Winning the Hardware Software Game Winning the Hardware-Software Game - 2nd Edition

Using Game Theory to Optimize the Pace of New Technology Adoption
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A copy of the full analysis can be downloaded by clicking on the link at the bottom of this blog entry.

 

In Part 1 of this analysis, I described recent trends in Internet advertising and Internet advertising pricing models. In Part 2, I introduced adblocking and described its use, together with the two major controversies surrounding the use of adblocking software. In this part of the analysis, Part 3, I describe the players and their motivations in the Adblocking Game. I also present a model of the Adblocking Game. In the last part of the analysis, Part 4, I will provide a discussion of the interesting aspects of the Game.

 

The Online Adblocking Game

Figure 15 presents the various players in the Online Adblocking Game. I describe below each of the (groups of) players, together with his motivations in the Game.

Figure 15

 

Advertisers

Advertisers pay to display advertisements on Content Providers’ websites. Advertisers are profit maximizers. They want to pay as little money as possible to (i) reach as many Potential Customers as possible and (ii) convince as many as those Potential Customers reached to purchase their products.

Advertisers compete with two sets of adversaries for the attention and interest of Potential Customers: (i) other Advertisers, and (ii) website content. Over time, the level of competition has increased as more Advertisers have placed more ads on more websites and as Potential Customers have learned to ignore old ads. This has lead Advertisers to continually increase the intrusiveness of ads in an attempt to win the attention and interest of Potential Customers.

In “The Internet with a Human Face,” Maciej Cegłowski explains this escalating nature of online ad quantities and intrusiveness as follows:

And your users, of course, HATE advertising. So to keep revenue from falling, you're stuck in an arms race where you have to keep changing up your approach.

...

Maybe some of you have seen these things popping up recently; paid ads that pretend to be related links. In another few weeks, people will learn to tune them out, and a different plague of ads will descend on us.

Advertising is like the flu. If it's not constantly changing, people develop immunity.



But investor storytime [ad-based online business models] is a cancer on our industry.

Because to make it work, to keep the edifice of promises from tumbling down, companies have to constantly find ways to make advertising more invasive and ubiquitous.
 

Content Providers - Non-Ad-Based Model

Content Providers who have non-ad-based business models include two different sets of Content Providers:

  Those Content Providers who don’t need to generate revenues to pay for the content they provide. Such Providers include, for example, bloggers and other providers of non-commercial content.

•  Those Content Providers who do need to generate revenues to pay for the content they provide, but who use non-ad-based business models to generate those revenues. Non-ad-based business models include, for example, selling subscriptions, selling products or services, or using online content to promote offline sales.

Content Providers with non-ad-based business models aren’t directly impacted by adblocking.

 

Content Providers - Ad-Based Models

Content Providers with Ad-Based Models are profit maximizers. They choose to place those ads on their websites that will generate the greatest amount of payments from Advertisers. Payments from Advertisers to Content Providers will be highest with those ads that generate the greatest User Click to the products advertised.

Unintrusive ads use less space and cause Users less annoyance than intrusive ads. This means that Content Providers will only choose to use intrusive ads if they will be more effective in generating User Click than the less expensive, unintrusive ads.

I assume that because more intrusive ads are more visible, Users are more likely to respond to them. At the same time, however, as more ads become intrusive (in both absolute and relative terms), the User experience becomes more encumbered, leading more Users to block ads. In some cases Users will respond to the encumbrance by blocking only intrusive ads, but in other cases Users will respond by blocking all ads, both intrusive and unintrusive.

 

Content Providers - Intrusive Ad-Based Models

Content Providers who have intrusive ad-based business models include those Content Providers who (i) currently display intrusive ads to generate revenues to support their production of content, and also (ii) are not willing to change their ads to become unintrusive.

These Content Providers stand to gain more revenues from having Users respond to more visible ads, but they also stand to lose revenues from Users who use adblocking software to block either all ads or just some/intrusive ads.

 

Content Providers - Unintrusive Ad-Based Models

Content Providers who have unintrusive ad-based business models include those Content Providers who (i) currently display either intrusive or unintrusive ads to generate revenues to support their production of content, but (ii) would be willing to change their ads to become unintrusive, and (iii) would pay to be whitelisted by Adblocking Software Providers.

The Content Providers in this group include the 300 who are currently (as of February 3, 2015) whitelisted on Adblock Plus (see Megan Geuss, “Over 300 businesses now whitelisted on AdBlock Plus, 10% pay to play”).

These Content Providers stand to lose revenues from either

(i)  Users who use adblocking software to block all ads, and/or

(ii)  Users who respond to intrusive ads but not unintrusive ads.

 

Users

Users buy hardware from Hardware Manufactures and pay ISPs and Mobile Carriers for connection services to access Content Providers’ online content. Users want access to as much (quality) content as possible for the lowest price.

The price to Users of accessing non-ad-sponsored content from Content Providers who use Non-Ad-Based Models is either (i) zero, for Content Providers who don’t have to pay for the creation of their content, or (ii) the price of the products and services offered by Content Providers who use some other non-ad-based business model.

A small portion of Users accounts for the vast majority of all User Clicks to online ads. Khalid Saleh, in “Effectiveness Of Online Advertising– Statistics And Trends,” indicates that, “Only 8% of internet users account for 85% of clicks on display Ads.” This suggests that most Users do not benefit from the information aspect of advertising, but rather only their impact on enabling the provision of content. In other words, most Users free-ride on content funded by a small minority of Users.

Advertising theory indicates that brand awareness and recognition is important for creating customer loyalty, that is, generating repeat purchases. More specifically, according to “The Top 5 Benefits of Increased Brand Awareness”,

Ongoing brand awareness ramps up customer loyalty: Since acquiring new customers is such a costly process, retaining customers and bringing them back again and again is critical to long-term business sustainability. Brand loyalty creates a certain level of security for businesses. Brand awareness plays an important role in repeat customer activity.

Advertising theory suggests that by merely having Users view banner and other display ads – even without them clicking through to get more information – increases brand awareness and recognition. I identify Users who are influenced by brand awareness and recognition as “Impressionists” (see Figure 15). I assume that Impressionists are included among all subgroups of Users: the minority of Users who click through online advertisements, the majority of Users who don’t click through, and the growing stock of Users who user adblocking software.

The price to Users of accessing content from Content Providers who use an Ad-Sponsored Models includes

  The loss of security and/or privacy associated with targeted advertising,

  The extra time requirements associated with slower download rates and the navigation of ad-filled content, and

  The energy and data costs associated with downloading advertisements

These prices to Users of accessing ad-sponsored content are generally higher when ads are more intrusive. Users are better off with a greater quantity of ads to the extent that those ads (i) provide valuable information or opportunities to Users about advertised products and/or (ii) enable the provision of and access to more content for Users. The tension here for Users who don’t like ads is that while less intrusive ads are less costly to Users, they generate fewer sales by certain Advertisers, which ends up decreasing the amount of content provided by certain Content Providers, which ends up being worse for Users.

Users must choose whether or not to install adblocking software, and if they choose to do so, which types of ads to block (i.e., the configurations of their filter settings).

 

Adblocking Software Providers

Adblocking Software Providers provide software that prevents ads from loading, prevents advertisers from tracking Users’ information, and enhances security associated with potential malware.

Adblocking Software Providers provide adblocking software to

  Users (e.g., Adblock Plus, Ghostery)

•  Hardware/OS Providers (e.g., Apple and Google)

  Mobile carriers (e.g., Shine)

Adblocking Software Providers are profit maximizers who must choose (i) the type of blocking services to provide, (ii) the player group to sell or license their software to, and (iii) the type of business model to use to maximize profits. Adblocking Software Providers are better off when there are more online ad revenues, when ads are more intrusive, and when more Users use adblocking software.

 

Adblocking Services Providers

Adblocking Services Providers provide services to Content Providers with Ad-Based Models to help those Content Providers address the use of adblocking by Users. Adblocking Services Providers must choose the type of services to offer that will maximize profits.

Adblocking Services Providers include, for example,

  Companies that provide Content Providers and Advertisers with information on the nature of adblocking use by Users and help Content Providers and Advertisers get their ads whitelisted by adblockers (e.g., PageFair, ClarityRay just bought up by Yahoo!)

  Companies that provide Content Providers with software to block adblocking software by Users (e.g. Anti-Adblock Killer, Hide My Adblocker)

Adblocking Services Providers are better off when there are more online ad revenues, when ads are more intrusive, and when more Users use adblocking software.

 

Non-Mobile and Mobile ISPs

ISPs sell Internet connection services to Users.

When Users download more (intrusive) ads from Content Providers’ websites, Users consume more bandwidth. This greater consumption of bandwidth by the downloading of ads

  Benefits ISPs to the extent that it leads Users buy more expensive data plans;

•  Hurts ISPs to the extent that it causes congestion on the ISPs’ networks;

  Hurts ISPs to the extent that the use of bandwidth by Users for ads consumes a portion of Users’ data allotment, slows their Internet speed, and/or otherwise hampers their surfing experience, which they don’t like, thereby creating ill-will by Users toward ISPs.

If ISPs are more harmed than helped by more (intrusive) ads, then they would benefit from having Users install adblocking software. In fact, this case, ISPs could actually increase profits through the use of adblocking software. In fact, this is adblocking company Shine’s model. From Lara O’Reilly, “This ad blocking company has the potential to tear a hole right through the mobile web — and it has the support of carriers”:

Where Shine will differ from other ad blockers is that it will run as a white-labeled piece of software, licensing the service out to mobile carriers.

It's up to the carriers to decide how they roll it out. They could choose to make it a premium service, where customer pays a couple of dollars extra a month or year. They could make it an opt-in, where customers get their rates dropped because they are using less infrastructure. It could be completely free, or even pre-loaded on smartphones.

It is also the carriers who will decide how much they will charge publishers, developers, and ad tech companies to get their content and networks "unblocked" from the system. Adblock Plus currently charges major publishers up to "30% of the additional ad revenues" they would have made were ads unblocked…

 

Hardware/OS Providers

Hardware/OS Providers sell hardware and operating systems for use by Users to access content on the Internet. Hardware/OS providers generate no benefits from online ads. They will thus be better off to the extent that they can generate benefits from the online ad/adblocking issue.

Apple recently announced that the newest version of web browser, Safari on iOS9, will contain extensions that enable content blocking. Apple doesn’t directly benefit or suffer from the placement or blocking of ads on websites. So why would Apple develop a web browser with this capability? Joshua Benton, in “A blow for mobile advertising: The next version of Safari will let users block ads on iPhones and iPads” puts forth three theories to explain this, the most convincing of which is the fact that Apple is releasing a new news app that will benefit from having “external” ads blocked by Safari.

An Apple partisan might argue it just wants to give users control of their iPhone experience, and having debuted extensions in the last version of iOS, allowing them to alter web content is a natural next step.

An Apple realist might argue that its great rival Google makes more than 90 percent of its revenue from online advertising — a growing share of that on mobile, and a large share of that on iPhone. Indeed, Google alone makes about half of all global mobile advertising revenue. So anything that cuts back on mobile advertising revenue is primarily hurting its rival…

An Apple cynic might note that the company on Monday unveiled its new News app, which promises a beautiful reading experience — and a monetization model based on Apple’s iAds. iAds will, one can assume, never be blockable by third-party extensions available in the App Store.

What this sounds like is that Apple is creating its own news ecosystem in which Apple will now be able to generate revenues from Advertisers. The Trefis Team explains this in more detail in “How Apple Is Bolstering Its Advertising Strategy With iOS 9”:

Apple will finally allow third-party Ad blockers on its iPhones and iPads, with the latest version of its mobile operating system, iOS 9 ... While Apple’s primary motive for allowing ad blockers on its iDevices is likely improving the web experience for its users, it could also help the iAd platform.  iAds, which appear at the operating system level via applications, are unlikely to be blockable by third-party extensions available in the App Store. This could make the iAd platform more valuable to marketers who want exposure to Apple’s valuable user base.



Apple also appears to be increasing its control over content on its iDevices with the launch of its native News application on iOS 9. News will combine articles from news outlets including the New York Times, ESPN and Condé Nast, presenting them in a unified format, much like a digital magazine. While publishers can sell their own advertisements on the news platform, keeping 100% of the revenue generated, they can also opt to leverage iAd and Apple’s increasingly robust ad targeting capabilities. Under this arrangement, content producers will pay Apple 30% of revenues, while retaining 70%.

Similarly, Google is trying to benefit from the adblocking phenomenon by providing a service, Contributor, which provides Users with an ad-free web experience, for a fee, of course. From Tim Peterson, “Google to Help Publishers Make Money by Blocking Ads”:

Google's Contributor is effectively an ad blocker, but one that benefits publishers as well as users. Like a traditional ad blocker, albeit one in which publishers give their consent, Contributor blocks the ads on a participating publisher's page so that visitors can focus on the content they came for. The space the banners would otherwise occupy will still be there, but the actual ads will be replaced with a "Thank you" message.

 

Model of Online Advertising Game

In this section I present a simple model in which I examine the decision regarding the optimal intrusiveness level of an ad for Advertisers and for Content Providers who use an Ad-Based Model.

The Advertiser pays to design an Ad and to place the Ad on the Content Provider’s website. I make the following assumptions:

•  The gross Value to the Advertiser when a User clicks on the Ad is the same, regardless of the Ad’s Intrusiveness Level:

(1)       Value (Level) = Value (Level*) = Value, where Level is the level of intrusiveness of the Ad.

•   The cost of designing the Ad, Cost(Level), is higher when the Ad is more intrusive:

(2)       Cost(Level) > Cost(Level*) when Level > Level*.

•  More intrusive ads take up more space on the Content Providers’ website and cause Users more annoyance. As such, the Payment the Advertiser makes to the Content Provider when a User clicks on the Advertiser’s Ad placed on the Content Provider’s website is larger when the ad is more intrusive:

(3)       Payment (Level) > Payment(Level*) when Level > Level*.

•  Users can respond to an Ad in one of four ways:

°  If the User has not installed adblocking software, then

•  The User can ignore the Ad;

•  The User can click on the Ad, where the probability a User clicks on the Ad is higher when the Ad is more intrusive:

(4)       PrClick(Level) > PrClick(Level*) when Level > Level*;

•  The User can respond to the Ad by installing Adblocking software, which means he won’t see any ads in the future.

°  If the User has already installed adblocking software, then the User will not see the Ad. The probability the User has already installed adblocking software is higher when the relative stock of online Ads is higher:

(5)       PrBlock(%Intrusive) > PrBlock(%Intrusive*) when %Intrusive > %Intrusive*

In addition, if the User has not installed adblocking software, then he can choose to not return to visit the Content Provider’s website during future periods.

My model lasts two periods, so I can capture the impact that more intrusive ads during the first period have on increasing User blocking during the second period.

If N Users visit the site, then expected two-period profit to the Advertiser associated with an Ad is

(6)       E(Π) = N x [1 – PrBlock(%Intrusive)] x PrClick(Level) x [Value – Payment(Level) – Cost(Level)]

+ β x N′(Level) x [1 – PrBlock(%Intrusive′)] x PrClick(Level′) x [Value – Payment(Level′) – Cost(Level′)]

where β is the one period discount factor, and ′ indicates second period levels.

The Advertiser faces a tradeoff when choosing the intrusiveness level of an Ad. Specifically, when the level of intrusiveness is higher,

•  The probability a User will click on the Ad, PrClick(Level), is greater, which increases the Advertiser’s profit;

•  The payment the Advertiser must make to the Content Provider to host the Ad, Payment(Level) is higher, which decreases the Advertiser’s profit;

•  The cost of designing the Ad, Cost(Level), is higher, which decreases the Advertiser’s profit;

•  The probability a User will block the Ad, PrBlock(%Intrusive′), will be higher, which will increase the probability that the User will not see the Ad during the second period, which will decrease the Advertiser’s profit; and

•  The probability a User will not revisit the site during the following period, N′(Level), will be higher, which will decrease the Advertiser’s profit.

In other words, a higher level of Ad intrusiveness will increase the probability the Advertiser will generate a profit, but it will decrease the level of profit. The existence of this tradeoff means the Advertiser’s expected profit curve will be concave, yielding a middling level of optimal intrusiveness.

The expected two-period payment to the Content Provider associated with an Ad is

(7)       E(Payment) = N x [1 – PrBlock(%Level)] x PrClick(Level) x Payment(Level)

+ β x N′(Level) x [1 – PrBlock(%Level′)] x PrClick(Level′) x Payment(Level′)

The Content Provider faces much less of a tradeoff than does the Advertiser. More specifically, when the level of intrusiveness is higher,

•  The User is more likely to click on the Ad, that is, PrClick(Level) will be higher, which will increase the Content Provider’s profit;

•   The Payment the Content Provider receives from the Advertiser if the User does click on the Ad is higher, which will increase the Content Provider’s profit; but

•  The number of Users who will visit the Content Provider’s site during the following period, N′(Level), will be lower, which will decrease the Content Provider’s profit. This issue turns out to not have a big impact on the Content Provider's decision.

The lack of a substantial tradeoff for the Content Provider means his payment curve will be relatively convex, leading to high optimal levels of ad intrusiveness.

The model thus suggests that Advertisers will want less intrusive ads than will Content Providers. I must admit that this is the opposite of what I would have thought.

Figure 16 provides a sample graph of the first, second and total profit and payment curves for the Advertiser and for the Content Provider. When I vary the parameters, the curves shift somewhat, but the relative outcomes remain the same: Advertisers want low to middling levels of ad intrusiveness, while Content Providers want high levels of ad intrusiveness.

Figure 16

 

 

Go to Part 4: Discussion of the Adblocking Game

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