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This paper presents a monopolistic model of price discrimination
by means of targeted informative advertising. Targeting
is defined as the ability of the firm to direct messages
with different contents to different segments of consumers.
Segmentation is based on different valuations of the firm's
product. The monopolist chooses the level of advertising
for each segment of consumers and discriminates price accordingly.
The paper shows that when targeting is imperfect the monopolist
will over advertise to the highest valuation group of consumers
to the detriment of the lowest valuation group. Only when
targeting is perfect will the seller behave in a socially
desirable manner.
The welfare properties of advertising have been the subject
of an ongoing debate that goes back to Kaldor's (1940) classical
paper. The strand of industrial organization literature
that followed, helped to clarify several concepts such as
those pertaining to the distinction between informative
and persuasive advertising. The seminal paper of Butters
(1977), represented the first successful attempt at modeling
the impact of informative advertising in a context where
all involved agents act in an optimal fashion. He formally
showed that in a monopolistically competitive structure,
if informative advertising was the sole source of information,
and advertisements (ads, for short) were provided in a purely
random fashion to homogeneous consumers, then firms would
select a socially optimal level of advertising. This puzzling
result was confirmed by Stahl (1994) who extended it to
oligopolistic markets and more general advertising technologies.
Variations of Butters' (1977) model such as introduction
of product differentiation (Grossman and Shapiro, 1984),
or heterogeneity among buyers (Stegeman, 1990) were shown
to easily offset this result and helped establish the idea
that increased competition stimulated additional advertising
(the `business stealing effect'), while the inability of
the firm to appropriate the social surplus it generates,
acts as a deterrent to advertising (Tirole, 1988). Thus,
we may opine that with heterogeneous buyers a monopolist
will have an incentive to underprovide informative advertising.
Nowadays, it is more realistic to admit that firms have
an increasing ability to convey their messages to particular
market segments. Indeed, as e-commerce retailing grows and
information technologies advance, firms become increasingly
able to provide specific ads and prices to different types
of customers. Price discrimination by means of targeted
advertising becomes a possibility and the welfare implications
of this new setting is not clear. Research on targeted advertising
and price discrimination is therefore of particular importance.
Although recently some theoretical work has been done on
the role of targeting as a mechanism that can improve the
reach of the firm (Hernandez-Garcia, 1997; Roy, 2000; Esteban
et al., 2001; and Iyer et al., 2005), as far as our knowledge
is concerned there is no analytical research on targeted
advertising and price discrimination.
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