A Dynamic Model of Sponsored Search Advertising

Marketing Science, Vol. 30, No. 3, pp. 447-468, May-June 2011

NET Institute Working Paper No. 08-16

70 Pages Posted: 19 Oct 2008 Last revised: 5 Aug 2014

See all articles by Song Yao

Song Yao

Washington University in St. Louis - John M. Olin Business School

Carl F. Mela

Duke University - Fuqua School of Business

Date Written: September 15, 2010

Abstract

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 affect 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 affects consumer welfare and firm profits. The dynamic structural model we propose serves as a foundation to explore these outcomes. We fit 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 find evidence of dynamic bidding behavior. Advertiser value for clicks on their sponsored links averages about 26 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 find that frequent clickers place a greater emphasis on the position of the sponsored advertising link. We further find that about 10% of consumers do 90% of the clicks.

We then conduct several policy simulations to illustrate the effects of changes in search engine policy. First, we find the search engine obtains revenue gains of 1% by sharing individual level information with advertisers and enabling them to vary their bids by consumer segment. This also improves advertiser revenue by 6% and consumer welfare by 1.6%. Second, we find that a switch from a first to second price auction results in truth telling (advertiser bids rise to advertiser valuations). However, the second price auction has little impact on search engine profits. Third, consumer search tools lead to a platform revenue increase of 2.9% and an increase of consumer welfare by 3.8%. However, these tools, by reducing advertising exposures, lower advertiser profits by 2.1%.

Keywords: Sponsored Search Advertising, Two-sided Market, Dynamic Game, Structural Models

Suggested Citation

Yao, Song and Mela, Carl F., A Dynamic Model of Sponsored Search Advertising (September 15, 2010). Marketing Science, Vol. 30, No. 3, pp. 447-468, May-June 2011; NET Institute Working Paper No. 08-16. Available at SSRN: https://ssrn.com/abstract=1285775

Song Yao (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

HOME PAGE: http://www.songyao.org

Carl F. Mela

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7767 (Phone)

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