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.