Advertising and price targeting on the Hotelling line

We study two types of targeting in this paper, exogenous targeting and endogenous targeting. By exogenous targeting we mean targeting by product preferences: advertising levels and prices geared to specific consumer preferences. Exogenous targeting presumes observability of consumer preferences (or of factors correlated with them). This is the sort of targeting that is much in the news in contemporary media, and is also the subject of a recent academic literature, e.g., Chen and Iyer (2002), Iyer et al. (2005). By endogenous targeting we mean the subtler, covert targeting that happens naturally, when firms choose different levels of awareness advertising, and optionally follow that up with randomized prices (McAfee 1994, Fershtman 1993, Boyer and Moreaux 1999). This kind of targeting can happen even when firms are not exogenously targeting anyone. In this paper we examine how these two types of targeting play out along the Hotelling line. We show that exogenous targeting of consumers with a stronger preference for your brand generally entails advertising more and pricing higher; endogenously, this enables the stronger brand to target its “loyalists” while the weaker brand targets “switchers.” In general, endogenous targeting creates differentiation, even among homogeneous consumers, while exogenous targeting vitiates it, even among heterogeneous consumers. The targeting strategy game has the characteristics of a Prisoners’ Dilemma when exogenous targeting costs are low: while each firm would prefer that neither did any exogenous targeting, the only equilibrium involves both firms doing full targeting, and being worse off as a result (both individually and collectively).