Advertising competition between platforms and their sellers under price parity clauses: the investment and welfare channel left open by Wang and Wright (2023)

Platforms such as online travel agencies impose price parity clauses (platform most-favored-nation restraints) preventing sellers from charging lower prices in other channels. Wang and Wright (2023) showed that wide parity clauses lead platforms to over-invest in search-cost reduction while narrow or no parity leads to under-investment, that wide parity always lowers consumer surplus, and that its effect on total welfare is ambiguous, with the sign depending on the convexity of investment cost and on which fee-setting equilibrium is selected. Their conclusion explicitly leaves open the advertising channel: platforms and the firms they host simultaneously compete in advertising to attract consumers (for example through a general search engine), and heavy platform advertising reduces firms' direct exposure to consumers, weakening the outside option that disciplines platform fees. The problem is to build and solve a model of platform-mediated sales in which platforms and firms endogenously choose advertising and narrow versus wide parity is in force, determine equilibrium advertising and investment levels, and characterize whether advertising competition amplifies or mitigates the over- and under-investment results and the welfare-ambiguous regimes. No work is known to model this platform–seller advertising competition jointly with price parity, so the question remains open.

Background

Price parity clauses — also called platform most-favored-nation (MFN) clauses or price coherence requirements — are contractual restraints imposed by intermediation platforms (e.g. Amazon or the online travel agencies (OTAs) Expedia and Booking.com) that forbid a seller from charging a lower price for the same item elsewhere. A 'narrow' parity clause covers only the seller's own direct sales channel (its own website), while a 'wide' clause covers every channel, so the seller offers its best price on the platform. Such clauses are controversial: several European countries have banned them for hotel booking, while platforms defend them on the grounds of preventing 'showrooming' — the behavior in which a consumer uses the platform's superior search and matching technology to find a good match, then switches to a cheaper channel to buy, which undermines the platform's incentive to invest in improving search. The earlier literature established the core antitrust concern: Boik and Corts (2016) and Johnson (2017) showed platform MFNs can soften platform competition and raise prices, and Edelman and Wright (2015) showed that price coherence inflates retail prices, generates excessive use of the intermediary, and leads to over-investment in buyer benefits. Wang and Wright (2020) embedded showrooming in a search model of platforms and showed that, even allowing for showrooming, price parity clauses often harm consumers. Wang and Wright (2023) then added the investment defense explicitly: a platform invests $y$ at convex cost $C(y)$ to reduce the search costs consumers incur when searching through it. In a monopoly-platform version, the platform does not invest at all without parity (its fee is pinned down by showrooming, so investment cannot be recovered) but invests excessively with parity, since parity lets it extract both the social surplus and the sellers' intensified on-platform competition margin. With a competing incumbent and entrant platform, fee competition admits a continuum of equilibria indexed by a selection parameter $\alpha \in [1,2]$ that divides industry revenue between the platforms ($\alpha = 1$ selects the symmetric-fee equilibrium; $\alpha = 2$ gives all revenue to the lower-search-cost platform). There, wide parity clauses generate excessive platform investment while narrow (or no) parity generates insufficient investment — search investment is a public good that each platform can free-ride on under narrow parity. Wide parity always reduces consumer surplus, but its total-welfare effect is ambiguous, with the sign depending on the convexity of $C(\cdot)$ and on $\alpha$ (over-investment, and hence possible welfare reduction under wide parity, arises for $\alpha$ close to 2); the full characterization of these parameter regions is not provided. Crucially, all of this concerns investment in search-cost reduction. The published conclusion states explicitly that the analysis has not been extended to advertising investments, noting that platforms like Expedia and the firms they host (e.g. hotels) compete in advertising to attract consumers (e.g. through a general search engine such as Google), that heavy platform advertising can lower firms' direct exposure to consumers and weaken their outside option of withdrawing and selling independently, and that this may dampen firms' own advertising propensity, making them increasingly reliant on platforms. How this advertising channel works, with and without price parity clauses, is the unresolved question.

Problem Statement

As stated in the conclusion of Wang and Wright (2023): extend the analysis of price parity clauses to advertising investments, allowing for the fact that platforms and the firms they host compete in advertising to attract consumers — for example, both an OTA and its hotels advertising through a general search engine. Specifically, construct and analyze a model of platform-mediated sales in which (i) platforms endogenously choose how much to spend on advertising that reaches consumers (in addition to, or instead of, investing in search-cost reduction at cost $C(\cdot)$), (ii) firms also choose their own advertising, and heavier platform advertising lowers firms' direct exposure to consumers, weakening their outside option of withdrawing from the platforms and selling independently and potentially dampening firms' own advertising incentives, and (iii) either narrow or wide price parity clauses are in force (or chosen). Within this model, determine the equilibrium advertising and investment levels under each parity regime relative to the efficient benchmark, and establish whether advertising competition amplifies or mitigates the established results that wide parity leads to excessive platform investment while narrow or no parity leads to insufficient investment. Jointly supporting the same objective — a complete welfare assessment of parity clauses under endogenous platform investments — the answer should characterize the welfare comparison across regimes, including the parameter regions (in the primitives, such as the convexity of the investment cost $C(\cdot)$ and the fee-equilibrium-selection parameter $\alpha \in [1,2]$) in which wide parity reduces or raises total welfare, a characterization the source states or shows is ambiguous but does not provide.

References

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