Perfect versus imperfect direct advertising, and market performance

This paper studies how database advertising based on historical sales records affects the functioning of a horizontally-differentiated market under high versus low consumer loyalty. We show that direct advertising can fragment the market into local monopolies. Further, under high consumer loyalty, or under low loyalty and weak product differentiation, the use of the database yields perfect targeting, i.e. monopoly pricing does not generate quantity distortions and all informed consumers buy a product. By contrast, low consumer loyalty and high product differentiation yields imperfect targeting, i.e. there are quantity distortions and some informed consumers do not buy any product. We find that, compared to the case where firms can use only the mass media, when targeting is perfect, price competition yields an intertemporal transfer of market power and, although the impact of database advertising on profits and consumer surplus is ambiguous, it is always welfare improving. However, when targeting is imperfect, sellers charge lower intertemporal prices, which strongly benefit consumers, but the level of profits decreases, and we prove that the use of a more cost-efficient advertising technology can lead to a welfare loss.