Terrific article in this month’s Wired on Google’s secret sauce.
“The microeconomics of Google is more complicated. Selling ads doesn’t generate only profits; it also generates torrents of data about users’ tastes and habits, data that Google then sifts and processes in order to predict future consumer behavior, find ways to improve its products, and sell more ads. This is the heart and soul of Googlenomics. It’s a system of constant self-analysis: a data-fueled feedback loop that defines not only Google’s future but the future of anyone who does business online . . .
One key innovation was that all the sidebar slots on the results page were sold off in a single auction. (Compare that to an early pioneer of auction-driven search ads, Overture, which held a separate auction for each slot.) The problem with an all-at-once auction, however, was that advertisers might be inclined to lowball their bids to avoid the sucker’s trap of paying a huge amount more than the guy just below them on the page. So the Googlers decided that the winner of each auction would pay the amount (plus a penny) of the bid from the advertiser with the next-highest offer. (If Joe bids $10, Alice bids $9, and Sue bids $6, Joe gets the top slot and pays $9.01. Alice gets the next slot for $6.01, and so on.) Since competitors didn’t have to worry about costly overbidding errors, the paradoxical result was that it encouraged higher bids.
“Eric Veach did the math independently,” Kamangar says. “We found out along the way that second-price auctions had existed in other forms in the past and were used at one time in Treasury auctions.” (Another crucial innovation had to do with ad quality, but more on that later.)”
Really interesting (if somewhat geeky) stuff.
Secret of Googlenomics: Data-Fueled Recipe Brews Profitability