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.

Background

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.

our study

We examined the effect of the EU Privacy and Electronic Communications

online advertising
became much less
effective in europe
relative to elsewhere
after the regulation
was enacted.

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.

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 ef-
fectiveness, 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 per-
mitted comparison of different adver-
tising campaigns over time in order
to allow advertisers to benchmark the
effectiveness of different ads. In this
“a/b” test, some randomly selected peo-
ple 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 peo-
ple 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 advertis-
ing. 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 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 Eu-