The Impact of Targeting Technology on Advertising Markets and Media Competition

Transcription

1 From the SeectedWorks of Joshua S Gans December 2009 The Impact of Taretin Technooy on Advertisin Markets and Media Competition Contact Author Start Your Own SeectedWorks Notify Me of New Work Avaiabe at:

2 Tite: The Impact of Taretin Technooy on Advertisin Markets and Media Competition Authors: Susan Athey (Correspondin) Department of Economics, Harvard University, 1805 Cambride St., Cambride, MA Phone: Fax: Emai: Joshua S. Gans Mebourne Business Schoo, University of Mebourne, 200 Leicester St, Carton VIC 3053, Austraia. Phone: Fax: Emai: Session: Desinin Onine Advertisin Markets (L1) Presidin: Michae Schwarz (Yahoo! Research) Discussants: Scott Kominers (Harvard University); Michae Grubb (Massachusetts Institute of Technooy) This version: 11 st January 2009

3 1 The Impact of Taretin Technooy on Advertisin Markets and Media Competition by Susan Athey and Joshua S. Gans 1 An important component of advertisin effectiveness is the quaity of the match between advertisers and the intended recipients of ads. Traditionay, media has been abe to tihten such matches by providin content taiored for specific roups of consumers. For exampe, oca media outets attract audiences from their ocaities, ensurin that when oca advertisers pace ads, they are mosty viewed by their potentia customer base. Recenty, onine advertisin has afforded new technooies that taret consumers directy rather than indirecty throuh taiored content. A eadin exampe of such taretin is based on eoraphic ocation (as inferred from IP addresses). So whie the Boston Gobe may have had an advantae in sein ads to Boston advertisers, now the New York Times can offer Boston-based ads to consumers ocated in Boston. Industry specuation is that such technooies may spur hiher demand for onine advertisin, but that these technooies wi benefit enera outets more than oca newspapers. 2 It may be probematic for the future of oca news industry if enera outets ain at their expense. To date there has been itte anaysis on how the market for advertisin miht be impacted by taretin. 3 Intuition suests that in an outet adoptin taretin technooies wi 1 Athey: Department of Economics, Harvard University, 1805 Cambride St., Cambride, MA athey@fas.harvard.edu. Gans: Mebourne Business Schoo, University of Mebourne, 200 Leicester St, Carton VIC 3053, Austraia. j.ans@unimeb.edu.au. For hepfu comments we thank Emiio Cavano, Jonathan Levin, seminar audiences at Monash and the SIEPR/Microsoft Conference on Internet Economics, and especiay Michae Grubb. We thank the Tououse Network for Information Technooy and the Austraian Research Counci for fundin. 2 Behavioura taretin, The Economist, 5 th June Some papers have expored the impact on product market competition (Ganesh Iyer, David Soberman and J. Miue Vias-Boas (2005); Esther Ga-Or, Mordechai Ga-Or, Jerrod H. May and Wiiam E. Spaner (2006)) and

4 2 increase demand for advertisin and with that prices (for impressions or cicks); see Ambarish Chandhra (2009). In this paper, however, we deveop a forma mode which identifies a separate suppy-side impact of taretin. Specificay, taretin aows enera outets to more efficienty aocate scarce advertisin space, resutin in an increase in the number of advertisers who can be accommodated. This increase in effective suppy pushes prices downwards and wi ceary affect the returns to adoptin taretin technooies. The resoution of these demand and suppy effects depends upon how taretin aters the incentives of the enera outet in choosin its advertisin space. When such space can be freey chosen (that is, there are no costs in expandin ad space or consumer disutiity from ads) and when advertisers are not themseves capacity constrained, we demonstrate that an appropriatey chosen expansion of ad space is a perfect substitute for taretin. That is, the adoption of such technooies does not ater prices or equiibrium profits. We then anayze three extensions of the mode in which taretin does benefit enera outets: advertisin space is imited or costy; there is heteroeneity across oca media markets; or advertisers are capacity-constrained (creatin competition between outets on the advertisin-side of the industry). Even in these cases, however, the impact of taretin is mitiated by the fact that when taretin is introduced, it is optima for outets to cut back on their suppy of ad space. Our forma anaysis focuses on the case where the market shares of outets are exoenous. Ceary, the hiher are the profits per consumer, the more the outets are wiin to invest in their quaity, expandin their market shares. When taretin increases enera outet ad avoidance (Justin Johnson, 2009). An independent and compementary paper by Dirk Beremann and Aessandro Bonatti (2009) is a notabe exception; takin suppy as exoenous, that paper deveops a mode of taiored media content and expores a number of comparative statics about the impact of taretin on advertisin demand.

5 3 profits at the expense of oca ones, we expect equiibrium market shares of outets (and/or outet surviva, iven the need to cover fixed costs) to move in the same direction as profits. I. Baseine Mode Our mode invoves a set of ocaities m {1,..., M} with N consumers in each ocaity, M oca media outets (one for each ocaity), and a sine enera outet (). Consumers (exoenousy) visit ony one outet, either their own oca outet or the enera outet; in the terminooy of the two-sided market iterature, they sine-home. 4 In oca market, m, there are N consumers, where n,m choose the oca outet. Our first resuts rey on a symmetry condition: (S) Market shares for the oca and enera outet are symmetric across ocations. Under condition (S), we et n denote each ocaity s readership for its oca outet. Each advertiser i is aso oca and so it does not vaue advertisin impressions for consumers outside its market. In our baseine case, we make the foowin assumption: (CV) Per-consumer advertiser vaue, v i, is invariant to the number of consumers. This condition wi hod if the advertisers are not capacity constrained and have constant marina cost. Mutipe impressions on the same consumer are wasted, but outets track consumers so that ony one impression per consumer is offered to each advertiser. There is a continuum of advertisers with vaues drawn from [0,1] with distribution F(v i). Each outet j { 1,.., M, } has a choice over the number of ads, a j, that can be impressed on a consumer. Advertisers are assumed to bid for ad space and so wi be rationed accordin to vaue with the marina advertiser, v j bein defined by 1 Fv ( ) a. j j 4 This is a standard assumption in the media economics iterature (Simon Anderson and Steven Coate, 2005), athouh in Susan Athey, Emiio Cavano and Joshua S. Gans (2009), we consider the impications of what happens when consumers can easiy switch between outets (i.e., some of them muti-home).

6 4 II. Taiorin versus Taretin in the Baseine Mode We now turn to sove for the equiibrium in the advertisin market under condition (CV). Each outet seects its suppy of ad space. 5 Let p j denote the impression price of outet j. Note that (CV) impies that outet decisions are independent of one another, so each outet focuses on its own inventory decisions in isoation and our resuts are invariant to the number of outets. On the demand side, advertisers wi purchase impressions on an outet if jvi pj. j is the probabiity that a iven impression is paced in front of a consumer in the advertiser s ocaity. For each oca outet, 1, since its content is taiored and ony read by consumers in the advertiser s ocaity. In contrast, for the enera outet, condition (S) impies 1/ M. An advertiser i on a enera outet reaches a consumers in its own ocaity (in addition to those in others), earnin surpus of nv i Mnp. Usin this, we estabish a benchmark resut. Proposition 1. Under (S) and (CV), the enera outet earns the same per consumer profit as oca outets reardess of whether it adopts taretin or not. Its advertisin space in the absence of taretin is M times its advertisin space with taretin. PROOF: Let 1 F( p / ) be the tota demand for impressions in a ocaity to a iven reader of j j outet j. For a oca outet,, in m, p,m wi be determined by the point where demand equas suppy; that is, 1 F( pm, ) am, or p F (1 a ). For, usin (S), M (1 F( Mp )) a or, 1 m, m, p M F M a. soves: 1 (1 / ) (1 (1 / ) ) 1 max a af (1 ) a whie, if there is no taretin, soves: 1 max a (1/ M ) af (1 (1/ ) ) Ma. Note that these probems are the same but for a scain factor, 1/M. Thus, Ma a and * * p Mp * *. Substitutin these into profits, it is cear that per 5 The industry refers to the choice of ad inventory as the yied manaement probem and numerous firms and products exist to hep an outet optimize its advertisin output.

7 5 consumer profits are identica. If adopts taretin, its probem becomes identica to s probem but, since the maximized profits were identica, its profits do not chane. By (CV), s behavior does not chane as a resut of s taretin. To understand this resut, it is instructive to compare the impression prices for oca and enera outets. First is the demand-side efficiency effect: advertisements in the enera outet are priced ower because they are ess productive than those in the oca outet whose consumers a come from a particuar ocaity. Second is the suppy-side scarcity effect: without taretin, for a fixed eve of advertisin space, the suppy of advertisements by the enera outet to a particuar ocaity is reduced because a market s advertisers compete for that outet s scarce advertisin space with advertisers from other ocaities. This pushes up prices on the enera outet. The baance of the effectiveness and scarcity effects determines whether taiorin is, indeed, a driver of reater profitabiity or not. Suppose for a moment that a is fixed and exoenous. Then, the oba outet earns hiher prices (and profits) with taretin if (1) F (1 a ) F (1 a ) M M To understand the condition, note that the first 1/M on the riht-hand side refects the efficiency effect. The factor 1/M in the second term refects scarcity: without taretin, a / M advertisers from a iven ocaity purchase advertisements, whie with taretin, to fi the same space, a advertisers from a sine ocaity purchase advertisements. If Fv () v, (1) becomes M /( M 1) a, and so that the taretin profits are hiher uness a is fairy hih (for the case of M=2, at east 2/3, which is hiher than 1/2, the optima eve of a with taretin). When the enera outet chooses its advertisin space a in each case, in the absence of taretin it expands advertisin space to M times what a oca outet woud provide. Consequenty, it serves the same rane of advertisers, athouh to do this it chare a price of 1/M

8 6 of the price it woud chare with taretin. Athouh impressions are wasted on mis-matched consumers, the enera outet repicates the oca outet (monopoy, due to (CV)) outcomes. III. Constraints or costs to the outets of advertisin space Our baseine case demonstrates that taretin is not so much a substitute for taiorin (in terms of aowin more effective ads) but a mechanism that aows an outet to achieve outcomes without wasted impressions. When there is no cost to providin those impressions, there is no return to adoptin taretin. Of course, advertisin space may be costy in terms of direct costs (e.., printin and bandwidth) but aso in terms of opportunity cost (e.., deterrence of readers who may have a disutiity associated with advertisin cutter). In that case, taretin woud save those costs. To keep thins simpe, we incorporate the costs of advertisin space usin a constraint, but the resuts are quaitativey simiar when there is a cost of advertisin space. Proposition 2: Suppose that advertisin space on the enera outet is constrained to be no reater than a. Then the adoption of taretin by the enera outet eads to hiher impression prices, hiher profits, and hiher socia wefare, reative to the case of no-taretin. The proof is a straihtforward impication of the fact that the optima eves of advertisin for the oba outet with and without taretin are such that profits are equa between the two, but when the oba outet is too constrained to increase its output enouh to compensate for the inefficiency of its impressions, its profits fa. The wefare impication arises from the fact that taretin aows more advertisers to be accommodated by the enera outet for a iven advertisin space constraint. This aso means that the private return to adoptin taretin technooy is ess than the socia returns. This suests issues for patforms tryin to promote such technooies and their diffusion; somethin we eave for future research.

9 7 IV. Heteroeneous demand across ocaities Consider what happens if our symmetry condition (S) does not hod, so that oca outet demand varyin across ocaities. In this case,, m n, m / n, m, so that an advertiser in a ocaity where the enera outet has a hiher presence has a hiher wiinness to pay than in other ocaities. Without taretin, suppy must be aocated across a advertisers: M M F ( p / ) a. For a specific functiona form, we show that taretin stricty heps. m 1 m, b Proposition 3. Suppose that (CV) hods and that F() v v for some b 0 for v [0,1]. Then the adoption of taretin increases enera outet profits for a ( n,1,.., n, M). Its advertisin space in the absence of taretin is M times its advertisin space with taretin. PROOF: Let, b m m M m 1. Since there is no strateic interaction, we can mode the choice of b price. Without taretin, the enera outet soves: p p M p max. With taretin, it b soves max p (1 p ) in each market (where the objective is independent of the market p identity). It is straihtforward to show that per impression profits with taretin are equa to T ( b 1)/ b b/( b 1) whie without taretin they are. Since NT T M (1 b)/ b 1/ b 1 b M (with 1 b M under (S)), the concusion hods. No-taretin profits are proportiona to with-taretin profits, and the size of the ain depends on the shape of the demand curve as we as the cross-market heteroeneity. Note that advertisers in some markets wi be worse off as a resut of taretin. In markets where the enera outet had a hih readership share without taretin, advertisin demand was reativey hih. Taretin means some of those advertisers are no oner served. In effect, taretin makes it possibe for the enera outet to price discriminate across markets.

10 8 V. Capacity-constrained advertisers Condition (CV) impies that outets do not compete for advertisers. In contrast, it may be that advertisers are capacity constrained and ony wish to reach, at most, a specific number of consumers (for simpicity in the mode, just one). With advertiser capacity-constraints, the enera and oca outets wi compete for advertisers at the marin. Consider this condition: (CC) Each advertiser i vaues at most one consumer impression from its own market. A oca outet can se an advertiser, i, a sine impression that wi reach a reevant consumer; yiedin surpus of vi p. For the enera outet, an impression has a 1/M th chance of reachin a consumer in the advertiser s ocaity. Thus, the advertiser miht want to purchase mutipe impressions. Let C( x) 1 ( M 1)/ M x denote the probabiity that an advertiser who purchases x enera outet impressions reaches at east one reevant consumer; advertiser i s payoff from x impressions is Cxv ( ) i xp. Let (2) x * ( v; p ) armax C( x) v xp. i x i Note that C( x) v xp v p; that is, for equa impression prices, any advertiser woud prefer to be on the oca outet. 6 This means that, in equiibrium, x v p p. * () In effect, the oca and enera outets are verticay differentiated in their offerins to advertisers. This means that hih vaue advertisers, in the sement [ v,1], wi sort onto the oca outet, whie the sement, [ v, v ), advertises on the enera outet. (3) (4) v p C x v v x v p * * ( ( )) ( ) Cx v v x v p * * ( ( )) ( ) 6 In this section, we inore the fact that impressin a consumer from a iven market reduces sihty the ikeihood that the next consumer comes from the same market; this effect is neiibe with sufficienty many consumers.

11 9 The first condition states that the marina advertiser on the oca outet is indifferent between purchasin an impression on that outet or its optima number of impressions on the enera outet. The second condition says that the marina advertiser on the enera outet (and by impication in the market) earns no surpus when purchasin its optima number of impressions on that outet. The outets advertisin space choices wi impact on their impression prices which in turn wi be constrained by the choices of their riva. On the suppy-side, the oca and enera outet suppy constraints are: (5) 1 F( v ) na (6) v x * (; v p) df() v na / M, v where the eft-hand side of (6) is the tota advertisin demand in each market. The two countervaiin effects (the efficiency effect and the scarcity effect) that we found in the baseine mode are sti present here. On the efficiency side, taretin means that advertisers can achieve their desired quantity with certainty, and so they vaue a sine impression from the oca outet more than an arbitrary number from the enera outet. However, there is aso a third, strateic effect. A move to taretin removes the vertica differentiation between oca and enera outets and there wi be a sine impression price, p, in the market determined by: na n a 1 F( p). Our forma anaysis shows that, ike in the baseine mode, the first two effects exacty baance out within the no-taretin reime: increasin the number of markets has no impact. Proposition 4. Suppose that (S) and (CC) hod. Then in the absence of taretin, both oca and enera outet profits as we as the set of advertisers served by each are independent of M for M 1, whie the advertisin space provided by the enera outet increases in M. PROOF: Since by (5), oca outet output has a one-to-one reationship with a that does not

12 10 depend on any enera outet choices or on M, we can consider the oca outet as directy choosin v rather than a. For fixed ( v, v ) and impression prices, the advertiser optimization constraints (2), (3), and (4) can be soved to express impression prices as a function of critica vaues: p v n[ M / ( M 1)] and p v (1 n[ v / v ]). In turn, these can be used to express profits as a function of ( v, v ). Cruciay, we find that the eft-hand side of (6) can be written (1 / n[ M / ( M 1)])( F( v ) F( v )) E [ n[ v/ v ] v v v ]. This and the expression for p impy that enera outet profits are independent of M for iven ( v, v ). Lettin v ( a ; v ) be the vaue of v that satisfies (6), v v ( a ; v ) does not depend directy on M. Substitutin in p, oca outet profits are n (1 F( v )) v ( a ; v )(1 n[ v ( a ; v )/ v ]), which does not depend directy on M. Thus, if ( v, v ) is an equiibrium for some M, it wi aso be an equiibrium for M M. The proposition shows that, in the absence of constraints on advertisin, the number of markets does not matter within the no-taretin reime. This somewhat counter-intuitive resut foows because of the suppy effect: the enera outet has the incentive to expand capacity to exacty offset the additiona inefficiencies created by addin markets. With constraints on advertisin capacity, increasin M does indeed cause the enera outet to suffer more from its inefficiency. How do we compare outcomes with and without taretin? For a fixed ( v, v ), enera outet profits under no-taretin are ess than under taretin by a factor of E [ n[ v/ v ] v v v ], which represents the averae surpus extracted from inframarina T T advertisers (hiher-vaue advertisers purchase more impressions). Lettin ( v, v ) be the equiibrium vaues with taretin (arbitrariy assinin the top advertisers to the oca firm), and T T T T v F( v ) F( v ) / f( v ), it is straihtforward to show that if reconizin that

13 11 T T T E [ n[ v/ v ] v v v ] 1, then without taretin, the enera outet s best response to v T is ower than T v : the enera outet serves more advertisers. Its expands its advertiser base because it extracts more on averae from inframarina advertisers at a ower v T. We expore the fu equiibrium anaysis and comparison of profits by sovin the mode for a functiona form: b Exampe: Suppose that F() v v ( v [0,1], b 0 ). When comparin equiibrium without taretin to that with taretin, the oba (respectivey oca) outet serves a arer (resp. smaer) set of advertisers but receives ower (resp. hiher) profits. An expansion of advertisin space cannot repicate fuy the with-taretin profits for the enera outet because there is one impression price posted for a advertisers, with impression demand varyin by advertiser vaue. With non-inear prices (e.. the outet ses ony a are bunde rather than individua impressions), much or a of this inefficiency can be eiminated. VI. Concusions We have estabished that when advertisin space is unconstrained, enera outets can expand advertisin space to mitiate most or a of the inefficiency that arises due to their heteroeneous audiences, so that taretin has itte or no vaue. Athouh more reaistic assumptions such as imits on advertisin space or advertiser capacity constraints create a reater roe for taretin, the suppy effect sti operates within the bounds of these constraints. Our anaysis supports the broad intuition that advances in taretin technooy wi ead to the rowth of enera outets at the expense of taiored outets, but our findins quaify the extent of the impact and suest that enera outets wi adopt and utiize taretin technooy more sowy than the technooica efficiency improves. Of course, this does not rue out the possibiity that industry structure wi be reaty atered as a resut of other technooica chanes in advertisin or chanes in consumer habits as a resut of the internet (Athey, Cavano and Gans, 2009).

14 12 VII. References Anderson, Simon P. and Steven Coate Market Provision of Broadcastin: A Wefare Anaysis. Review of Economic Studies, 72(4): Athey, Susan, Emiio Cavano and Joshua S. Gans Wi the Internet Destroy the News Media? mimeo., Harvard. Beremann, Dirk and Aessandro Bonatti Taretin in Advertisin Markets: Impications for Od and New Media? mimeo., Yae. Chandra, Ambarish Tareted Advertisin: The Roe of Subscriber Characteristics in Media Markets. Journa of Industria Economics, 58(1): Ga-Or, Esther, Mordechai Ga-Or, Jerrod H. May, and Wiiam E. Spaner Tareted Advertisin Strateies on Teevision. Manaement Science, 52(5): Godfarb, Avi and Catherine E. Tucker Privacy Reuation and Onine Advertisin. mimeo., Toronto. Iyer, Ganesh, David Soberman, and J. Miue Vias-Boas The Taretin of Advertisin. Marketin Science, 24(3): Johnson, Justin Tareted Advertisin and Advertisin Avoidance. mimeo., Corne.