Google’s Ad Auction System

Business Week provides some insights:

What makes Google’s auction so different? Auctions come in two main flavors. In a typical first-price auction, participants put in sealed bids, then the winner pays his or her bid. But the danger is the high-bidder ends up regretting having won, an effect known as the winner’s curse. A second-price auction lessens winner’s curse because the highest bidder gets the prize but pays only the minimum necessary to win, namely the second-highest bid, plus perhaps a penny.

Kamangar, Veach, and colleagues chose a second-price auction. But not knowing theory, they designed one that differed in a key respect from the one economists had studied. In the economists’ version, bidders always have the incentive to tell the truth. In Google’s auction they don’t, say Edelman, Ostrovsky, and Schwarz, since in some cases, by understating the top price they’re willing to pay, advertisers could get a slightly lower position on the search page for a lot less money. They conclude that naive advertisers who told the truth could overbid. Google’s system has pluses for advertisers, too, says Varian. It’s easier to understand than the academic version. And it’s proven to work on a large scale.

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Rajesh Jain

An Entrepreneur based in Mumbai, India.