Michael Arnold, Eric Schmidbauer, and Lan Zhang
We model optimal firm pricing and advertising intensity strategies under both uniform and targeted advertising regimes in a duopoly market in which firms have asymmetric loyal market shares and must engage in costly informative advertising to attract customers. In addition to loyal customers who only purchase from their preferred firm, there are shoppers who purchase at the lowest advertised price. Under uniform advertising, prices are communicated to the entire market while under targeted advertising the firm can limit advertising to its own loyal customers or to its loyal customers and the shoppers. Our main results explore the strategic trade-off between advertising intensity and price competition and demonstrate how optimal firm pricing, advertising strategies, and equilibrium outcomes differ with the relative size of a firm’s loyal market and with the advertising regime. We also show that targeted advertising may or may not increase social welfare, and that it increases consumer surplus only if the cost of advertising is sufficiently high. In addition, it is possible that the firm with the larger loyal market earns lower profits under targeted rather than uniform advertising. Notwithstanding this, in an extension we show firms generally have an incentive to invest ex-ante in targeting technology.