Working Knowledge
Business Research for Business Leaders
05 Mar 2009Working Paper Summaries

CPC/CPA Hybrid Bidding in a Second Price Auction

by Benjamin Edelman and Hoan Soo Lee
How should online advertisers measure and pay for advertising deliveries? Options include pay per impression (CPM), per click (CPC), per action (CPA), or in proportion of the dollar value of merchandise sold. The advertisers who choose to pay one way may differ, systematically, from those who choose to pay in some other way. HBS professor Benjamin Edelman and doctoral student Hoan Soo Lee present the problem in an algebraic model in anticipation of measurement to follow in future work. Key concepts include:
  • When advertisers and ad platforms evaluate payment metrics, it seems they currently focus on effects on parties' incentives. For example, parties recognize that if billing is proportional to the number of measured clicks, then click fraud would expose advertisers to unwarranted advertising expense. With such constraints in mind, parties attempt to balance the various competing incentives.
  • We propose an additional factor advertisers and ad platforms ought to consider: which advertisers are systematically most likely to favor which payment metrics. Averages that fail to condition on advertisers' choices may badly misestimate an advertiser's true characteristics—causing the platform to select ads that later prove to be ill-advised.

Readers with suggestions are invited to contact Professor Edelman and Hoan Soo Lee.

Author Abstract

We develop a model of online advertising in which each advertiser chooses from multiple advertising measurement metrics—paying either for each click on its ads (CPC), or for each purchase that follows an ad-click (CPA). Our analysis extends classic auction results by allowing players to make bids using two different pricing schemes, while the driving information for bidders' endogenous selection—the conversion rate—is hidden from the seller. We show that the advertisers with the most productive sites prefer to pay CPC, while advertisers with lower quality sites prefer to pay CPA-a result that may be viewed as counterintuitive since low quality sites cannot proudly tout their conversion rates. This result holds even if an ad platform's assessment of site quality is correct in expectation. We also show that by offering both CPC and CPA, an ad platform can weakly increase its revenues compared to offering either alternative alone.

Paper Information

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