Performance-based Pricing Models in Online Advertising

30 Pages Posted: 3 Mar 2004  

Yu Jeffrey Hu

Georgia Institute of Technology - Scheller College of Business

Date Written: January 14, 2004

Abstract

The Internet is a much more accountable and measurable medium than traditional media. The unique property of the Internet being a medium with bidirectional information flows has enabled performance-based pricing models that tie online advertising payments directly to campaign measurement data such as click-throughs and purchases. These pricing models have become increasingly popular in the online advertising industry.

This paper provides explanations as to when and how incorporating performance-based pricing models into advertising deals can be profitable. We argue that the publisher can make non-contractible efforts that may improve the effectiveness of advertising campaigns. These efforts are costly to the publisher. Therefore, performance-based pricing models can be used to give the publisher proper incentives to make its efforts.

We derive an optimal contract that maximizes the sum of the advertiser's utility and the publisher's utility, and show that key factors that influence the use of performance-based pricing models are the importance of the publisher's incremental efforts, precision of click-through measurement, and uncertainty in the product market. We also clarify issues that are being debated in the industry, such as how the importance of the advertiser's incremental efforts and existence of non-immediate purchases affect the use of performance-based pricing models.

Keywords: Online advertising, pricing model, incentive, performance

Suggested Citation

Hu, Yu Jeffrey, Performance-based Pricing Models in Online Advertising (January 14, 2004). Available at SSRN: https://ssrn.com/abstract=501082 or http://dx.doi.org/10.2139/ssrn.501082

Yu Jeffrey Hu (Contact Author)

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

800 West Peachtree St.
Atlanta, GA 30308
United States

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