Economics of First-Contact Advertising

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1 Econocs o Frst-Contact Eal Advertsng Ra Goal Oeratons and Inoraton Manageent Unversty o Connectcut Storrs, CT, 0669 Tel: Eal: Arvnd K Trath Manageent Scence eartent, Box Unversty o Washngton Busness School Seattle, WA Tel: Eal: Zhng Walter College o Busness and Adnstraton Unversty o Colorado at enver, Box 65 P O Box 73364, enver, CO, 807 Tel: Eal: Ths research s suorted n art by the Trbe Electronc Coerce Intatve TECI at the School o Busness Adnstraton, Unversty o Connectcut Author naes n alhabetcal order

2 Econocs o Frst-Contact Eal Advertsng Abstract Snce the advent o the Internet eal has eerged as an ortant new or o ersonal councaton The ocus o ths research s on coercal advertsng through the eal channel We analyze the underlyng econocs o a busness odel tered adedaton that acltates eectve rst-contact eal advertsng Adedary s a trusted thrd arty that acltates a utually desrable councaton between buyers and sellers va eal, and oerates under the ot-n ode wdely suorted by the consuer advocacy grous Our analytcal odel exanes the ncentve structures or all artcatng enttes, and derves rcng strateges, rot lcatons and characterstcs o the eal lsts We develo and odel a or o rce dscrnaton we ter sequental elnaton rce dscrnaton that can be ractced va eal Our results ndcate that the transactons acltated by the adedary can create sgncant value-added whereby every artcatng entty realzes ncreased benets These ndngs underscore the otental o adedaton to restore eal as an eectve councaton eda or onlne advertsng

3 Introducton Astronocal growth o e-coerce has turned the Internet nto a doan o ntense cororate actvty E-coerce has rovded oortuntes or coanes, rresectve o ther sze, to coete globally Ths has roted tradtonal aret-layers to adat e-coerce busness strateges to rean coettve n ths electronc aretlace Along wth other busness unctons there has been a rearable boost n onlne-aretng actvty, wth coanes attetng to develo new ethodologes to ore eectvely aret ther wares onlne Accordng to Interactve Advertsng Bureau, onlne ad sendng n US totaled nearly $ bllon n the ourth quarter o 003, u ore than 38 ercent ro the sae erod n 00, and ncreased % over the thrd quarter o 003 For all o 003, ths nuber totaled just under $73 bllon, u nearly % ro the 00 total o $60 bllon As the nuber o Internet users, currently estated at 79 llon, contnues to grow, ths trend s exected to contnue Internet technologes oer a nuber o otons or ursung onlne advertsng The ajorty o current advertsng dollars are generated through banner advertsng and content sonsorsh over the Web 3 However, accordng to e-mareter, an onlne aret research coany, eal stands out as the ller-a o the onlne advertsng world Ths s because eal can be recson-targeted, resonded to nstantly, and unbelevably chea 3 Furtherore, t oers oortuntes or rvate councaton, and when roerly utlzed, hels buld consuer trust on a long-ter bass But snce ts nceton, ths ode o advertsng has been lagued by a roble coonly tered as Unsolcted Coercal Ealng 4 UCE The roble o UCE arses due to the ecular cost structures nherent wth eal advertsng Sellers can relatvely easly obtan unrocessed lsts o eal addresses, and the cost o sendng eal solctatons to these lsts s nal The tas o talorng the lsts to target lely consuers s qute exensve, and oten s not easble due to unavalablty o the Interactve Advertsng Bureau htt://wwwabnet/resources/ad_revenueas Global Reach htt://wwwglobal-reachbz/globstats/ndexh3 3 e-mareterhtt://wwweareterco/estats/ _abhtl 4 Other descrtve ters nclude jun eal and sa 3

4 necessary noraton to denty nterested consuers Fro a seller s ersectve, t aes econoc sense to sly lood the entre lst wth solctatons as they becoe cost eectve even at extreely low resonse rates The ncentves to do so are esecally hgh or saller establshents that can ll-aord the tradtonal and ore exensve advertsng channels and or establshents that care lttle about the negatve ublc stga assocated wth UCE In act, the ajorty o solctatons are or objectonable roducts and servces, whch are oten llegal and raudulent Well-establshed and reutable rs have shed away ro UCE as t has becoe synonyous wth raud The true costs o such advertsng caagns sht to the consuers and ISPs nternet servce rovders The negatve externaltes borne by the eal users arse ro the requency, volue, and rrelevance o eal solctatons and the lac o control and ntrusons to ersonal rvacy [] Whle not all unsolcted eals are necessarly unwanted, the ajorty are Most eal users erceve no value n recevng these essages Accordng to a recent reort wwwerrsco, the worldwde cost o dealng wth jun eal exceeded $3 bllon n 00 So ervasve s the roble that over 30% o the 30 llon eals rocessed er day by AOL s categorzed as UCE 5 Consderng the serousness o the roble, the FTC 6 has set u a secal albox to assess the eergng trends and develoents The FTC albox has receved over 83 llon eces o eals ro consuers On average, consuers orward 0,000 eces o UCE er day to ths albox A nuber o consuer organzatons 7 have ralled together to address ths roble, ro both techncal and legslatve venues A lethora o techncal solutons based on schees such as sender s address vercaton 5, reverse lterng 8, counterattacs and blaclstng o nown UCE senders have been leented Whle not oolroo, as senders constantly revse and udate the tactcs they deloy, these technques have heled lower the overall burden on consuers and ISPs The ght on the legal ront s also ganng oentu Begnnng wth the state o Washngton n 998, a slew o states have enacted laws to rovde legal rotecton to ther consttuents A nuber o ederal laws are also under actve consderaton 9 It s wdely 5 The E-Coercetesco htt://wwwecoercetesco/erl/story/8730htl 6 The Federal Trade Cosson wwwtcorg 7 Such as The Coalton Aganst Unsolcted Coercal Eal CAUCE, wwwcauceorg 8 The E-Coercetesco htt://wwwecoercetesco/erl/story/880htl 9 Wwwsalawsco rovdes u-to-date legslatve noraton on UCE 4

5 beleved that eectve legslatve eorts wll begn to ose sgncant costs on the oenders and wll thus serve as an ortant deterrent A sgncant ont o debate n cratng the legslaton relates to the legal denton o UCE Consuer advocacy grous avor a ore strngent verson that entals ot-n The otn aroach allows busnesses to send eal solctatons only to ndvduals wth who they have ror busness relatonsh n that they have receved an exlct consent to send solctatons or roduct and servces Thus, any ode o advertsng that nvolves ang a rst-contact eal solctaton wth otental rosects wll be deeed llegal under ths schee The rect Maretng Assocaton MA, reresentng legtate advertsng agences, argues that the ot-n aroach wll have a throw the baby out wth the bath water eect n that eal wll cease to exst as a vable channel or any or o advertsng that entals a rst-contact wth rosects [4] Whle they are suortve o eorts to curb raudulent advertsng, ther nterests le n ensurng the avalablty o the eal channel or legtate and reutable sellers to reach otental custoers They also argue that ot-n can sgncantly ncrease the search costs or consuers to obtan noraton about roducts and rootons, as they would have to ntate and bear the eort o contactng otental sellers They suort an ot-out aroach wheren busnesses can ae rst contact wth consuers but ust honor a recent s request to be reoved ro the eal lst Consuer advocacy grous are strongly oosed to the ot-out aroach, as they beleve that t wll contnue to legtze UCE It would rovde every seller at least one ree shot at each otental consuer The volue o eals, ajorty o whch consuers have no nterest n, wll contnue to be large, and consuers wll contnue to ace the burden o otng out ro all eal lsts that nclude ther noraton Gven the conlctng nterests o the busness and the consuer grous, the nature o the uture legslaton aganst UCE reans unclear Regardless, the ublc outcry aganst the roble o UCE has led the ajorty o reutable coanes to adot an ot-n aroach As a result the eal channel s tycally excluded ro the advertsng arsenal, deste ts otental to be an eectve advertsng tool Recently, a new tye o advertsng busness odel has eerged to enable these coanes to solct rosects va eal Goal et al [4] ter ths busness odel adedaton An adedary enables sellers to ae rst contact wth otental 5

6 consuers whle oeratng wthn the ot-n ode The econoc vablty o ths busness odel and the ensung nature o eal solctatons s the central ocus o the aer Concet o Adedaton The busness odel o adedaton derves ts roots ro the well-establshed concet o nteredaton and creates value through ncentve-based aroaches that atch nterested buyers and sellers [4] Consuers rovde to the adedary ther eal addresses, buyng reerences, and consent to receve eal n exchange or useul roduct and rcng noraton, onetary ncentves, and a guaranty ro the adedary that the ndvdual ersonal noraton wll be saeguarded Fro ths ersectve, the adedary rovdes a realzaton o a reverse aretlace by brngng roducts and servces ro the sellers n the aret to a consuer s door Sellers subscrbe to the adedary n order to solct otental custoers In return, the sellers coensate the adedary Besdes the targeted lst o consuers, the sellers are also attracted due to the act that ths ode o advertsng s erectly legal under all legslatve schees under consderaton and s accetable to the ublc Ths s because the eal tsel orgnates ro the adedary who has an exlct consent ro the subscrbed consuers, even though the content o eal ay orgnate ro sellers that wsh to ae rst contact wth consuers Snce the sellers need to ay the adedary to aval o the servces, ths odel s only attractve to legtate busnesses Coanes that engage n questonable busness ractces or exale, those eddlng ornograhc roducts or racle edcal roducts would contnue to nd UCE attractve To these coanes, long ter age o ther roduct actors less nto the botto lne, and even the low cost o advertsng va an adedary s astronocal coared to the close to zero argnal cost o UCE As we deonstrate later n the aer, the servces oered by the adedary are artcularly attractve to legtate busnesses whose consuers ncur hgh search costs to acqure noraton on the roducts and servces oered by these busnesses A nuber o advertsers are begnnng to oer eal servces that are based on the concet o adedaton A recent Busness Wee artcle [6] hghlghts the unque advantages o ther busness odel Consuers base ther decsons on ther own crteron and thus weld colete control over the rocess Also, unle auctons, consuers don t have to coete 6

7 wth other buyers and thus avod the roble o wnner s curse The oularty o these stes aears to be growng and s evdenced by the act that any o these stes have large subscrber base and very hgh resonse rates o ther eal lsts Table rovdes an llustraton o a ew reresentatve coanes and the ey characterstcs o ther eal oerngs These coanes have undertaen a nuber o ortant stes to revent abuse o ther subscrbers ersonal noraton and rvacy requreents As a art o the overall trust buldng eort, all adhere to strct rvacy olces that revent the ro sharng, dstrbutng or sellng subscrber noraton to any thrd arty Further, they lt the volue o eals that are orwarded to the subscrbers, and oer the oton to consuers to ot-out o the subscrber lsts Interestngly, the coensaton schees oered to consuers or consent and readng eals ro sellers do vary aongst the adedares Per eal coensaton vares ro zero to as hgh as $008 er eal that s sent to a consuer Nae o coanes oerng advertsng va eal Table : A lst o Coanes oerng advertsng va eal Coensaton or Readng Eals Lts Volue o Eals er day PadBzOalco Yes Yes U Hts4Payco Yes U 50% Absolute-E-Malsco Yes Yes U Resons e Rates Inboxollarsco Yes Yes 5%-55% Cash-a-ay Yes Yes 50% E-Mal Pays U Yes U 50% HTMal Yes Yes 0%-3% oubleclc No U U : All the coanes ollow strct rvacy olces or consuer data and gve oton to ot-out ro ther alng lsts U: Not exlctly lsted on the webste The ossblty o coensaton or sly readng eal advertsng essages, and the urely voluntary and ncentve based subscrton decsons rase the secter o oral hazard and adverse selecton robles The oral hazard arses ro the nablty o noral contracts to acheve an ecent allocaton [, 9] The oral hazard n ths case arses ro the 7

8 ossblty o subscrbers jonng eal lsts or the sole urose o recevng coensaton oered by adedary, wth no ensung nterest n the roduct or servce oered by the orgnatng seller Most o the coanes that oer onetary coensaton or eal advertseents lace ltatons on the volue and requency o eals they send to ndvduals As a result, the ncentve or ndvduals to subscrbe urely to extract coensaton s tgated The adverse selecton roble s rooted n asyetrc noraton and can create serous sallocatons and rases the ossblty o colete aret breadown [] In the case o adedaton, the adverse selecton roble leads to the queston o the qualty and desrablty o the rosects on the subscrber lsts, ro the vewont o the sellers I otentally low-valued consuers donate the subscrber lsts, then such lsts are o lted value to advertsers Such a scenaro can rase ortant questons on the long-ter vablty o ths ode o advertsng However, the overall ncentves oered by adedares, when roerly leented, should attract both hgh and low valued consuers Hgh valued consuers are tycally less rce-senstve and are less attracted by the low values o coensaton tycally less than $0/eal or eal advertseents The ncentve or such consuers coes rarly ro savngs n the te and eort exended to search, evaluate and acqure roducts and servces Thus the subscrber lsts can cature otental consuers across the value sectru and the hgh resonse rates reorted by a nuber o adedares rovdes credence to ts eectveness n addressng the adverse selecton roble Research Issues The ocus o ths artcle s on analyzng the econocs nvolved n the busness odel o adedaton We address ssues that nclude: what tyes o sellers are attracted to adedaton? What coensaton olces to consuers and rcng echanss to sellers are vable? What are the characterstcs o eal lsts under varous coensaton schees? What are the rcng lcatons o adedaton? What are the consuer surlus and welare lcatons? We begn the odel develoent by consderng a sngle seller Consuers are consdered to have ex ante bele about roduct characterstcs and rcng o such characterstcs A large art o seller artcaton decson s based on how costly t s or ther rosectve custoers to search or ther roducts We also address the oral hazard roble 8

9 that arses because o otental coensaton oered to eal recents An ortant rooston derved ro ths analyss states that the sellers whose roducts or servces nvolve hgher search costs or custoers have sgncantly hgher ncentves to artcate wth adedary We then develo and odel a unque or o rce dscrnaton tered sequental elnaton rce dscrnaton that s acltated by the eal technology The assuton that value o a roduct to a consuer dscounts over te s crucal n ths or o rce dscrnaton When ths dscount actor s sgncant or nstance, seasonal goods, consuers tend to ae a urchase as soon as the rce s less than ther valuaton o the roduct When ths dscount actor s neglgble, consuers wll not ae a urchase they now the rce wll coe down they wat When the dscount actor s n between, at each subsequent lower rce oerng, soe consuers ay wat whle others ay ae a urchase Our analyss ndcates that even though ths or o rce dscrnaton nvolves ultle solctatons, the adedary rcng structure ensures that the volue o eals reans under chec We extend the odel to consder ultle sellers and derve otal rcng strateges or the adedary Ths s ollowed by sulaton exerents to rovde addtonal nsghts The results suggest that rce dscrnaton, when easble, wll eerge as the donant rcng strategy Adedary rots, seller rots and artcaton rates, consuer surlus, and socal welare are all hgher n ost stuatons when the rce dscrnaton strategy s leented Consuer surlus s also hgher or roducts and servces wth hgher qualty Interestngly, sellers whose roducts ncur lower search costs on consuers tend to send ore sequental solctatons than sellers whose roducts ncur hgher search costs Snce hgher search costs roducers are currently the ost coon racttoners o UCE, our analyss valdates the role o adedaton n otentally dscouragng UCE Together these results underscore the econoc vablty o adedaton and ts ablty to rovde sgncant valueadded or all the artcatng enttes The reander o the aer s organzed as ollows Secton rovdes the underlyng ethodology and develos the econoc odel or the sngle seller case The oral hazard roble that arses n ths context and echanss to deal wth ths roble are also addressed Secton 3 develos the otal rcng strateges or the case o ultle sellers and 9

10 the sulaton exerents are resented n Secton 4 Secton 5 resents suary coents and hghlghts drectons or uture research Model eveloent or Sngle Seller We begn the odel develoent by consderng the case o a sngle onoolstc seller Multle seller case s dscussed n Secton 3 Each artcatng arty s assued to exhbt a value axzng behavor In artcular, the seller and the adedary attet to axze ther rots Consuers ae sgnu and urchase decsons to axze ther utlty The consuers ace noraton uncertanty regardng the eatures and the rce o the roduct or servce oered by the onoolst A custoer ncurs a cost o s to search and locate the roduct, and to acqure noraton on the eatures oered and the rce charged The adedary sets u a alng lst or the roduct n order to reduce the search cost or the consuers Interested consuers sgn u and consent to receve eal essages ro the sellers va the adedary The adedary charges the seller or each eal sent to each address Each artcatng consuer receves a ayent o θ or each eal that they receve ro the adedary I a consuer does not sgn u, she ncurs a xed search cost o s to locate the roduct I the consuer does sgnu wth the adedary, she ncurs a cost R to read an eal essage We ae the sae, ractcal assuton that s > R Note that ror to the search sgnu decson, the exected total cost o urchase ncludes the search cost or readng cost less coensaton ro the adedary and the exected rce o the roduct However, once the consuer conducts the search or reads the eal, these becoe sun costs The subsequent decson to urchase s based on the revealed actual value and the actual rce o the roduct The ntal odel assues that each consuer receves a sngle eal essage ro the adedary The secter o ultle solctatons resents ossbltes or nterestng rcng strateges and s dscussed later n ths secton Sngle Seller Sngle Solctaton Model Consuers ae subscrton decsons based on ther exectatons regardng the value, eatures and the rce o the roduct, and the servces oered by the adedary We assue 0

11 that the roduct ebodes a unversal set o eatures, e all ossble eatures that can otentally be oered n that roduct Wthout loss o generalty, we consder the eleents o ths set to consst o equal-valued eatures We assue that the deand uncton or the ullyeatured roduct s lnear wth a downward sloe o and ntercet o V, e the deand uncton s V - Thus, the total deand would be 0 and V at rces V and 0, resectvely Wthout loss o generalty, the argnal cost o the roduct s assued to be zero The seller s actual roduct oers a racton, 0,], o the unversal set o eatures s rvate noraton to the seller However, seller councates ths noraton to the adedary Consuers, a ror, are uncertan about the actual subset o eatures,, oered by the seller Ths level o uncertanty s catured by consuer ex ante bele about the dstrbuton o Ths bele s drawn ro dstrbuton U[0, ] The actual realzaton o s revealed to consuers n the eal oerng, together wth the rce The deand uncton or a roduct wth a racton o eatures s hence V -/ We analyze the strateges o the adedary, seller, and consuers as a dynac gae wth ncolete noraton as detaled below The deand uncton, search cost s, and readng cost R are coon nowledge n ths settng Nature reveals to seller and seller councates to adedary Adedary announces and θ θ R 3 Seller sgns u wth adedary 4 Consuers, observng and θ, and who have a bele syste about, ae decsons to sgn u based on ths bele and the bele that other layers wll adot an otal strategy 5 Seller decdes on rce, based on the sgn u lst, deand uncton and 6 Seller announces and to consuers who have sgned u va eal 7 Consuers ae urchase decsons Snce s > R, all consuers wth ostve exected utlty wll reer sgnng u to search The argnal consuer who sgns u has exected utlty o zero Let v reresent the lowest valuaton o the ull-eatured roduct by consuers who sgn u v s then the valuaton o the ull-eatured roduct by consuers wth exected utlty o zero Snce a seller can always change the rce based on the alng lst status ror to sendng eals to consuers, the

12 consuers ndeed ove rst n ths gae wth ncolete noraton For a sequental gae wth ncolete noraton, the Perect Bayesan Equlbru s o nterest We have the ollowng rooston: Prooston : I,θ,, v s a Perect Bayesan Equlbru to the gae descrbed above, then θr Proo: See Aendx A In the reander o the aer, we wll only analyze cases where θr 0 A trval equlbru under the condton θr s that no consuers would sgn u Ths can occur when ether the consuers or the sellers or both are always better o gong through the tradtonal channel no atter what above-cost rcng strategy the adedary adots In our subsequent analyss, we lt our araeter values such that no consuers would sgn u s not an equlbru soluton, that s, there are values such that the adedary wll ae ostve rots Seller s Prcng Snce θr, that s, all consuers who sgn u wll be coensated or the cost o readng each eal, all consuers wth ostve valuaton o the ull-eatured roduct wll decde to sgn u Once the consuer receves an eal ro the seller wth noraton about and, R s sun A consuer wll ae a urchase the valuaton o the roduct s greater than Exectng ths reacton; the seller sets the rce to axze rot Ths rot axzaton roble can be reresented as ollows: ax [ V ] V Note that the nuber o essages sent equals the custoer base o V The seller s rot axzaton roble s reduced to onoolstc rcng wth no constrants, whch yelds 0 Mxed strategy equlbra do exst when θ<r However, we only analyze ure strateges as consuers, n ractce, would not tae a rando aroach n ang sgn-u decsons

13 V and a axu rot o V V 3 4 Alternatvely, the seller can decde not to sgn u wth the adedary We assue that U 0 s the seller s rot when not utlzng the adedary s U 0 s, U 0 s, where < 0, s e seller s rot through tradtonal eans decreases as the search cost or consuers ncreases Snce V s the onoolstc rot when search cost s zero, 4 U < The seller wll only sgn u V V U s0, or s V V V U 0 s 4 Adedary s Prcng The adedary axzes rot subject to the constrant that the seller has the ncentve to sgn u ax,θ θ V 4 st V V U0 s 4 5 θ R 6 V U 0 s Ths results n 4 V 7 Consuer Surlus All consuers wth valuaton hgher than seller rce o surlus Ths s calculated as ollows: V contrbute to consuer 3

14 V V d V 8 V 8 Prooston : For a gven value o, a seller wth larger search cost roduct or servce has a hgher ncentve to artcate wth the adedary Proo: I the seller decdes not to subscrbe to the adedary, the rot U 0 s decreases wth ncreasng search cost When s xed, decreasng search cost wdens the rot derences between sgnng u wth the adedary and not sgnng u Hence sgnng u s ore rotable or a seller wth hgher search cost QE Establshents wth hgher search cost roducts and servces have tradtonally resorted to UCE Prooston llustrates that the adedary can rovde a ore eectve and erectly legal alternatve to such establshents to reach ther otental consuers V U 0 s Observaton : The charge to a seller set by the adedary,, s 4 V roortonal to the eatures qualty oered by the seller Observaton : Consuer surlus s hgher through the Adedary than through the tradtonal channel The consuer surlus when the seller sgns u s the excess o the value receved by the consuers through roduct consuton over the rce or the roduct snce the coensaton or readng a essage equals the cost o readng a essage When the seller does not sgn u, the consuer surlus s the excess o the value receved by the consuers through roduct consuton over the rce or the roduct and the search cost Snce search cost reduces the socal welare, consuer surlus through the tradtonal channel decreases wth ncreasng search costs Snce consuer surlus through the adedary equals onoolstc consuer surlus when search cost s zero, the econocs o adedaton ensure that consuers do not bear the negatve externaltes o eal advertsng Observaton hghlghts the consuer surlus lcatons o adedaton and suggests that adedaton s not a aret echans that sly transers the surlus ro the consuers to the sellers and the adedary Under 4

15 certan condtons, t s a value-creaton echans where every artcatng entty realzes ncreased benets The basc odel valdates the econoc vablty o adedaton As long as the search cost s hgher than the cost ncurred by a consuer to read an eal essage, adedary has an ncentve to set u an eal lst As artcaton s urely voluntary, adedary ensures that the charges rean attractve or sellers to subscrbe Adedaton, unle UCE, does not ose negatve externaltes on consuers In act, the consuer surlus wth adedaton s hgher Observaton The results ro the sngle solctaton odel are suarzed n Aendx C Table C Sngle Seller Multle Solctaton We now consder the ossblty o ultle solctatons ro the seller Recall that the equlbru condton s that the adedary oers ull coensaton Under ths condton, all consuers wth a ostve exected valuaton or the roduct would enlst wth the adedary Ater recevng eal councatons ro the seller, only those whose value exceeds the oered rce would urchase the roduct However, ater a erod o te, the seller ght benet ro oerng the roduct at a lower rce or the non-buyers Ths strategy reresents a or o rce dscrnaton over te that wors by a sequental elnaton o the subscrbers ro the eal lst There exsts a wealth o lterature on rce dscrnaton over te [0], and the etus or these studes s the observaton that or a large nuber o roducts, the rces tend to declne over te [7, 8] A undaental queston that arses n ths context s: why would a consuer urchase a roduct at a hgher rce, and not wat untl t s oered at a lower rce? Clearly rce dscrnaton over te s easble only consuers ace a enalty or loss o value due to watng Such enaltes arse n a nuber o scenaros, ncludng a otental lac o avalablty o the roduct n the uture or a loss o realzed value due to nonconsuton or a erod o te [3, 5, 0] The orer arses, or exale, when lted quanttes are roduced and there exsts a dstnct ossblty that the roduct ay not be avalable n the uture An exale o the latter s ashon goods, where consuers are wllng to ay a hgher rce when the good s n ashon deste the rosect o sgncantly lower rce n the uture Another exale s seasonal goods such as gol accessores whose rce s 5

16 sgncantly hgher at the begnnng o the season and declnes sharly towards the end o the season Soe consuers succub to hgher rces to ensure usage and hence realze hgher value over the whole season, rather than wat and then obtan only a lted usage Such roducts ert a seller to ractce a or o rce dscrnaton that wors on the rncle o sequental elnaton o subscrbers ro the eal lst The echancs underlyng ths or o rce dscrnaton as aled to adedary wor as ollows The adedary oers ull coensaton to the consuers, and those wth a ostve exected valuaton or the roduct sgnu The seller sends an ntal eal solctaton to all consuers on the lst, oerng the roduct at a rce Ater a certan erod o te, the seller reoves the buyers ro the eal lst, and sends a subsequent eal to the reanng lst, oerng the roduct at a rce o where < Let v denote valuaton o the ull-eatured roduct by a artcular consuer Then v denote hs valuaton o the roduct wth eatures Consder a consuer wth v> The net utlty o ths consuer she resonds to the rst solctaton s v- On the other hand, she can choose to wat or the second solctaton and acqure the roduct at a lower rce Let, 0, characterze the consuer s wllngness to wat or the value dscount actor We assue that all consuers have the sae wllngness to wat and that t s ublc nowledge I ths consuer wats or the second solctaton, the net value s v- Note that when all consuers wat or the cheaest rce, and when 0 a consuer aes a urchase as soon as an oerng s ade as long as hs valuaton v s hgher than the oered rce When 0<<, consuers wth lower valuatons reer to wat and wll buy at only v > v or v > The seller can reeatedly solct the consuers, each te oerng the roduct at a rce lower than the recedng one Fgure dects seller revenues ro sequental elnaton rce dscrnaton 6

17 Fgure : Sequental Elnaton Prce scrnaton Non -buyers Consuers who resond to the second solctaton Consuers who resond to the ntal solctaton 3 V v The econoc ratonale or a seller to rce dscrnate as above s to extract addtonal consuer surlus The tetaton o a seller to ractce unettered rce dscrnaton s curbed by the act that the adedary charges or each eal solctaton The adedary, n turn, needs to coensate consuers or each eal The ollowng dscusson resents the analytcal develoent o the ultle solctaton odel Consuer Sgnu and Purchase Note that once the ntal solctaton s sent, consuers can calculate the rot-axzng nuber o solctatons,, and the corresondng rces o,, A subscrbed consuer wll not resond to any o the oers v < Otherwse the consuer resonds to the th solctaton where v > v and v > v, or equvalently > v and v <,,, - A consuer would urchase at v > v and v > 0, or equvalently < v and v > Seller s Prce scrnaton Strategy The seller s roble s to deterne the nuber o solctatons and the rce to oer wth each solctaton The nuber o consuers who wll buy at s V, the nuber o 7

18 8 consuers who wll buy at,,, -, s, and the nuber o consuers who wll buy at s Thereore the seller s rot axzaton roble s: ax, V s π V, Alternately, ax, π s V V 9 In the above exresson, V reresents the total ee ad to the adedary or the alngs The otzaton yelds the ollowng results detals are resented n Aendx B 3 V 0 V V 3 π V V V Charge eternaton by the Adedary The adedary s rot axzaton roble s to set the rce or access to each eal address, The adedary obtans a revenue o V ro the seller and ays each consuer who receves an eal θ R er eal The adedary s rot axzaton roble s the ollowng: The assuton that the seller ays or the entre lst or each solctaton s ade rarly to obtan closed-or analytcal solutons The results are qualtatvely slar when the seller ays only or the consuers who receve eal n subsequent rounds o alng

19 ax π a V R R 3 V V V st 3 U 0 s 4 In equaton 3, V reresents the nuber o consuers who receves the rst solctaton and s the nuber o consuers who receves the th solctaton The constrant 4 arses ro the need to antan ncentve coatblty wth the artcatng seller Ths les that the seller s rot n ust be hgher than U s, U 0 s 0 Solvng or ths constraned otzaton roble, we obtan the otal soluton, n,, where s the largest satsyng 4 Ths yelds b b 4ac 5 a where a V 3, b V V, and V U 0 s c s the soluton to the rst order condton n 3, whch s,, where x s the soluton x to the ollowng V 3 V R R x x V Adedary rot s the ollowng detals are resented n Aendx B V V R R V R r r 3 VR V r 7 9

20 Consuer Surlus Note that consuers whose valuatons are between and resond to the th solctaton ro the seller The surlus to these consuers s ther value or the roduct n excess o Thus the total consuer surlus ro solctatons can be reresented as ollows π 9 c Where V a v dv v dv a a a V [ 3 ] yelds a total consuer surlus as ollows: V The results are suarzed n Aendx C Table C Slyng the above and eloyng equaton 0 Observaton 3: The nuber o tes a seller rce dscrnates s negatvely correlated wth the rce charged by the adedary or each eal solctaton Prooston 3: Consuer surlus s the hghest wth sngle solctaton and decreases wth the nuber o solctatons π c Proo: Ths ollows ro < 0 QE Prooston 4: Hgher search cost sellers rce dscrnate ewer nuber o tes Proo: We need to rove that < 0 Ths ollows ro < 0 s and > 0 QE s A drect lcaton ro roostons 3 and 4 s that consuers ay n act reer that the seller ractce rce dscrnaton or hgh search cost tes 0

21 3 Multle Sellers In ths secton, we extend the revous odels to consder ultle sellers n the aret We consder n non-coetng sellers n the aret, wth each sellng one roduct The deand or the roducts s assued to be ndeendent o others The adedary doesn t dscrnate aong sellers and charges the sae ee to all sellers We assue consuers o all arets have the sae readng cost o R As beore, the equlbru condton s that θ R The adedary s roble s then to deterne to axze hs rot Gven the ee set by the adedary, the seller deternes the artcaton strategy A artcatng seller sets and rce at each solctaton to axze hs rot Note that the exact nature o rce dscrnaton ollowed by the artcatng sellers ay vary, and n act soe sellers ay solct consuers only once, or nstance Consder the lcatons o on the adedary rots A hgher value o ncreases adedary rot er eal but elcts lower seller artcaton A lower value o reduces er eal rots but attracts ncreased seller artcaton Let denote the rot axzng charge osed on each eal ene the set U {,,, n, j K} j,, where j s the otal ee to set wth only one seller who solcts j tes, and K s a large nteger constant We have the ollowng rooston rovdng the otal value o Prooston 5: U Proo: Sort j s n ascendng order and re-label the as,, M, where M nk and t t, or all t, t,, M- We edately have artcate wth the adedary wth a charge hgher than M M because no seller would We also have because charges lower than lower rots ro each seller, and do not attract any addtonal sellers We rove that does not all between a ar o t s by contradcton Suose t < < t or soe t 0, t 0 <M We need to show that s not otal Consder ε such 0 0

22 that t < ε < t Note that ncreasng the charge ro to ε does not change seller 0 0 artcaton Moreover, or artcatng sellers, snce t < ε < t and has to be 0 0 nteger, the otal nuber o solctatons does not change Hence the adedary s strctly better o chargng ε than Contradcton QE The otal rce and rot coutaton or the adedary s rocedurally straghtorward Interestngly, the rcng strategy adoted by the adedary ay dssuade soe sellers ro artcaton However, hgh search cost sellers always have a hgher ncentve to utlze the servces oered by the adedary, and would on average would solct ewer nubers o tes In the next secton, we exlore these and other roertes n a sulaton settng 4 Exerental Study The urose o the sulaton exerentaton s to rovde nsghts nto adedary s rcng strateges, rot and welare lcatons, and condtons that oster seller artcaton or the aret settng descrbed n Secton 3 U0 s In the sulaton, snce < 0 and U0 s < V, we utlze U 0 s V µ s, s 4 4 where µ reresents act o search cost, 0 µ The exerental desgn conssts o sx ey aret varables: the nuber o sellers n the aretlace n; and or each seller s roduct the search cost s, consuers wllngness to wat, act o search cost µ, roduct eatures or qualty oered by the seller, and the axu valuaton V The value ranges consdered or these aret varables are shown n Table 3 The values R $05 and were used or all settngs All ossble cobnatons o these aret varables were sulated, resultng n a total o ,00 dstnct exerental settngs Fty nstances o the roble were generated or each settng, and the average results are reorted or each The ey results are suarzed below

23 Paraeter Nuber o Sellers,n Hghest Valuaton or Each Product,V Search Cost or Each Product,s Consuer s Wllngness to Wat Iact o Search cost µ Product Features Oered Table 3: Exerental Settngs Range 5 to 00 n stes o 5 4 dstnct settngs V ~U[5,50] to U[45,550] n stes o 00, 0 to 3 4 dstnct settngs s V ~ U[003, 004]V to U[0, 03]V, n stes o 00, 0 to 9 0 dstnct settngs ~U[03,04] to U[08,09] n stes o 0, 0 to 5 6 dstnct settngs µ ~U[05,06] to U[09,0] n stes o 0, 0 to 4 5 dstnct settngs ~U[07,08] to U[09,0] n stes o 0, 0 to 3 4 dstnct settngs, wth 4 th settng o Table 4 rovdes a snashot o adedary rot, seller rot, and consuer surlus n ters o ratos Ratos hgher than ndcate that allowng ultle solctatons generates hgher rot or surlus Not surrsngly, adedary and seller rots are always hgher wth rce dscrnaton N Wth Prce scrnato n Seller Partcaton Table 4: Iact o Prce scrnaton Wthout Prce scrnaton Ratos Wth Prce scrnaton/ Wthout Prce scrnaton Socal Adedary Seller Consuer Welare s Prot Prots Surlus 5 000% 930% % 900% % 930% % 900% V ~U [5,50], s V ~ U[005, 006]; ~U[05,06], µ ~U[09,0] and ~U[09,0]; Results are averaged over all cases or each N Interestngly, consuer surlus s also hgher wth rce dscrnaton than wthout Ths s due to the act that when ultle solctatons are allowed, ore sellers are nterested n artcatng wth the adedary Consuer surlus suered when only sngle solctatons are allowed because any sellers wthdraw ro artcaton The socal welare su o the adedary, seller rots, and consuer surlus s thereore sgncantly hgher n every exerental settng wth rce dscrnaton 3

24 Table 5: Nuber o tes o solctaton and search costs s Average o all s The adedary does not oster unettered nuber o solctatons as the average nuber o solctatons over all the exerental settngs was 404 As exected, sellers wth hgher search costs tend to solct ewer nubers o tes Table 5 Table 6: Iact o Wllngness to Pay on Consuer surlus Sngle Solctaton Partcaton Rate Multle Solctaton Partcaton Rate Average Total Consuer Surlus n Sngle Solctaton Average Consuer Surlus n Multle Solctaton SurlusRatos Wth Prce scrnaton/ Wthout Prce scrnaton ~U[03,04] 9494% 0000% ~U[04,05] 9497% 9999% ~U[05,06] 9495% 9988% ~U[06,07] 9497% 997% ~U[07,08] 9497% 9956% However, as llustrated n Table 6, the act o rce dscrnaton decreases wth ncreasng wllngness to wat Ths ay due to the act that as consuers wllngness to wat ncreases, there s less oortunty or the sellers to extract consuer surlus Thereore, t s less lely that a seller realzes hgher rots through the adedary than through the tradtonal channel Hence, seller artcaton would decrease and consuer surlus would suer I sellers are only allowed to solct once, the orton o artcatng sellers should not change because wllngness to wat does not aect rots n sngle solctaton case In act, Table 6 shows that artcaton rato ollows ths attern The slght decrease n sngle solctaton artcaton rate n the last row o Table 6 s ostly due to changes n other sulaton araeters Thereore the rato o consuer surlus n Table 6 declnes wth ncreasng wllngness to wat 4

25 Table 7: Iact o Product Features on Prots and Consuer surlus Sngle Solctaton Adedary Prot Multle Solctaton Adedary Prot Sngle Solctaton Total Seller Prot Multle Sollctaton Total Seller Prot Sngle Solctaton Consuer Surlus Multle Solctaton Consuer Surlus n ~U [07,08] ~U [08,09] ~U [09,0] Results are averaged over all other varable settngs In absolute ters, adedary rot, seller rot, and consuer surlus all ncrease wth the nuber o eatures oered n the roducts Table 7 Table 8 llustrates the act o search cost and the sze o the eal lsts on the charges set by the adedary, and the seller s ensung rce dscrnaton strategy For hgh search cost tes, the adedary nhbts the tendency o sellers to ractce ndscrnate solctatons by chargng a hgher rce Interestngly, when the sze o the eal lst s large, sellers send larger nuber o solctatons However, the nuber o solctatons decreases wth the search cost, due to the act that the charge er eal s hgher Ths underscores the crtcalty o the sze o the subscrber base on the adedary s botto lne V s V Table 8: Charge Per Eal and Nuber o Solctatons V ~U [5,50] avg avg V ~U [5,350] avg avg V ~U [35,450] avg avg V ~U [45,550] s V ~U[ ] s V ~U[ ] s V ~U[ ] s V ~U[ ] s V ~U[ ] s V ~U[ ] s V ~U[009-00] s V ~U[00-0] s V ~U[0-0] s V ~U[0-03] Results are averaged over all other varable settngs The results deonstrate that sellers are better o wth low search cost tes However, ooste condtons benet both the adedary and the consuers These results also suggest that the adedary sets a reerence or tes wth hgh search costs n order to rea hgher rots avg avg 5

26 5 Suary Coents The analytcal odels together wth the ercal study rovde the ollowng ey ndngs: as long as the search cost or the roduct or servce s larger that the cost to read an eal essage, the adedary has an ncentve to create an eal lst; the transactons acltated by the adedary create sgncant value-added, as evdenced by ts ostve act on socal welare; and 3 adedaton draws sellers wth hgh search cost roducts and servces These ndngs llustrate the otental o adedaton to restore eal as an eectve councaton eda or onlne advertsng Our analyss suggests that rce dscrnaton, whch entals ultle solctatons, wll eerge as the donant advertsng strategy At the sae te, adedaton ncororates selregulatory echanss to ensure that consuers do not bear any negatve externaltes, and that the volue o eals reans under chec For hgh search cost tes, consuers reer rce dscrnaton as t draws ore sellers to artcate and hence ncreases consuer surlus Currently, ost adedares ollow a sngle solctaton odel By rovdng ull coensaton to the consuers and allowng sellers to rce dscrnate, these organzatons can rove ther botto lne and gan ncreased subscrton Our analyss also reveals that the sze o the eal lst s a crtcal actor that draws sellers A nuber o ssues deserve urther nvestgaton Our assutons regardng the constancy o readng and search costs, and a consderaton o only non-coetng sellers need to be relaxed to derve urther lcatons o adedaton The or o rce dscrnaton develoed n ths aer wors on the rncle o sequental elnaton o consuers based on ther valuatons that dscount over te When ths dscount actor s not sgncant, consuers wll wat and not ae a urchase as long as they exect the rce to coe down Thus ths or o rce dscrnaton s only vable or roducts whose value dscounts sgncantly over te such as seasonal goods Other echanss, such as auctons, rovde alternatve ways to segregate consuers Integraton o other echanss wthn the raewor o adedaton ay enhance ts scoe and eectveness Whle the current odels utlze eal as the rary councaton tool, other technologes, such as ntellgent agents that wor on behal o users, can be slarly exlored 6

27 Aendx A: Proo o Prooston Prooston : I,θ,, v s a Perect Bayesan Equlbru to the gae descrbed above, then θr We rove rooston by contradcton Let,θ, L, H, v be a Perect Bayesan Equlbru to the dynac gae wth ncolete noraton, and θ<r Wthout loss o generalty, we assue that the realzaton o s ether L or H, wth equal robablty Let v denote the lowest valuaton or the ull-eatured roduct aongst the consuers who sgnu wth the adedary Snce s >R, all consuers wll reer sgnng u to search Hence all consuers wth ostve exected utlty ro sgnng u wll do so and the argnal consuer who sgns u s the one whose exected utlty s zero Thereore, the exected utlty or consuer wth v s 0 Thus, 0 5 L v -L -R-θ 0 5 Hv -H -R-θ 0 Slyng, L H R-θ v L H We now rove that,θ<r, L, H, v satsyng Perect Bayesan Equlbru cannot satsy equaton A We roceed by consderng all ossble values o v Snce ether v V or v > V ust be true, we construct a contradcton or each ossble value o v Case : v V I L s the realzaton o, the onoolstc rce s L v A L L V Snce v V, we have L V, that s, all consuers whose valuatons are hgher than the onoolstc rce would have sgned u Hence, the otal rce or the seller to set s when H s the realzaton o, the otal rce to set s A can be exressed as: V R-θ v L H L L V Slarly, H H V Thereore, equaton 7

28 Snce θ<r t contradcts v V Case : v > V In ths scenaro the seller does not set the rce to onoolstc rce because all consuers who have sgned u have valuatons hgher than that rce The otal rce to set s then the lowest valuaton o all consuers who have sgned u, that s, Substtute these values nto equaton A and slyng we obtan: L Lv and H H v R-θ v v L H Snce θ<r, ths results n a contradcton In concluson, there s no Perect Bayesan Equlbru when,θ<r, L, H, v 8

29 9 Aendx B: Prce scrnaton Strategy The seller s roble nvolves deternng the otal nuber o eal solctatons to consuers, and the rce to oer wth each solctaton We begn the otzaton by deternng the otal rces or a gven value o The otzaton roble s ax π s V V B The rst order condtons or rces yeld [ ] 0 V s π B [ ] 0 s π,,,- B3 [ ] 0 s π B4 The otal rces satsy the above lnear equatons A atrx reresentaton o B-B4 taes the or b A, where A 0 0 V b The otal rces can be obtaned ro b A By nducton, we obtan [ ] [ ] V,,, 3 B5 Substtutng equaton B5 n the equaton B yelds the seller s rot [ ] [ ] π V V s 3 B6 Now consder the otal nuber o solctatons by the seller The rst order condton s 0 π s, and ro equaton B6 we obtan

30 V 3 Substtutng B7 bac to B6, we obtan V V V π s 3 B7 B8 The adedary s rot axzaton roble s to set the rce or access to each eal address The rot axzaton roble, ro equaton 9, s: ax π a V R R B9 V V V st 3 U 0 s B0 The otal value o occurs ether ro the boundary condton dctated by B0 or ro the rst-order condton o B9 Solvng B0 we obtan V 3 V V V V U0 s { } 0 V b b 4ac The eanngul soluton s B a V U 0 s where a V 3, b V V, and c Now consder the rst order condton or B9 Let V [ ] [ ] 3 Slyng, V [ ] r r Now consder the ollowng ter ro B0 V Usng B7, we have 30

31 3 R ] [ r r RV ] ][ [ r r RV The adedary rot exresson B0 can be sled as ollows R R V a π R V r r RV r V ] ][ [ 3 R V r R R r R r V } 3 { Now consder the rst-order condton We have } 3 { 3 π R R V a } 3 { 3 R R V It can easly be vered that the second dervatve s negatve, and thus the rst-order condton rovdes the unconstraned rot axzng value o Let x, we need to solve the ollowng or x x R x R x Rewrtng, 0 3 ] [ 4 3 x R x R B Hence, n,, where s the largest satsyng B and x, x solves B

32 Aendx C: Suary o Analytcal Results Table C: Seller Prce, Prots, and Consuer Surlus n Sngle Solctaton Model Adedary Prce Scenaro Adedary Prot Prce Set by the Seller Seller Prots θ R V U s 4 V 0 V V, or <, or V U 0 s V U 0 s 4 4 RV RV < V U 0 s V U 0 s 4 4 RV 0 4 V V V U 0 s Seller does not sgn u Seller obtans rots through tradtonal ways Consuer Surlus / 8 V Consuers wll not sgn u and acheve consuer surlus less than / 8 V 3

33 Adedary Prce Prce/nuber o solctatons Set by the Seller Adedary Prot Table C: Multle Solctaton Model θ R n,, where b b 4ac, where a V 3, a V U 0 s b V V, and c, where x s the soluton to x R 3 R V x 3 x x 0, where 4 V 3 V,,, 3, whch [ ] [ ] gves V V V R R, whch gves V V R R V R r r 3 VR V r Seller Prots V [ ] V [ 3 ] Consuer Surlus, whch gves V V V π 3 V [ 3 ] V 33

34 Reerences Aerlo, G, The Maret or Leons: Qualtatve Uncertanty and the Maret Mechans, Quarterly Journal o Econocs, August 970, Baron, avd P, and Besano, avd, Montorng, Moral Hazard, Asyetrc Inoraton, and Rs Sharng n Procureent Contractng, The RAN Journal o Econocs, Vol 8, No 4, Wnter 987, Chao, H, and Wlson, R, Prorty Servce: Prcng, Investent, and Maret Organzaton, The Aercan Econoc Revew, Vol 77, ec 987, Goal, R, Walter Z, and Trath AK, Adedaton: New Horzons n Eectve Eal Advertsng, Councatons o the ACM, Vol 44, No, ec00, Harrs, M, and Ravv, A, A Theory o Monooly Prcng Schees wth eand Uncertanty, The Aercan Econoc Revew, Vol 7, June 98, Ho, R, Shoers: Tae Charge!, Busness Wee, May 5, Krshnan, Trchy V, Bass, Fran M, Jan, a C, Otal Prcng Strategy or New Products, Manageent Scence, Vol 45, No, ec 999, Lazear, E P, Retal Prcng and Clearance Sales, The Aercan Econoc Revew, Vol 76, No, Mar 986, Marshal, John M, Moral Hazard, The Aercan Econoc Revew, Vol 66, No 5, ec 976, Png, IPL, Most-Favored-Custoer Protecton versus Prce scrnaton over Te, The Journal o Poltcal Econoy, Vol 99, No 5, Oct 99, Schlosberg, J, As Eal Ads get Resectable, Sendng goes Through the Roo, e-mareter, htt://wwweareterco/eservces/eal_edaleht, 000 Shan, anel R, When E-Mal becoes jun al: The welare lcatons o the advanceent o councaton technology, Revew o Industral Organzaton, :35-48,996 3 Wesul, Kberly, The Net Beore Chrstas, Busness Wee Fronter, ec 4, 000 htt://ronterbusnessweeco 34

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