The Risks and Rewards of Targeted Ads

Not long ago, Jiwoong Shin, a professor of marketing at Yale SOM, was on Facebook when he saw an advertisement for heart disease medicine. Had the vast analytic machinery of Zuckerberg’s empire discovered something? Had Facebook flagged risk factors based on Shin’s activities, or age, or gender, or demographics? He searched online, extensively. He had a doctor test his heart. And it struck him that when he sees an advertisement for heart medicine on TV he simply ignores it.

Curious.

In a new paper with Jungju Yu from the City University of Hong Kong, Shin built a model to “formally study how targeting accuracy affects consumers’ inferences” and search behavior about a product marketed to them. In other words, when consumers are targeted with an advertisement, what do they tend to think about the product and what do they go on to do with this information? “Our results can shed important insight into trade-offs between advertising reach and targeting accuracy, a topic of ongoing debate,” Shin and Yu write.

Their model follows three basic steps: first, two firms enter into competition in a product category in which both firms have access to information about whether a given customer is likely to enjoy the product. Second, based on this information, which is imperfect, firms choose which customers to target with advertisements. Third, based on this targeting, consumers make certain inferences about how much they would enjoy the category and whether to engage in a relatively costly search for more information.

Central to Shin and Yu’s findings is the tension between “prominence” and freeriding. On one hand, a company may want to invest heavily in targeted ads and that way quickly gain prominence, meaning it will be the first firm to reach the most relevant new customers. On the other hand, targeted consumers tend to consider categories more favorably — they infer it to be a better fit — and so targeted advertising can actually lead consumers to search out competitors. This counter-pressure implies that companies may want to invest less in targeted advertising and simply freeride off the investment of other companies.|

“For these reasons, the effects of improved targeting capability on the firms’ incentives to engage in targeted advertising are ambiguous,” Shin and Yu write. “This raises interesting questions of whether, and which firms should lead efforts in targeted advertising.”

Ultimately Shin and Wu find that targeted advertising efforts are in a firm’s best interest when the technology and available information are sufficiently accurate, and so consumers make positive inferences about a category. (Facebook’s accuracy, compared to television’s, explains Shin’s response to the heart medication advertisement.) The findings, in short, urge managers to think carefully about how consumers may respond to targeted advertisements — with positive inferences? with further search? — and how these responses may affect competition. Without acknowledging the subtle effect of targeted advertising on consumer spillover, firms may overestimate the value of such advertising.

“If targeting is highly accurate, firms invest in advertising more intensively, which can increase the firms’ profits,” the researchers write. “However, when the accuracy is not sufficiently high, firms can be better off relinquishing customer data and engaging instead in non-targeted advertising.”