Pricing with Endogenous Direct Advertising
in a Monopoly
LOLA ESTEBAN, AGUSTI
N GIL and JOSE
Departamento de Ana
mico, Facultad de Econo
micas, University of Zaragoza, Gran
ıa 2, 50.005 Zaragoza, Spain
Abstract. This paper develops a model of informative advertising in which a ﬁrm builds a
database using its historical sales records in order to directly target ads on those consumers
who have a high probability of purchasing its products. We show that the ﬁrm can use this
type of direct advertising as a screening mechanism to identify high demand consumers. As
a result, direct advertising can work essentially as a device to increase a ﬁrm’s monopoly
power. From a social point of view, this implies that the transition from traditional mass-
advertising to direct advertising can generate a trade-oﬀ between higher advertising eﬃ-
ciency and greater monopoly power. We compute the model to shed light on the relative
strength of these two forces, and ﬁnd that while direct advertising might have a substantial
negative impact on consumers, this advertising technology can only occasionally reduce
Key words: Direct advertising, informative advertising, monopoly, price discrimination.
JEL Classiﬁcations: D42, L12, M37.
The way in which ﬁrms promote their products has undergone signiﬁcant
change over recent years, as a consequence of the move from the gener-
alized use of mass media to more personalized marketing techniques. This
phenomenon can be explained by reference to the dramatic improvements
in computer technology, which have helped ﬁrms to develop bigger, more
complex databases containing vast amounts of information on consumers.
On the basis of this information, ﬁrms can now track good customers
and establish direct contact through the mail, telephone etc., thereby
increasing the eﬀectiveness of promotional expenditures. As a result, direct
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Review of Industrial Organization 25: 129–154, 2004.
Ó 2004 Kluwer Academic Publishers. Printed in the Netherlands.