Google’s automated auction method is called a Generalized Second Price
auction or GSP and works like this. Suppose a number of online advertisers are
vying for three sponsored links positions. The top slot is the most valuable; its
prominence means it gets the most clicks and ultimately the greatest expected
sales revenue. (The second position is next most valuable, and so on.) The adver-
tisers submit price bids via the automated system, and the highest bidder claims
the top slot, the second-highest bidder gets the next slot, and the third-highest
gets the last slot. The twist is that the high bidder pays Google a price equal to
the second-highest bid; the second bidder pays the third-highest bid, and the
third bidder pays the fourth-highest price. As in the Vickrey or second-price auc-
tion discussed earlier, winning bidders benefit via this automatic price break. For
instance, if the top four bids are 30¢ per click, 25¢, 22¢, and 19¢, the three slots
would sell for 25¢, 22¢, and 19¢. For Google, the method is economical and scal-
able. A single auction (rather than three separate auctions) suffices to allocate
all the slots at once. It’s also dynamic. New online advertisers can submit bids at
any time. If the newcomer outbids a current slot holder, that advertiser and each
slot holder below are bumped down a slot. Finally, the GSP method is known to
promote stable bids. By their bids, advertisers find their spots in the pecking
order. An advertiser in the third slot is there because it has discovered that it is
too costly (and less profitable) to beat the going bid price for the second slot
(even accounting for the increased click-through rate).
Google’s CEO Eric Schmidt sees automated auctions fueling all sorts of
transactions. In 2004, Google surprised the investment banking world by using
a variation on a Dutch auction to sell shares in its Initial Public Offering. Rather
than hiring an investment bank to set the offer price and control the sale of
shares, Google hoped to secure the highest price for its shares by soliciting bids
from all investors, large and small.DUTCH AUCTIONS Dutch auctions are used to sell many commodities world-
wide, including produce, fish, and most notably flowers in Holland. In a Dutch
auction, the auctioneer starts the sale by calling out a high price and then low-
ers the price by small increments until a bid is made. The first bidder obtains
the item at the current price.
Optimal bidding strategies are significantly different in the Dutch and
English auctions. The Dutch bidder faces a decision under uncertainty. Once
the price descends below the bidder’s reservation price, the bidder must decide
how long to wait—that is, until how low a price—before placing a bid. A buyer
with value 10 might choose not to bid when the price has fallen to 9, hoping
to win the bid when the price drops to 8.5. The risk, of course, is that another
buyer will be first to bid and win the item at a price of 8.7. Thus, the decision
when to bid depends on one’s value and the assessed strength of the competi-
tion (as embodied in the number of rival buyers and their likely values for the
item). By contrast, the English bidder faces no such risk because there is always
the opportunity to better the current price.676 Chapter 16 Auctions and Competitive Biddingc16AuctionsandCompetitiveBidding.qxd 9/26/11 1:09 PM Page 676