Internet Advertising and the Generalized Second Price Auction: Selling Billions of Dollars Worth of Keywords

Benjamin Edelman, Michael Ostrovsky, Michael Schwarz
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excerpt Beginning in 1994, Internet advertisements were largely sold on a per-impression basis. Advertisers paid flat fees to show their ads a fixed number of times (typically, 1,000 showings or “impressions”). Contracts were negotiated on a case-by-case basis, minimum contracts for advertising purchases were large (typically, a few thousand dollars per month), and entry was slow. 245 on 6/8/2019, 12:38:32 PM

excerpt Generalized First-Price Auctions.—In 1997, Overture (then GoTo; now part of Yahoo!) introduced a completely new model of selling Internet advertising. In the original Overture auction design, each advertiser submitted a bid reporting the advertiser’s willingness to pay on a per-click basis, for a particular keyword. The advertisers could now target their ads: instead of paying for a banner ad that would be shown to everyone visiting a Web site, advertisers could specify which keywords were relevant to their products and how much each of those keywords (or, more precisely, a user clicking on their ad after looking for that keyword) was worth to them. Also, advertising was no longer sold per 1,000 impressions; rather, it was sold one click at a time. Every time a consumer clicked on a sponsored link, an advertiser’s account was automatically billed the amount of the advertiser’s most recent bid. The links to advertisers were arranged in descending order of bids, making highest bids the most prominent. The ease of use, the very low entry costs, and the transparency of the mechanism quickly led to the success of Overture’s paid search platform as the advertising provider for major search engines, including Yahoo! and MSN. However, the underlying auction mechanism itself was far from perfect. In particular, Overture and advertisers quickly learned that the mechanism was unstable due to the fact that bids could be changed very frequently. 246 on 6/8/2019, 12:40:57 PM

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