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Facebook Ads: too high performance might turn on you (theoretically)

Introduction

Now, earlier I wrote a post arguing that Facebook has an incentive to lower the CPC of well-targeting advertisers because better targeting improves user experience (in two-sided market terms, relevance through more precise targeting reduces the negative indirect network effects perceived by ad targets). You can read that post here.

However, consider the point from another perspective: the well-targeting advertiser is making rents (excessive profits) from their advertising which Facebook wants and as the platform owner is able to capture.

In this scenario, Facebook has an incentive to actually increase the CPC of a well-targeting advertiser until the advertiser’s marginal profit is aligned with marginal cost. In such a case, it would still make sense for the advertiser to continue investing (so the user experience remains satisfactory), but Facebook’s profit would be increased by the magnitude of the advertiser’s rent.

Problem of private information

This would require that Facebook be aware of the profit function of its advertisers which as for now might be private information to the advertisers. But had Facebook this information, it could consider it in the click-price calculation. Now, obviously that would violate the “objective” nature of Facebook’s VCG ad auction — it’s currently set to consider maximum CPC and ad performance (negative feedback, CTR, but not profit as far as I know). However, advertisers would not be able to monitor the use of their profit function because the precise ad auctions are carried out in a black box (i.e., asymmetric information). Thus, the scenario represents a type of moral hazard for Facebook – a potential risk the advertisers may not be aware of.

Origin of the idea

This idea I actually got from one of my students who said that “oh, I don’t think micro-targeting is useful“. Then I asked why and he said “because Facebook is probably charging too much from it”. I said to him that’s not the case, but also that it could be and the idea is interesting. Here I just elaborated it a bit further.

Also read this article about micro-targeting.

Micro-targeting is super interesting for B2B and personal branding (e.g., job seeking).

Another related point, that might interest you Jim (in case you’re reading this :), is the action of distributing profitable keywords by the platform owner between advertisers in search advertising. For example, Google could control impression share so that each advertiser would receive a satisfactory (given their profit function) portion of traffic WHILE optimizing its own return.

Conclusion

This idea is not well-developed though; it rests on the notion that there is heterogeneity in advertisers’ willingness to pay (arising e.g., from different in margins, average order values, operational efficiency or such) that would benefit the platform owner; I suspect it could be the case that the second-price auction anyway considers this as long as advertisers are bidding truthfully, in which case there’s no need for such “manipulation” by Google as the prices are always set to maximum anyway. So, just a random idea at this point.

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