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Prof. Jiwoong Shin
Professor of Marketing
School of Management
Yale University

ABSTRACT

We study an advertiser’s optimal targeting strategy and its implications for the consumer’s data privacy choices, both of which determine the advertiser’s targeting accuracy. When consumers are uncertain about their preferences, an ad targeted to a consumer carries an implicit message: an algorithm predicts that the product matches her preferences. This implicit recommendation influences the consumer’s beliefs and purchase decision but also introduces misaligned incentives; the advertiser may want to exploit the consumer’s beliefs by sending ads even to the wrong consumers predicted to have a bad match with the product. As the prediction accuracy improves, the consumer makes stronger inferences from targeted ads but so does the firm’s incentives to engage in mistargeting. Thus, under exogenous price, as the advertiser’s prediction becomes more accurate, the advertiser adopts a less precise targeted advertising strategy. Even if the prediction is perfect, the advertiser intentionally targets the wrong consumers, some of whom unknowingly purchase the product of a bad match. Despite the negative consequences, the consumer surplus can remain positive because the advertiser can better identify consumers with a good fit for the product, and thus consumers do not withhold information from the firm. In contrast, under endogenous price, a better prediction leads to a more targeted advertising strategy, although mistargeting persists. To better exploit the recommendation effect of advertising, the advertiser raises its price instead of diluting its recommendation power. The higher price leads to lower consumer welfare, which sometimes induces consumers to opt-out of data collection.