The Modern Advertising Agency Selection Contest: The Case for Stipends to New Participants

In the modern advertising agency selection contest, each participating agency specifies not only its proposed creative campaign, but also the budget required to purchase the agreedupon media. The advertiser selects the agency that offers the best combination of creative quality and media cost. To participate in the contest, each agency needs to incur an upfront bidpreparation cost arising from the development of a customized creative. Agency industry literature calls for the advertiser to fully reimburse such costs to all agencies that enter the contest. We analyze the optimal stipend policy of an advertiser facing agencies with asymmetric bid-preparation costs: the incumbent agency currently serving the account faces a lower bidpreparation cost than a competitor agency considering whether to participate in the contest. We model the contest among full-service advertising agencies as a score auction. We show that reimbursing bid-preparation costs in full is never optimal and neither is reimbursing any part of the incumbent’s bid-preparation cost. However, a stipend that partially defrays the competitor’s cost can be profitable under certain conditions.