Open Slots: An Economics Analysis of Sponsored Listings on E-tailing Platforms

Abstract

Inspired by the popularity of the advertising model at search engines, many online retailing platforms have added a new revenue stream of advertising (i.e., sponsored ads) to their traditional commission-based business model. While this new hybrid model is intuitively appealing, questions on its relative value to the traditional commission-based model have not been carefully examined. In practice, despite being embraced by top retailing platforms, sponsored ads are still quite rare among the majority of e-commerce platforms. It is of both theoretical and practical interest to examine whether adding sponsored ads is always economically attractive to retailing platforms. Toward this goal, we study the merits of the hybrid model relative to the traditional commission-based model by incorporating consumer search behavior, product characteristics, and seller bid behavior. We find that, while the hybrid model often weakly dominates the commission model, strict dominance only occurs in specific settings. A key reason is the substitution effect between the commission and advertising income. Furthermore, we show that the reverse - the commission model strictly dominates - can happen, depending on consumers' search costs and sellers' placement. Our findings suggest that platforms should carefully examine their seller and consumer profiles before implementing the advertising service.