Targeted advertising, platform competition, and privacy

• Author: Gijsbert Zwart,Henk Kox,Bas Straathof
• Published date: 01 September 2017
• Date: 01 September 2017
• DOI: http://doi.org/10.1111/jems.12200

Received: 2 November2015 Revised: 14 November2016 Accepted: 30 November 2016

DOI: 10.1111/jems.12200

ORIGINAL ARTICLE

Targeted advertising, platform competition, and privacy

Henk Kox1,2 Bas Straathof1Gijsbert Zwart3

1CPB Netherlands Bureau forEconomic

Policy Analysis(Email: hlmk@kvl-epr.eu;

s.m.straathof@cpb.nl)

2KVL Economic Policy Research,Den Bosch,

The Netherlands

3Universityof Groningen, The Nether-

lands and TILEC, Tilburg University

(Email: g.t.j.zwart@rug.nl)

Abstract

Targeted advertising can benefit consumers through lower prices for access to web

sites. Yet, if consumers dislike that web sites collect their personal information, their

welfare may go down. We study competition for consumers between web sites that

can show targeted advertisements. We find that more targeting increases competition

and reduces the web sites’ profits, but yet in equilibrium web sites choose maximum

targeting as they cannot credibly commit to low targeting. A privacy protection pol-

icy can be beneficial for both consumers and web sites. If consumers are heteroge-

neous in their concerns for privacy, a policy that allows choice between two levels

of privacy will be better. Optimal privacy protection takes into account that the more

intense competition on the high-targeting market segment also benefits consumers

on the less competitive segment. Consumer surplus is maximized by allowing them

a choice between a high-targeting regime and a low-targeting regime which affords

more privacy.

1INTRODUCTION

In 2015, Internet advertising revenues in the United States for the first time exceeded17 billion dollars per quar ter. The share of

Internet advertising has been rising steadily, currently totaling a third of total U.S. advertising revenues, and almost equals that

of broadcast television.1

Internet advertising allows for more precise targeting, compared to traditional media.2Whereas a televisioncommercial will

be the same for all those watching a particular show, and therefore tailored to consumers’ average interests conditional on their

watching the show, the Internet allows targeting on each individual’s specific characteristics.

Targeting of advertisements is valuableto advertisers as it increases the probability that the advertisement leads to a purchase.

This is also reflected in pricing schemes, which are increasingly based on click-through rates or other performance measures,

rather than mere numbers of viewers. A web site that can target its advertisements better will collect higher per-viewer revenues

from advertisers, which may be partly reflected in lowersubscr iption prices (if present) or higher quality to attract more visitors.

The advantages of targeting for advertisers induce firms to collect personal information on their consumers. Personal infor-

mation used for targeting includes keywords entered in search engines, recent browsing history, previous Web purchases, or

even the topics in their e-mails. Web companies such as Axciom or Bluekai collect information on individuals’ Web behavior

and use that to categorize consumers into profiles, which they then sell on to advertising sites.3

Better targeting has a potential drawbackfor consumers: consumers may care about the associated loss of privacy. Consumers

have limited possibilities to verify what kind of personal information firms collect and how they use this information. Howwell

do firms protect personal information against theft or manipulation by criminals? Do firms use personal information to raise

We are grateful to Paul Westrafor research assistance. We thank Susan Athey, Leon Bettendorf, Michiel Bijlsma, Marco Haan, Marielle Non, and Ryannevan

Dalen for comments and discussions.

J Econ Manage Strat. 2017;26:557–570. © 2017 WileyPeriodicals, Inc. 557wileyonlinelibrary.com/journal/jems