Econometa

—– Google, auctions, and arbitrage —–

As always, the picture comes before the explanation, and clicking on it will give you a bigger version. This one shows how the Google advertising system works.

—– Google —–

Since Google has been so successful in advertising, and since AdSense is currently the main player in placing ads on smaller publisher sites, it is worth going into some detail on how Google advertising solutions work. Many other companies use elements of these solutions as well, so a lot can be learned about the market in general by studying Google.

Google has two advertising programs, one for advertisers and one for publishers:

- AdWords: This program allows advertisers to buy ad inventory based on keywords. The ads may appear on Google SERPs, within Google applications, on other search engines such as AOL, and on publisher sites subscribing to the AdSense program.
- AdSense: This program allows publishers to sell ad inventory to advertisers participating in the AdWords program. Ads may be targeted either contextually or based upon search keywords entered in a site-specific Google searchbox.

So Google is both a publisher and an ad network. One reason for Google’s success as an ad network is that every advertiser customer as a publisher automatically becomes an advertiser customer as an ad network. This neatly solves the problem all “two-sided markets” have, which is how to prime one side of the market before the other exists.

—– Keyword auctions —–

Another factor in Google’s success is its pioneering use of keyword auctions in selling ad inventory. As we noted previously, a huge advantage of search is that it automatically generates very high quality targeting data, the search keywords themselves. A keyword auction increases market efficiency by linking pricing to targeting data, and also lowers Google’s cost of sales by setting prices and fulfilling purchases automatically.

The auction itself operates in a straightforward way. For each set of keywords, advertisers choose:

- The ad that will appear
- Additional targeting criteria (geo and/or specific sites)
- The maximum CPC that will be bid
- The maximum daily dollar amount of ad inventory that will be bought

For a given ad space, Google then collects all active bids on the keywords associated with the search or web page, and places ads taking into account the maximum bid amounts. To encourage advertisers to enter high bids, Google reduces the CPC of the top bidder to be just over the next highest bid.

However, a key innovation in Google’s ad placements is that the CTR for a given ad is taken into account along with the maximum bid in determining placement position. This means that an ad with a high CTR can be placed more prominently than another ad with a higher bid, but a lower CTR. This has two consequences:

- Users see more ads that other users have previously clicked on, and which are therefore presumably more relevant and helpful.
- The overall CTR of displayed ads is higher, increasing transaction volume and thus Google’s income, which is a percentage of CPC.

—– Keyword arbitrage —–

It is neither difficult nor capital-intensive to set up an intermediary site that is paid based upon leads or referrals, and then to drive users to the site by buying keyword ads. This has resulted in arbitrageurs trying to take advantage of market inefficiencies to “buy users” for less than they “sell” them.

There are several ways to approach this arbitrage, including the following:

- By acquiring better knowledge of the auction system, one can buy users that vendors have missed for a CPC that is less than vendors are willing to pay for a referral.
- By acquiring better knowledge of user behavior, one can buy users based upon non-obvious low-CPC keywords and sell them for a higher CPC or CPA to vendors.
- By adding value to the user experience, one can buy users at a CPC and sell them to vendors at a CPA that generates a profit.

It’s probably worth noting that while they do act to decrease inefficiencies in the market, the first two techniques also can tend to pollute search results with spurious links that deteriorate the user experience. However, they also increase the number of bidders in the keyword auction, thus keeping prices high and benefiting the search engine, so it’s not clear where motivations lie on this topic.

—– Tracking and reporting —–

Along with the auction mechanism itself, Google and others also provide tools for both advertisers and publishers to track and calculate various relevant quantities, including CPC, CTR, ROI, and eCPM. In order for advertisers to take advantage of these tools, they must consider two more pages in the marketing process:

- Landing page: the page that users see after clicking on an ad.
- Conversion page: the “thank you” page that users see after completing the action desired by the advertiser, such as entering information or purchasing a product.

Since the JavaScript that a publisher places on a web page in order to insert ads comes from Google, Google can do several things:

- Identify the publisher page on which the ads will appear
- Count the impression against the selected ads
- Determine technical targeting data for the user
- Place a cookie in the user’s browser

When a user clicks on an ad, the link is actually to Google, who then redirects the browser to the advertiser’s landing page. This lets Google:

- Count the click against the ad and the publisher page the ad appears on
- Identify the ad and publisher page in the user’s cookie

Finally, to track ROI advertisers must place a Google beacon on the conversion page. This lets Google read the user’s cookie and count the action for use in ROI calculations.

It’s probably worth noting that during this process, Google can collect information on ads clicked and conversions achieved per user. This comprises additional valuable targeting data on the user, and if the user is logged into a Google user account, can potentially be aggregated across browsers and computers. Google requires advertisers to make the conversion page beacon visible as a link marked “Google site stats,” which leads to a page explaining why the beacon is present and for what purposes the data will be used.

This entry was posted on Saturday, January 28th, 2006 at 12:32 am and is filed under Marketing. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.