Key-strokes of the ‘faint-hearted’ closet economist: Auction & Clicks

The number of ads that the search engine can show to a user is limited, and different positions on the search results page have different desirabilities for advertisers: an ad shown at the top of a page is more likely to be clicked than an ad shown at the bottom. Hence, search engines need a system for allocating the positions to advertisers, and auctions are a natural choice. Currently, the mechanisms most widely used by search engines are based on auctions.

In the simplest such auction, for a specific keyword, advertisers submit bids stating their maximum willingness to pay for a click. When a user enters a keyword, he receives search results along with sponsored links, the latter shown in decreasing order of bids. In particular, the ad with the highest bid is displayed at the top, the ad with the next highest bid is displayed in the second position, and so on. If a user subsequently clicks on an ad in position p, that advertiser is charged by the search engine an amount equal to the next highest bid, i.e., the bid of an advertiser in position p + 1.

A combination of several features makes the market for Internet advertising unique.

First, bidding takes place continuously. For example, the advertiser with the second highest bid on a given keyword at some instant will be listed as the second sponsored link at that instant. But any other advertiser can revise his bid at any time, and the order of sponsored links and prices will change accordingly. These changes can be very rapid because advertisers can employ automated robots, including commercially available software, in responding to others’ bids.

Second, the search engines effectively sell flows of perishable advertising services rather than storable objects: if there are no ads for a particular search term during some period of time, the “capacity” is wasted, much like in electricity markets.

Over time, the search algorithms undergo multiple iterations to reflect the changing consumer perceptions and the landscape. At the same time technology has empowered consumers and businesses to preempt information and beat the machine. As things come a full circle, the information loops back making the system stronger and better. Search engines of the future will be better in part because they will understand more about the individual user. Maybe the search engines of the future will know where one is located, maybe they will know what one knows already or maybe they will fully understand our preferences and hence, throwing up information which is more needed and advertising which is more relevant.

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