Google AdWords Auction – A Second Price Sealed-Bid Auction
One may wonder how free search engines, such as Google, reel in billions of dollars in revenue each year. These search engines do not charge users a fee for every search, rather, it chargers advertisers to display their ad on the search engine.
Google uses AdWords Auction to generate $32.2 billion in advertising revenue. The way Google’s auction works is similar to a second price sealed-bid auction. Each time a user searches for a word or phrase, Google saves the data and groups the keywords by relevance. Advertisers associate advertisements with various keywords. Google then matches the keywords from internet users with keywords associated with the advertisements and auctions the advertisement slot to multiple advertisers. The ad rank of each advertisement is calculated based on the maximum bid the advertiser makes for the ad and the quality score. Quality score is a metric determined by multiple components of the advertisement. The product of those is the ad rank. The advertiser with the highest ad rank wins the auction and will have their ad displayed on Google’s website for specific internet users whose search queries match the advertisement’s keywords. However, the price that advertiser pays is not the advertiser’s maximum bid price, rather, it is the minimum amount the advertiser can pay to win the ad auction. In other words, the lowest amount the advertiser can pay to outbid the next highest bid. The price is calculated by the ad rank of the person below the highest bidder divided by the highest bidder’s quality score plus 0.01.
This type of advertisement auction is essentially the second price sealed-bid auction. The auction is a sealed-bid auction because advertisers do not know what other advertisers are bidding. The highest bidder wins the auction and gets their advertisement placed on specific pages for specific users, but pays the price of the second highest bidder plus $0.01. The $0.01 is to differentiate the highest bidder from the second highest bidder and to allow the highest advertiser to outbid the next highest bid. This type of auction awards the advertiser with the highest bid but sells the advertisement slot to the highest advertiser at the price of the second highest bid.
Link: http://www.wordstream.com/articles/what-is-google-adwords