How does Google Rank its Ads?
How does GoogleAds determine where to place each interested advertiser on a page? For the purpose of our class, we simplified Google’s strategy by considering solely the quantity of an advertiser’s bid. In reality, an advertisers’ bid alone does not determine its overall rank; rather, Google evaluates ad rank using a simplified formula, quality score * bid. Quality score measures the relevancy of an advertisement by evaluating how closely the content relates to what the searcher is looking for – this is important because in order to maximize its revenue, Google wants to accurately predict the likelihood of a searcher to actually click an advertisement. For instance, if an advertiser with a quality score of 5 bids a higher price of $10, another advertiser with a quality score of 10 bidding a score of only $6 would still generate more money for Google because its ad has higher relevancy. After generating ad ranks, the highest rank gets the top spot, which in turn receives the most clicks per search. This system of assigning bidders to advertising spots roughly parallels a second price auction system – the amount paid by bidders is the lowest amount necessary to beat the second place bid below. As a result, we can generalize the price of placing an ad using the equation: ad ranked below / quality score + $0.01.
In class, we learned that the top bidder in a second price auction pays the price of the second highest bidder; as a result, it may be counterintuitive to consider that in the case of GoogleAds, the highest advertising bidder often pays less than the bidders below them. How does that work?
Consider an advertiser with quality score 8 bidding $100 for the top spot. The next competitor has a quality score of 5 on a $10 bid. The third bidder has a quality score of 7 with a $7 bid. Therefore, the ad rank for the first place bid to beat is 50, and when we divide that by the quality score, the price for the top bidder is only $6.26. Bidder two must beat ad rank 49, which divided by its own quality score of 5 amounts to $9.81. In this instance, we observe that the first place bidder pays less than the second place bidder even for the top spot! When calculating the price of an advertisement, it is essential note that we divide the price of the ad ranked below by a quality score – therefore, the higher the quality score, the lower the price of an advertisement.
http://www.forbes.com/sites/quora/2014/08/15/how-exactly-does-google-adwords-work/2/#71a233b61f8f