Optimal targeting with entry

Abstract

We study an advertising agency's optimal choice of targeting technology with endogenous market structure, namely, when targeting changes firms' entry strategies into the advertising and product market. We show that the advertising agency faces a trade-off between demand-expansion and profit-dissipation: The former arises as targeting induces more entry and increases the demand for advertising; the latter refers to that targeting relaxes competition by inducing more differentiation. We show that perfect targeting is not optimal for the advertising agency. Compared to social optimum, the advertising agency underinvests in targeting when investment cost is low and overinvests when targeting is costly. JEL Codes: L1; L8; M3286 LIU These two observations determine the incentive to invest in targeting for the advertising agency. Specifically, a better targeting technology affects the profit of the advertising agency in three ways. First, it induces more entry (the entrant is more likely to enter) and thus increases the profit, which is a demand-expansion effect. Second, it induces more entry with niche product, when the entrant could have entered with a general product. This is a competition-relaxing effect: LIU David Zvilichovsky, and participants at seminars and conferences in Toulouse, Liège, Mannheim, Würzburg, Paris, and Paderborn for useful comments. All remaining errors are mine. ORCID Xingyi Liu