A Dynamic Model of Sponsored Search Advertising

A Dynamic Model of Sponsored Search Advertising Sponsored search advertising is ascendant— Jupiter Research reports expenditures rose 28% in 2007 to $8.9B and will continue to rise at a 26% CAGR, approaching 1/2 the level of television advertising and making it one of the major advertising trends to a¤ect the marketing landscape. Yet little empirical research exists to explore how the interaction of various agents (searchers, advertisers, and the search engine) in keyword markets a¤ects consumer welfare and …rm pro…ts. The dynamic structural model we propose serves as a foundation to explore these outcomes. We …t this model to a proprietary data set provided by an anonymous search engine. These data include consumer search and clicking behavior, advertiser bidding behavior, and search engine information such as keyword pricing and website design. With respect to the advertisers, we …nd evidence of dynamic bidding behavior. Advertiser value for clicks on their sponsored links averages about 27 cents. Given the typical $22 retail price of the software products advertised on the considered search engine, this implies a conversion rate (sales per click) of about 1:2%, well within common estimates of 1-2% (gamedaily.com). With respect to consumers, we …nd that frequent clickers place a greater emphasis on the position of the sponsored advertising link. We further …nd that 10% of consumers do 90% of the clicks. We then conduct several policy simulations to illustrate the e¤ects of changes in search engine policy. First, we …nd the search engine obtains revenue gains of nearly 1:4% by sharing individual level information with advertisers and enabling them to vary their bids by consumer segment. This also improves advertiser revenue by 11% and consumer welfare by 2:9%: Second, we …nd that a switch from a …rst to second price auction results in truth telling (advertiser bids rise to advertiser valuations), consistent with economic theory. However, the second price auction has little impact on search engine pro…ts. Third, consumer search tools lead to a platform revenue increase of 3:7% and an increase of consumer welfare by 5:6%. However, these tools, by reducing advertising exposures, lower advertiser pro…ts by 4:1%: