Informative Advertising with Discretionary Search

We consider a model of strategic information transmission in which a firm can communicate its quality to consumers through informative advertising. Our main result is that informative advertising claims can be credible even when the firm faces consumers with ex ante homogeneous preferences. A fundamental assumption of our model is that whether the product is available for purchase is independent of consumers’ information acquisition efforts (i.e., search is discretionary). This assumption, in conjunction with the pricing problem of the firm, provides incentives for truth-telling. When quality is common knowledge, increases in quality lead to a higher market price. However, firm profit and consumer welfare are non-monotonic in product quality. The firm may be worse off with a better product because of increased consumer search and resulting preference heterogeneity. Consumers may also become worse off with a higher quality product when the option value of searching is low because in this case the firm raises price quickly in order to target consumers who do not search. Finally, when product quality is unknown but credible information is available, consumers become worse off with the probability of facing a high type firm because this firm is able to extract value from trade most effectively. ∗Respectively, Stanford University, Graduate School of Business, 655 Knight Way, Stanford CA, 94305, USA, [email protected] and CUHK Business School, Chinese University of Hong Kong, Shatin, Hong Kong, China, [email protected].