Ex Ante Information and the Design of Keyword Auctions

  • Authors:

  • De Liu;Jianqing Chen;Andrew B. Whinston

  • Affiliations:

  • Gatton College of Business and Economics, University of Kentucky, Lexington, Kentucky 40506;University of Calgary, Haskayne School of Business, Calgary, Alberta T2N 1N4, Canada;Red McCombs School of Business, The University of Texas at Austin, Austin, Texas 78712

  • Venue:
  • Information Systems Research
  • Year:
  • 2010

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Abstract

Keyword advertising, including sponsored links and contextual advertising, powers many of today's online information services such as search engines and Internet-based emails. This paper examines the design of keyword auctions, a novel mechanism that keyword advertising providers such as Google and Yahoo! use to allocate advertising slots. In our keyword auction model, advertisers bid their willingness-to-pay per click on their advertisements, and the advertising provider can weight advertisers' bids differently and require different minimum bids based on advertisers' click-generating potential. We study the impact and design of such weighting schemes and minimum-bid policies. We find that weighting scheme determines how advertisers with different click-generating potential match in equilibrium. Minimum bids exclude low-valuation advertisers and at the same time may distort the equilibrium matching. The efficient design of keyword auctions requires weighting advertisers' bids by their expected click-through-rates, and requires the same minimum weighted bids. The revenue-maximizing weighting scheme may or may not favor advertisers with low click-generating potential. The revenue-maximizing minimum-bid policy differs from those prescribed in the standard auction design literature. Keyword auctions that employ the revenue-maximizing weighting scheme and differentiated minimum bid policy can generate higher revenue than standard fixed-payment auctions. We draw managerial implications for pay-per-click and other pay-for-performance auctions and discuss potential applications to other areas.