Incentive Problems in Performance-Based Online Advertising: Cost Per Click versus Cost Per Action

Management Science, Forthcoming.

32 Pages Posted: 3 Apr 2015 Last revised: 25 Jan 2017

See all articles by Yu Jeffrey Hu

Yu Jeffrey Hu

Georgia Institute of Technology - Scheller College of Business

Jiwoong Shin

Yale School of Management

Zhulei Tang

Purdue University - Krannert School of Management

Date Written: March 1, 2015

Abstract

The multibillion-dollar online advertising industry continues to debate whether to use the CPC (cost per click) or CPA (cost per action) pricing model as an industry standard. This article applies the economic framework of incentive contracts to study how these pricing models can lead to risk sharing between the publisher and the advertiser and incentivize them to make efforts that improve the performance of online ads. We find that, compared to the CPC model, the CPA model can better incentivize the publisher to make efforts that can improve the purchase rate. However, the CPA model can cause an adverse selection problem: the winning advertiser tends to have a lower profit margin under the CPA model than under the CPC model. We identify the conditions under which the CPA model leads to higher publisher (or advertiser) payoffs than the CPC model. Whether publishers (or advertisers) prefer the CPA model over the CPC model depends on the advertisers' risk aversion, uncertainty in the product market, and the presence of advertisers with low immediate sales ratios. Our findings indicate a conflict of interest between publishers and advertisers in their preferences for these two pricing models. We further consider which pricing model offers greater social welfare.

Keywords: Online advertising, cost-per-click, cost-per-action, incentive, adverse selection, moral hazard, pricing model

Suggested Citation

Hu, Yu Jeffrey and Shin, Jiwoong and Tang, Zhulei, Incentive Problems in Performance-Based Online Advertising: Cost Per Click versus Cost Per Action (March 1, 2015). Management Science, Forthcoming.. Available at SSRN: https://ssrn.com/abstract=2588499

Yu Jeffrey Hu (Contact Author)

Georgia Institute of Technology - Scheller College of Business ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States

Jiwoong Shin

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

HOME PAGE: http://faculty.som.yale.edu/JiwoongShin/

Zhulei Tang

Purdue University - Krannert School of Management ( email )

1310 Krannert Building
West Lafayette, IN 47907-1310
United States

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