Electronic Commerce Research, 1: 169–181 (2001)

 2001 Kluwer Academic Publishers

Internet Advertising, Game Theory and Consumer

Welfare
MARCUS CHI-HUNG LING marcus.ling@sunderland.ac.uk
Visiting Lecturer, Sunderland Business School, St. Peter’s Campus, University of Sunderland, Sunderland,
SR6 0DD, UK

KEVIN LAWLER kevin.lawler@sunderland.ac.uk

Reader in Industrial Economics, Sunderland Business School, University of Sunderland, Sunderland,
SR6 0DD, UK

Abstract

The aim of this paper is to consider the implications of Internet advertising, for prospective consumer welfare
gains/losses. The implications of imperfect information among buyers are discussed to highlight the role of
intermediaries and search agents in enhancing consumer welfare in a world of complex products and uncertainty.
The argument demonstrates that despite possessing welfare enhancing potential the retailing of complex products
on the Internet increases the scope for price discrimination among sellers. Hence, buyers may pay different
prices for the same product/services. The paper shows how “agents” may restrict this type of market failure if
they possess the ability to search all databases. That the Internet intrinsically exhibits welfare enhancing and
reducing characteristic a game model is develop to show how entry of new sellers may proceed or be checked by
incumbents.

Keywords: Internet advertising, game theory, consumer welfare, Internet economics

1. Introduction

When the first Internet advertising came out around five years ago, the direct effects on
sales were trivial. In recent years, firms spent increasing volumes of advertising resources
on the Internet to develop e-commerce. The rising trend is phenomenal and is evident in
growth rates, rising from $50 million in 1995 to $2.8 billion in 1999 (Table 1). The emerg-
ing effects created by Internet advertising are wide-ranging spanning different marketing
strategies, which can be illustrated by the expected volume of trade via consumers and
businesses (Table 2). In strategic terms, Internet advertising reduces barriers created by
geography, thus facilitating the emergence of potential entrants and affecting traditional
market shares. With respect to consumer choice, Internet advertising provides a tremen-
dous extra impetus for firms wishing to practise product differentiation (Ling et al., 1997).
Prices are normally vital parameters affecting choice. Ling et al. (1999) uses a game theo-
retical model to analyse Internet price regimes widely used by Internet retailers. The key
implication of this multi-period game shows that time-constrained consumers form rational
expectation about prices offered by different Internet retail outlets, and that agents try to
170 LING, LAWLER

Table 1. Internet advertising revenues.

Source: Internet Advertising Bureau (IAB)
2000, + www.Internetnews.com/

On-line advertising (US$ million)

1995 40
1996 266.9
1997 906.5
1998 1,920
1999 2,800*
2002 6,500**

* First three quarters total only.

** Forecast value.

Table 2. Transaction values via the Internet (US$ million).

1995∗ 1996** 1998+ 2000∗ 2002+

All 100 500–600 32,000 168,000 425,000

Consumer – – 11,200 – 93,500
Business – – 20,800 – 331,500

Source: ∗ The World in 1997, p. 115.

** The Economist, May 10, 1997.
+ Nairn (1999).

employ different pricing/advertising strategies to match consumer expectations with price

incentives and price-quality relationships. In the subsequent analysis, the major focus is
on quality aspects and the economic implications of Internet advertising. A probability
analysis is utilised to investigate how agents and firms may improve the expected payoffs
(gains in quality) for consumers in an uncertain world. Furthermore, a game theoretical
model is constructed to isolate strategic functions offered by Internet advertising assisting
agents’ effort to boost sales. Finally, emergent roles for Internet auctions and advertising
are considered.

2. Internet advertising, agent and trade

On the Internet, numerous products with varying qualities are advertised and offered to
consumers. However, Internet consumers are normally time-constrained and are puzzled
by the vast matrix of qualities of goods on sale. Assume that there exists a range of prod-
ucts in a micro-segment environment all with identical selling prices but with different
intrinsic qualities. Here quality refers to the “package” including elements such as prod-
uct design, standard compliance, delivery, and after-sales services. Consumption via the
Internet can be seen as a service facilitator when prices on offer are identical. Hence, the
well-known Hotelling (1929) model of product differentiation may be applied in service-
oriented situations, where buyers are assumed to be equally distributed along a straight-line
horizontal spectrum where firms are located in different territories to maximise sales. The
model predicts that the greater the geographical distance between sellers and buyers, the
INTERNET ADVERTISING 171

higher the time/transaction cost required for delivery or, for waiting for deliveries, and
this lowers consumer utilities. The implications of the spatial element are crucial for agent
involved in competitive direct marketing via the Internet. For instance, Amazon.com recog-
nises this spatial dimension and consequently has been actively expanding its network of
warehouses. The ultimate aim of these outlets is to create a distribution network capable
of selling and delivering any item requested by Internet consumers (Tett, 1999). In fact,
the prerequisite for efficient delivery is particularly important in areas where consumers
are already well served by efficient retailers and good communications infra-structure. At
the same time, an efficient business environment implies that Internet retail agents have to
face tougher competition being surrounded by traditional retail outlets especially in terms
of service qualities and efficiency.
On the Internet, consumers can search for different categories of goods and services.
Nelson (1978) argues that experiential goods are more likely to be affected by advertis-
ing than search goods. This is the reason why traditional main media advertising fo-
cuses on non-durable and experiential goods/services. However, when advertising costs
get cheaper, as advertising space is virtually unlimited on the Internet, there exists many
potential opportunities for previously inactive and non-advertised product sectors to ad-
vertise on the Internet. However, when more advertising is conducted on the Internet,
this creates problems of information overload for buyers. Common knowledge among
consumers is extremely limited on the Internet where imperfect knowledge is likely to
predominate. Thus, buyers face uncertainty and time-constrained problems when making
purchases (Kreps, 1990). To model the informational problems confronting consumers
given imperfect knowledge, a simple probability analysis is undertaken. The crucial idea
in the example is consistent with the choices offered by used-car markets. Hence, due to
lack of information about the true mechanical features of used cars, consumers are thrown
into dark and so have to gamble when purchasing. Given that used cars with similar engine
characteristics are grouped together, under an identical offer price. Despite the fact that
these cars are different in certain quality aspects, sellers who advertise to attract Internet
buyers not normally willing to give information on the true mechanical features of cars
on offer. Consumers are therefore ignorant of quality levels and do not possess sufficient
information to evaluate the potential reliability standards before delivery. This type of
buying environment is seen at auction web sites and at used-product supermarkets on the
Internet. Retail prices in this analysis are kept identical to facilitate comparisons. How-
ever, to reflect the varying levels of utilities to be gained by consumers, there exist different
perceived buyer values.
For instance, we assume that before making a purchase, buyers form the expected mean
valuation of that £6000 matches a good quality used car and that £3000 represents a po-
tential ‘lemon’ with low quality. If the market price for all used car models is £5000,
consumers are drawn into a gamble. On one hand, if a used car turns out to be of good
quality, the purchase is a bargain, representing a £1000 gain. On the other hand, buying a
bad quality car results in losses of £2000. In this gambling situation, risk averse consumers
will not purchase impulsively and will seek ways to improve their knowledge base. How-
ever, any buyers may not have sufficient information/time/ability to make a better choice.
As economic search is costly and human beings are often restrained by time, consumers
172 LING, LAWLER

Table 3. Divergency of users and market values.

Buyers perception Users perceived value Probability Market price

Good quality £6000 1/3 £5000

Low Quality £3000 2/3 £5000

may seek help from intermediaries – search agents, who posses higher levels of expertise
and are exposed to more specialised buying techniques. Imagine a situation where an In-
ternet intermediate agent obtains market research information regarding the probability of
quality distribution (Table 3). Then they work out a “fair” value for a random purchase,
which is £4000 (6000 · 1/3 + 3000 · 2/3). Based on the above “fair” value (£4000), the
market price (£5000) implies an average gross profit of £1000 is made on every car sold at
Internet site. However, buyers are disadvantaged if they are equipped with insufficient data.
To improve payoffs, agents can investigate vehicle histories and make professional judge-
ments accordingly. The agent’s intention is to search for a used car, which has quality at
least equivalent to £5000 (good quality as expected by consumers). Obviously, agents can
also bargain on behalf of consumers knowing that there is a divergence between the “fair”
and market prices. However, price variables are not the major concern of this analysis.
This analysis is a simplified picture of how consumers may be badly served with dis-
criminating pricing practices, and how agents may operate between retailers and buyers.
Inevitably, the values of probability distributions help predict market “fair” values. In re-
ality, there are more quality variables forming the formulae for deducing a “fair” price and
for other quality evaluations. Indeed, agents equipped with specialised information and
marketing techniques will be attentive to special features relating to an optimal consump-
tion choice such as product durability, brand quality, ISO standards and maintenance. The
key role played by agents essentially transforms time-constrained consumers into non-time
constrained buyers or, eliminates consumer ignorance of potential choices. Agents possess
complex databases of quality performance indicators for ranges of products. For instance,
within a specific market subsegment, when consumers specify a range of prospective pur-
chase prices, agents then utilise search technologies to select the mechanise with the high-
est quality rating. Without such systems organised by search agents, consumers are likely
to trade-off time saved against lower merchandise quality. Assuming that the probability
distribution in the previous example was reversed between the two quality categories, the
resulting “fair” price becomes £5000 (6000 · 2/3 + 3000 · 1/3), which is exactly the same
as the market price. If consumers accept to pay this market rate, the role of agents is to
ensure that the purchased car is of good quality. This demonstrates the potential welfare-
enhancing role played by intermediate agents.
The issue of incomplete buyer information is crucial for e-commerce, particularly if
consumers are sensitive to product quality variations. In traditional economic models,
asymmetric information problems normally do not apply to suppliers, hence suppliers on
Internet may play a dual role in retailing competition. On one hand, they advertise as much
information as possible to match consumer expectations effectively, whereas, on the other
hand, they may conceal vital information as evident in the used-car market example; or,
they may focus on advertising favourable quality dimensions to motivate sales. Thus, sell-
INTERNET ADVERTISING 173

ers may advertise to strengthen brand image and implicit by-products, such as “goodwill”
and generic brand quality. These countervailing economic features arise from the informa-
tive and persuasive elements in the advertising process.1 The former is regarded as welfare
enhancing while the latter may be wasteful in resources. The two conflicting advertising
influences are becoming common on the Internet as sellers invest ever-increasing volumes
of advertising outlays at the expense of more traditional advertising media (Ling et al.,
1999).
The persuasive aspects of advertising are strategically employed to strengthen “brands”
and retail value. The “quality” element created by Internet advertising is the “perceived”
quality derived from inherited brand “reputation”, recognition and prestige. According to
Kreps and Wilson (1982), reputation effects can be easily established. Logically, therefore,
the heavier the target advertising becomes the more favourable the perceived quality rating.
Consequently, persuasive advertising tends to pull consumers nearer to advertised brands
and further away from rival products with less attached advertising. If advertising via the
Internet is utilised optimally and follows certain strategic patterns, some firms are likely to
eliminate rivals or obtain higher market shares.

3. A game model for optimal advertising and product entry

To examine the realistic interactions between a set of close competitors, a game theoretical
approach is employed in the following section. This approaches follows zero-sum game
principles, which is a close reflection of a mature market rivalry (Kreps, 1991). This ana-
lytical approach here allows for the concept of strategic groups to prevail and the product
heterogeneity to exist.
The game model demonstrated below aims to indicate the optimal allocation of adver-
tising outlays in competitive environments with common knowledge of the prospects of
profitable entry. This model enables arch rivals, with equal financial strength to tailor ad-
vertising strategies to maximise returns in target markets. The following resource matrix
represents the “knowledge” of common competitive strategic conditions in the industry.
Realising that an established firm cannot always defend all product categories in the
market, potential entrants have an incentive to get into any possible market gap and make
profits. To simplify the real world and concentrate on target segments, the model assumes
that an incumbent produces two products T1 and T2, yielding a constant unit return of M1
and M2, respectively. Incumbent, however, usually possess more market information and
expertise, which allows them to take more exact control over strategic moves. Profit-driven
incumbents will choose to maximise returns by concentrating advertising on a product with
higher profitability, leaving potential entrants with a credible threat, which minimises their
prospects of fruitful entry. This condition is compatible with a classical two player zero
sum game. To avoid unnecessary clashes into the incumbent’s target product area, rational

1 The two major economic characters of advertising are supported by two polarised schools of thought.
Stigler (1961), Telser (1964) and Nelson (1974) stress those informative functions of advertising. While Co-
manor and Wilson (1967), Schmalensee (1972) and Lambin (1976) employ a persuasive view on advertising.
174 LING, LAWLER

Table 4. An advertising investment matrix.

Target products Entrant Incumbent

T1 e i
T2 A−e A−i

Note: e and i refer to volume of advertising

investment (units), A refers to total advertising
resource.

Figure 1. The expected payoff for the entrant in product area T1.

entrants tend to take actions after an incumbent does. The potential entrants are followers
in a multistage game.
If M1 > M2, the incumbent will invest i to enhance sales of T1, allowing A − i for T2
(Table 4). This implicitly assumes that incumbent takes the first move and entrants react
accordingly based on observed market potential, thus,
If i > e, then A − e > A − I. (1)
This implies entrant obtains a payoff of


(A − e) − (A − i) M2 = (i − e)M2. (2)

Note. The payoff is assumed to be a multiple of the unit of successful advertising messages
(e − i) and the marginal rate of return of advertising messages (M).

If an entrant becomes aggressive, with an intention to dominate product market T1,

it needs to create sufficient successful advertising messages to eliminate the advertising
impact from the incumbent, hence,
for e > i, the resulting payoff = (e − i)M1. (3)
Therefore, the overall expected payoff for the entrant is shown as follows:

M1(e − i), if e > i,
E(e, i) = (4)
M2(i − e), if e < i.
Figure 1 shows the payoff matrix for an entrant using a convex function of E(e, i).
This indicates that an entrant can get a positive payoff from product from T1, providing its
advertising investment volume is above i. However, the primary objective of the incumbent
INTERNET ADVERTISING 175

is to minimise the payoff of potential entrants. This means the incumbent needs to identify
its strategic investment for minimising M2(i) and M1(A − i).
At i, M2(i) = M1(A − i)
⇒ M2(i) + M1(i) = M1 · A
⇒ i = M1 · A/(M1 + M2). (5)
The location of i in Figure 1 refers to the optimal investment i ∗= M1 · A/(M1 + M2)
for defending incumbent’s product territory T1. Based on this probability indicator, the
corresponding optimal investment for T2 is M2 · A/(M1 + M2). The model enjoys some
degree of flexibility. As profitability changes among product alternatives, the relative ratio
[M1/(M1 + M2)] adjusts accordingly to indicate new optimal allocations of advertis-
ing outlays among different products. With an optimal strategic advertising game model,
incumbents can work out a detailed strategic action plan, which is consistent with the fun-
damental economic principle of maximising the expected returns in major product areas.

4. Further analysis

The use of a game model is to demonstrate that competitions between advertising agents
are rational. They act and react with respect to each other’s actions. Advertising very often
can affect pricing. Moreover, the cost of advertising can be passed onto consumers. This
means that rising competition via expansion of advertising outlays can result in escalat-
ing pricing if players cannot optimize their advertising budgets. From the point of view
of consumers, unlimited increase in competition via advertising can be socially wasteful,
too. Ironically, advertising can be very costly to firms. Hence, continuous up-scaling of
advertising may not be financially viable for firms with smaller marketing budgets. This
motivates market players to use advertising budgets strategically in order to trigger differ-
ent expected responses from market players. Hence, each agent can be expected to act in
accordance with certain strategic patterns following game model interactions as described
in the previous section.
The intention of players for this type of game model is to maximise market share. How-
ever, the welfare status of consumers is largely neglected. Internet advertising emerges as a
break-though in terms of provision of informative data. Before the Internet era, due to the
constraints imposed by the lack of efficiency of information exchange and diffusion, asym-
metric and imperfect information were the biggest barriers for bridging buyers and sellers.
With more intermediate agents serving as filtering processors for final data users, the wel-
fare implications of advertising on the Internet become more difficult to be evaluated. This
is because quality aspects of advertised merchandises cannot be easily determined by In-
ternet users and even intermediate agents in the short run. Moreover, with the problem of
information overload, consumers may collect more irrelevant information and formulate
undesirable expectation which may affect their judgement and rational expectation.
In the market place, it is common that a seller provides more than one category or type
of goods. For instance, big international brewers have been utilising heavy advertising
176 LING, LAWLER

budget for advancing their market shares. Ling (1998) illustrates brewers can employ
advertising to establish long run accumulative effect on sales. Given the fact that brewers
are not selling a single type of beer products, their marketing forces have to deal with a
proliferation of beers offering for beer drinkers. In terms of market share competition,
each of these international brewers is aiming to enhance their existing market share and at
the same time each is actively exploring new market potential to strengthen the aggregate
market portfolio. With the growth of Internet advertising, many big players have been
placing huge budget for the creation of Internet advertising influences, such as famous
brewers like Guinness, Heineken and Asahi. This type of non-price competition, to certain
extent, can create puzzling effects on consumption. However, at the same time, Internet
advertising represents a strategic influence to deter or accommodate market entry.
As said, the nature of Internet advertising is largely divided into two main categories,
one is to highlight its persuasive power for pulling in consumers, while the other is to give
better information with respect to advertised products. The role of intermediate agents is
more significant for the latter as information expertise can facilitate the execution of con-
sumption and enhance the value derived from prospective consumption. Assuming that
human beings are constrained by time, the role of intermediate agents can consequently
increase the welfare of consumers by providing value-added services for consumers. The
process represents a transformation of consumption mode from time-constrained to non-
time-constrained. Of course, in our business world, there is a value attached to the respec-
tive transformation. Rational consumers requesting services from intermediate agents are
supposed to gain a benefit which exceeds, or at most equal to, the cost paid to an agent.
Simply, this also represents an improvement of social welfare and in simple term a gain in
time cost. For services or consumption processes which can allow the ease of comparison
on prices, such as beer prices between international brewers, the role of intermediate agents
is less significant. However, market players can utilise Internet advertising to reach cer-
tain strategic objectives which will be examined in the following section. Concerning the
welfare implication of the Internet advertising of the N-product case, the resulting market
performance may limit the dimension of future competition. Therefore, Internet can create
changing market environment for market players and the structure of competition. These
eventually can introduce changing welfare implications such as choice availability and the
possibility of practising price discrimination.

5. N -product case

In actual markets, firms usually produce more than one product. With increasing use
of product differentiation strategy to penetrate market gaps, a more advanced analy-
sis for sophisticated interactions between product groupings is required. For N-product
case, the above theoretical concepts are employed. When an incumbent intends to al-
locate advertising resources QC for N-products, namely C1 , C2 , . . . , CN , these prod-
ucts also assigned relative profitability values (i.e., the constant marginal return), namely
M1 , M2 , . . . , MN , respectively, and where profit indices are arranged in such a way that
0 < M1 < M2 · · · < MN . Assuming that an entrant has QE units of advertising outlay
INTERNET ADVERTISING 177

for promoting target products, namelyE1 , E2 , . . . , EN , and QC > QE . The entrant is

expected to use a strategy such that, Ei = QE , for i = 1, . . . , N.  Similarly, the in-
cumbent will employ a strategy which is of the same format, such that Ci = QC , for
i = 1, . . . , N. In economic terms, the resource allocation for each of the C is is to give a
best response for each incumbent’s product against the entrant’s attack.
The model requires more realistic assumptions if an N-product case is employed for
strategic game predictions. First, one unit of incumbent advertising outlay is equivalent
to one unit of entrant advertising in terms of absolute advertising influence on sales. The
effect of advertising on competitor’s sales is countervailing. The countervailing remaining
influence depends on the volume of outnumbering units of advertising outlays. To measure
successful market penetration power, the higher the number of non-matched attacking mes-
sages, the better the resulting penetrating forces to gain market share from the incumbent.
Secondly, the payoff for a player is the sum of the resulting penetrations for each of the
target products.
 Hence, for an entrant with products E1 , . . . , EN , the expected
 payoff is
E(EC) = M i max(0, E i − Ci ), for i = 1, . . . , N, where, E i ≥ 0, Ci ≥ 0, Ei = QE
and Ci = QC , for i = 1, . . . , N. The resulting outcome is determined by the convex
function of E(EC) in C for each E and vice versa. Consequently, the optimal solution
consists of a pure strategy for incumbent and a mixed strategy for the entrant. A point
consistent with some empirical studies is that since each entrant uses a mixed strategy, it
is therefore not rational to attack low profitability product groups. Instead, entrants usu-
ally employ random selection strategies and put entire budgets on single products to create
greater “outnumbering messages”. In response, the incumbent will always defend the high
return product grouping and leave low return items with less protection. If the game is
played optimally, incumbent will stay in the market presenting no soft targets for potential
entrants. As argued by Friedman (1977), the incumbent must defend her market against a
significant attack from a single entrant. Ironically, there appears to be chances for entrants
in the markets with low returns, however, entrants will obtain less than the value of game if
they attack these. With the information on M1 , M2 , . . . , MN , the precise solutions for op-
timal allocation of advertising can be calculated. In utilising game models and the concept
of optimal advertising, a computer programme was generated for calculating the precise
figures for resources used in an entry deterrence game. The simulation results indicate
that the Gaussian technique for solving simultaneous systems is able to determine optimal
game solutions. This provides more potential avenues for future research in this area.

6. The emerging role of internet commerce

The on-line auction web site, e-Bay attracted sales of $307 million in the last three quarters
of 1998 and its popularity is expected to achieve $3.2 billion sales in 2002 (Taylor, 1999).2
Rather than providing listed prices for products, this Web site allows people to auction

2 The auction business via the Internet is expected to experience healthy growth as this line of business has
low overheads. In 1998 e-Bay enjoyed gross margins as high as 86% and unlike other on-line businesses, it
discovered opportunities for profit and achieved a net income of $19.5 M (Taylor, 1999).
178 LING, LAWLER

goods and the web sites invite bids from interested parties. The advertising process on this
site is more or less like classified newspaper advertisements, which facilitate the exchange
of goods and services. The buying environment allows more negotiation compared to
traditional retail markets. The goods sold via this auction site go to the highest bidder.
This implies traded prices are set by the highest offer made by potential buyers for every
period when offers are agreed. Bakos (1998) argues that web-based auctions reverse the
traditional functions of retail markets. Certainly, they provide more complicated matching
processes for demand and supply.
Apart from e-Bay, there are many other on-line auction sites. For instance, last-minute
unsold air-tickets are auctioned by airlines; thus Onsale.com carries out on-line auctions
in a way similar to financial markets; moreover, Priceline allows prospective bidders to
specify requirements for the goods they intend to buy and place offers for auctioned good
with participating sellers. In a world puzzled by uncertainty and imperfect information, this
auction channel actually converts Internet advertising information into a more powerful
strategic tool enhancing the practice of price discrimination.
From economic welfare principles, enhanced discriminatory power results in reductions
of consumer surplus and increases in sellers’ profits. However, auctions are an efficient
way for solving negotiations in one-to many situations. Binmore (1985) uses sequential
negotiation processes to demonstrate results of negotiations between rational economic
agents recorded at auctions. When transaction costs especially time and communica-
tion costs are substantial, auctions eliminate unnecessary inefficiency in retail markets.
In the case of auctions with reservation prices, Riley and Samuelson (1981) and Myer-
son (1981) argue that no matter how many bidders exist, sellers impose minimum reserva-
tion prices above true values. This phenomenon tends to move equilibrium auction prices
away from true equilibria, thus reducing the overall efficiency of market institutions. Levin
and Smith (1996) argue that competition should serve to enhance the efficiency of auctions
and to reduce sellers’ incentives to deviate from the efficient valuations. In their earlier
studies, Levin and Smith (1994) showed that at auctions with sufficient entry, sellers have
no economic incentive to overstate true reservation prices.
Due to the fact that Internet commerce focuses on personalisation and customisation ser-
vices, bargaining processes are essential in determining the payoffs for parties involved in
transactions, especially for one-to-one negotiations. The extent to which consumes surplus
is extracted depends on the types of bargain, levels of competitive responsiveness and key
knowledge of the players. Game theoretical principles can be applied to the bargaining
process over the Internet. Relative strengths in bargaining are determined by the relative
levels of data owned by parties to the negotiation. The second aspect of a bargaining game
concerns the time duration. In most cases in the Internet trade, counter-offers are possible
between traded parties. The use of strategic delays in the bargaining game can be em-
ployed to signal strengths in the negotiation process. This concept was first introduced by
Admati and Perry (1987). The use of counter-offers implies that it is possible to generate
a series of sequential equilibria during the complex bargaining process as in the models
studied by Chatterjee and Samulson (1987). Stronger agents simply wait (strategic delays)
for the weak opponent to reply (crack) and then reveal choices, preferences and other de-
cisive elements for the bargain. The number of rounds in the bargaining process depends
INTERNET ADVERTISING 179

on the number of elements needed to be revealed until an opponent cracks. This is typical
in one-to-one bargaining processes. In welfare terms, consumers always welcome an “ef-
ficient deal” with the lower transaction time costs. In fact this is a crucial service “quality”
offered intermediaries.
For a one-to-many bargaining regime, the situation is similar to auction trades on-line.
If the seller invites bids for specific contracts of services, the contract falls to the bidder
with the best price. However, if the traded good is specific, search and negotiation are car-
ried out simultaneously, until equilibrium price is reached. In general, sellers may control
bargaining processes as they have power to screen all prospective buyers and practise price
discrimination implicitly. This may be the reason why prices on Internet are not necessarily
lower than goods transacted via traditional retail markets. Bailey and Brynjolfsson (1997)
find little evidence to support the existence of lower prices in the Internet trading environ-
ment compared to normal retail outlets. However, shorter transaction times can be regarded
as better quality service provided by the Internet. Moreover, Milgrom (1987) argues that
if sellers are able to re-offer an unsold item, there are incentives for them to overstate
true values. The sheer size of the Internet marketplace makes it easy to attract potential
buyers. This motivates sellers to set reservation prices above the true values, resulting in
market failures in some auction markets. However, when the number of bidders falls short
of expected/pre-determined levels, reservation prices may be adjusted downwards creat-
ing a “flexible reserve” phenomenon as illustrated by Smith (1989). Hence, overstating
true product values are not likely in these cases. Smith (1996) argues that auction prices
based on “flexible reserve systems” usually relate to objects that have obvious ‘common’
or affiliated values. When the number of similar websites increases, the bidding processes
and bargaining operations become more competitive. Buyers accumulate more knowledge
and form better judgements about assessing market values for good/services sold via the
Internet. Therefore, the price of goods sold via these Internet auction web sites should not
deviate much from the “perceived” market values in the long run. With regards to Inter-
net commerce utilising agents, Vulkan (1999) argues that there exist suppliers who do not
allow their sites to be interrogated by search agents. The technical limitation of inaccessi-
bility restricts the possibility of searching genuine low prices, or better quality services. To
a large extent, Internet developments are consumer-driven phenomena. However, central
to the potential successes of smart agent Internet shopping are supply-side retailers atti-
tudes towards smart agents. For instance, Yovovich (1995) argues on-line retailers are not
amenable to smart search agents entering in their databases.

7. Conclusions

The paper has examined the role of imperfect information and “agents” where buyers are
time constrained. The potential for the Internet to transform the “knowledge” environment
for buyers is clearly cost. However, Internet advertising—like other forms—possesses
“persuasive” and informative features. These enhance or reduce consumer welfare po-
tential. Where buyer information is limited, and where common knowledge is restricted
the key role of Internet “search agents” is shown a balance to be likely to be welfare in-
180 LING, LAWLER

creasing. As e-commerce develop the linkages between retailers, agents and consumers
may become more complex. Generally, in the long run, as the “knowledge domain” of
consumer increases via Internet activity agents will perform a key “quality” service for
buyers by matching prices, consumer expectations with “quality” sellers. Profit maximis-
ing search agents who fail to do this consistently for consumers with rational expectations
will go bankrupt. The consumer driven philosophy of the Internet e-commerce activity will
be the dominating feature in Net development in the next five years.

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Marcus Ling is a project manager at the Asia Marketing Intelligence Business Con-
sulting in Hong Kong. He is an Applied Economist who has a considerable number of
publications on Internet Advertising, the Telecommunications Market, South East Asian
Economics and UK Brewing. Dr. Ling worked as a Visiting Lecturer at the University
of Sunderland in the UK since 1993. Recently, he has contributed to various chapters to
three texts for both undergraduate and post-graduate students.

Kewin Lawler is a Reader in Industrial Economics at the University of Sunderland. His

research interests cover all areas of econometrics, especially those connected with ap-
plication of game theory. He has recently published two texts in these areas. He has
supervised a large number of PhD candidates in Economics and Business.