Performance-based Advertising: Price and Advertising as Signals of Product Quality Juan Feng and Jinhong Xie University of Florida
Performance-based Advertising: Price and Advertising as Signals of Product Quality
Juan Feng and Jinhong Xie University of Florida
Performance-based advertising
the advertiser pays the publisher only when an “action” is generated by the ad;
action: click-through, purchase, download,
registration… traditional impression-based pricing model:
advertisers are charged for exposure, independent upon the actual performance of advertising
Major Benefits
Internet makes it possible to measure the performance of ads Provide links to the specific web sites
Pay only for results! Advertisers are charged only if someone
clicks their ads, not when the ads are displayed.
Popular Practice
Led by Yahoo! (Overture), Google (AdWords and Adsense), MSN (AdCenter), eBay (AdContext)
more aggressive performance-based measures the “cost-per-action” model ( Snap.com), ZiXXo (pay-per-print) Ingenio (pay-per-call),
Research Questions:
What is the impact of performance advertising on one of advertising’s fundamental functions --- SIGNALING product quality?
Why Important?
Internet lowers the barriers of advertising Quality uncertainty increases.
Is “signaling” possible? In traditional advertising, consumer may learn
the advertising expenditure from advertising exposure.
Consumer may not be aware of the pricing scheme;
Advertising expenditure is NOT directly observable.
Information Policies
Should the publisher reveal the pricing scheme?
Should the publisher reveal advertiser’s per-unit advertising expenditure?
Literature
Keyword auctions Feng et al. (2007), Liu and Chen (forthcoming),
Weber and Zheng (forthcoming), Balachander and Kannan (2006), and Animesh (forthcoming), Feng (2008), Chen and He (2006),Ghose and Yang (2007), Viswanathan et al (2008)
Publisher’s incentive to promote advertising Hu (2004), Zhao (2005), Sundararajan (2003)
Literature (cont.)
Advertising spending and quality of the product/service Gerstner (1985), Shoemaker et al. (2000),
Zhao (2000), Zhang (2001), Horstmann and Moorthy (2003)
Advertising and Signaling: Phillip (1974), Kihlstrom and Riordan (1984),
Milgrom and Roberts (1986), Kirmani and Rao (2000) and Bagwell (2005)
Model Framework
A monopolist advertiser with uncertain quality level (H or L) Decides its product price (P), as well as per-
unit advertising expenditure (a) Consumers decide
whether to purchase, Whether to repurchase (with probability q=H,L)
Publisher decides whether to announce the pricing scheme, as
well as per-unit advertising expenditure
Model Features (I)
Advertiser is risk-averse about the performance of advertising. Risk-aversion factor r Performance of advertising
An Illustrative Model (cont.) First period demand is: , where
Assume advertisers are risk-averse with risk-aversion factor and :
Mean-variance representation:
Impression-based Advertising (Benchmark)
Advertising CAN signal high quality if and only if:
The optimal advertising expenditure is:
Model Features (II)
Assume a proportion of consumers repurchase the product through the same link provided by the publisher
The advertisers are charged for this proportion of consumers Over-charge factor
I. Full Information
Advertising CAN signal if and only if:
The H type advertiser needs to pay in order to prevent the L advertiser from mimicking
II. Only price-scheme information
The exposure of advertising does not tie with advertising expenditure,
when consumer observe positive advertising, they believe the advertiser to be an H type with probability 0.5,
No separating equilibrium in which one advertiser advertises and the other does not
III. No information
Consumers mistake the performance-based advertising as traditional impression-based advertising,
Consumer uses advertising exposure to infer advertising expenditure,
No separating Eq. Consumer may misbelieve the H advertiser
as an L one.
Equilibrium---Performance-based Advertising
Condition for Equivalence
Full Informaion Case
Conditions for advertising to signal
When full information is revealed to consumers, switching from impression-based to performance-based advertising: Destroys advertising’s signaling function if ; Make it easier for advertising to signal quality
if , and vice versa. decreases in .
Advertiser’s Profit
Advertising Expenditure
What do we learn?
Performance-based advertising benefits advertisers by reducing risk
For publisher Communication of the pricing scheme Communication of advertising prices Reduce
For advertisers Attract repeat purchase directly
Combination of impression-based and performance-based pricing?
A Full Model
Price and advertising can both serve as signals, and are endogenizely determined.
Examine the impact of performance advertising on The conditions for advertising to serve as a
signal Price in a separating equilibrium Advertising expenditure in a separating
equilibrium H type advertiser’s welfare
Conditions Required for Price to Signal
Proposition 3 (Equilibrium Price)
Proposition 4 (Advertising Expenditure)
Proposition 5 (Advertiser's Profit)