Direct advertising and opt-in provisions: Policy and market implications

Abstract

This paper formulates a game of pricing and informative advertising with horizontally-differentiated products in which two firms, first, compete with mass advertising and, later, build a database using their historical sales records and compete by targeting the ads to their potential customers. We study market interaction under two types of direct advertising: opt-in advertising, where firms ask consumers for their consent to send them ads with information about new products, and direct advertising without permission, where sellers use consumer contact information without their explicit consent. We show that, compared to the case where firms only use mass media, the use of direct ads (with or without permission) results in an intertemporal reallocation of market power from the first to the second period and that, compared to opt-in advertising, direct advertising without permission results in lower or equal prices. We also evaluate the impact of a regulatory policy aimed at protecting consumer privacy by banning the use of direct advertising without permission in favor of opt-in advertising. We find that this policy lowers social welfare and, if the degree of product differentiation is sufficiently high (vs. low), it does not affect (vs. lowers) firm profits and lowers (vs. increases) consumer surplus.