The Economics of Micro-Influencers: Reputation, Pricing, and Market Structure

It’s been a dream since the dawn of video games: play an electronic game and get paid to do it!  This dream expanded in the early 2000s with the rise of social media, allowing users to post content for others to view.  Internet users, rather than getting their entertainment from Hollywood studios, musicians with album deals, or published authors, could turn to hustling, ambitious amateurs for free.  As platforms grew and evolved, the position of influencer was born.  Popular content creators could get paid to promote products to their thousands, or even millions, of viewers.

Economics of Influencing

Generations ago, companies paid celebrities to endorse products and/or be featured in advertisements.  This could cost millions of dollars, and was no guarantee that it would increase sales.  From Babe Ruth in the late 1920s to Michael Jordan and Oprah Winfrey in the late 1990s, famous athletes and entertainers were paid to promote specific brands and products.  Starting slow in the 1960s and exploding in the 1980s, product placement in theatrically-released movies allowed for indirect promotion.  Both direct celebrity endorsement and product placement in video content have evolved to the micro level, with companies paying smaller dollar amounts per promotion to be featured hundreds or thousands of times.

Micro-Influencers Generate Greater ROI

Why the shift from established celebrity to social media user?  Companies have found that smaller influencers generate a greater return on advertising investment.  One reason is likely that consumers identify more closely with influencers they see on Tik Tok or YouTube and are more likely to invest in those products.  By contrast, relatively few people think that they can be like Michael Jordan, a Sports Illustrated swimsuit model, or James Bond.  However, a popular local figure who styles him- or herself as a relatable person is seen as aspirationally possible.  Many Internet users may have even seen an influencer in real life, such as a friend of a friend, and thus have greater trust in the influencer’s recommendation.  

Product Demonstrations and Trust

A slick commercial featuring a celebrity may show a product or service in action, but it feels staged.  An influencer’s Tik Tok or Instagram Reels video, however, is not as polished and may actually show a real person using the product as a consumer might.  This generates relatability and trust, with the viewer feeling the product must work well because they saw a non-celebrity using it.  Bits of awkwardness in an influencer’s video, such as an unkempt house or a momentary struggle to turn a product on, may actually increase sales because it feels more realistic: the product did work, even for a layman, to complete the task to satisfaction.  An influencer’s unpolished discussion of the product may also feel more trustworthy than a celebrity’s scripted praise.

Reputation as Capital

Over time, some influencers become widely renowned among social media users for giving entertaining, but also honest and reliable, product reviews.  As their number of loyal followers increases, these influencers can command greater compensation from sellers looking to promote their goods and services.  However, there is also the economic concept of diminishing marginal returns: as an influencer becomes more popular, he or she risks becoming seen as less relatable.  

After a peak in terms of marketability, with an influencer possessing thousands of loyal followers while also being seen as relatable and honest, additional growth starts to detract from the trustworthiness.  Total returns diminish (marginal returns become negative) when additional product promotions become seen as forced or explicitly paid for.  The popular local person who consumers could trust to honestly rate a product becomes seen as money-hungry and willing to give a positive endorsement to any company that is willing to pay.

Influencer Marketing and Efficiency

Ultimately, efficiency drives many companies to utilize influencer advertising over traditional TV commercials and Internet ads.  Most commercials and ads are static, meaning they show up periodically based on how much the seller is paying, regardless of who is watching at the time.  Often, sellers may inadvertently pay for ads in television markets and on websites that are frequented by relatively few of their customers.  This results in very low rates of advertising-generated sales.  Influencers, however, are more likely to overtly promote themselves as able to reach specific audiences…especially target audiences for different types of goods and services.

Influencer Pay Based on Follower Alignment

Today, companies can engage in price discrimination when it comes to paying influencers.  Thanks to modern algorithms and data mining, it is possible for companies to determine which influencers have more followers from target demographics than others.  Previously, all influencers of similarly-sized followings were paid similarly; it was difficult to separate out those whose followers were more likely to purchase the product. 

The ability to invest specifically in micro-influencers of target demographics gives influencer marketing a greater return-on-investment (ROI) than traditional advertising.  For the same amount of money as paying a widely-known celebrity for a commercial endorsement, a firm can pay scores of micro-influencers whose primary audiences are the most likely to buy the product.  This targeted advertising is far more efficient.

Monopolistically Competitive Advertising Market

Paying only specific influencers based on their audience demographic results in far greater efficiency than ads or commercials intended for the masses.  In terms of market efficiency, micro-influencers make advertising more akin to a monopolistically competitive market versus a traditional oligopoly market.  Monopolistically competitive markets are more efficient than oligopoly markets and allow for more flexibility and creativity in products; there is no “industry standard” default.  Micro-influencers can promote products more authentically to select demographics that they know well, making sales more likely.

However, monopolistically competitive markets are also more risky for producers.  Micro-influencers, as opposed to traditional celebrities, are more likely to see their popularity and ability to attract audiences fizzle rapidly.  There are few barriers to entry in the influencing industry, creating intense competition for landing paid promotions.  Therefore, it can be difficult for sellers to develop long-lasting relationships with influencers and develop improved pitches and product promotions.  Followers of one influencer may quickly grow bored and seek newer content creators, forcing influencers and sellers to expend lots of resources pursuing likes and follows.  This is known as “churn” and can be expensive to manage.