Stubborn Stupidity Vs Hidden Motives
I too used to believe that these tech giants were all-knowing entities. But while writing this story, I have come to realise that this belief is as wrong as it is popular. …
The experiment continued for another eight weeks. What was the effect of pulling the ads? Almost none. For every dollar eBay spent on search advertising, they lost roughly 63 cents. …eBay was not alone in making this mistake. The benchmarks that advertising companies use – intended to measure the number of clicks, sales and downloads that occur after an ad is viewed – are fundamentally misleading. None of these benchmarks distinguish between the selection effect (clicks, purchases and downloads that are happening anyway) and the advertising effect (clicks, purchases and downloads that would not have happened without ads).
Economists at Facebook conducted 15 experiments that showed the enormous impact of selection effects. … selection effects were almost 10 times stronger than the advertising effect alone! And this was no exception. Selection effects substantially outweighed advertising effects in most of these Facebook experiments. … So we arrive at our final question: who wants to know the truth? … Following the news about the millions of dollars eBay had wasted, brand keyword advertising only declined by 10%. The vast majority of businesses proved hell-bent on throwing away their money. The fact that the eBay news did not even encourage advertisers to experiment more was perhaps the most striking.
Rao did observe the occasional ad stop at Bing. Rao was able to use ad stops like these, just as Tadelis had at eBay, to assess the effects on search traffic. When these experiments showed that ads were utterly pointless, advertisers were not bothered in the slightest. They charged gaily ahead, buying ad after ad. Even when they knew, or could have known, that their ad campaigns were not very profitable, it had no impact on how they behaved. (More; eBay details)
Why do firms overpay for ads? The most common explanation I hear offered is random stubborn stupidity; they are too stupid to understand critics, and too stubborn or distracted to change their minds when they see critics clearly proven right. I just don’t buy it. Consider these multiple lines of evidence:
1) When it can substantially increase profits, firms consistently apply complex tech that CEOs don’t understand. They use engines, machines, robots, computers, and much else. In many such cases firms are capable of applying expert understanding, often requiring much math, and are not at all limited to CEO intuitions.
2) We know of many concrete cases where complex expert understanding was tested and verified in simple clear experiments. Doubts at this point could have been addressed by more larger experiments. But instead we see a clear pattern of the closest folks just looking away. Others with application areas more distant in space or time typically use the excuse that this distance makes those experiments irrelevant to their area.
3) The simple theory of random stupidity strongly predicts a random pattern of overspending on some things, and underspending on others. In terms of statistical inference, such a theory is relatively easily beat by any other theories that can explain patterns in over and underspending in any other terms. Yes, you might try to retreat to a correlated-randomness theory, which posits that over versus underspending is correlated in “related” areas. But then you’ll need a theory of “relatedness” of areas.
We also seem to see overspending in medicine, law, school, investment analysis, campaign spending, and much else. A consistent pattern I think I see is overspending in areas where spending lets one associate with prestigious folks. So I suggest that much of this overspending is better explained via motives to gain prestige via association.
Re ads, consider that in order for a CEO to be promoted to run a bigger firm, people at other firms need to hear about that CEO and his or her firm. Within firms, the ambitious are often told to “toot their horns” and let everyone know about their accomplishments; productive people who don’t toot tend to be overlooked. Similarly, CEOs may want to overspend on ads just to make sure others hear about their firm.
This seems a bit like a comment Richard Wagner once made in his Public Finance class regarding interpreting the waste, inefficiencies and over spending by government and politicians. The politicians are often blamed as stupid and uninformed (or corrupt but lets put that aside). However, it is also pretty clear on average successful politicians are not average or below average intelligence people.
Your post seems to look more to a status based type explanation. I have often wondered what we might find from more of a public choice analysis of big business and large corporation behavior. My sense is that internally the issues are at least as much about distribution as they are about allocation.
Yes of course we can distinguish different types of ads, and inefficiency can look different for the different types. But it seems you agree that overspending is a common pattern. You are tempted to explain it in terms of a lack of understanding; the point of my post is to suggest other explanations.