Let’s play the search game: Strategic and behavioral properties of sponsored search auction mechanisms

Abstract

Abstract This paper develops a model of buyer (consumer) and seller (advertiser) strategic behavior in sponsored search auctions. Through its various extensions, the model is able to predict the effect of different ranking and payment policies on auction performance in terms of consumer surplus as well as advertisers’ and search engine profits. The theoretical model demonstrates that 1) payment policies should not have an effect on auction performance, 2) ranking policies that do not include the advertiser’s bid as a ranking criterion should not have an effect on auction performance 3) policies that use advertisers’ bids as the single ranking criterion should be just as good as using advertisers’ bids combined with other criteria over which advertisers have no short-term influence (e.g., relevance and click-through rate), 4) some sort of a coordination mechanism is necessary in order for buyers and sellers to achieve a fully efficient outcome, however, coordination should prove much more difficult when the bid is not used as at least one of the ranking criteria, 5) decreasing the number of sponsored links shown to consumers and displaying product prices should improve coordination and increase the likelihood of a fully efficient outcome. We use economically-motivated human subjects and the methods of experimental economics to test the first two of the model’s predictions. We investigate six different sponsored search auction formats: two different pricing policies (pay-per-transaction and pay-per-click) and three different ranking policies (rank by relevance, rank by click-through rate, & rank by both relevance and click-through rate). As predicted by the model we find no significant effect due to difference in ranking policies. However, contrary to the model’s predictions, we find significant differences in total surplus due to payment policies. We discuss two behavioral effects that could be the reason for these differences.