CUSTOMER POACHING AND ADVERTISING^*

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.

Pricing with customer recognition

“…In contrast to Chen and Zhang (2009) and Esteves (2009a) where some consumers are captive and others are shoppers, here although consumers have a preference for one of the firms all of them may be induced to switch. If price discrimination is permitted it will only occur when both firms share the market in period 1.…”

“…4 In a recent study Brynjolfsson and Smith (2000b) have found that Amazon customers are willing to pay up to 5-8% more before they consider switching to another seller. 5 Mixed pricing is also obtained in Chen and Zhang (2009) and Esteves (2009a).…”

“…When one firm has information to use price discrimination while the other does not it may happen that some prices rise (see Esteves (2009a)). 23 This no poaching result is a consequence of the two-point distribution of demand, and would not extend to a discrete model with more than two types.…”

“…Another closely related papers are Zhang (2009) andEsteves (2009a). The first, investigates the profitability issue of BBPD in the brand preference approach using a discrete version of the Fudenberg and Tirole (2000) model.…”

“…The equilibrium is in mixed strategies and they show that when only one firm can engage in BBPD both firms can attain higher profits with discrimination. Esteves (2009a) investigates the effects of BBPD in a market where firms need to invest in informative advertising to generate demand. Consumers are initially uninformed about the firms' existence and price.…”