Reports

Online Marketplace Advertising

Hana Choi and Carl F. Mela, 2018, 18-112-05

With buyers on one side and third-party merchants on the other, online marketplaces are two-sided platforms of substantial economic importance, and they are expected to continue rapid growth in coming years.

Hana Choi and Carl Mela consider the allocation of “shelf space” in these online marketplaces, where items’ position is linked to advertising. They examine the trade-off between advertising revenue and transaction revenue by modeling both sides of the platform. On the demand side, they develop a joint model of search (impressions), consideration (clicks), and choice (demand). On the supply side, they consider sellers' advertising competition under various fee structures and ranking algorithms. They use buyer, seller, and platform data from a Korean online marketplace (the-nuvo.com) specializing in handmade goods.

They find that, though beneficial for consumers, reordering items by utility decreases the platform's and sellers' revenue by 53% and 49% respectively. This result is mainly driven by the fact that consumers are price sensitive, and the increase in sales volume is not large enough to offset the decrease in total revenue or the transaction commissions.

On the supply side they find that the seller's valuation from demand under the current fee structure is negative (-6% of the transaction amount) when the seller opts-in for advertising. In other words, sellers are worse off on each advertised sale.

Further, high advertising commissions encourage “web-rooming”, that is, they incentivize sellers to advertise items to generate traffic via clicks or exposures to the advertisers' own site where there are no commissions to be paid. The median valuation from consideration (click) is estimated to be $0.13.

Because of the high value for clicks and low value for sales, policy simulations show that lowering the cost-per-action/fees (CPA) and increasing the cost-per-consideration/click (CPC) yield a “win-win" outcome for the platform and its advertisers.

Hana Choi is a Ph.D. student at the Fuqua School of Business, Duke University. Carl F. Mela is the T. Austin Finch Foundation Professor of Business Administration at the Fuqua School of Business, Duke University, and 2017-2019 MSI Executive Director.

Acknowledgments
The authors thank Peter Arcidiacono, Bryan Bollinger, Garrett Johnson, Chris Nosko, Emily Wang, and seminar participants at the 2016 International Choice Symposium, the 2016 Economics of Advertising Conference, the University of Chicago, Columbia University, Duke University, Emory University, the University of Minnesota, University College, London, the University of Pittsburgh, and Yale University for comments and suggestions.

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