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The Impact of Performance-Based Advertising on the Prices of Advertised Goods

57 Pages Posted: 16 Oct 2009 Last revised: 27 Oct 2012

Chrysanthos Dellarocas

Boston University, Questrom School of Business - Department of Information Systems

Date Written: August 7, 2009

Abstract

An important current trend in advertising is the replacement of traditional pay-per-exposure (aka pay-per-impression) pricing models with performance based mechanisms in which advertisers pay only for measurable actions by consumers. Such pay-per-action 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 pay-per-action advertising. I find that, if the prices of advertised goods are endogenously determined by advertisers to maximize profits net of advertising expenses, pay-per-action mechanisms induce firms to distort the prices of their goods (usually upwards) relative to the prices that would maximize profits in settings where advertising is sold under pay-per-exposure methods. Upward price distortions reduce consumer surplus and one or both of advertiser profits and publisher revenues, leading to a net reduction in social welfare. They persist in current quality-weighted pay-per-action schemes, such as the ones used by Google and Yahoo. In the latter settings they always reduce publisher revenues relative to pay-per-exposure methods. I propose enhancements to today’s quality-weighted pay-per-action schemes that resolve these problems and show that the steady state limit of my enhanced mechanisms has identical allocation and revenue properties to those of an optimal pay-per-exposure mechanism.

Keywords: online advertising, pay-per-action, keyword auctions, game theory

JEL Classification: M37, D44

Suggested Citation

Dellarocas, Chrysanthos, The Impact of Performance-Based Advertising on the Prices of Advertised Goods (August 7, 2009). Boston U. School of Management Research Paper No. 2009-12. Available at SSRN: https://ssrn.com/abstract=1489599 or http://dx.doi.org/10.2139/ssrn.1489599

Chrysanthos N. Dellarocas (Contact Author)

Boston University, Questrom School of Business - Department of Information Systems ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States

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