Chapter 2

Pricing Models in Web Advertising

Abstract The method to determine the price of web advertising is one of the most
striking innovations. In the early phases, most of the web advertisements were sold
through traditional exposure-based pricing models, such as the flat fee model or the
cost per impression model. However, over time, some other models also emerged
in practice where the pricing is based on a visitor taking some specifically defined
action in response to an advertisement. In fact, such models are now becoming more
popular than the traditional models. This chapter presents different pricing models
used in web advertising and analyze them.

2.1 Traditional Exposure-Based Pricing Models

In the early days of web advertising (around late 1994 and early 1995), few websites
or advertisers understood the real value of the web as an advertising medium, let
alone what price to assign to web advertising. The advertising managers certainly
understood the value of a 30 s television spot or a classified ad in the back of the
book, due to factors including industry norms, program ratings, years of marketing
research, and managerial experience. But, except for a handful of pioneering online
programs like CDNOW’s BuyWeb, which produced measurable results, there was
simply no way to understand the value of web advertising [9]. This presented a
dilemma for those managers who wished to advertise online.
Given little knowledge about the effectiveness of web advertising, the flat fee
pricing model were the earliest web advertising pricing model [10]. Flat fee pric-
ing charges the advertiser for their ads on a website in a certain period (e.g., per
month). Flat fee can be without or with traffic guarantees [2]. Naturally, it would be
advantageous for the advertiser to request guarantees of traffic level. At a minimum,
accurate information on site traffic must be made available to the advertiser, so that
the advertiser may evaluate alternative web media vehicles. Hence, the advertisers
started requesting for the traffic information. Assuming accurate traffic information,

© The Authors 2016 9

S. Kumar, Optimization Issues in Web and Mobile Advertising, SpringerBriefs
in Operations Management, DOI 10.1007/978-3-319-18645-0 2
10 2 Pricing Models in Web Advertising

flat fee prices may be readily converted into a CPM (cost-per-thousand-exposures)

model. In the CPM model, an advertiser pays an amount based on the number of
impressions (exposures) of an ad [12]. The number of impressions during a visit
is the number of times that the ad is displayed to the user during the visit [16].
As with conventional broadcast and print advertising, this approach measures only
the amount of advertising delivered, broken down, at best, by demographic or psy-
chographic segments.
In the early phases of web advertising, CPMs were inflated and flat fee deals
were even worse. There were no guarantees and there was no rationality to the mar-
ket. Many of the early online selling efforts were conducted by magazine salespeo-
ple with little experience regarding how new media actually worked. Thinking of
banner ads in the same way as they thought of a 30 s television spot or a print ad
in a magazine, they sought to base their prices on the number of people who would
see an ad—what in the trade was called “exposure-based cost-per-thousand pric-
ing” [9]. Hence, they quite literally invented CPM rates in the low $70s or charged
flat fees from $5000 to $10,000 per month to advertise on some of the earliest com-
mercial websites. It did not take long for the advertisers to determine that those
current CPMs were inflated and an obvious bad buy. At the flat rate of $10,000,
the ad would never even generate enough revenues to cover its costs. Consider the
following. Suppose the price of a single banner ad exposure (i.e., one page view)
was seven cents, because the web provider demanded a $70 CPM. If 1 % of the vis-
itors that saw the banner actually clicked, a single click would cost $7. But, since
only a small percentage of those visitors were converted into paying customers,
the customer acquisition costs were actually sky high. Assuming a 1 % conversion
rate, the cost to acquire that new customer was $700 [9]. As advertisers started real-
izing such problems with the high costs of CPM pricing model, the web advertising
industry increasingly moved towards performance-based pricing models. However,
until 2005, the CPM pricing model was the most prominent model in web advertis-
ing. Even in 2013, approximately 33 % of the total web advertising revenues were
priced on the basis of CPM [11].

2.2 Performance-Based Pricing Models

The performance-based pricing has been the most prevalent pricing model since
2006. In 2013, approximately 65 % of the web advertising revenues were priced
on a performance basis [11]. The earliest performance-based pricing model in web
advertising is the cost-per-click pricing model.
2.2 Performance-Based Pricing Models 11

2.2.1 Cost-Per-Click Pricing Model

Paying by the number of viewers (i.e., the CPM model) remained the norm until
Procter & Gamble negotiated a deal with Yahoo! in 1996 that compensated the
web portal for ads based on the “cost-per-click,” commonly known as “CPC” [4].
Yahoo! was paid only when a user clicked on the ad; this was the web-version of
paying for direct response commonly used by advertisers for things such as mail
and telephone solicitations. By 2002, the CPC model had been adopted by both
Google and Yahoo!, and it became the most widely used pricing model in paid
search advertising [3].
A relatively small proportion of those exposed to a banner ad actually click on
the banner. In 2006, DoubleClick reported that 4 % of web site visitors who were
exposed to a banner ad clicked on the ad the first time they saw it [10]. The top
25 % performing ads in the DoubleClick Network had an average click-through rate
(defined as the number of times that the ad is clicked upon divided by the num-
ber of times that it is exposed) of 8 %, with some click rates as high as 12–15 %.
Click-through rates decline after the first exposure, falling to 2 % for the second
and third exposures, and to 1 % or less at four exposures. Therefore, the payment
based upon the number of clicks guarantees that the visitor is not only exposed to
the banner ad, but also actively decides to click on the banner (to become exposed
to the target communication). Therefore, the payment based on the number of clicks
may be viewed as payment for target communication exposures. In other words, the
CPC model was an attempt to develop a more accountable way of charging for web
advertising [12].
In spite of its benefits, CPC model also had its controversies. Some website
providers continued to feel that this pricing strategy was unfair, arguing that the
click-through was at least partially a function of the level of creativity of the ad
and the level of interest generated in the viewer by it, which were not under the
control of website providers [16]. On the other hand, as discussed above, applying
only traditional exposure-based models to the web does not take into account its
unique, interactive nature. Additionally, the Internet is the first commercial medium
in which it is actually possible to measure consumer response, not just to assume
it. Although the CPC model might not represent the optimal approach to measuring
the value of interactivity, it offered a departure point from which to proceed.

2.2.2 Cost-Per-Action Pricing Model

Although the payment based on CPC model guarantees that there was visitor
exposure to target communications, it does not guarantee that the visitor liked the
communication or even spent any substantial time viewing it. Hence, it is proposed
that an additional measure of the value of an ad should be based upon the degree
to which the visitor interacts with the target communication [10]. An interactivity
metric might be based upon the duration of time spent viewing the communication,
12 2 Pricing Models in Web Advertising

the depth or number of pages of the target communication accessed, the number of
repeat visits to the target communication, or some other elements. Such a practice
was announced for the first time in 1996 when a member of the Internet mailing list
posted to the list that Modem Media, the interactive advertising agency, had devel-
oped a pricing model in which its clients would pay, not for exposures or clicks, but
only for activity at the client’s website.
This development raised anew the controversy surrounding the best web media
pricing models, with website providers arguing that the problem with performance-
based measures, such as the number of clicks or some action, is that the website
provider cannot be held responsible for the activity related to an ad. An analogy is
drawn to print, with the web publisher arguing that the print medium charges for
ads, regardless of whether they lead to sales. Not surprisingly, advertisers and their
agencies continue to argue that, since the web medium allows for accountability, it
is possible and desirable to develop models that measure consumer behavior [16].
Therefore, some leading practitioners are now moving toward measures as the “cost-
per-action” (CPA) pricing model proposed by Snap.com, where an action refers
to a realized purchase, download, registration, subscription, or lead [5]. A number
of merchants are following this trend, including Google, ZiXXo (pay-per-print),
Ingenio (pay-per-call), and others [3]. In 2006, Google attracted media attention
when it started to test a CPA model [7, 8]. Google regards CPA as the “Holy Grail”
of targeted advertising [6], and many online advertising companies have adopted it,
including eBay, ValueClick, and Snap.com.

2.2.3 Outcome-Based Pricing Model

The advertisers are eventually interested in outcomes, and the ultimate outcome is
purchase. As Stephen Klein, former I/PRO manager, stated: “One hundred thousand
people going to a site is worth something, but a site that only five people visit can
be worth more if they are the right five people” [14]. The metrics discussed above
relates to early stages of the purchase process: Banner ads affect the consumer’s
awareness, and the action affects the consumer’s comprehension and understanding.
Beyond these initial stages are the marketing objectives of attitude change, purchase
intention, and, ultimately, purchase. An outcome-based pricing model begins by
specifying precisely the advertiser’s goal for the target communication. Examples of
typical outcomes include influencing attitudes, motivating the consumer to provide
personal information, or leading the consumer to purchase. Whatever the marketing
objective, the web provides a vehicle for integrated marketing campaigns, which
allows the marketer to track and to measure the effectiveness of the ad. An example
is per-inquiry (PI) ads where the royalty is paid only on actual product sales, and no
other payment is required [10].
References 13

2.3 Hybrid Pricing Models

The CPM model and the performance-based model represent two extreme pricing
strategies. Pure CPM pricing favors the website provider because there is no risk:
The website provider is paid whether or not the ad is clicked upon. On the other
hand, the performance-based pricing model favors the advertiser because the web-
site provider carries all the risk: If the performance criterion of the advertiser is not
met, no revenue accrues to the website provider [12]. Several recent studies analyze
and compare different pricing models (e.g., see [1, 5, 13, 15]). These studies recom-
mend a hybrid pricing model that shares the risk between the website provider and
the advertiser. In [12], a hybrid pricing model is considered for optimal schedul-
ing and placement of web ads. In 2013, approximately 2 % of the web advertising
revenues were priced on a hybrid basis [11].

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