Advertising Competition on the Internet: Operational and Strategic Considerations

The emerging click†based pricing models for Internet advertising provide the firm with two possible decision processes to manage an advertising campaign, namely, spending†based and traffic†based. The spending†based process starts with the spending budget and determines the traffic accordingly, whereas the traffic†based process starts with a target level of traffic and determines the spending budget accordingly. We consider a duopoly where two electronic retailing firms—that compete for customer traffic—make demand generation (advertising) and demand fulfillment (IT capacity) decisions in equilibrium. Our analysis shows that the inclusion of operational considerations softens the level of competition between the firms and is better for both firms. Concerning the decision process, we find that traffic†based competition generates higher profits for both firms than those generated in spending†based competition. However, when the decision process is itself a choice, a spending†based advertising is chosen by both firms in equilibrium. We discuss how managers can be strategic about the choice of the decision process when competing for customer traffic.