CUSTOMER POACHING AND ADVERTISING

Authors


  • *An earlier version of this paper was awarded the EARIE 2006 Young Economist Essay Award. I am extremely grateful to Mark Armstrong, Francisco Cruz, Paul Klemperer, Robin Mason, Emmanuel Petrakis, Alberto Pinto and Odd Straume. Thanks are also due to the Editor and two anonymous referees who provided constructive comments and suggestions. Financial support from the Portuguese Science Foundation is gratefully acknowledged. Any errors are my own.

Abstract

This paper is a first look at the dynamic effects of customer poaching in homogeneous product markets, where firms need to invest in advertising to generate awareness. When a firm is able to recognize customers with different purchasing histories, it may send them targeted advertisements with different prices. It is shown that only the firm which advertises the highest price in the first period will engage in price discrimination, a practice that clearly benefits the discriminating firm. This poaching gives rise to ‘the race for discrimination effect,’ through which price discrimination may act actually to soften price competition rather than intensify it. As a result, all firms may become better off, even when only one of them can engage in price discrimination. This paper offers a first attempt to evaluate the effects of price discrimination on the efficiency properties of advertising. In markets with low or no advertising costs, allowing firms to price discriminate leads them to provide too little advertising, which is not good for consumers and overall welfare. Only in markets with high advertising costs, might firms overadvertise. Regarding the welfare effects, price discrimination is generally bad for welfare and consumer surplus, though good for firms.

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