Allocating Spending Between Advertising and Information Technology in Electronic Retailing

• Published in: Management science 2005-08, Vol.51 (8), p.1236-1249
• Main Authors: Tan, Yong, Mookerjee, Vijay S
• Format: Article
• Language: English
• Subjects: Advertising; Advertising expenditures; Advertising rates; Analysis; Applied sciences; Business management; Business studies; Capacity costs; capacity planning; coordination schemes; Cost allocation; Cost efficiency; Customers; Demand functions; demand generation; Economic aspects; Electronic commerce; electronic retailing; Exact sciences and technology; Forecasts and trends; Information technology; Management science; Marketing; Mathematical methods; Online shopping; Operational research. Management science; Retail stores; Retail trade; Retailing; Sponsored search; Studies; Uncertainty; Word of mouth advertising
• ISSN: 0025-1909; 1526-5501
• DOI: 10.1287/mnsc.1050.0424

This study examines coordination issues that occur in allocating spending between advertising and information technology (IT) in electronic retailing. Electronic retailers run the risk of overspending on advertising to attract customers but underspending on IT, thus resulting in inadequate processing capacity at the firm’s website. In this paper, we present a centralized, joint marketing-IT model to optimally allocate spending between advertising and IT, and we discuss an uncoordinated case where marketing and IT make suboptimal advertising and capacity decisions. We show how these decisions can be coordinated either by reducing the value of a customer session or by designing an optimal processing contract between marketing and IT. Both the coordination methods can be implemented with only local knowledge of the IT function, yet they generate a solution that almost matches the quality of the centralized solution. We extend our basic model to consider demand uncertainty, lagged advertising effects, and uncertainties in the lead time to acquire IT capacity. With demand uncertainty, electronic retailers should reduce spending on advertising and increase IT capacity if there is potential for a demand upswing and the cost of IT capacity is relatively low. The value of a customer session should be further reduced when uncertainties exist. This is required to share the risk of excess or inadequate IT capacity.