Information and Incentives in Online Affiliate Marketing

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.