A Twist on the Second-Price Auction? It Worked for Google
Google. The company that arguably has the best search engine to date. So, how did Google become so successful and make so much money? By auctioning ads on the side of search results. Their auction procedure is similar to that of a second-price sealed-bid auction, but there is a slight twist to it. Google gives the best ad space to the highest bidder, but the highest bidder pays the price per click multiplied by the probability (that Google calculates) that a user will actually click on the ad.
In a typical second-price sealed-bid auction, the dominant strategy for bidders is to bid their true value. However, in Google’s version of the second-price auction, the dominant strategy may not necessarily be to bid one’s true value. Advertisers can bid lower than their true value for a lower position on the ad space, but for a much cheaper price. This means that advertisers that bid their true values could be overbidding. Compared to other search engine’s advertisement auctions at the time, Google offers the best prices for advertisers. Previously, Yahoo simply implemented a first-price sealed-bid auction, until it adopted some similar principles to Google’s successful advertisement auction.
It is interesting to see the variation on the second-price sealed-bid auction that greatly affects the decisions of advertisers. With a second-price sealed-bid auction, the minimum payoff for an advertiser is zero, where the advertiser does not receive the ad space or the second highest price is the same as the advertiser’s bid. However, with this altered version of the second-price auction, advertisers have an incentive to bid slightly less than their true value, meaning that they will always have a positive payoff if they receive the ad space. This way of auctioning is much more appealing to advertisers, which ultimately led to Google’s success.
-jgo
http://www.businessweek.com/stories/2006-03-05/the-secret-to-googles-success