Working Paper: CEPR ID: DP18591
Authors: Heiko Karle; Markus Reisinger
Abstract: The ability to successfully target consumers has been substantially affected by recent developments in digital markets, such as improvements in tracking technologies or GDPR regulation. In this paper, we set up a game-theoretic model to examine the implications of such changes in targeting success on firms' targeting strategies and profits. We explicitly consider that firms can target different consumer groups—i.e., high- or low-valuation consumers—and that targeting is imperfect—i.e., a firm may not reach the intended consumer. We find that a higher targeting success rate has a non-monotone effect on firms' profits—i.e., lowering profits if targeting is rather imprecise, but raising profits if targeting is relatively accurate. If the probability of successful targeting is low, firms target high-valuation consumers (competition for cherries). More fine-tuned targeting then amplifies competition and decreases profits. Instead, if targeting is sufficiently precise, more fine-tuned targeting increases profits because firms segment the market by targeting different consumer groups. Improvements in the targeting ability also have profound effects on the number of products a firm offers and on the profitability of offering products that appeal not only to a single consumer group. First, although increased targeting success raises the attractiveness of introducing an additional product, it also heats up competition. A firm may therefore optimally reduce the number of products it sells if targeting success increases. Second, if products have a broader appeal, market segmentation is more likely to occur. However, aggregate profits are lower compared to when products are narrow.
Keywords: targeted advertising; price competition; market segmentation; multi-product firms
JEL Codes: D3; L13; M37
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Higher targeting success rate (C52) | Firms' profits (D21) |
| Low probability of successful targeting (D80) | Targeting high-valuation consumers (D12) |
| Targeting high-valuation consumers (D12) | Increased competition (L13) |
| Increased competition (L13) | Decreased profits (D33) |
| Precise targeting (F12) | Market segmentation (M31) |
| Market segmentation (M31) | Increased profits (D33) |
| Improved targeting (F12) | Reduction in number of products offered (L15) |