Targeted Advertising: How Do Consumers Make Inferences?

DSA ADA Course - 2021


Using increasingly granular customer data, firms have improved their targeting capabilities to proactively reach customers who are not even aware of their needs or wants for the product. The mere fact that consumers get targeted by firm’s advertising can influence their inference about unknown utility from a product. We build a micro-model in which multiple firms compete through targeted advertising, and consumers make inferences from targeted advertising about their unknown match value for the product category, as well as the advertising firm’s unobserved quality. We show that in equilibrium, upon being targeted by a firm, consumers make optimistic inferences about the product category, as well as the quality of the firm. So, With the improved beliefs, a targeted consumer may be more likely to engage in costly search throughout the category. We find that this increase in consumer search creates advertising spillover and firms’ equilibrium amount of targeted advertising can be non-monotonic in the targeting accuracy. Therefore, consumer search can mitigate competition in targeted advertising. We show that, without consumer search, advertising competition intensifies significantly that it can be optimal for firms to relinquish the customer data, and instead engage in non-targeted advertising. The results provide insights into trade-offs between advertising reach and targeting precision.

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