Targeted Advertising and Consumer Inference

The mere fact that consumers are targeted by advertisements can affect their inference about the expected utility of a product. We build a micromodel where multiple firms compete through targeted advertising. Consumers make inferences from targeted advertising about their potential match values 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 more positive inferences about the product category and the firm’s quality. With such improved beliefs, a targeted consumer is more likely to engage in a costly search throughout the category. We find that the increase in consumer search creates an advertising spillover beyond the level of the mere awareness effects of advertising and that firms’ equilibrium level of targeted advertising can be nonmonotonic in targeting accuracy. Additionally, we show that sometimes it can be optimal for firms to relinquish customer data and instead engage in nontargeted advertising. The results provide insights into the tradeoffs between advertising reach and targeting accuracy.