Internet Advertising and the Generalized Second-Price Auction: Selling Billions of Dollars Worth of Keywords

Abstract

We investigate the "generalized second-price" (GSP) This paper investigates a new auction mechanism, which we call the "generalized secondprice" auction, or GSP. GSP is tailored to the unique environment of the market for online ads, and neither the environment nor the mechanism has previously been studied in the mechanism design literature. While studying the properties of a novel mechanism is often fascinating in itself, our interest is also motivated by the spectacular commercial success of GSP. It is the dominant transaction mechanism in a large and rapidly growing industry. For example, Google's total revenue in 2005 was $6.14 billion. Over 98 percent of its revenue came from GSP auctions. Yahoo!'s total revenue in 2005 was $5.26 billion. A large share of Yahoo!'s revenue is derived from sales via GSP auctions. It is believed that over half of Yahoo!'s revenue is derived from sales via GSP auctions. As of May 2006, the combined market capitalization of these companies exceeded $150 billion.Let us briefly describe how these auctions work. When an Internet user enters a search term ("query") into a search engine, he gets back a page with results, containing both the links most relevant to the query and the sponsored links, i.e., paid advertisements. The ads are clearly distinguishable from the actual search results, and different searches yield different sponsored links: advertisers target their ads based on search keywords. For instance, if a travel agent buys the word "Hawaii," then each time a user performs a search on this word, a link to the travel agent will appear on the search results page. When a user clicks on the sponsored link, he is sent to the advertiser's Web page. The advertiser then pays the search engine for sending the user to its Web page, hence the name-"pay-per-click" pricing.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 GSP.In the simplest GSP 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,

Examining the Yahoo! Sponsored Search Auctions: A Regression Discontinuity Design Approach

“…For search engines, the best scenario is that each of the bidders truthfully spends his maximum willingness to pay on purchasing the links. However, as pointed out by Edelman et al (2007), bidders have incentive to game the auction system to reduce their costs. In theory, McAdams and Schwarz (2007) argue that the costs that buyers incur while trying to "game" an auction mechanism are fully passed through to the seller.…”

“…In their seminal and influential work, Edelman et al (2007) and Varian (2007) propose a Generalized Second Price (GSP) auction framework to understand the sponsored search auctions from 2002 through 2007. Edelman et al (2007) and Varian (2007) argue that this game framework "describes the basic properties of the prices observed in Google's ad auction reasonably accurately." However, Borgers et al (2007) suggest that "this static GSP auction model actually may have a very poor explanation power on the real data collected from the Yahoo!…”

“…switched its sponsored search auction from the Generalized First Price (GFP) auction to the Generalized Second Price (GSP) auction. Auction theory claims that "superior designs" have replaced the "inefficient market institutions" (Edelman et al, 2007 andJansen andMullen, 2008). The GSP game framework predicts that, in the new auction, bidders will be less likely to "game the system".…”

“…switched to the GSP auction system was that Yahoo! believed that the GSP auction was more stable and the "second-price structure makes the market less susceptible to gaming" (Edelman et al, 2007).…”

“…Recent theories on the sponsored search auction, including Edelman et al (2007), Varian (2007 and Athey and Ellison (2007), are basically based on a static game theory structure. One salient fact these theories miss is that bidders often adopt automated bidding robots to manage their bidding.…”