Mass versus Direct Advertising and Product Quality

This paper analyzes how the use of mass vs. direct advertising can affect the pattern of price and quality competition in a market where two firms compete with vertically differentiated products. We show that, compared to the case where sellers employ only mass advertising, the use of database advertising based on historical sales records improves the competitive position of the low-quality firms, which achieves a larger market share and can obtain higher profits. As a result, the high-quality firms lowers the supply of quality, which decreases the degree of product differentiation in the market and triggers strong price competition, thus decreasing its profits and increasing consumer surplus. Finally, we show that, although database advertising is more cost-efficient than mass advertising, the market distortion in the provision of quality implies that the use of direct advertising can yield a welfare loss.