FULL TRANSCRIPT OF VIDEO
Hal Varian: Hi. I’m Hal Varian. I’m the chief economist here at Google and today I want to talk with you a bit about how the ad auction works. So to make a successful auction, we have to reconcile the interest of three parties and those parties are the advertiser, the user and Google. The advertiser wants to show relevant ads so that users click on them. The users want to see relevant ads. They don’t want to be bothered with spam or other irrelevant material and Google wants to make a good experience for both the advertisers and the users to they come back and use our services in the future.
Now that we understand the motivation to players, we can look at how their actions are reconciled in the auction so I’m going to do a very simple example to start with. It’s a case where there are three slots so three positions we’re asking up here and there’s four bidders who are competing for these slots. What happens is every time a query is made on Google, we run an auction and the auction is an auction for clicks so advertisers only have to pay when they receive a click. In this particular case, we have our four advertisers with different bids, four, three, two and one and the ads are ordered in terms of those bids. Highest bidder gets the first position. Second highest bidder the second position and so on.
They don’t have to pay their bid when they receive a click. They only have to pay the bid of the advertiser below them. So in this particular case, we have the first advertiser bidding $4 but they only have to pay $3 which is the bid of the second highest advertiser. Same thing for advertiser two and for advertiser three. So in this way, each advertiser can bid their maximum willingness to pay but what they have to pay is just enough to beat the competition.
So I told you that was a simplified version of the auction. Let’s try to do something a little more complicated. What’s left out of the example I just gave was a concept of ad quality. So remember, users want to see relevant ads. Advertisers want to present relevant ads to users and Google wants both users and advertisers to have a good experience so they come back and continue to use the system. So, what we want to – what we’re concerned with at Google is making sure that the ads that are shown to users have a high ad quality.
So what is quality score? So there are three components of the quality score. And the biggest one by far is clickthrough rate. By allowing users to vote with their clicks, we have millions of people who are helping us to decide which ads are best for each search query. Google’s philosophy is always [Indiscernible] [0:02:54] user feedback is a key drive decision-making so using clickthrough rate and quality scores is our way of incorporating that feedback at the ad serving.
Relevancy is the second largest component of quality score. Both the relevancy of a key word to the ads as well as to the user’s search query, Google determines relevancy by analyzing the language and context of an ad or query in determining how well it relates to a keyword. Google uses relevance to make sure that only useful ads are displayed to users and it prevents advertisers from paying their way on to search those unrelated to their product or service.
The third component of quality score is landing page quality. An ad is only useful to a user if the landing page leads to help them find the information they’re looking for. A high quality landing page that have relevant, original content, be easy, navigable with quick load times and minimum pop-ups or pop-unders and be transparent about the nature of your business, how your site interacts with the visitor’s computer and how you intend to use the visitor’s personal information.
So how does this quality score affect the way the auctions run? What we do is we have a concept of ad rank. An ad rank is going to be the bid of the advertiser times the quality of the ad. So in this particular example, I’ve got four advertisers. They’re bidding four, three, two and one and the ads have different quality. In this case, it’s a quality of one, three, six and eight. So to determine the ad rank, we just multiply these two numbers together.
And then, what we do is we rank the ads by the ad rank so the best performing ad here is 12. Second best is this ad, nine. Third best is this ad and up here, the advertiser is bidding four. Has such a low quality but it doesn’t get shown at all.
So now we know how the ads are ranked. How much do I actually pay for a click? Well, we use the same logic as in the simple example I presented a few minutes ago namely you pay the minimum amount that’s necessary to retain your position.
So, think about advertiser in position one. He’s competing with advertiser in position two and the amount that advertiser one has to pay is determined by – here’s the price he has to pay. Here’s the quality of advertiser one. It’s going to be just enough to beat advertiser two who bids B2 and has quality level Q2. So if you solve that equation, the price that advertiser one has to pay, his actual CPC is going to be the ad rank. So the advertiser below him divided by the quality score of advertiser one.
So let’s see how this works in a slightly more complicated example. Here we’ve got three advertisers and they’re each bidding the same price so we’ve got max bid is $4 for each of them but they had different qualities. In this case, the quality is eight, six and three. So the ad rank is determined by multiplying the bid times the quality to give us ad ranks of 3, 32, 24, and 12. So what determines the price? Well, the price is going to be the ad rank of the advertiser below divided by the quality score of the given advertiser. So in this particular case, it’s going to be 24 divided by eight or three. In this case, it’s going to be 12 divided by six or two. And finally, for the last advertiser, in this example, there’s no advertiser below the last advertiser so the price this person ends up paying per click is just the minimum price that’s determined for that auction.
We can use this example to illustrate an important point. What happens if an advertiser increases their quality score by having for example a more relevant ad? Well, take advertiser one. Suppose his quality score goes up to 10, then his ad rank is going to go up to 40. What happens to his price, the price that he has to pay per click? That goes down to $2.40. So by increasing your quality score, you can decrease the price that you have to pay per click.
So why do we use ad rank in this way? We’ll go back to the ecosystem that I talked about at the beginning. Makes users happier because users get to see more relevant ads. Makes the advertisers happier because the advertisers are showing more relevant ads, ads that are more likely to get results from the viewers. It makes Google happy because with happy users, with happy advertisers, we get more people using our system.
I hope that this discussion has helped demystify the Google ad auction. If you have any further questions or want to see additional material, go to AdWords.Google.com/support. Thank you for your attention.