Keyword Auctions, Unit-Price Contracts, and the Role of Commitment

Abstract

Motivated by the enormous growth of keyword advertising, this paper explores the design of unit-price contract auctions, in which bidders bid their unit prices, and the winner is chosen based on both their bids and performance levels. The previous literature in unit-price contract auctions usually considers a static case where bidders' performance levels are fixed, and suggests giving preferential treatment to those bidders with low performance levels in order to promote competition. This paper extends such research by allowing bidders with lower performance levels to improve their performance at a certain cost. We examine the impact of the preferential policy on overall bidder performance, the auction efficiency, and the auctioneer's revenue, and derive the revenue-maximizing and efficient policy accordingly. Moreover, the possible upgrade in bidders' performance levels gives the auctioneer an incentive to modify the auction rules over time, as is confirmed by the practice of Yahoo! and Google. We thus compare the auctioneer's revenue-maximizing policies when she is fully committed to the auction rule and when not, and show that she should give less preferential treatment to low-performance advertisers when she is fully committed.

Keywords: Performance-base pricing, Unit-price auctions, Keyword auctions, Commitment