Abstract
This paper studies how the emergence of specialized communication media focused on both high quality contents and high quality advertised products, affects the functioning of a vertically differentiated market. To that end, we formulate a simultaneous game of pricing and targeted advertising with two firms producing different levels of quality. We find that the transition from uniform advertising to targeted advertising can turn a pure vertically differentiated market into a hybrid market which incorporates some features of a monopoly, thus changing the pattern of price competition between the firms. In particular, we show that (1) compared to uniform advertising, targeting leads both firms to always charge higher prices, (2) the increase in prices is more intense in highly competitive (low differentiated) markets, (3) the expected price of the low-quality firm is non-monotonic with the degree of product differentiation, and (4) the low-quality product may be sold at a higher expected price than the high-quality product. We also show that a progressive growth of specialized advertising vehicles leads to a further increase in prices. In addition, more specialized targeting may raise price competition, so firms may find it optimal to use low specialized targeting.
Highlights
The way in which firms promote their products has undergone significant change in recent years
As a result of both the progressive fragmentation of traditional media and the emergence of new and highly specialized communication channels, nowadays advertisers have the possibility of targeting their ads on particular segments of the potential demand, which may change the pattern of price competition between firms
We note that (1) the media industry has recently produced a huge amount of highly specialized communication channels which reach particular audiences with one or more common interests, and (2) these selective segments of potential consumers tend to have a relatively high valuation of the products advertised in these media
Summary
The way in which firms promote their products has undergone significant change in recent years. As a result of both the progressive fragmentation of traditional media (radio, TV, etc.) and the emergence of new and highly specialized communication channels (the Internet, cable TV, specialized press, etc.), nowadays advertisers have the possibility of targeting their ads on particular segments of the potential demand, which may change the pattern of price competition between firms Against this background, it is important to determine how the strategic use of targeted advertising can affect the functioning of a market, and this paper offers a first attempt at analyzing this issue in the context of vertically differentiated products.
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