Risk, Information, and Incentives in Online Affiliate Marketingby Benjamin Edelman, Wesley Brandi

Journal of Marketing Research

About

Year
2015
DOI
10.1509/jmr.13.0472
Subject
Economics and Econometrics / Business and International Management / Marketing

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Journal of Marketing Research, Ahead of Print

DOI: 10.1509/jmr.13.0472 *Benjamin Edelman is Associate Professor, Harvard Business School,

Harvard University (e-mail: bedelman@hbs.edu). Wesley Brandi is Chief

Executive Officer, iPensatori (e-mail: wesleyb@ipensatori.com). The authors thank George Baker, Florian Ederer, Francesca Gino, Robert

Glazer, Brian Hall, Zhenyu Lai, Ian Larkin, Tyler Moore, Frank Nagle,

Dave Naffziger, Steve Tadelis, NOM seminar participants, and two JMR anonymous reviewers for comments and suggestions on earlier drafts of this article.

BENJAMIN EDELMAN and WESLEY BRANDI*

The authors examine online affiliate marketing programs in which merchants oversee thousands of affiliates they have never met. Some merchants hire outside specialists to set and enforce policies for affiliates, whereas other merchants ask their marketing staff to perform these functions. For clear violations of applicable rules, the authors find that outside specialists are the most effective at excluding the responsible affiliates, which can be interpreted as a benefit of specialization. However, in-house staff are more successful at identifying and excluding affiliates whose practices are viewed as “borderline” (albeit still contrary to merchants’ interests), forgoing the efficiencies of specialization in favor of the better incentives of a company’s staff. The authors consider the implications for marketing of online affiliate programs and for online marketing more generally.

Keywords: affiliate marketing, fraud, marketing management, incentives, outsourcing

Online Supplement: http://dx.doi.org/10.1509/jmr.13.0472

Risk, Information, and Incentives in Online

Affiliate Marketing © 2014, American Marketing Association

ISSN: 0022-2437 (print), 1547-7193 (electronic) 1

For decades—perhaps centuries—marketers have bemoaned the effectiveness of their advertising campaigns. When paying for advertising up front and receiving benefits later, advertisers are vulnerable to low-performing or nonperforming ad placements. Against this backdrop, affiliate marketing seems to offer a refreshing change: in this performancebased approach to online marketing, advertisers pay only when a sale occurs. With robust online tracking that can attribute sales to affiliates, advertisers often perceive an unprecedented reduction in risk. The Economist (2005) captured advertisers’ excitement for the apparent alignment of incentives, calling affiliate marketing “the holy grail of online advertising.”

As it turns out, however, affiliate marketing is neither as easy nor as safe as proponents initially anticipated. Most advertisers struggle to find reliable affiliates that deliver new customers in desired quantities, in exchange for reasonable compensation. Meanwhile, despite the promised alignment of incentives, bad affiliates can exploit shortcomings in tracking and attribution to claim commissions they have not fairly earned. Informed by these problems, affiliate marketing raises long-standing questions of judgment, partnership, and incentives reminiscent of decades of media-buying.

This article offers two contributions. We begin by presenting affiliate marketing in a general sense; we explore its institutions and participants as well as key risks uncovered to date. Then, we explore advertisers’ efforts to address those risks. Specifically, we evaluate advertisers’ management structures by measuring relative prevalence of affiliate fraud. By examining the common methods of affiliate program management, we identify the vulnerabilities best addressed by outsourcing marketing management to external specialists versus the problems better handled by keeping management decisions in-house. We find that outside specialists are most effective at enforcing clear rules, whereas in-house staff are better at preventing practices viewed as “borderline” under industry norms.

While our results apply most directly to advertisers considering the management structure of their online marketing programs, our analysis also speaks to the broader literature on outsourcing and boundaries of the firm. Managers often face a trade-off between keeping functions in-house (typically with greater supervision and greater control over quality) versus outsourcing to a specialist (that may have greater capabilities or a cost advantage due to scale and experience). In general, these questions make empirical estimation difficult: it is usually challenging to find a context that offers numerous similar insourcing/outsourcing decisions.

Furthermore, companies’ structures are generally confidential and, thus, unobservable to researchers. In contrast, we examine an online marketing context in which advertisers often reveal their management structures as they recruit marketing affiliates. We enjoy the additional advantage of a novel data set. Typically, both firms and researchers lack top-quality data on opportunistic behavior because those providing low-quality services usually attempt to conceal their activities from the principals that pay them. If principals cannot determine quality, researchers usually also struggle to determine what has occurred. In contrast, we developed custom software to examine affiliates’ behavior— information often unavailable even to the advertisers and networks that purport to supervise these affiliates.

AFFILIATE MARKETING AND AFFILIATE FRAUD

Affiliate marketing combines sharp performance incentives with the broader efficiencies of online advertising. In particular, affiliate marketing compensation is usually purely performance-based—offering perhaps a $5 or 10% advertising fee for each purchase. Under standard rules, an affiliate earns a commission only if (1) a user browses to an affiliate’s site, (2) the user clicks the affiliates specially coded link to the merchant, and (3) the user makes a purchase from the merchant (Edelman 2013). These additional requirements importantly differ from better-known methods of online advertising: most display ads (“banner ads”) require an advertiser to pay as soon as a website serves an ad to the user, and almost all search ads require an advertiser to pay as soon as a user clicks on an ad.