Flexible and Committed Advertising Contracts in Electronic Retailing

Dengpan Liu (), Subodha Kumar () and Vijay S. Mookerjee ()
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Dengpan Liu: School of Economics and Management, Tsinghua University, 100084 Beijing, China;
Subodha Kumar: Fox School of Business, Temple University, Philadelphia, Pennsylvania 19122;
Vijay S. Mookerjee: Naveen Jindal School of Management, University of Texas at Dallas, Richardson, Texas 75083

Information Systems Research, 2020, vol. 31, issue 2, 323-339

Abstract: We use a differential games framework to study two modes of dynamic advertising competition, namely flexible (or closed loop) and committed (or open loop), between two e-retailers that compete for traffic. In closed-loop competition, the advertising contract allows firms to adjust their advertising levels during the advertising campaign. However, in open-loop competition, the contract requires the firms to commit upfront to an advertising plan (however, not necessarily one that advertises at a fixed rate). We ask the following question: Which contract (flexible or committed) is better for the firms (advertising agent)? We find that the firms advertise less and earn more under flexible contracts. As a result, the advertising agent earns less from the two firms under flexible contracts. Flexible and committed contracts become more interesting to study if operational considerations are included. These considerations arise from information technology (IT) costs incurred to process the traffic that arrives at the e-retailers’ websites. Operational considerations reduce the difference in advertising spending between the two contracts. Interestingly, to increase the revenue earned under flexible contracts, the advertising agent should offer such contracts at a price that is discounted relative to committed contracts. The discount exploits the force of competition and induces the firms to spend more on advertising. The optimal discount offered under a flexible contract decreases as the IT cost increases.

Keywords: differential games; advertising competition; operational considerations; electronic retailing (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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