Information and Incentives in Online Affiliate Marketing

by Benjamin G. Edelman & Wesley Brandi

Overview — Compared to historic advertising methods, online marketing invites advertisers to attempt a sharply increased quantity of partnerships. Online relationships reduce the transaction costs of buying ad placements. In many advertising marketplaces, standardized contracts let an advertiser accept a proposed placement with a single click, and ad networks widely sell bundles of hundreds or thousands of placements. Meanwhile, many advertisers find they can get valuable leads and favorable pricing from the Internet's myriad small sites. These numerous relationships entail costs, too, such as selecting, compensating, and supervising the sites, making sure each site is suitable to show the advertiser's offer, and making sure sites in fact deliver the promised benefits. Advertisers thus turn to specialists and outside firms to handle important aspects of advertising-buying. In this paper, the authors evaluate advertisers' chosen management structures by measuring the relative prevalence of advertising fraud targeting advertisers engaged in online "affiliate marketing," a performance-based compensation system increasingly common in online ad campaigns. Specifically, the authors identify the vulnerabilities best addressed by outsourcing marketing management to external specialists, versus the problems better overseen by keeping management decisions in-house. They find outside advisors most effective at enforcing clear rules, but in-house staff excel at preventing practices viewed as "borderline" under industry norms. While the results apply most directly to advertisers considering the management structure of their online marketing programs, the analysis also speaks to broader concerns of outsourcing and the boundary of the firm. Key concepts include:

Affiliate marketing broadly aligns incentives between advertisers and affiliates by compensating affiliates only when sales occur.
Rogue affiliates may seek commissions they have not fairly earned, typically by claiming to have referred customers who were already going to buy.
Alternative structures of affiliate program management can influence merchants' vulnerability to affiliate fraud.
Outsourced marketing managers tend to enjoy superior information about affiliates' practices, but outsourcers' incentives differ from advertisers' objectives.

Author Abstract

We consider alternative methods of supervising staff who have significant discretion and whose efforts are subject to both incomplete information and skewed incentives. Specifically, we examine online affiliate marketing programs in which merchants oversee thousands of affiliates they have never met. Some merchants hire specialist outside advisors to set and enforce policies for affiliates, while other merchants ask their ordinary marketing staff to perform these functions. For clear violations of applicable rules, we find that outside advisors are most effective at excluding the responsible affiliates-which we interpret as a benefit of specialization. However, in-house staff are more successful at identifying and excluding affiliates whose practices are viewed as "borderline" (albeit still contrary to merchants' interests), foregoing the efficiencies of specialization in favor of the better incentives of a company's staff. We consider implications for marketing of online affiliate programs and for online marketing more generally.