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Separating Advertising and Marketplace Functions of E-commerce Platforms: Is it Social Welfare Enhancing?

Zhe Zhang, Young Kwark, Srinivasan Raghunathan, Peng Wang

TL;DR

The paper analyzes regulatory proposals to separate advertising from the marketplace on e-commerce platforms using a stylized two-seller Hotelling model with sponsorship ads. It compares an Integrated Setup (ads and marketplace on one platform) to an Independent Setup (advertising handled by an outside firm) under a targeting-precision parameter $\beta$ and ad-positions with CTRs $\alpha$ and $\delta$, solved via backward induction. The main finding is that separation often reduces sellers' profits and need not improve social welfare; in some cases, consumer surplus rises due to lower prices, but social welfare can fall unless consumer misfit costs are low or ad-CTR asymmetries are small. The results imply that regulator-driven structural separation may unintentionally undermine platform efficiency and pricing dynamics, and that integrated structures can better coordinate incentives to improve welfare, with policy implications for competition and data-use regulation in digital marketplaces.

Abstract

The use of sponsored product listings in prominent positions of consumer search results has made e-commerce platforms, which traditionally serve as marketplaces for third-party sellers to reach consumers, a major medium for those sellers to advertise their products. On the other hand, regulators have expressed anti-trust concerns about an e-commerce platform's integration of marketplace and advertising functions; they argue that such integration benefits the platform and sellers at the expense of consumers and society and have proposed separating the advertising function from those platforms. We show, contrary to regulators' concerns, that separating the advertising function from the e-commerce platform benefits the sellers, hurts the consumers, and does not necessarily benefit the social welfare. A key driver of our findings is that an independent advertising firm, which relies solely on advertising revenue, has same or lesser economic incentive to improve targeting precision than an e-commerce platform that also serves as the advertising medium, even if both have the same ability to target consumers. This is because an improvement in targeting precision enhances the marketplace commission by softening the price competition between sellers, but hurts the advertising revenue by softening the competition for prominent ad positions.

Separating Advertising and Marketplace Functions of E-commerce Platforms: Is it Social Welfare Enhancing?

TL;DR

The paper analyzes regulatory proposals to separate advertising from the marketplace on e-commerce platforms using a stylized two-seller Hotelling model with sponsorship ads. It compares an Integrated Setup (ads and marketplace on one platform) to an Independent Setup (advertising handled by an outside firm) under a targeting-precision parameter and ad-positions with CTRs and , solved via backward induction. The main finding is that separation often reduces sellers' profits and need not improve social welfare; in some cases, consumer surplus rises due to lower prices, but social welfare can fall unless consumer misfit costs are low or ad-CTR asymmetries are small. The results imply that regulator-driven structural separation may unintentionally undermine platform efficiency and pricing dynamics, and that integrated structures can better coordinate incentives to improve welfare, with policy implications for competition and data-use regulation in digital marketplaces.

Abstract

The use of sponsored product listings in prominent positions of consumer search results has made e-commerce platforms, which traditionally serve as marketplaces for third-party sellers to reach consumers, a major medium for those sellers to advertise their products. On the other hand, regulators have expressed anti-trust concerns about an e-commerce platform's integration of marketplace and advertising functions; they argue that such integration benefits the platform and sellers at the expense of consumers and society and have proposed separating the advertising function from those platforms. We show, contrary to regulators' concerns, that separating the advertising function from the e-commerce platform benefits the sellers, hurts the consumers, and does not necessarily benefit the social welfare. A key driver of our findings is that an independent advertising firm, which relies solely on advertising revenue, has same or lesser economic incentive to improve targeting precision than an e-commerce platform that also serves as the advertising medium, even if both have the same ability to target consumers. This is because an improvement in targeting precision enhances the marketplace commission by softening the price competition between sellers, but hurts the advertising revenue by softening the competition for prominent ad positions.

Paper Structure

This paper contains 9 sections, 7 theorems, 2 equations, 1 figure, 2 tables.

Table of Contents

  1. Introduction
  2. Literature Review
  3. Model Setup
  4. Equilibria in the Integrated and Independent Setups
  5. Consumers' Purchase Decisions and Sellers' Demand Functions
  6. Sellers' Pricing and Bidding Strategy
  7. Targeting Precision Decision
  8. Impact of Separating Advertising from the Platform
  9. Conclusion

Key Result

Lemma 1

For targeting precision $\beta$, the following prices and bids constitute an equilibrium in both the Integrated Setup and the Independent Setup. (i) $p_A^*=p_B^*=\frac{\alpha \delta t+v ((1-\alpha ) \delta+\alpha (1-\delta))+\beta (\alpha -\delta) (t-v)}{2 (\alpha +\delta)-3 \alpha \delta-2 \beta

Figures (1)

  • Figure 1: Social welfare given the optimal precision in the Integrated Setup (dashed line) and the Independent Setup (solid line), i) with increasing $t$ where $v=1 ,r=0.25, \alpha=0.7, \delta=0.65$; ii) with increasing $\alpha$ where $v=1 ,r=0.35, \delta=0.55, t=0.54$

Theorems & Definitions (7)

  • Lemma 1
  • Lemma 2
  • Lemma 3
  • Lemma 4
  • Corollary 1
  • Proposition 1
  • Corollary 2