41 Pages Posted: 2 Feb 2011
Date Written: February 1, 2011
This paper studies the strategic aspects of contextual advertising. Contextual advertising entails the display of relevant ads based on the content that a consumer views and exploits the possibility that consumers' content preferences are indicative of their product preferences. The results show that contextual targeting impacts advertiser profits in two ways: first, advertising through relevant content topics helps advertisers reach consumers who have strong preferences for their products. Second, heterogeneity in consumers' content preferences can be leveraged to reduce product market competition, even when consumers are relatively homogeneous in their product preferences. The intermediary offering contextual advertising has the following incentives to strategically design its content structure and its targeting precision: (1) When product market competition is high, the intermediary offers homogeneous content and increases its targeting precision. This encourages the advertisers to bid for multiple content topics in order to prevent their competitors from advertising to the consumers, potentially leading to one advertiser preempting competition by monopolizing all the advertising space. (2) When product market competition is low, the intermediary offers heterogeneous content and intentionally decreases its targeting precision. This encourages the advertisers to bid for multiple advertising slots in order to reach consumers who prefer their product.
Keywords: Contextual Advertising, Targeting, Competition, Game Theory
JEL Classification: c70, d83, m31, m37, o14
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