In the past couple of weeks, I have moved across from SEO to the PPC (Pay – Per – Click) team. A different channel of digital marketing; a different challenge. Whereas SEO rankings depend entirely upon the quality of our site; the uniqueness of content and relevancy against search queries, PPC adds another level of complexion: auctions and bidding. In PPC, the best quality advert needn’t always surface in position 1 on the SERP (Search Engine Results Page) – if the price is right that is!

In this article I’ll introduce 4 types of auction and the merits and weaknesses of each. Then I’ll discuss the auction Google uses within their PPC advertising set-up. Let’s get started.   

When to use an Auction?

Auctions were first used by the Greeks and Romans. Women were sold off as brides and slaves were auctioned off to the highest paying families. Much later in history, the large auction houses of London and New York were established in the 18^th century, selling jewelry, art and celebrity artefacts. In the late 1990’s the advent of the internet saw the launch of eBay allowing bidding to take place remotely across the globe. Auctions work well in lots of scenarios and are here to stay.

For an example of when an auction is not so well suited, imagine taking a trip to your local supermarket. Picture the scene. You round the corner of the tinned food aisle ready to pick up a can of beans but are met with an auctioneer and a crowd of other shoppers bidding on individual cans. You panic and reach for your wallet. Are these the last beans in town? Is there a war on? Peering over shoulders, you see that there are hundreds more cans of beans on the shelf and relax. For items in abundance, bidding isn’t necessary. If demand for beans increases, we can produce more beans at little cost. Scarcity drives value and hence increases prices. Auctions do better in situations of limited resource.

Now, suppose I have 2 identical paintings, the last 2 in the world. I want to sell them off to the highest bidder. What should I do to maximise my earnings? Answer at the end.

Auctions are also great if the seller doesn’t know the value of the item. They let the buyers set the price through competition. We all have an intuitive expectation of what to pay for a can of beans. If pressed, we could probably even break down and estimate the cost to make, package and distribute each can. Far less so with a rare painting, or a classic car. Auctions work better if the value is up for debate, with different bidders holding different views on this.

Types of Auction

An auction is any process for buying and selling goods or services in which the items are sold to the highest bidder. The process varies; there are 4 primary auction methods.

• Ascending Bid (English) Auction: The auction format we are most familiar with. The auctioneer gradually increases the price until only one bidder remains. The bidder pays the second highest bid, plus a small increment.
• Descending Bid (Dutch) Auction: This type of auction starts the bidding at an arbitrarily large price, then the price falls gradually. The first bidder to place their bid wins the auction and pays what they bid.
• First-Price Sealed Auction: Prior to the auction, all bidders submit their bid to the seller simultaneously. Upon opening, the item is sold to the highest bidder. The bidder pays their high bid.
• Second-Price Sealed (Vickrey) Auction: Prior to the auction, all bidders submit their bid to the seller simultaneously. Upon opening, the item is sold to the highest bidder, as in the First-Price Sealed Auction. However, in this format, the bidder pays the second highest bid in the auction. eBay uses this approach to sell items across the globe and Google uses a variant of this auction type to sell online advertising.
  

Equivalencies

Within these 4 methods, we find that we can further group them. Some are equivalent as shown by the following arguments.

In a First-Price Sealed Auction, we are blind to the bids of others. This is the same in a Dutch auction. We don’t know the price the other bidders are willing to pay until the auction is over. Whilst no one has bid, we know is that everyone thinks the price is still too high for them to buy, but we do not know at what price they will raise their hand. In both auctions, the item goes to the highest bidder and in both auctions all bidders do not what the others will bid. We can consider these auctions equivalent.

Can we draw a similar equivalence between an ascending bid auction and a Second-Price Sealed Auction? It turns out that we can. In an Ascending Bid Auction, the eventual winner pays what the second highest bidder was willing to pay*. It’s the same in a Second-Price Sealed Auction, hence the equivalence.

*In practice this isn’t true, since a small increment is added. When modelling the 2 auction types side by side, this increment is insignificant, and we draw the equivalence anyway. The price is directly related to the bid of the second highest bidder.

As an example, let’s suppose I had written a book based on my introduction to SEO talk last month and was selling the book on eBay. The auction begins: £5, £10, £15 – a battle between 2 bidders. Bidder A bids £20 but then places no further bids, and Bidder B bids £25 to win the auction. With a minimum bid interval of 50p, Bidder B will pay £20.50.

Choosing an Auction Type

Even with the same bidders holding the same beliefs of item value, different auction types may earn a seller more than others. One reason for this is the influence of others on our behaviour and rationale. Bidders often talk of the thrill of the auction house. The price rises and the bidders feel excited, stressed and bid with their hearts instead of their brains.

Suppose we’re in an Ascending Bid Auction. Watching someone bid on an item tells us that they believe the value of the item to be greater than or equal to their bid. Despite having our own belief of the item value, we consider this as evidence to reevaluate our assigned value, and likely outbid them. This influence is known as Social Proof. Other bidders, seeing our new bid undergo the same process. We have provided some social proof and confidence that the value of the item is higher still. And so, the bidding continues! Each bidder is this scenario has succumbed to the power of social proof and can be enough to drive the selling price that little bit higher.

From a seller’s perspective, auctions are great, but which should you use to make the most money out of your bidders? When would you want the bids to be kept private? And when would you use a Vickrey Auction over a Dutch Auction? These are all questions of auction design.   

Should I disclose bids as they are made?

As discussed earlier, Social proof can be a major influence in Ascending bid auctions. In this scenario, disclosing the bids of others leads people to bid higher than they normally would.

Additionally, bidders commonly fall for the Endowment Effect – we feel a stronger emotional connection to objects that we own. I argue that this applies during bidding. Even if we don’t own the item, the sense of ownership acquired from holding the current high bid may drive us to bid further in order to retain the item. In short – we don’t like to lose!

When to use the Dutch auction?

When the value of an item is not known so well or differs greatly across bidders, a Dutch auction may be a better bet as a seller. Suppose Sellers A, B and C value an item as follows:

A             £1000

B             £500

C             £1500

With a min bid increment of £10 in each case, an Ascending Bid Auction or Vickrey Auction generates £1010, but a Dutch auction generates £1500. Both auctions would expectedly be won by bidder C, but for very different amounts. The seller in this case can take advantage of the bidding variance.

Vickrey gone wrong?

In the example above, the seller using a Vickrey auction would lose out on nearly £500. Not great, but far better than the situation the New Zealand government fell into in 1990. Auctioning off 8 identical licenses for telecommunication spectra, a company that bid NZ$7 million paid only the second highest big of NZ$5000. With public information, the media took hold of the failure. Once the final hammer went down, NZ$36 million had been raised, far short of the NZ$250 million expectation. Selling things too cheap is a danger of a Vickrey auction but is easy to fix: set a reserve price!

Enter PPC

The query ‘grey check curtains’ has been entered into Google. Assuming that Google is going to show ads, then in the fraction of a second before the SERP is returned, an auction takes place between advertisers, who bid on the advertising space at the top of the SERP. The winner of the auction has their ad shown right at the top, with the runners up in positions 2,3,4… respectively. How is this auction set up, and what can we learn from this?

We pay google for showing our adverts if and only if the searcher clicks on them. Hence the name Pay Per Click!  Prior to any auction, each advertiser decides on their bid for each search query or ad. This is the maximum amount they would be willing to pay Google each time the ad is clicked on, called the Maximum Cost Per Click, and often written as the Max CPC for short.

But the highest bid doesn’t automatically win the auction and hence top spot on the SERP. Google factors in the Quality Score of the adverts. This is a measure of how ‘good’ each ad is and is where the principles of SEO begin to show through.

Just as Meta Titles and Descriptions dictate the presentation of natural search listings on the SERP, the display of each Google Ad can be equally manufactured with headlines, descriptions, product images, a display URL and ad extensions such as phone number or star rating. Google obtains a measure of ad relevancy against the entered search query. Together with landing page experience and the expected Click Through Rate (extrapolated from historical search data), Google assigns a Quality Score to our Ad. From a mathematical perspective we could write that Quality Score = f(Ad Relevancy, Expected CTR, Landing Page Experience). It’s an undisclosed function of several factors. In a vein similar to the SEO ranking algorithm, Google doesn’t share the inner workings.

Alongside this information, Google has knowledge of the Bids (Max CPC) for each advertiser. From here, the Ad Rank is calculated as follows:

Ad Rank = Quality Score * Bid.

The higher the Ad Rank of an advert, the higher up the SERP you will be. The winner of the auction is the ad with the highest ad rank. From here, Google calculates the price that each advertiser pays (Actual CPC) as follows:

Actual CPC = Ad rank of advert directly below / Quality Score + 1p

The intuition is that each ad pays just enough to beat the Ad rank of the advert directly below. The exception is for the ads at the bottom, who pay just enough to beat the ad rank threshold. In summary, it’s a variant of a Vickrey Auction, favoured towards ads with a higher quality score. Here’s a wordy, though illustrative example from Google:

“Assume five advertisers are competing for a maximum of four ad positions above search results on the Google search results page. The respective Ad Rank of each of the advertisers is, say, 80, 50, 30, 10 and 5.

If the minimum Ad Rank necessary to show above the search results is, say, 40, only the first two advertisers (with Ad Ranks of 80 and 50) exceed the minimum and show above the search results. The advertiser with the Ad Rank of 80 pays just enough (e.g. rounded up to the nearest billable unit, which in the U.S. is $0.01) to beat the advertiser with the Ad Rank of 50. Since there’s no other eligible competition, the advertiser with the Ad Rank of 50 pays just enough to beat the minimum Ad Rank of 40.

If the minimum Ad Rank necessary to show below the search results is 8, then two of the three remaining advertisers (with Ad Ranks of 30 and 10) will show beneath the search results. The advertiser with an Ad Rank of 30 will appear in the first position beneath the search results and will pay just enough to beat the advertiser with an Ad Rank of 10. The advertiser with an Ad Rank of 10 will show beneath that advertiser and will pay just enough to beat the minimum Ad Rank of 8. The advertiser with an Ad Rank of 5 didn’t meet the minimum Ad Rank and so won’t show at all.”

How much to Bid?

Now we know how different auctions works, the next question concerns how much you should bid to maximise the likelihood of winning your item at the lowest price. I’ll save this for a future post; there is some interesting mathematics which warrants proper discussion.

Until next time,

Scott

The Paintings

Earlier we considered owning the last 2 in the world of a certain painting. How can we maximise our earnings in an auction?

A: We should destroy one of the paintings prior to the auction – this will more than double the price of the other!