Pricing Models for Online Advertising: CPM vs. CPC

Online advertising has transformed the advertising industry with its measurability and accountability. Online software and services supported by online advertising is becoming a reality as evidenced by the success of Google and its initiatives. Therefore, the choice of a pricing model for advertising becomes a critical issue for these firms. We present a formal model of pricing models in online advertising using the principal–agent framework to study the two most popular pricing models: input‐based cost per thousand impressions (CPM) and performance‐based cost per click‐through (CPC). We identify four important factors that affect the preference of CPM to the CPC model, and vice versa. In particular, we highlight the interplay between uncertainty in the decision environment, value of advertising, cost of mistargeting advertisements, and alignment of incentives. These factors shed light on the preferred online‐advertising pricing model for publishers and advertisers under different market conditions.