Sponsored Search Auctions: Simple Economics and Implications for Antitrust Policy

Renato Gomes, Jul 27, 2010

The most valuable asset of many two-sided platforms is their user base. In a celebrated example, Internet search engines (such as Google, Yahoo! or Bing) derive most of their revenue from selling the eyeballs of millions of searchers to advertisers. For each query entered by searchers, search engines return a list of sponsored links displayed to the right of the algorithmic (also called organic) search results. The knowledge of what searchers are looking for enables search engines to create very precise matches between searchers and advertisers.

The ability to target consumers has great value to advertisers. The average price of a click on a sponsored link from Google in 2006 was $2.00 and, for certain keywords, a click may cost more than $100. On aggregate, keyword advertising has impressive figures: in 2007, the U.S. search traffic totaled more than eighty billion queries, of which 40 percent have commercial potential. The total revenue generated by keyword advertising alone amounted to more than 20 billion dollars in 2007.

Recently, the three major search engines announced plans to collaborate in search technology and advertising. In June 2008, Google and Yahoo! issued a proposal according to which Google would deliver ads next to Yahoo’s search results. In July 2009, Microsoft and Yahoo! announced a deal to share search technology and to join forces in search-generated advertising. The Department of Justice raised concerns about the anticompetitive effects of such partnerships, which were ultimately aborted. Still, the prospect of future mergers brings many new questions to the antitrust debate in online advertising. Would a merger between the leading search engines be beneficial to searchers or advertisers? How would market conditions affect the pricing and the selection of sponsored search ads?

Search engines have traditionally employed auctions to sell sponsored links to advertisers. The use of auctions in two-sided markets is a novel phenomenon, and its antitrust implications have no parallel in one-sided settings. In this short note, I review the simple economics of sponsored search auctions, and describe its main insights for antitrust policy. Surprisingly, concentrated markets can be welfare-improving when search engines are not able to subsidize (or charge) searchers for their clicking behavior.



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