Contextual Advertising

This paper studies the strategic aspects of contextual advertising. Such advertising entails the display of relevant ads based on the topic of the content a consumer views and takes advantage of the possibility that consumers’ content browsing preferences are indicative of their product preferences. The results show that contextual targeting impacts advertiser profit in two ways: first, advertising through relevant content topics helps advertisers reach consumers who have strong preferences for their products. Second, heterogeneity in consumers’ content preferences can be leveraged to reduce product market competition, even when consumers are homogeneous in their product preferences. The contextual advertising intermediary’s incentives to strategically design its content structure and the targeting precision are governed by the following forces. When product market competition is high, the intermediary offers homogeneous content and increases its targeting precision. This encourages each advertiser to bid for multiple keywords to preventing its competitors from advertising to the consumers. This may lead to an asymmetric equilibrium where one advertiser monopolizes all the advertising spaces to completely preempt competition. When product market competition is low, the intermediary offers heterogeneous content but intentionally decrease its targeting precision. This encourages each advertiser to bid for multiple advertising spaces in order to reach consumers who prefer its product.