Ad Auctions are Not Auctions

Posted on Tuesday, August 24th, 2010 by Print This Post Print This Post

Categories - Featured, SEM

There’s this unusual farm stand I go to. I walked up once and said “I’d like some pineapples, please.” The farmer said, “No pineapples for you, but I’ll sell you mangoes.” So I asked, “How many will you sell me for $1 each?” He said, “This many!” and held up a basket with 10 mangoes in it. Well, I like mangoes more than that. So I asked, “How many will you give me for $2 each?” He held up a bigger basket.

Some other guy stopped by and started eying the mangoes. So, I said “I’ll take the big basket for $2 a piece, please.” The farmer handed me the small basket. I said, “No, I want the big basket.” And the farmer replied, “Well now there’s someone else here who wants mangoes, so I’ll only sell you the small basket for $2 a piece. If you want the big basket, they’re now $5 each.”

So I gave him $20 for the 10 mangoes in the small basket and he gave me back $6 in change. ”What’s the change for?”, I asked. “Ten mangoes at $2 each should be $20.” “Well,” he said, “I count every dollar from you as if it’s worth $1.25.” So I held up the $6 and asked, “Then can I have a few more mangoes?”

“Don’t be ridiculous!” he replied. “What crazy kind of farm stand do you think this is?”

Click traffic is like food for a website and that crazy farm stand I go to, of course, is paid search. The search engines claim that their systems are auction-based. Some even say that the second-price mechanism by which ad slots are allocated promote ‘truthful’ bidding – that is, each advertiser, by the design of the system, has the incentive to bid honestly, without any regard to the bids of other participants.

If paid search is an auction, though, it’s a very strange one indeed. Here are some ways:

1. In paid search, both the seller and the auctioneer are the same entity. This is seen in some auctions, like those by governments for public debt or broadcast spectrum rights, but in most auctions (like eBay) the auctioneer and the seller(s) are different groups.

2. The rules are not fully disclosed. The search engines claim that fully disclosing the rules would make their systems more vulnerable to spammers and other low-grade advertisers. But if their systems encourage truthful bidding, then this should not be the case. Logically, they cannot claim both that (1) truthful bidding is an equilibrium outcome of their system and that (2) they need to keep some aspects of the system confidential in order to avoid low-grade advertisers. If truthful bidding is an equilibrium outcome, then it should be possible for them to fully disclose the rules.

3. Bidders can be excluded from any single auction (or category of auctions) on a whim. It’s strange and disturbing that the search engines often provide no greater explanation for why an ad is not showing for a particular keyword besides saying that the ad is ‘low quality’.

4. There are advertiser-specific minimum bids. One little-known aspect of AdWords, for example, is that for each keyword, for each advertiser, Google sets a minimum bid that advertiser must supply to be allowed into the auction. If no advertiser bids more than their minimum amount, no ads are shown. If one or more ads are shown, the lowest-placed ad must pay the minimum CPC chosen for that advertiser.

5. Bids are weighted. As with the farm stand above, in paid search the auctioneer treats money from some advertisers as being worth more than money from others, via the ‘Quality Score’ or ‘Quality Index’. (And again, the exact calculations behind these weighting factors are secret.) Dictionary.com says an auction is “a publicly held sale at which property or goods are sold to the highest bidder” (emphasis added) yet the search engines readily admit that the highest bidder is not guaranteed top placement in the results, or even placement in the results at all. (It’s surprising how often people get this wrong. A recent LA Times article said: “[Google] continues to advocate an advertising auction model that’s been successful in its core search business, whereby search terms are sold to the highest bidder.” This is simply untrue.)

6. You can bid against yourself. Say you bid on the phrase-match version of the word “shoes” and the phrase-match version of “leather”. A user enters a search for “leather shoes”. Which of your ads (if either) gets shown? Presumably, the search engine picks whichever will make them more money per impression, on average. If you raise the bid on the lower-CTR ad sufficiently, the search engine will make more money by starting to show that ad instead. So, a bid increase on “leather” can cause your traffic for “shoes” to drop, and vice versa. If you don’t spot the conflict, the engine has you bidding against yourself.

7. The auctioneer will bid for you. Google’s ‘Conversion Optimizer’ and its new ‘enhanced CPC‘ feature bid based on the performance of an advertiser’s ads. The advertiser puts code onto its website which gives Google conversion data (sales, revenue, and so forth). Of course, this makes it so that Google knows the full spectrum of data in the search process, from how many queries occur to how many sales result, and their value. Their feature is called the ‘Conversion Optimizer’, but what exactly they are ‘optimizing’ for is not made clear. (Notice that it is not called the ‘Conversion Maximizer‘.)

8. The auctioneer only reveals whatever data it wants to. When I went to an antiques auction near The Search Agency’s office recently, they had a viewing period before the auction started. Every bidder was allowed to browse the items and examine them (with the seller’s permission). As each auction ran, the participants bid by holding up paper signs. That is, every piece of information known to the auctioneer was known to all of the bidders. But in paid search, the engine only reveals the information it wants to. You cannot audit the records to find out who appeared where in any individual auction nor how much they bid, nor even to simply make certain that the engine has done its accounting correctly.

9. The auctioneer charges you to set or change your bid. To keep down the frequency of bid changes, Google permits advertisers to access their system a certain number of times per month via API for free. Additional requests for information incur a charge. (If AdWords promoted truthful bidding, it would not be necessary to surpress the frequency of bid changes.)

10. The ‘second-price’ mechanism is novel. The process the search engines use to allocate space is called the “generalized second-price” (or GSP) mechanism, but this term did not appear in auction theory literature until 2005. Many different kinds of auctions have been developed over the centuries (the Dutch auction, the rising-price English auction, and so on), yet the GSP mechanism apparently was not devised until just a few years ago. Perhaps the reason why the term ‘generalized second-price’ never before appeared in auction theory literature prior to this is that this system is just not an auction at all.

What then is paid search if not an auction? At Search Engine Watch, Alex Cohen called the system a ‘negotiation‘ and with that term I think he struck the nail on the head. With each keyword you choose and bid you submit, you are providing information to the search engine about your interest in buying certain traffic. The presence of other advertisers, the bids and the budgets, simply act as constraints with which the search engine must contend in order to maximize their own revenue. Just like at the farm stand, when dealing with paid search advertising, it’s not the other customers you need to worry about.

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4 Responses to “Ad Auctions are Not Auctions”

  1. Alex Cohen says:

    Hey Bradd,

    Great breakdown of the Google sales process. I like how you draw a fine point on the fact that Google has advertiser specific minimums. I’d really like to see them disclose account level Quality Score, so we can get a better sense of how that factor plays a role in our costs.

    Cheers,
    -Alex

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