Competition and price discrimination in yellow pages advertising.

RAND Journal of Economics | June 22, 2005 | Busse, Meghan; Rysman, Marc | Copyright

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We examine the effect of competition on second-degree price discrimination in display advertising in

Yellow Pages directories. Our main empirical finding is that while competition is associated with
lower prices, the association is not proportional along the range of product offerings. Instead,
directories that face more competitors offer price schedules that display a greater degree of
curvature than directories facing less competition. This means that purchasers of the largest ads pay
less per ad size relative to purchasers of small ads in more-competitive directories.

1. Introduction

* As a general rule, competition drives down prices. But how much so can be complicated when
firms offer a menu of prices. To the degree that competition affects firms' ability to price
discriminate, competition is likely not only to lower the level of prices, but also to change prices
within a menu relative to one another. This article examines empirically the association between
competition and price discrimination in the market for Yellow Pages advertising.
For several reasons, Yellow Pages advertising is well suited to examining the link between
competition and price discrimination. First, in the great majority of markets, advertising prices vary
nonlinearly with the size of the advertisement purchased, which suggests the possibility of second-
degree price discrimination. (1) Second, Yellow Pages advertising markets vary in competitiveness.
While all markets are served by a telephone company publisher, many markets are also served by a
varying number of independent publishers. Finally, publishers offer a standard range of
advertisements, making products comparable across markets. Our dataset consists of a cross-section
of almost all Yellow Pages directories in the United States in 1997.

We find, as might be expected, that directories that face more competition offer lower price levels
than do less-competitive directories. However, the differences are not uniform across buyers.
Instead, we find that facing more competition is associated with offering proportionally lower prices
per size for the purchase of large advertisements than for small advertisements.

While we focus on documenting these empirical effects, there are several different explanations for
what we observe and we describe them briefly here. (2) Recent theoretical work such as Rochet and
Stole (1999) and Stole (1995) addresses nonlinear pricing under competition and finds that under
some circumstances, prices decline proportionally more at the top of the product range. Also, the
presence of a positive feedback loop between consumer usage and advertising documented in
Rysman (2004) suggests that publishers may discount large advertisements more in order to attract
users. It is also possible that new entrants focus on selling to large advertisers first, which would also
imply our result.

Our article contributes to the growing literature on second-degree price discrimination by

empirically describing the association between competition and the structure of relative prices
within a price schedule. Several previous articles have studied second-degree price discrimination.
Shepard (1991) identifies price discrimination at gas stations that have both self-serve and full-serve
capacity. Ivaldi and Martimort (1994) analyze price schedules for electric utilities in France. Leslie
(2004) considers the welfare implications of nonlinear pricing at a Broadway theater. McManus
(2000), Cohen (2001), Clerides (2002), and Crawford and Shum (2003) all consider monopoly or
oligopoly markets (coffee shops, paper towel manufacturers, book publishers, and cable television
providers, respectively) and show that firms use product quality as a screening device. Nevo and
Wolfram (2002) consider couponing by ready-to-eat cereal producers. Closely related to our article,
Miravete and Roller (2003) take a structural approach to study quantity discounting schemes in
cellular telephone plans. The investigation most similar to ours is in Borenstein (1989), which finds
some evidence that competition affects low fares more than proportionally in airline pricing,
although that is not the main focus of his article. (3)

The remainder of the article proceeds as follows. In Section 2 we describe the Yellow Pages
advertising industry. Section 3 describes the data we use. In Section 4 we describe the identification
strategy we use to test the association between competition and price discrimination. We present
our results in Section 5. Section 6 concludes.

2. Industry characteristics

* The Yellow Pages industry is characterized by competition between small groups of asymmetric
publishers. Most publishers publish directories yearly and distribute them free, one to every phone
line. Utility publishers are associated with a telephone company, either a regional Bell operating
company (RBOC) or an independent local telephone company. Directories published by utility
publishers rarely compete. Most competition is provided by nonutility publishers that differentiate
their books from those published by utilities by choosing different distribution areas and by including
different information or organizing their books in a different way. (4)

As Figure 1 shows, the median household is served by two directories from two separate publishers;
more than 15% of households are served by three or more publishers. Utility directories typically
dominate their markets, both charging higher prices and selling more pages of advertising. The
average price for a double quarter-column advertisement in a utility directory is $1,177, while the
average price in a nonutility directory is $926. Rysman (2004) reports (in a smaller data set) that
telephone company directories are larger in terms of page size and garner substantially more usage.
Rysman (2004) ascribes this asymmetry to consumer preference for utility-published directories and
the presence of a positive feedback loop between advertising and usage. For the purposes of this
article we take the asymmetry among directories as given and analyze the associated prices.

Yellow Pages advertising is particularly important to small local businesses. The categories that users
refer to most frequently are generally served by local businesses, such as auto repair, doctors,
lawyers, and beauty salons. (5) These businesses value Yellow Page advertising because customers
are exposed to it at exactly the time they ate poised to buy. Size, color, placement, and graphic
design all contribute to the effectiveness of a Yellow Pages ad, although industry participants
disagree over which elements generate the greatest return on investment for advertisers.

3. Data

* Our data are compiled from several sources. The centerpieces of the data are prices and
distribution areas for directories. Prices come from the Rate and Data publication of the Yellow
Pages Publishers Association (YPPA), ah industry trade group that represents 95% of the sales in the
industry. These data ate cross-sectional and contain the price for every type of advertisement sold at
every directory published in 1997 whose publisher is a member of the YPPA. Multiple sources in …