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The Holy Grail of Advertising? Quality Signaling and Revenue Implications of "Pay- Per-Performance" Advertising

While there is a growing stream of research examining online sponsored search advertising, an important area that has not yet received enough attention is the interplay between pay-per-performance advertising and the quality of the firms who choose to invest in it. Our objective in this work is to explore how the shift from pay-for-exposure to pay-for-performance advertising affects the ability of firms to credibly signal their quality by spending resources to acquire more prominent advertising slots. Our main result is that, in settings where a noisy signal of a firm’s true quality is available to some consumers before they take the action that counts as “performance” (e.g. before they click on a sponsored search link or before they make the “qualifying” phone call) if the allocation of advertising slots is made purely on the basis of firm bids, pay-per-performance advertising reduces quality signaling incentives relative to traditional pay-per-exposure. More concretely, this means that there exist settings where pay-per-exposure would induce the highest quality firms to bid more for an advertising slot, whereas pay-per-performance would induce the lowest quality firms to bid more. This is a potentially important shortcoming of pay-per-performance advertising, especially in markets with high fractions of naive consumers who are accustomed to associating higher advertising expenditures with higher quality. Empirical evidence from Google and Yahoo provides support for our theoretical predictions. Half the money I spend on advertising is wasted; the trouble is, I don’t know which half. John Wanamaker, owner of America’s first department store