Search Advertising: Is There a Feedback Effect?

Abstract

Like many other media services, internet search services provide two-sided platforms that coordinate interactions between media consumers and media advertisers. For some media services, it has been argued that positive feedback between the consumer/audience and advertiser sides of their businesses are a force contributing to high market concentration and for newspapers, yellow pages and magazines, empirical evidence for positive feedback effects has been produced. As with these other media services, the possibility as been raised that positive feedback may contribute to high concentration in search markets. However, whether feedback from the consumer/searcher side of a search service to the advertiser side is positive or negative depends on whether consumers prefer more or fewer paid ads on search results screens and is not a priori obvious. To our knowledge, this paper presents the first formal empirical evidence regarding the directionality of consumer/searcher-advertiser feedback effects for internet search services. Because the consumer/searcher and advertiser sides of a search service may influence each other, the two sides of the market cannot be studied independently if one wants to understand search market dynamics. The study reported in this paper employed a simultaneous equations model to test for a feedback relationship between consumer usage of an Internet search engine’s paid advertisements from local advertisers and local advertisers’ demand for paid search placements, using data for Yahoo’s local search service for metropolitan markets corresponding to broadcast television markets across the United States. Use of metropolitan markets data for search terms employed by local businesses for a single search service was necessary because, while their services are very similar, the different major independent search services in the U.S. (Google, Yahoo and Microsoft at the time our data was collected) differed sufficiently in the types of data and geographic options they offered advertisers that econometrically sound direct comparisons were not feasible. Use of local markets within a single large country as a source of cross-sectional variation was also deemed preferable to constructing an international cross-section because it would have been difficult to adequately control for country-specific differences in culture, internet use, and regulations affecting the larger advertising market. Our three-stage-least squares estimates support the existence at the local level of positive and quite large two-way feedback effects between the consumer and advertiser sides of Yahoo’s local internet search service. We use estimates for the model’s parameters to show how feedback between the consumer and advertiser sides of a search service increases the financial return to resources invested in efforts to increase the number of consumers using the service and how large this effect might be. Promotion through other media and investments to improve search accuracy are examples of such investments. We also discuss the importance of positive two-way feedback as a mechanism that may contribute to the observed pattern of high concentration in national internet search markets. While our understanding of any media service can be improved through further research, search services are still relatively new that we have much more to do before we have a knowledge base sufficient to be fairly confident in our understanding of the economic logic driving competition in search markets and, especially, the extremely high levels of concentration in just about all national search markets. Nevertheless, the impacts of search services on societies, the markets for products advertised on search engines, and other media (through competition for advertisers) is potentially quite large and policymakers and competition authorities have already felt compelled to take actions against dominant search service providers. The empirical findings presented in this paper contribute toward a more complete understanding of search service economics and this in turn should contribute to development of policies that better address the challenges raised by dominant search engines.