Targeted Advertising and Costly Consumer Search

Abstract

We study a model of advertising targeting based on information about the consumer’s likely ranking of products. With horizontally differentiated goods and costly search, ads then convey to consumers a noisy, positive signal of their unknown willingness to pay for the firms’ products. That implies a higher expected willingness to pay for a yet not sampled firm, which increases the incentives to search, but also a lower expected differentiation of the products that the consumers learn about, which reduces the incentives to search. The first effect is more important for lower search costs, and the second for larger number of products. Also, the equilibrium intensity of advertising will affect the precision of consumers’ information. Larger marginal cost of advertising results in larger endogenous segmentation and larger prices.