The encyclopedia · Finance & Accounting · Financial decision · 2002
Google priced each ad click at the next bidder's offer, and ads became a market.
AdWords Select switched to a generalized second-price auction in 2002; by 2004 Google made 98% of its revenue from it.
the move
When Google launched AdWords in 2000, ads were sold by the impression at a fixed price. On February 20, 2002 Google introduced AdWords Select: cost-per-click pricing where advertisers pay only when someone clicks, and ads are ranked by bid and click-through.
The ranking and pricing engine became a generalized second-price auction: the advertiser in each position pays the bid of the advertiser below it. Edelman, Ostrovsky and Schwarz's NBER paper noted GSP was first used in 2002 and that by September 2005 it generated billions of dollars a year.
The economics matter: because payment does not depend directly on your own bid, bidders can bid close to their true value instead of shading. The paper estimated Google's 2004 revenue at $3.189 billion, with over 98% of it coming from GSP auctions.
why it works
- Payment equals the next bid, so bidders do not need to guess and shade.
- Ranking by bid times expected clicks puts the most valuable ad on top.
- Click-based pricing aligned cost with the outcome advertisers actually wanted.
- The rule scaled to millions of keyword auctions a day.
what transfers
A pricing rule that decouples what you pay from what you bid invites honest bidding, which makes the market more efficient and more profitable than a rule that punishes honesty.
what came after
GSP became the standard way search ads are sold and the financial engine of Google's growth; its properties were studied by economists for years after. Later revisions added quality scores and reserve prices, but the second-price core remains.
references
- Internet Advertising and the Generalized Second Price Auction: Selling Billions of Dollars Worth of Keywords (NBER Working Paper 11765)
- Google Introduces New Pricing For Popular Self-Service Online Advertising Program
- Google unveils new pay-for-play plan
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