Search Engine Advertising: Pricing Ads to Context

Abstract:     
Each search term put into a search engine produces a separate set of results. Correspondingly, each of the sets of ads displayed alongside these results is priced using a separate auction. There is growing debate whether this marketing strategy merely makes advertising more informative, or whether using context to price also effectively price discriminates. To inform this debate, we examine advertising prices paid by lawyers for 174 Google search terms in 195 locations and exploit a natural experiment in "ambulance-chaser" regulations across states. Where state laws impose limits on lawyers' contingency fees limits, the relative price of advertising is $2.27 lower. This suggests that context-based pricing allows prices to reflect heterogeneity in the profitability of customer leads. When lawyers cannot contact a client by mail, the relative price per ad click is $0.93 higher. This suggests that context-based pricing allows prices to reflect heterogeneity in advertisers' other advertising options, even within a given local market. This last result emphasizes that search engine's pricing clout depends on the extent of competition, both online and offline.

Keywords: search engines, advertising, market power, advertising prices

JEL Classifications: L86, M37

Working Paper Series