Computing Applications Economic and business dimensions

Online Advertising, Behavioral Targeting, and Privacy

Studying how privacy regulation might impact economic activity on the advertising-supported Internet.
  1. Introduction
  2. Background
  3. Our Study
  4. Our Results
  5. Limitations
  6. What It Means
  7. References
  8. Authors
  9. Footnotes
Online Advertising, Behavioral Targeting, and Privacy illustration

Data on the online behavior of consumers has allowed companies to deliver online advertising in an extraordinarily precise fashion. For example, a Lexus dealership can target advertising so that its ads are shown only to people who have been recently browsing high-end cars on auto Web sites. Such behavioral targeting has obvious benefits to advertisers because fewer ad impressions are wasted. Instead, advertisers focus their resources on the consumers most likely to be influenced by the ads. For consumers, however, ads that are behaviorally targeted can appear unauthorized and even creepy. As a result there have been calls in the U.S. and elsewhere for new regulation to restrict the collection and use of online data for advertising purposes.

Unfortunately, there has been little empirical evidence about the consequences of such regulation for the future of advertisers and Web publishers on the advertising-supported Internet. In a recent research paper2 we begin to fill this gap by examining how earlier privacy regulation in Europe affected the performance of online display advertising in Europe relative to the U.S. and elsewhere. In this column we summarize the key findings and discuss how our results inform recent proposals for privacy regulation in the U.S.

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Advertisers spend $8 billion each year on online display advertising and even more on search engine advertising. At the heart of this industry is the detailed collection, parsing, and analysis of consumer data, often without consumers’ consent or knowledge. This data allows firms to target their advertising to specific groups who might be most influenced by advertising, and to measure how well the advertising then performs as they track the subsequent behavior of users who were exposed to an ad. There are growing concerns that such unregulated data collection may harm consumers. Specifically, the recent Federal Trade Commission (FTC) preliminary staff report, "Protecting Consumer Privacy in an Era of Rapid Change," (see http://www.ftc.gov/os/2010/12/101201privacyreport.pdf) identifies three groups of consumers who might be harmed in the current environment:

  • Consumers troubled by the collection and sharing of their information.
  • Consumers who have no idea that any of this information collection and sharing is taking place.
  • Consumers—some teens for example—who may be aware of the sharing that takes place, but may not appreciate the risks it poses.

The FTC document then argues that there might be benefits to increased regulation. At the same time, the document makes it clear that another objective of any policy is "preserving the ability of companies to innovate, compete, and offer consumer benefits." Given this objective, it is important to understand how privacy regulation might impact economic activity on the advertising-supported Internet.

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Our Study

We examined the effect of the EU Privacy and Electronic Communications Directive (2002/58/EC—sometimes known as the E-Privacy Directive) on online advertising in Europe. Specifically, we looked at how consumer responses to advertising changed in Europe after it came into effect, relative to changes in consumer responses to advertising in the U.S. and elsewhere.

Online advertising became much less effective in Europe relative to elsewhere after the regulation was enacted.

Several provisions of the Privacy Directive limited the ability of companies to track user behavior on the Internet. These changes made it more difficult for the Lexus dealership in our earlier example to collect and use data about consumers’ browsing behavior on other Web sites.

The interpretation of this E-Privacy Directive has been somewhat controversial as it relates to behavioral targeting. For example, it is not clear the extent to which a provision that requires companies who use invisible tracking devices such as Web bugs to use them only with the "knowledge" of consumers means that companies need explicitly to obtain opt-in consent. This is one of the reasons why, in the recent "Telecoms Reform Package," the EU amended the current regulation to require a user’s explicit consent before placing a cookie on a computer. Therefore our estimates also capture business responses when there is some ambiguity over how privacy regulation should be interpreted.

To measure online advertising effectiveness, we use unusual data from a marketing research company that ran various "a/b" tests of online display ads across the world over eight years. The research company developed a straightforward methodology that permitted comparison of different advertising campaigns over time in order to allow advertisers to benchmark the effectiveness of different ads. In this "a/b" test, some randomly selected people are exposed to the ad for a certain product, while others were exposed to a placebo ad, usually for a charity. The market research firm then surveyed these Web users about their likelihood of purchasing the advertised product. This allows a clean measurement of the effect of the ad: Because these people are randomly selected, any increase in expressed purchase intent toward the product for the group exposed to the ad relative to those who were not exposed can be attributed to advertising. We use data on 3.3 million of these survey responses for 9,596 different online display advertising campaigns conducted on hundreds of different Web sites across many countries.

Our research links changes in privacy protection in Europe to changes in the advertising-induced lift in purchase intentions. Specifically, we use regression analysis to compare and contrast:

  • People who were randomly exposed to the ad and those who were not;?
  • The EU and elsewhere; and
  • Before and after privacy regulation was enacted in Europe.

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Our Results

We found that in Europe, after privacy protection was enacted, the difference in stated purchase intent between those who were exposed to ads and those who were not dropped by approximately 65%. There was no such change for countries outside Europe. In other words, online advertising became much less effective in Europe relative to elsewhere after the regulation was enacted.

One possible explanation for this result is that our estimates reflect a change in attitudes among Europeans toward targeted advertising, rather than something that can be causally attributed to the change in law. To examine this possibility, we looked at the behavior of Europeans on non-European Web sites and of non-Europeans on European Web sites. We found no drop in ad effectiveness for Europeans browsing non-European Web sites and a substantial drop in advertising effectiveness for non-Europeans browsing European Web sites. The drop does not appear to be a result of changing consumer attitudes in Europe. Instead, it suggests that, coincident with the timing of the enactment of European privacy regulation, advertising at Web sites in Europe became less effective.

This drop in ad effectiveness was not uniform across all types of Web sites and advertisements. In fact, many Web sites and ad formats were barely affected. We did not see any significant decline in ad effectiveness on Web sites that had specialized content, such as baby and automotive Web sites. It was Web sites that did not have content that was easily matched to a specific product (Web sites like CNN.com and Dictionary.com) that drove the measured drop in advertising effectiveness. We believe this result is driven by the difficulty of matching a customer to an ad on such Web sites because the Web site content does not reveal specific preferences. In contrast, it is easy to target advertising to a visitor at a Web site for parents of babies, even without data on browsing behavior.

Large, intrusive ads also showed little decline in effectiveness. Instead, the fall in ad effectiveness in Europe was largely driven by plain banner ads. This makes sense because more discreet ads rely on the inherent interest of a customer in that kind of product, rather than on a striking ad design.1

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Before concluding, we clarify some of the limitations of this analysis:

  • Our measures of advertising effectiveness are representative only for people who are willing to answer an online market survey. Though respondent demographics seem representative of the general population, they may be unusual in dimensions we do not observe. Therefore, a conservative interpretation of our results is that we measure a decline in a measurement of advertising effectiveness commonly used by the online advertising industry.
  • The campaigns we study are representative of those launched by large firms who had substantial resources. We do not know how privacy regulation affected smaller firms. On the one hand, the costs of compliance may have been higher for such firms. On the other hand, small firms may have been less careful about compliance.
  • The campaigns we study were placed directly by the advertiser on particular Web sites rather than being distributed through an advertising network—a common distribution channel for online advertising. It is possible that advertising networks were better able to invest resources to mitigate the effects of privacy regulation, and therefore experienced less of a decline.
  • We do not know whether the change in advertising effectiveness affected advertising revenues. This would depend on substitution patterns between online and offline media.
  • It is not clear whether our results generalize to Web sites that explicitly offer users control over their privacy settings, such as Facebook. Such proprietary opt-in Web sites may even benefit from regulation of this kind, if it means they are more efficient at delivering ads than their competitors.

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What It Means

Notwithstanding these limitations, our results provide some of the first empirical evidence about the likely consequences of privacy regulation. This is important because of recent developments in the U.S. concerning regulation. In their preliminary staff report, the FTC made the following proposal: The most practical method of providing such universal choice would likely involve the placement of a persistent setting, similar to a cookie, on the consumer’s browser signaling the consumer’s choices about being tracked and receiving targeted ads. Commission staff supports this approach, sometimes referred to as "Do Not Track."

Our results provide some of the first empirical evidence about the likely consequences of privacy regulation.

Obviously this persistent "opt-out" is a different approach from the EU regulation that we study. However, our estimates suggest that one could reasonably expect a large drop in advertising effectiveness for consumers who choose to opt out of targeting. Therefore, the likely effects of the proposed regulation depend on the number of consumers who would ultimately choose to persistently opt out, which in turn will be driven by the specifics of the regulatory framework.

Any decline in advertising effectiveness that results from the new regulation will not be borne equally by all Web sites.

Crucially, our empirical findings suggest any decline in advertising effectiveness that results from the new regulation will not be borne equally by all Web sites. In the long run, this may change the kind of Web sites and firms that prosper on the advertising-supported Internet, perhaps leading to fewer free (ad-supported) general-interest Web sites. Our results also suggest that advertisers may move toward more visually arresting types of advertising in order to compensate for their inability to target. Therefore, the potential benefits to consumers of increased privacy should be weighed against the consumer benefits of a potentially broader advertising-supported Internet that has fewer visually distracting ads.

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