Keyword Search Advertising and First-Page Bid Estimates: A Strategic Analysis

In using the generalized second-price (GSP) auction to sell advertising slots, a search engine faces several challenges. Advertisers do not truthfully bid their valuations, and the valuations are uncertain. Furthermore, advertisers are budget constrained. In this paper we analyze a stylized model of the first-page bid estimate (FPBE) mechanism first developed by Google and demonstrate its advantages in dealing with these challenges. We show why and when the FPBE mechanism yields higher profits for the search engine compared with the traditional GSP auction and the GSP auction with advertiser-specific minimum bid. In the event that a high-valuation advertiser is budget constrained, the search engine can use the FPBE mechanism to alter the listing order with the intent of keeping the high-valuation advertiser in the auction for a longer time. The resulting increase in the search engine’s profits is not necessarily at the expense of the advertisers because the combined profits of the advertisers and the search engine increase.

This paper was accepted by J. Miguel Villas-Boas, marketing.