Flexible and Committed Advertising Contracts in Electronic Retailing
Dengpan Liu, Subodha Kumar, Vijay S. Mookerjee
Information Systems Research · 2020 · Volume 31 · Issue 2
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
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