Advertising and Pricing in Markets with Asymmetric Customer Loyalty

Abstract

This paper explores the strategic tradeoff between advertising and pricing when firms have asymmetric loyal market segments and also can compete for shoppers who purchase at the lowest advertised price. Two advertising structures consistent with real world settings are considered. In the first setting firms are limited to advertising campaigns that reach a chosen proportion of the entire market and present all consumers with a uniform price. The analysis is then extended to allow firms to target ads to specific market segments, both with and without the ability to price discriminate. Our model nests other well-known models as special cases and provides novel results. We find that targeted advertising may or may not increase social welfare, while it increases consumer surplus only if the cost of advertising is sufficiently high. In addition, it is possible the firm with the larger loyal segment earns lower profits under targeted rather than uniform advertising. Notwithstanding this, in an extension we show firms have incentive to invest ex-ante in targeting technology, even when they lack the ability to price discriminate.