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Applying Contest Theory

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Alongside the development of contest related theoretical literature is empirical research. With the outstanding applicability of contest theory to numerous areas, many possibilities to test hypotheses are created. Advertising within a promotional competition, for example, has characteristics of a tournament. Firms engage in marketing activities with the ultimate goal of a favorable market share. The majority of the work is done up-front (e.g. the creation of the campaign or advertisement) and can be classified as efforts. Applying contest theory, the choice of effort determines the allocation of the companies’ market share. Advertisement within such a framework has been studied early on by Friedman (1958) who developed a model to determine the optimal advertising …show more content…

Usually, a company conducting R&D is either looking for a cost-reducing solution or a completely new product with profitability potential. Whichever company releases the product first, wins the contest and thereby receives the full payoff (until substitute products enter the market). This implies that such a contest allocates one single prize to the winner of the contest. Companies spend resources on research and development, i.e. they exert effort, to increase their chances of winning. Loury (1979) formulates a model studying the impact of market structures on R&D performance and the effect on social welfare. Boudreau, Lacetera & Lakhani (2011) conduct empirical tests in similar structures using software development data. The analysis confirms decreasing incentives for a growing number of participants, especially in a secure environment, meaning that the approach for R&D is mostly known. In more uncertain environments, a contest designer might want to increase the number of competitors. R&D often aims at the one “perfect” solution. Especially in uncertain environments, the likelihood to achieve this is found to increase with the number of

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