EXPRESS: Why are products so similar despite diverse consumer needs? The interplay between advertising and horizontal product differentiation

Firms are often less differentiated than standard price-competition models predict. We explain this gap by showing how firms can use informative or reminder advertising to soften competition. When firms choose locations, advertising, and prices endogenously, they may choose to soften price competition through limited advertising rather than greater product differentiation, allowing them to locate closer together while limiting price competition. This outcome of low advertising and central collocation is especially likely when advertising costs are high. We also observe that partially-differentiated equilibria, with one firm locating centrally and the other at an edge, and full differentiation, can each emerge under certain conditions. Thus, firms endogenously choose a mix of advertising and product differentiation to moderate price competition. Further, the shape of travel costs influences the equilibrium outcome. If the disutility from distance is highly convex, such as occurs when consumer preferences exhibit satisficing, central collocation becomes the unique equilibrium when more consumers are concentrated at the edge locations. However, when the disutility from distance is linear, having more customers located towards the edge locations makes collocation less likely. Overall, the interaction of advertising costs, consumer preferences, and location choices help explain why firms often forgo product differentiation.