactions in dynamic environments: methodological issues and an empirical illustration

Using cointegration analysis for modeling marketing interactions in dynamic environments: methodological issues and an empirical illustration

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Using cointegration analysis for modeling marketing interactions indynamic environments: methodological issues and an empirical illustration
Rajdeep Grewal
*, Jeffrey A. Mills
, Raj Mehta
, Sudesh Mujumdar 
 Department of Marketing, Washington State University, Pullman, WA, 99164-4730 USA
University of Cincinnati, Cincinnati, OH, USA
Received 6 June 1999; accepted 2 February 2000
The authors argue that cointegration analysis is an intriguing development for analyzing marketing interactions in dynamic environments.Methodologically, the use of cointegration analysis requires statistical tests to determine whether this technique is appropriate for the systemunder investigation and, if it is appropriate, other statistical tests are needed to interpret the results. The authors collate a set of statistical testsand techniques to advance a comprehensive methodological framework that utilizes cointegration analysis to examine marketing interactionsin dynamic environments. The framework is useful for analyzing marketing parameter functions with time-varying coefficients to investigatethe relationship between market performance (e.g., sales, market share), marketing effort (e.g., advertising, sales promotion), andenvironmental conditions (e.g., market growth, inflation). The authors illustrate the utility of the framework for the famous case of LydiaPinkham Medicine Company (LPMC).
2000 Elsevier Science Inc. All rights reserved.
Cointegration analysis; Marketing interactions; Dynamic environments; Lydia Pinkham Medicine Company
1. Introduction
At the nucleus of marketing research and theorizing, liemarketing interactions. Marketing interaction mechanismsdetermine the relationship between marketing performance(e.g., sales, market share), marketing effort (e.g., advertis-ing, personal selling), and environmental conditions (e.g.,growth rate, competitive activities). Typically, researchersuse market response models to investigate marketing inter-actions in order to examine the behavior of markets and predict the impact of marketing actions (Hanssens et al.,1990; Leone, 1995). Given the importance of marketinginteractions, scholars have proposed various methodologicalframeworks to model these interactions (cf., Wildt andWiner, 1983; Gatignon and Hanssens, 1987). Recent meth-odological advances in econometrics concerning cointegra-tion analysis provide a new technique to analyze theseinteractions. In this paper, we utilize recent advances ineconometrics concerning cointegration analysis to illustratea framework for analyzing marketing interactions.Since the path breaking paper by Granger (1981) and thesubsequent conceptual and methodological developments by Engle and Granger (1987), cointegration analysis has become an integral part of non-stationary time series ana-lysis. Murray (1994) provided an intuitive explanation of cointegration. Murray (1994) uses the analogy of a drunkardwalking her dog to explain the notion of cointegration. Thedrunk and her dog wander aimlessly, but make sure that theyhave an eye on each other and do not separate by more thana certain distance. Thus, even though both of them do not know where they are going, they do know that they aregoing together. In a way, the drunk and her dog arecointegrated. Formally speaking, two or more non-station-ary variables, which are integrated of the same order, arecointegrated if there exists a linear combination of thesevariables that is stationary. Specifically, cointegration ana-lysis involves time series data and multi-equation time seriesmodels, allowing for systematic and random parametevariation, with two or more variables.Marketing researchers have used multi-equation timeseries models to investigate various phenomena. For exam- ple, such models have been used to study the interaction between the structure of marketing function (brand vs.category management) and competition (cf., Zenor, 1994;
* Corresponding author. Tel.: +1-509-335-5848; fax: +1-509-335-3865.
 E-mail address
: grewal@wsunix.wsu.edu (R. Grewal).0148-2963/01/$ ± see front matter 
2000 Elsevier Science Inc. All rights reserved.PII: S0148-2963(99)00054-5Journal of Business Research 51 (2001) 127±144
Curry et al., 1995); advertising and price sensitivity (cf.,Eskin and Baron, 1977; Krishnamurthi and Raj, 1985);advertising, temperature, price, and consumer expenditure(Franses, 1991); advertising, price sensitivity, and competi-tive reaction (Gatignon, 1984); advertising and product quality (Kuehn, 1962); advertising and product availability(Kuehn, 1962; Parsons, 1974); advertising competition(Erickson, 1995); advertising expenditure and advertisingmedium (Prasad and Ring, 1976); advertising and prior sales person contact (Swinyard and Ray, 1977); advertisingand personal selling (Carroll et al., 1985); competitive behavior (Hanssens, 1980b); sales force effectiveness andenvironmental hostility (Gatignon and Hanssens, 1987);integrated marketing communications (cf., Beard 1996;Hutton, 1996); persistence modeling (Dekimpe and Hans-sens, 1995a,b); and consumer confidence (Kumar et al.,1995) among others.In most cases, conventional multi-equation time seriesanalysis involves the use of Vector Autoregressive (VAR)models with two or more stationary variables (cf. Hamil-ton, 1994; Enders, 1995). Typically, one differences non-stationary difference variables to make them stationaryand then uses them in a VAR model to investigateunderlying data generation mechanisms (cf., Curry et al.,1995; Dekimpe and Hanssens, 1995b). Differencing non-stationary variables results in loss of information (cf.,Enders, 1995). Cointegration analysis provides a metho-dology for analyzing non-stationary variables, without making them stationary, thereby preventing loss of infor-mation due to differencing.Examples of marketing systems with non-stationaryvariables, which are related to each other and, thus, would benefit from cointegration analysis are plentiful. For in-stance, in a typical diffusion of innovation setting, where anew product is replacing an existing product, the sales of these two products, promotion and advertising spending,along with sales of competing products, are likely to movetogether and thereby be cointegrated. In addition, cointegra-tion analysis is a useful tool to examine sales force effec-tiveness (cf., Gatignon and Hanssens, 1987) and inunderstanding the implications of various pricing decisionsand strategies on marketing performance (cf., Curry, 1993).These explications for application of cointegration analysisin marketing are by no means exhaustive and are meant asmere illustrations of the usefulness of cointegration analysisin investigating marketing interactions.Marketing researchers are just beginning to use coin-tegration analysis to study marketing interactions. Specifi-cally, a couple of studies (Baghestani, 1991; Zanias, 1994)examine the advertising±sales relationship and Franses(1994) has studied the sales of new products. These studiesand our illustrations demonstrate the utility of cointegrationanalysis; however, the intricate nature of theoretical re-search on cointegration limits its use. Our primary objec-tive is to summarize theoretical cointegration literature tofacilitate its use by marketing scholars. Utilizing cointegra-tion analysis requires that all data series under investigationto be integrated of the same order, which implies that onehas to perform statistical tests on the data series under investigation to make sure that the system under investiga-tion is suitable for cointegration analysis. In addition,drawing conclusions from the estimation results of coin-tegration analysis requires more statistical tests. The mainobjective of this article is to demonstrate a comprehensivemethodological framework for analyzing multi-equationtime series data using cointegration analysis. Such a frame-work is of considerable interest to both marketing scientistsand marketing managers, as better understanding of mar-keting interactions is of interest to both parties. Both areinterested in marketing interactions because they want toknow what drives marketing performance. Our framework  provides both parties with tools and a systematic method tostudy these interactions. Further, a comprehensive andconsistent framework makes it easy to identify unifying principles that aid in empirical generalization and advance-ment of marketing science (cf., Bass, 1993, 1995; Bass andWind, 1995). Finally, such a framework would be usefulfor pedagogic exposition.To achieve our objectives, we survey recent develop-ments in the econometrics and time series literature tocollate a set of statistical tests and estimation techniques,which are useful in exploration of marketing interactions.
Based on our literature review, we illustrate the usefulnessof cointegration analysis in marketing and provide therationale for expecting specific type of behavior fromvarious marketing variables. Furthermore, we demonstratethe proposed framework to model marketing interactionsfor the famous case of Lydia Pinkham Medicine Com- pany (LPMC).
2. Methodological framework and conceptualunderpinnings
Marketing interactions, by their very definition, implythat interactions among several marketing effort variables,along with their interaction with environmental variables,determine marketing performance. Further, when firms takedecisions concerning marketing effort, they may take mar-keting performance into consideration. In addition, environ-ment interacts with both performance and effort to further complicate matters. For example, the time of the year andadvertising expenditure in the previous month together determine sales which in turn determines advertising ex- penditure this month which in turn influences sales. Multi-equation modeling helps in capturing this dynamic behavior 
We choose the statistical tests that in our opinion are most appropriate. We do not claim that these are the only or universally the best statistical tests for the purpose. Our objective is to provide andillustrate the steps of our framework and not to determine the goodness of one test vis-a-vis another.
 R. Grewal et al. / Journal of Business Research 51 (2001) 127±144
in the market place. In Appendix A, we present a typicalmulti-equation model, which captures the dynamics of marketing interactions.To capture marketing interactions in a cointegrationframework, we propose a nine-step framework to investi-gate the complex system represented in the two equationswe present in Appendix A (Fig. 1). In the first four steps of the framework, i.e., unit root test, structural break test, unit roots with structural tests, and reconciling the results fromthe two unit root tests, we are concerned with determiningthe data generation process of each individual variables.Uncovering these aspects of the data generating mechan-isms, provides information whether the variables beingstudied are suitable for cointegration analysis or not. Sub-sequently, in the next two tests, i.e., cointegration test andestimation techniques, we use the results from the first four steps to model the interactions between environment, effort,and performance variables. Finally, in the final three steps,i.e., Granger causality, variance decomposition, and impulseresponse functions (IRFs), we use the inputs from thecointegration results to uncover interrelationships betweenthe variables under investigation. In the remainder of this
Fig. 1. Methodological framework.
 R. Grewal et al. / Journal of Business Research 51 (2001) 127±144

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