Abstract: In this paper, studies the interrelationship between the manufacturer's targeted advertising strategy and the retailer's targeted pricing strategy is studied in a two-echelon distribution channel. The market is segmented into two types of consumers:the ones who have a high valuation for the product and the ones who value the product less. Consumers can be informed about the existence of the product only through the manufacturer's advertising. A four-stage game is modelled:In the first stage, the retailer decides whether to acquire the ability of targeted pricing. In the second stage, the manufacturer decides whether to acquire the ability of targeted advertising and once it owns the targeting capability, it also decides how many customers to advertise to. In the third stage, the manufacturer decides the wholesale price. In the fourth stage, the retailer decides the selling price and if it owns the targeting capability, it can charge different prices toward different consumer segments. Using backward induction method, the equilibrium results including the manufacturer's advertising strategy and the retailer's pricing strategy are derived. It is found that targeted advertising not only saves advertising cost but also helps the manufacturer extract more channel profits, thereby making the retailer worse off. This is because by advertising only to one consumer segment, the manufacturer is able to reduce the heterogeneity among consumers, under which the manufacturer needs not to sacrifice on wholesale price to induce full market coverage. The retailer, on the other hand, can use targeted pricing to extract more consumer surplus. However, the retailer may not enjoy the fruit of targeted pricing due to the manufacturer's free-riding behavior:expecting that the retailer has more pricing flexibility, the manufacturer will raise the wholesale price to appropriate more channel profits. Surprisingly, although harmful, the retailer may still apply targeted pricing to maintain equilibrium. This counter-intuitive finding lies in that targeted pricing can work as a strategic tool to discourage the manufacturer from launching targeted advertising. That is, if the retailer implements targeted pricing, the manufacturer tends to apply uniform advertising that will leave the retailer a fraction of channel profit; while if the retailer does not use targeted pricing, the manufacturer tends to introduce targeted advertising that will leave the retailer zero profit. As a result, the retailer will optimally choose targeted pricing in order to induce uniform advertising.

Key words: targeted advertising, targeted pricing, distribution channel, uniform advertising, uniform pricing