jump to navigation

The Prisoner’s Dilemma in online advertising August 1, 2007

Posted by jeremyliew in ad networks, advertising, Consumer internet, economics, video, web 2.0, widgets.
11 comments

I posted previously about how increased innovation in online advertising is driving up costs. Online media companies would generally prefer more standarization and less customization in online advertising; this makes their processes more scalable and keeps their costs down. However, they face a prisoner’s dilemma situation that has made it hard to drive standardization as an industry.

The prisoner’s dilemma is a staple of game theory classes. Wikipedia summarizes the problem as follows:

Two suspects, A and B, are arrested by the police. The police have insufficient evidence for a conviction, and, having separated both prisoners, visit each of them to offer the same deal: if one testifies for the prosecution against the other and the other remains silent, the betrayer goes free and the silent accomplice receives the full 10-year sentence. If both stay silent, both prisoners are sentenced to only six months in jail for a minor charge. If each betrays the other, each receives a five-year sentence. Each prisoner must make the choice of whether to betray the other or to remain silent. However, neither prisoner knows for sure what choice the other prisoner will make. So this dilemma poses the question: How should the prisoners act?

Classic game theory predicts that in a single instance of the game, the dominant strategy is to betray your accomplice. However, if the game is repeated, the best strategy for rational players repeatedly interacting for indefinitely long games can lead to sustaining the cooperative outcome.

The Wikipedia article cites several real world examples of the prisoner’s dilemma, including one involving cigarette advertising.

When cigarette advertising [on TV and radio] was legal in the United States, competing cigarette manufacturers had to decide how much money to spend on advertising … cigarette manufacturers endorsed the creation of laws banning cigarette advertising [on TV and radio], understanding that this would reduce costs and increase profits across the industry.

While not advocating that we use cigarette companies as a role model, I believe that the online advertising industry currently faces a similar opportunity to reduce costs and increase profits over the issue of increasing customization in online advertising that I posted about last week.

So how does this relate to the prisoners dilemma? Rather than the police asking suspects to confess, advertisers are asking online media companies for costly custom advertising. If one media company is willing to customize and its competitor isn’t, then the customizing company is more likely to win the deal.

But if both companies customize then creative and production costs go up while the size of the ad spend does not. More money is spent on creating the campaign, and less goes to buying media. Thus both media companies suffer.

If neither company customizes, then less money is spent on creative and more goes to buying media and filling the online media companies’ coffers.

To make this situation more complicated, there aren’t just two prisoners who need to cooperate, but rather many online media companies. With many players, it can be very hard to drive towards a cooperative outcome.

For media companies, the “cooperation” case means adhering to a set of standards in creative format. While this doesn’t eliminate the costs of creative, it does at least set boundaries to help control creative costs.

While these standards exist in banner advertising, (728×90, 300x 250, 160×600 etc), they do not yet exist in other, newer forms of online advertising (including social media marketing, widget marketing, online video marketing, and casual immersive world marketing). But through the IAB, we saw standards eventually emerge in banner advertising, and hopefully we will see the IAB and other standards bodies (perhaps the newly formed Widget Marketing Association?) help set standards within the newer forms of online advertising as well.

This is a necessary but not sufficient condition for the industry to converge to a stable “cooperative” equilibrium in this version of the prisoner’s dilemma. I’ve campaigned for standards in social network advertising before.

What else do readers think can be done to promote cooperation?

Irrationality and Ebay July 19, 2007

Posted by jeremyliew in auctions, ebay, Ecommerce, economics, irrational.
7 comments

USA Today has a fascinating article today about how some economists are puzzled by irrational eBay buyers. (via Techmeme). The article summarizes research by a number of economists. One showed how buyers in an auction frenzy will bid an item up above “buy it now” prices – almost half the time!

Ms. Malmendier tracked 166 auctions offering CashFlow 101, a personal-finance-themed board game. During the seven-month trial, the game’s designer sold the box set on his website for $195.

Meanwhile, eBay sellers usually offered an opening price of about $45 and set a one-click, “buy it now” price of about $125. It looked like a great deal for buyers. They could pay less than retail to end the auction immediately or place bids in the hope of fetching an even lower price.

But this is where eBay users fell prey to what Malmendier and her coauthor, Stanford University economist Hanh Lee, call “bidder’s curse.” Apparently, some bidders grew so enthusiastic about winning the auction that they lost sight of the “buy it now” price, sometimes offering more than $185.

“We found that in 43% of the auctions the bidders ended up paying more than the ‘buy it now’ price,” Malmendier says.

Other researchers also found that buyers will often ignore shipping costs in their bidding.

Instead of observing auctions initiated by others, like Malmendier, Hossain posts his own controlled auctions. He offers identical items, but plays with the specifics of the sale. For example, he auctioned pairs of popular music CDs. One copy would start at $4 and include free shipping. The other would open at 1 cent but charge $3.99 for shipping. Either way, the initial cost was four bucks.

But bidders didn’t see it that way. On average, the low-cost, high-shipping auction attracted more bids, more bidders, and 25% more money.

The article summarizes other research findings as well and is a fascinating read.

Slate published a related article in May when it asked “Are Ebay auctions rational?“. Apparently standard auction theory predicts that having a secret reserve price will maximize value, but research on Ebay showed the opposite:

… Katkar and Reiley put the theory to the test by simply selling 50 matched pairs of collectible Pokemon cards, half with an open reserve price and half with a secret reserve price of the same level. Their conclusion, contrary to the theoretic argument, is that secret reserve prices are counterproductive. Far from stimulating interest, they seem to put bidders off, perhaps out of fear that a secret reserve is secret because it is far too high. Not wishing to waste their time, many of them just click “back” on their browsers and find somewhere else to bid.

I love this stuff.

Follow

Get every new post delivered to your Inbox.