72 • Chapter 2 • The Horizontal Boundaries of the Firm

Small firms can take steps to offset these conditions and nullify purchasing economies. For example, nearly 10,000 independent hardware stores belong to the Ace and True Value purchasing groups. Ace and True Value obtain discounts from suppliers that are comparable to those realized by hardware superstores like Lowe’s and Home Depot. Ace and True Value also operate regional warehouses that hold down inventory costs for their independent retailers.

Sometimes, small firms may have purchasing advantages over large firms. U.S. mail order pharmacies often do not stock a full selection of therapeutically equivalent drugs. For example, a mail order pharmacy may stock either Merck’s Mevacor or Pfizer’s Lipitor but not both (both are statin drugs that can lower LDL cholesterol). This allows the pharmacy to play off Merck against Pfizer to obtain deep discounts. Large pharmacy chains like Walgreens tend to stock a complete line of drugs, which limits their bargaining power and drives up their purchasing costs.

Advertising

The advertising cost per consumer of a product may be expressed by the following formula:

Number of potential consumers Number of potential consumers receiving the message receiving the message

Larger firms may enjoy lower advertising costs per consumer either because they have lower costs of sending messages per potential consumer (the first term) or because they have higher advertising reach (the second term).

Costs of Sending Messages per Potential Consumer

There are important fixed costs associated with placing an ad, including preparation of the ad and negotiation with the broadcaster. If ad preparation costs and the costs of negotiating a single national and local advertising “buy” are about the same, the national advertiser will have a lower cost per potential consumer because these fixed costs get spread over a larger base of potential consumers.

To illustrate, suppose that Anheuser-Busch places an ad in USA Today and pays Gannett (the publisher of USA Today) $10 per thousand papers sold to run this ad. Because USA Today has a daily circulation of about 1.75 million, the direct costs of this ad to Anheuser-Busch would be $10 3 (1,750,000/1000) or $17,500. The same day, Hudepohl, a local brewery in Cincinnati, Ohio, owned by the Schoenling Brewing Company, places an ad in the Cincinnati Enquirer (the local paper) and, let’s say, pays the same rate of $10 per thousand papers sold. The Enquirer has a daily circulation of about 150,000, so the direct cost to Hudepohl would be $10 3 (150,000/1,000) or $1,500. Finally, suppose that for both companies the cost of preparing the ad is $3,500.

Let us now look at the advertising cost per potential consumer for AnheuserBusch and Hudepohl:

•Anheuser-Busch advertising cost per potential consumer ($17,500 $3,500)/ 1,750,000 $.012 per potential consumer, or $12.00 per 1,000 potential consumers.

•Hudepohl advertising cost per potential consumer 5 ($1,500 1 $3,500)/150,000 5 $.033 per potential consumer, or $33.33 per 1000 potential consumers.