A Structural Model of Sponsored Search Advertising Auctions

Post date: Dec 19, 2012 5:08:27 PM

Susan Athey and Denis Nekipelov

Sponsored links that appear beside Internet search results on the ma jor search engines are sold using

real-time auctions. Advertisers place standing bids, and each time a user enters a search query, the

search engine holds an auction. Ranks and prices depend on advertiser bids as well as “quality scores”

that vary over time, by advertisement and individual user query. Existing models assume that bids

are customized for a single user query. In practice queries arrive more quickly than advertisers can

change their bids. This paper develops a new model that incorporates these features. In contrast to

prior models, which produce multiplicity of equilibria, we provide sufficient conditions for existence

and uniqueness of equilibria. In addition, we propose a homotopy-based method for computing

equilibria.

We propose a structural econometric model. With sufficient uncertainty in the environment, the

valuations are point-identified; otherwise, we consider bounds on valuations. We develop an estimator

which we show is consistent and asymptotically normal, and we assess the small sample properties

of the estimator using Monte Carlo.

We apply the model to historical data for several search phrases. Our model yields lower implied

valuations and bidder profits than those suggested by the leading alternative model. We find that

bidders have substantial strategic incentives to reduce their expressed demand in order to reduce

the unit prices they pay in the auctions. These incentives are asymmetric, leading to inefficient

allocation, which does not arise in models that ignore uncertainty. Although these are among the

most competitive search phrases, bidders earn substantial profits: values per click are between 40

and 90 percent higher than prices for low-ranked bidders, but are between 90 and 270 percent higher

for high-ranked bidders. Our counterfactual analysis shows that for the search phrases we study,

the auction mechanism used in practice is only slightly less efficient than a Vickrey auction, but

the revenue effects are ambiguous, with Vickrey leading to substantially less revenue for one search

phrase and slightly more for the other. In addition, less efficient quality scoring algorithms can in

some cases raise substantially more revenue with relatively small efficiency consequences.