How Are Online Ads Priced?
Second Price Auction
A general second price auction or a GSP is a type of auction where the bidder has to pay the price bid by the next best bidder. For example, if you bid 10 rupees for an apple, while another bids 8, you get the apple, and that too at the price of 8 rupees.
Background
A big part of what we click on the web are ads, and these ads have a complicated pricing method. Unlike most other ads these are priced such that the platform where you’re advertising gets paid per click on that ad. So, when someone clicks on an ad you post, you pay ₹5 for example. Who sees that ad and whose ad is seen is determined by two different algorithms.
The “viewer” of the ad is determined by the data of the platform user. For example, the probability that you see a laptop ad on Facebook is much more if you recently searched for laptops or electronics. And that is not just because of the cookies saved by your browser, it’s also because all the clicks you make are recorded.
The “viewee” of the ad is determined by how much they are willing to pay. Usually the more you bid to pay, the more times your ads will be flashed. Web pages such as those of Facebook refresh themselves without disturbing your newsfeed, so new ads always keep appearing. That’s how ads by both the high paying viewee and low paying viewee may appear but for different durations.
The viewees bid for spots in that set. A score is calculated incorporating the relevance of the ad to the viewer and the bid prices. The highest scorer wins the auction and gets the top spot.
Example: Ad auction for an ad unit that shows two ads
| Advertiser | CPC bid | Quality Score | Ad shown? | Rate |
| Alice | $5 | 10 | Shown | 3.0 |
| Bob | $3 | 10 | Shown | 1.0 |
| Charlie | $1 | 10 | Not shown | N/A |
How is it better than a first price auction?
In terms of revenue generated by Google, in theory it stays the same. (however it has been observed that a GSP yields higher bids than a normal auction). But it isn’t about the revenue. In a first price auction I would try to guess what the person who valued it second most is going to bid, and then bid just a little more than that. (Complicated by the fact the that person is also playing the same game against me).
In a second price auction, it doesn’t matter how much I bid (as long as it’s above the 2nd price), because I still pay the same amount. So, I am not punished by bidding my own true value. This frees me to just worry about how much I value the object; and not try to second-guess how much the other people are going to second-guess me. So, in GSP you have a better pay off bidding your true valuation at once.
That being the case, it’s sensible for Google to use a second price auction, encouraging buyers to submit one true bid rather than constantly adjusting their bids, thereby making it convenient for both themselves and the bidders.
