The Modern Advertising Agency Selection Contest: A 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 agreed-on media. The advertiser selects the agency that offers the best combination of creative quality and media cost, similar to conducting a score auction. To participate in the contest, each agency needs to incur an up-front bid-preparation cost to cover the development of a customized creative campaign. Agency industry literature has called for the advertiser to fully reimburse such costs to all agencies that enter the contest. The authors analyze the optimal stipend policy of an advertiser facing agencies with asymmetric bid-preparation costs, such that the incumbent agency faces a lower bid-preparation cost than a competitor agency entering the contest. The authors show that reimbursing bid-preparation costs in full is never optimal, nor is reimbursing any part of the incumbent’s bid-preparation cost. However, a stipend that is strictly lower than the competitor’s bid-preparation cost can benefit the advertiser under certain conditions. The authors provide a sufficient condition (in terms of the distribution of agency values to the advertiser) for such a new-business stipend to benefit the advertiser.