DEVELOPMENT OF A BUSINESS MODEL

When Brin and Page started Google they did not have a business model in mind. At one point they offered to sell the PageRank algorithm they used to Yahoo! for US$1 million. When Yahoo! turned them down, they thought about selling intranet search services to companies.

Auctioning search results didn’t work very well, since willingness to pay for placement is not a very good indication of relevance to users, so GoTo eventually adopted a new business model in which they auctioned off advertisements to accompany what they referred to as the ‘algorithmic’ search results. At about the same time they changed their name to Overture. Two Google employees, Salar Kamangar and Eric Veach, watched what Overture was doing and decided they could improve upon it. During the fall of 2001 they developed the Google Ad Auction.³

In their model ads were ranked by the product of bids and estimated click-through rate. Since bids are expressed in units of cost/click and the click-through rate is clicks/ impressions, this means that ads are ranked by cost per impression. The idea was to put the ads that have the highest expected revenue in the best positions - that is, the positions where they would be most likely to receive clicks. Just as a firm cares about price times quantity sold, a search engine should care about the price per click times the number of clicks expected to be received since that is the total revenue from showing the ad. Of course, this requires a way to estimate the probability of a click - a non-trivial task. I will discuss how this is done below.

During the project development Google realized that a first-price auction (where advertisers paid their bid amount) was not attractive since advertisers would want reduce their bid to the lowest amount that would retain their position. This constant monitoring of the system would put a significant load on the servers, so Google decided to automati­cally set the price paid to be equal to the second highest bid - since that is what the adver­tisers would want to do anyway. This choice had nothing to do with Vickrey auctions⁴ - it was primarily an engineering design decision.⁵

Initially the Google ad auction only applied to the ads appearing on the right-hand side of the page, with the top ads (the best-performing area) reserved for negotiated pricing by a sales force. Eventually it became clear that the prices generated by the auction were more appropriate than those generated by negotiation, so Google switched to using an auction for all ads displayed.

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