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This paper explores the implications of market segmentation on firm competitiveness. In contrast to earlier work, here market segmentation is minimal in the sense that it is based on consumer attributes that are completely unrelated to tastes. We show that when the market is comprised by two consumer segments and when there is sufficient variation in the per-consumer costs firms need to incur to access the different consumer populations, then firms obtain positive profits in symmetric equilibrium. Otherwise, the equilibrium is characterized by zero profits. As a result, a minimal form of market segmentation combined with advertising cost asymmetries across consumer segments give firms an opportunity to generate positive rents in an otherwise Bertrand-like environment.

Individuals have unifying characteristics, such as age, gender, mother tongue, profession, sexual orientation, life-style, etc. Often, these characteristics influence individuals' media affinity and, as a result, firms can reach the various groups of buyers by placing advertisements in selected media. Moreover, by choosing advertising strategies appropriately, an individual firm can decide to address its advertisements to just one or, alternatively, more consumer segments at a time. Consider for example consumer segmentation based on mother tongue, like in Belgium. A firm operating in Belgium may want to address only the French-speaking community by inserting commercials in TV channels that broadcast only in French, or by inserting ads in newspapers and magazines written in French. Alternatively, the firm may decide to address only the Dutch-speaking community, or else all the consumers in the market, and proceed accordingly. Since different advertising strategies have distinct costs, the question for a firm is how to market its product optimally in these circumstances. In this paper we explore the implications of consumer segmentation on firms' profits, the distribution of prices and advertising strategies.1 For this purpose, we study a pricing and advertising simultaneous moves game where homogeneous product sellers operate in a market consisting of two consumer segments. Consumers are initially uninformed about the firms' offerings and prices. The key feature of the model is that firms' advertising strategies can be designed to reach the distinct consumer segments or, alternatively, the entire market. Specifically, there are two groups of consumers, groups A and B, of possibly different size. Firms may decide to send their ads to segment A's consumers at a cost ϕA and charge a price pA, or to segment B's ones at a cost ϕB and charge a price pB, or to all consumers at a cost ϕA + ϕB and charge a price p. In this setting, advertising costs should be seen as the cost of providing product and price information to the different consumer groups. Ceteris paribus, a segment is relatively more profitable than another if it has a lower per-consumer advertising cost.

We have examined a strategic game of advertising and pricing between homogeneous product sellers. The objective has been to clarify the role of market segmentation. When sellers operate in a market with a single consumer segment, price competition drives profits down to zero. When the market has two consumer segments instead, and when there are enough differences in per-consumer advertising costs across segments, firms obtain positive profits in equilibrium. As a result, we conclude, market segmentation weakens firm competitiveness. There is empirical evidence which shows that market segmentation helps firms to extract rents, e.g., Raj (1982) and Chakravorty and Nauges (2005). Generally, in these studies products are not homogeneous and therefore it is difficult to distinguishing whether these effects are due to market segmentation or to product differentiation. Our paper shows that a minimal form of market segmentation induces price variation across segments and this variation is inherently linked to the relative profitability of various segments. One of the empirical challenges for future research is to distinguish price variation due to targeting and price variation due to product differentiation. The analysis in this paper is also important for the study of the relationship between market competition and advertising in industries (for a recent study of the US PC industry see Sovinsky-Goeree, 2005). It suggests that not only the volume of advertising matters but also the firms' ability to target ads to distinct groups of consumers. Indeed, for fixed advertising volumes, one should expect greater price-cost margins in markets fairly segmented relative to more integrated markets.