Specialized advertising and price competition in vertically differentiated markets

This paper studies how the emergence of specialized communication media focused on both high quality contents and high quality advertised products, affects the functioning of a vertically differentiated market. To that end, we formulate a simultaneous game of pricing and targeted advertising with two firms producing different levels of quality. We find that the transition from uniform advertising to targeted advertising can turn a pure vertically differentiated market into a hybrid market which incorporates some features of a monopoly, thus changing the pattern of price competition between the firms. In particular, we show that (1) compared to uniform advertising, targeting leads both firms to always charge higher prices, (2) the increase in prices is more intense in highly competitive (low differentiated) markets, (3) the expected price of the low-quality firm is non-monotonic with the degree of product differentiation, and (4) the low-quality product may be sold at a higher expected price than the high-quality product. We also show that a progressive growth of specialized advertising vehicles leads to a further increase in prices. In addition, more specialized targeting may raise price competition, so firms may find it optimal to use low specialized targeting.