Imperfect Targeting and Advertising Strategies

Abstract

The ability to successfully target consumers has been substantially affected by recent developments in digital markets, such as improvements in tracking technologies or General Data Protection Regulation. In this paper, we set up a game theoretic model to examine the implications of such changes in targeting success on firms’ targeting strategies and profits. We explicitly consider that firms can target different consumer groups—that is, high- or low-valuation consumers—and that targeting is imperfect—that is, a firm may not reach the intended consumer. We find that a higher targeting success rate has a nonmonotone effect on firms’ profits—that is, lowering profits if targeting is rather imprecise but raising profits if targeting is relatively accurate. If the probability of successful targeting is low, firms target high-valuation consumers (competition for cherries). More fine-tuned targeting then amplifies competition and decreases profits. Instead, if targeting is sufficiently precise, more fine-tuned targeting increases profits because firms segment the market by targeting different consumer groups. Improvements in the targeting ability also have profound effects on the number of products a firm offers and on the profitability of offering products that appeal not only to a single consumer group. First, although increased targeting success raises the attractiveness of introducing an additional product, it also heats up competition. A firm may therefore optimally reduce the number of products it sells if targeting success increases. Second, if products have a broader appeal, market segmentation is more likely to occur. However, aggregate profits are lower compared with when products are narrow. This paper was accepted by Joshua Gans, business strategy. Funding: Financial support from the German Research Foundation [DFG Project 462020252] is gratefully acknowledged. Supplemental Material: The online appendices are available at https://doi.org/10.1287/mnsc.2023.03632 .

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