Optimal advertising outsourcing strategy with different effort levels and uncertain demand

Abstract

This paper studies the issue of advertising outsourcing and production planning for a manufacturer facing asymmetric advertising cost and uncertain market demand. To improve product sales, a manufacturer would hire an advertising agency to provide professional service on product advertising before the production takes place. A contract taking into account both advertising effort level and payment is introduced to incentivize the advertising agency to report the exact cost to the manufacturer. Furthermore, a model with the goal of maximising the manufacturer's net profit is proposed, in which both product demand and payment to the advertising agency are affected by the advertising effort level. Analytical solutions of the optimal strategies including the optimal advertising effort level and the optimal payment to the advertising agency are derived. Optimal retail price and the optimal production quantity are also obtained for the manufacturer in making managerial decisions.

Keywords:

• production
• advertising outsourcing
• principal-agent problem
• revelation principle
• uncertain demand

Acknowledgments

The authors would like to thank the two anonymous reviewers and the editor for their helpful comments and constructive suggestions. The extended abstract of the paper has been accepted for presentation in 2016 International Congress on Banking, Economics, Finance, and Business, 24–26 June 2016, Sapporo, Japan.

Disclosure statement

No potential conflict of interest was reported by the authors.

Supplemental data

Supplemental data for this article can be accessed at https://doi.org/10.1080/00207543.2019.1641235.

Additional information

Funding

This research work was supported by Research Grants Council of Hong Kong [grant numbers 17301214 and 15210815], National Natural Science Foundation of China [grant numbers 11671158, 71701032 and 71603238], Zhejiang Provincial Natural Science Foundation of China [grant number LQ19G010002], IMR and RAE Research Fund, Faculty of Science, The University of Hong Kong, and a grant from the Department of ISE, the Hong Kong Polytechnic University H-45-35-ZG3K.