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http://ssrn.com/abstract=1624708
 
 

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Double Marginalization in Performance-Based Advertising: Implications and Solutions


Chrysanthos Dellarocas


Boston University - Department of Management Information Systems

March 15, 2010

Boston U. School of Management Research Paper No. 2010-19

Abstract:     
An important current trend in advertising is the replacement of traditional pay-per-exposure (pay-per-impression) pricing models with performance-based mechanisms in which advertisers pay only for measurable actions by consumers. Such pay-per-action (PPA) mechanisms are becoming the predominant method of selling advertising on the Internet. Well-known examples include pay-per-click, pay-per-call and pay-per-sale. This work highlights an important, and hitherto unrecognized, side-effect of PPA advertising. I find that, if the prices of advertised goods are endogenously determined by advertisers to maximize profits net of advertising expenses, PPA mechanisms induce firms to distort the prices of their goods (usually upwards) relative to prices that would maximize profits in settings where advertising is sold under pay-per-exposure methods. Upward price distortions reduce both consumer surplus and the joint publisher-advertiser profit, leading to a net reduction in social welfare. They persist in current auction-based PPA mechanisms, such as the ones used by Google and Yahoo. In the latter settings they always reduce publisher revenues relative to pay-per-exposure methods. In extreme cases they also lead to rat-race situations where, in their effort to outbid one another, advertisers raise the prices of their products to the point where demand for them drops to zero. I show that these phenomena constitute a form of double marginalization and discuss a number of enhancements to today's PPA mechanisms that restore equilibrium pricing of advertised goods to efficient levels.

Number of Pages in PDF File: 45

Keywords: performance-based advertising, sponsored search, keyword auctions, double marginalization, mechanism design

JEL Classification: D43, D44, M37

working papers series





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Date posted: June 14, 2010 ; Last revised: October 27, 2012

Suggested Citation

Dellarocas, Chrysanthos, Double Marginalization in Performance-Based Advertising: Implications and Solutions (March 15, 2010). Boston U. School of Management Research Paper No. 2010-19. Available at SSRN: http://ssrn.com/abstract=1624708 or http://dx.doi.org/10.2139/ssrn.1624708

Contact Information

Chrysanthos N. Dellarocas (Contact Author)
Boston University - Department of Management Information Systems ( email )
595 Commonwealth Avenue
Boston, MA 02215
United States
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