The advertising agency selection contest : a competitive auction with an incumbent, differential qualities, and partially reimbursed participation costs

We model the contest among full-service advertising agencies as a score auction. The score auction allows the advertiser to select the agency that offers the best combination of creative quality and media cost, and to determine the contract price. To participate in the contest, each agency needs to incur an upfront bid-preparation cost arising from the development of a customized creative. Industry literature often calls for the advertiser to reimburse such costs to all agencies that enter the contest. e show that reimbursing bid-preparation costs in full is never optimal for the advertiser. However, a partial imbursement of the costs can be profitable under two conditions we find to be necessary: First, a sufficiently large difference must exist between the bid-preparation cost of the incumbent agency currently serving the account and that of a competitor agency wishing to replace it. Second, the population of agencies must not contain too many weak agencies that can only deliver a very small profit to the advertiser