http://www.gsb.stanford.edu/news/research/econ_ostrovsky_internetauction.shtml

Stanford economists say that under Google’s current auction system, inexperienced bidders often end up overpaying, while experienced ones funnel personnel and money that could be used for growing the company into instead figuring out how to beat Google’s system.

The problem is that Google says it is conducting a second-price auction using ideas from the Vickrey auction model, which makes advertisers think they should be bidding their true value. However, the amount of money that an advertiser pays is not actually the harm he does to the other bidders by winning his slot; instead, the advertiser pays $.01 more than the next highest bid. In many situations the advertiser will be better off underbidding his true value, because the savings from paying less for a lower slot outweighs the loss in revenue from advertising at a lower slot.

To illustrate this point, consider the following example offered by the economists.

Advertisers X, Y and Z truthfully bid $10, $8 and $7 dollars per click for slots a, b and c that receive 100, 70 and 50 clicks per hour. Thus, under the Vickrey auction model advertiser X would pay an amount equal to the harm he does to advertiser Y by Y not getting the first slot + the harm he does to advertiser Z by Z not getting the second slot. This equals $8 (30) + $7 (20) =$380 per hour, and the Vickrey model says that advertiser X should pay $380/100 = $3.80 per click. In this system bidders have incentives to state their true value, as illustrated in class.

Under Google’s system, however, advertiser X would be charged $8.01 per click. If he instead bids under $7, he would take the third position and pay a very small price, which likely would offset his loss in clicks from 100 to 50, and give him higher profits.

The authors urge Google to apply a true Vickrey model to its auction. The current system is volatile; advertisers are constantly observing each other’s bids and adjusting theirs accordingly, and ad placement changes from one minute to the next. However, a change may be unlikely as Google’s current system gives the company a lot more money than the Vickrey auction would.

Another reason for lower bids

An Ad Upstart Challenges Google

Google does not give advertisers the opportunity to bid for space on specific websites or a list of sites where their ads end up; as a result, most advertisers assume their ads will end up on many second and third-tier sites and thus lower their bids accordingly. Big name websites in Google’s AdSense network thus receive lower bids from advertisers and get less revenue than they would if the advertiser had known the website’s identity.

Quigo Technologies, a New York contextual ad company that has succeeded in luring away some Google customers (including ESPN), challenges Google’s lack of transparency on this front by offering its own customers opportunities to bid on specific sites and information about where their sites end up. Google and Yahoo! argue that because advertisers pay per click, the additional information Quigo supplies is not relevant. Still, Google has announced that it plans to share with customers the information Quigo currently gives out.