Monday, June 1, 2020

Sharing advertising risk

In general, if one party is less risk averse than another, contracts can create wealth by moving risk from a lower-value use to a higher-value one.  The classic example is insurance which moves a lottery from consumers who doesn't want it, to a risk-neutral insurance company who doesn't mind it.

Now Google is sharing cancellation risk with hotels through its pay-per-stay program that charges hotels for advertising (Ads) only after a guest has finished a stay.  If guests cancel, e.g., due to a pandemic, then the hotel does not have to pay Google for the ad that lead to the booking. Along with risk-sharing, there are other benefits as well:
  •  It allows the hotel to decentralize decisionmaking over Ad campaigns on Google. Lower-level employees, who may have better information about whether an Ad will work, do not need permission from sales managers or finance managers to initiate a new Ad campaign. If the campaign doesn't work, the hotel is not charged.
  •  It allows the hotel to better manage its cash flow, a crucial point for many hotels, especially seasonal ones. Previously Ad costs were incurred before the resulting Ad revenues were realized. Now Ad costs are incurred after the Ad revenue is realized.
  • I would add that it solves a potential moral hazard problem, e.g., under the pay per click model, web pages that host ads can click on the link to earn Ad revenue for themselves.
All of these benefits make Google Ads more attractive to advertisers. However, one can expect to see more failed or low quality Ad campaigns on Google because the cost of initiating a bad Ad campaign has gone way down.

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