Cost-Per-Impression and Cost-Per-Action Pricing in Display Advertising with Risk Preferences

Online advertising has grown over the past decade to over $26 billion in recorded revenue in 2010, IAB (2010). The revenues generated are based on different pricing models that can be fundamentally grouped into two types: cost per (thousand) impressions (CPM) and cost per action (CPA), where an action can be a click, signing up with the advertiser, a sale, or any other measurable outcome. A web publisher generating revenues by selling advertising space on its site can offer either a CPM or CPA contract. Web publishers and advertisers typically use the action probability (the so-called click-through rate in the case of cost-per-click) to convert between CPM and CPA prices. This simple conversion rule assumes that both parties are risk neutral. However, it is well known that publishers usually prefer CPM pricing as they find it less risky while advertisers prefer CPA pricing, which is performance based. Our paper is motivated by this misalignment between the two parties. We introduce a new conversion rule that takes risk into account and explains the preferences observed in practice. We analyze the conditions under which the two parties agree on each contract type, under the assumption that both players are risk averse. We then explore several natural variations to the core conversion rules, including the cases where action probabilities are uncertain and the contracts take different forms.