The Logic and Management of 'Digital Co-op' in Search Advertising
64 Pages Posted: 17 Apr 2018
Date Written: April 5, 2018
Manufacturers and the retailers through which they sell their products often advertise against the same keywords in search advertising. This implies that these retailers increase advertising costs for manufacturers while also appropriating a part of their channel margins. In spite of this, it is observed that manufacturers directly or indirectly subsidize retailers' advertising expenditures; this practice is known as ``digital co-op'' and essentially induces the retailers to advertise more against the manufacturers themselves. In this paper, we use a game theory model with two competing manufacturers and a common retailer to study the incentives of manufacturers to participate in digital co-op in search advertising, and provide guidance on how to manage it. A main insight that we obtain is that, because competing manufacturers are non-independent bidders, if they both have a strong incentive to win an ad slot, subsidizing the retailer to win the ad slot instead is a viable strategy to moderate their competition. We determine the subsidy rates and bids that manufacturers should use for different types of keywords reflecting different brand preferences of consumers, and the competitive responses and outcomes that they can expect. For instance, a manufacturer should subsidize the retailer's ad spend for category keywords at moderate levels and for the competitor's brand keywords at high levels, enabling the retailer to win in both cases. We also consider the case when the manufacturers cannot specify keyword-level subsidy rates and find that they may subsidize the retailer only if the relative search volume of category keywords is sufficiently high.
Keywords: search advertising, cooperative advertising, game theory, category keyword, brand keyword
JEL Classification: M31, M37, L86, D44
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