Vertical Differentiation and a Comparison of Online Advertising Models

Lin, M., X. Ke, ad A. B. Whinston, "Vertical Differentiation and a Comparison of Online Advertising Models," Journal of Management Information Systems, 29(1), summer 2012, pp. 195-236.

47 Pages Posted: 14 Sep 2010 Last revised: 22 Jun 2014

See all articles by Mei Lin

Mei Lin

Singapore Management University

Xuqing Ke

University of Texas at Austin

Andrew B. Whinston

University of Texas at Austin - Department of Information, Risk and Operations Management

Date Written: August 21, 2010

Abstract

Designing business models that take into consideration the role of advertising support is critical to the success of online services. In this paper, we address the challenges of these business model strategies and compare different ad revenue models. We use game theory to model vertical differentiation in both monopoly and duopoly settings, in which online service providers may offer an ad-free service, an ad-supported service, or a combination of these services. Offering both ad-free and ad-supported services is the optimal strategy for a monopolist, because ad revenues compensate for the cannibalistic effect of vertical differentiation. In a duopoly equilibrium, exactly one firm offers both services, when the ad revenue rate is sufficiently high. Furthermore, we find that a higher ad revenue rate may lead to lower service prices. Consistent across both monopoly and duopoly settings, such price reductions are more severe in the cost-per-thousand-impressions (CPM) model than in the cost-per-click (CPC) model. Our findings emphasize the role of advertising revenues in vertical differentiation and offer strategic guidance for monetizing online services.

Keywords: Vertical differentiation, ad-supported business models, online advertising, game theory, economic analysis, e-commerce

Suggested Citation

Lin, Mei and Ke, Xuqing and Whinston, Andrew B., Vertical Differentiation and a Comparison of Online Advertising Models (August 21, 2010). Lin, M., X. Ke, ad A. B. Whinston, "Vertical Differentiation and a Comparison of Online Advertising Models," Journal of Management Information Systems, 29(1), summer 2012, pp. 195-236., Available at SSRN: https://ssrn.com/abstract=1676051 or http://dx.doi.org/10.2139/ssrn.1676051

Mei Lin (Contact Author)

Singapore Management University ( email )

80 Stamford Road
Singapore
Singapore

HOME PAGE: http://www.mysmu.edu/faculty/mlin/

Xuqing Ke

University of Texas at Austin ( email )

2317 Speedway
Austin, TX Texas 78712
United States

Andrew B. Whinston

University of Texas at Austin - Department of Information, Risk and Operations Management ( email )

CBA 5.202
Austin, TX 78712
United States
512-471-8879 (Phone)

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