Double Marginalization in Performance-Based Advertising: Implications and Solutions

An important current trend in advertising is the replacement of traditional pay-per-exposure (pay-per-impression) pricing models with performance-based mechanisms in which advertisers pay only for measurable actions by consumers. Such pay-per-action (PPA) mechanisms are becoming the predominant method of selling advertising on the Internet. Well-known examples include pay-per-click, pay-per-call and pay-per-sale. This work highlights an important, and hitherto unrecognized, side-e ect of PPA advertising. I nd that, if the prices of advertised goods are endogenously determined by advertisers to maximize pro ts net of advertising expenses, PPA mechanisms induce rms to distort the prices of their goods (usually upwards) relative to prices that would maximize pro ts in settings where advertising is sold under pay-per-exposure methods. Upward price distortions reduce both consumer surplus and the joint publisher-advertiser pro t, leading to a net reduction in social welfare. They persist in current auction-based PPA mechanisms, such as the ones used by Google, Yahoo and Microsoft. In the latter settings they also reduce publisher revenues relative to pay-per-exposure methods. I show that these phenomena constitute a form of double marginalization and discuss a number of enhancements to today's PPA mechanisms that restore equilibrium pricing of advertised goods to e cient levels, improving both consumer surplus as well as the publisher's expected pro ts. Half the money I spend on advertising is wasted; the trouble is, I don't know which half. John Wanamaker, owner of America's rst department store