This behavioral targeting article talks about the Generalized Second Price Auction, which was effectively implemented by such huge online firms as Yahoo and Google. It talks about how it works from various levels in the online advertising framework.
Click here to read the original behavioral targeting article by Benjamin Edelman, Michael Ostrovsky, and Michael Schwarz: Internet Advertising and the Generalized Second Price Auction: Selling Billions of Dollars Worth of Keywords.
The generalized second price (GSP) auction is made for the online ads market. It is worth noting how commercially successful this new form of auction mechanism is, so much so that the combined market capitalization for both Google and Yahoo’s GSP auctions is 125 billion dollars. Compare this to all the airlines in the United States, which only have a total of 20 billion dollars.
How Generalized Second Price Auction Works
An online user uses the search engine to look up a keyword. After pressing enter, the search engine results page appears, containing links to the most relevant content, and sponsored links, or paid advertisements. These paid advertisements are links to the websites of advertisers, who pay the search engine if their sponsored link gets clicked by the user, which is called pay-per-click pricing.
Take the example of a travel agent who bought the keyword “Hawaii”. If a user searches for that keyword, a sponsored link to the travel agent’s website will appear in the search engine results page that the user will see. If that user clicks the sponsored link, the travel agent advertiser will pay the search engine for sending the user to his site.
Auctions happen in the online ads market because some positions in a results page are better places for putting up ads than others. For example, a sponsored link that appears on top of the page is more likely to be clicked by the user than the one at the bottom. The auction proceeds as follows:
Advertisers place bids on how much they will pay for a click on their sponsored links. When a user types a keyword, and the results and sponsored links show up, the sponsored link of an advertiser will show up in a position related to the bid that he placed, i.e. the highest bidder gets his ad placed on the top position, and the second highest bidder gets his ad displayed on the second position, etc. If a user clicks on the sponsored link at a certain position, the advertiser of that sponsored link will only have to pay for the bid for the next lower position. That’s why it’s called a second price auction.
Why Internet Advertising is Unique
Internet advertising involves continuous bidding. An advertiser on the second position can always change his bid any timen he wants, and so his position and order can change automatically and very rapidly due to automated robots. Another property of internet advertising is that it’s goods are perishable, so that it sells goods which cannot be stored. Finally, internet advertising cannot clearly be measured in terms of stanadardized units. An advertiser may think of a unit as the price necessary to make consumers purchase his goods, so he wants a pricing model wherein he will only pay if a consumer transacts completely. A search engine, on the other hand, may think of a unit as the revenue it will get every time a user searches a keyword. These two perspectives are combined together to form pay-per-click pricing.
Rules of Generalized Second Price Auction
GSP has unique rules for the unique environment of online advertising. One of its rules is that bidders should have only one bid per keyword. This study incorporates this rule, avoiding the complexities of a perhaps more refined way of bidding, which includes the possibility that advertisers care about other positions as well, or that the probability of being clicked in a certain position is different for ads from different advertisers, or click-through rates. Yahoo ignores CTR, while Google incorporates CTR in an overall expected revenue which is the basis for ranking. Therefore, this study assumes that all advertisers have equivalent CTRs.
VCG Mechanism and Generalized English Auction
This study investigates GSP and its relation with the VCG Mechanism and Generalized English auction. VCG auction and GSP are similar in that the payment made by the advertiser depends on the bids of the other players, but they have several differences. The two are the same for results page containing only one slot, but with several slots, the mechanisms of both will differ in terms of charging bidders, and it has been shown in this study that for true values, an advertiser bidding under GSP will always have higher revenues compared to VCG.
The generalized English auction corresponding to GSP auction is shown to have a unique equilibrium. This equilibrium’s properties include having explicit analytical formulas, and the auction outcome depends only on the realizations of the values of bidders. Therefore, English auction is a robust mechanism.