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Second Price Auction with Google AdWords

We see advertisements everywhere and one of the most prominent ads is Google AdWords. Google AdWords are the small ads at the top of the screen that you see whenever you make a search on Google. So we know what these are, but how do they work and how are they sold to clients? It turns out that Google uses a generalized second price sealed bid auction that is similar to the type of auction that we learned in class.

Every time a person make a search, Google takes the words/phrases that the person wrote and groups them together by relevance. When an advertiser makes a bid for his ad on Google, he will also put in relevant keywords. Using the relevant keywords from the advertiser and the keywords from the searches, Google matches them together and auctions off the multiple advertisement slots. There are two components that make up the actual bid of the advertisers. The maximum Cost-per-Click (CPC) is a value that you will be at most willing to pay based on the number of clicks on your ads. This would be equivalent to the “true value” in a typical second price auction. The second component if the Quality Score. Quality Score is a metric used by Google to determine how relevant and useful the ad is to the user. This is done using many factors such as keyword relevance and quality of the landing page of the ad. The final bid is the product of the maximum CPC and Quality Score and is called the Ad Rank.  Through Google AdWords auction, the advertiser with the highest ad rank wins the ad slot. However, unlike the traditional second price auction, the price that the advertiser pays is not the next highest Ad Rank or the max CPC. Instead, the price is the next highest Ad Rank divided by your Quality Score plus $0.01 (so that no one gets a free slot). With this price, advertisers can see that a higher Quality Score will usually result in a lower price and thus encourages advertisers to increase their Quality Score using better relevant keywords or better landing pages.

Google AdWords auction is very similar to the second price sealed bid auction that we learned in class. Much like a sealed bid auction, the advertisers do not know what the max CPC of other advertisers are. Furthermore, because the price that the advertisers pay is not equal to the bid price but actually less than than the bid price, this functions as a second price auction and the dominant strategy for advertisers is to put in their true value for their max CPC value. However, Google AdWords takes the idea of a second price sealed bid auction and improves upon it. By adjusting their bid by the factor of their Quality Scores, Google is able to incentivize the advertisers to create more relevant ads for the users. Using the Quality Score incentive, the ads not only benefit the advertisers by getting them lower prices, but also benefit the users by giving them more accurate and relevant ads.

 

Sites:

http://www.wordstream.com/articles/what-is-google-adwords

https://support.google.com/adwords/answer/116495?hl=en

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