How does AdWords auction work?

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We all are very familiar with auctions and AdWords auction is very similar to them. A traditional auction is a public process of bidding for (buying and selling) goods/services. Instead of fixed prices, participants place bids. The highest bid is declared the winner and the product is sold off. A bid is a price the participants are willing to pay for a good/service on auction.

Google AdWords also follows a similar approach. Advertisers use AdWords to bid on different keywords. A single keyword can have multiple bids. And a single keyword also has multiple winners.

What are advertisers bidding for on AdWords?

The simplest answer is Keywords. But it is not entirely true. Advertisers are bidding to show their ad copies for particular keywords. To make this idea easily understandable, I will use an example.

Let me introduce you to four advertisers Aman, Bob, Caity, and Disha. These advertisers are using AdWords to promote their Microwave Safe Boxes. Hence, all of their keyword lists are identical. For a keyword, Microwave Safe Boxes, all of them have placed a bid. Aman bids $2, Bob’s bid is $3, Caity’s bid is $4 and Disha’s bid is $5. A user looking for Microwave Safe Boxes types the same on Google Search.

Advertiser Max Bid Ad Position (tentative)
Aman $2 4
Bob $3 3
Caity $4 2
Disha $5 1

What would happen now?

Every time a search query is entered on Google Search, an auction takes place. Yes, on an average, Google runs three billion (approx) AdWords auctions each day. There are four participants and four bids in this auction for the keyword Microwave Safe Boxes. And the aim of these participants is to win the AdWords auction and get their ad shown to the user.

Whose ad will be shown to the user?

It is very obvious that the highest bidder wins. So in the above situation, Disha wins the AdWords auction and Google awards her ad the first position on the Search Engine Results Page (SERP). But that is not it. Caity’s ad will also be listed on the results page. Her ad will be in the second position followed by Bob’s ad in the third position.

To avoid any confusion, let me explain what just happened. Google offers more than one position for advertisers to showcase their ads. In fact, on a SERP, Google provides up to eight ad positions. Four of them appear on the top, i.e. above the organic results on the results page. And four more appear at the bottom, below the organic results.

Note: There are other parameters besides the advertiser’s bid. We have considered them to be constant for now. We shall discuss them a little later in this blog.

How much does an advertiser pay?

This question might sound very silly, but trust me, it isn’t. Most of the readers would give a definite answer very promptly. However, the bid amount an advertiser agreed to pay is not the answer.

Disha bid $5, but Google doesn’t charge her $5 for her ad. Google charges her $4.01. Caity bid $4, but she pays Google a sum of $3.01 to retain the second position. Similarly, Google charges Bob $2.01 to place his ad third on the results page.

What is Generalized Second Price Auction?

Before I clarify why Google charged Disha $4.01 only and Caity $3.01, let me introduce you to the concept of Generalized Second Price Auction (GSP). A Second Price Auction or Vickrey Auction is a bidding process where multiple bidders bid for a single item. The highest bidder wins, but they have to pay the price of the second highest to keep the product. Generalized Second Price Auction (GSP) is an adaptation of Vickrey Auction; Google uses this approach when selling AdWords ad positions.

When there are multiple items to be sold to bidders, auctioneers follow GSP. And in AdWords, these items are ad positions on the results page. Every bidder places their bid. Auctioneers sort all these bids in descending order. The highest bidder wins the first position and the second highest bidder wins the second position and so on. But Google charges each winning bidder the bid of the next highest bidder.

I believe you can now relate to why Google charged Disha only $4.01, Caity $3.01 and so on. The additional one cent is to outbid the next highest bidder and retain the current ad position.

This is a very easy breakdown of how Google auctions the ad position/slots for AdWords advertisers. But this is not it. Google considers various other factors besides an advertiser’s bid to decide whether an ad is listed or not.

Note:

In the above example and in the explanation that followed the example, please read an advertiser’s bid as Maximum Bid. Maximum Bid is the amount an advertiser is willing to pay to Google for a given keyword and the ad associated with the keyword. An advertiser defines the Maximum Bid well ahead of the auction. It is not the Actual Bid. Actual Bid is what Google charges the advertiser after the AdWords auction. Actual Bid for an advertiser is usually a cent greater than the bid of the advertiser in the second position.

What quality factors does Google consider before adjusting an advertiser a winner in the auction for ad position?

It is true that AdWords auctions don’t just use the Maximum Bid as a cue, there are other factors associated. And it is important to understand why these additional factors are essential.

Google follows a well-defined norm to help advertisers and user. And the additional factors (we haven’t discussed them yet) help Google stick to this norm.

“Showing relevant ads at a higher ad position.”

Google understands that its users want to see ads that actually mean something to them. Likewise, advertisers also want to present relevant ads to users to gain clicks and accelerate their business growth.

Now let’s look at the quality factors that Google uses to assess the quality of an ad before deciding the position of an ad.

  • Expected Clickthrough Rate: Google considers the feedback of the users. Google counts every click of a user as a vote. Hence, a good click-through rate means approval by majority users. Thus, Google deems an ad with a good click-through to be the best for a particular search query.
  • Landing Page Experience: Hal Varian, Google’s chief economist very rightly points out that an ad is only useful to a user if the landing page helps them find what they are looking for. For the benefit of users as well as advertisers, Google recommends a high-quality landing page.
  • Ad Relevance: Google equipped its algorithms to analyze the language in an advertiser’s ad copy. And by this analysis, the system determines how relevant it is to a search query. This way, advertiser’s don’t have to worry about losing money on irrelevant/low-quality clicks.

What is Ad Format?

Ad Format: Even though this isn’t a typical quality factor, Google is particular about the ad format too. An ad with an extension containing a phone number, website URL, and additional information is of more benefit to a user than a bland ad. Ads offering more value will also drive a better click through rate. Likewise, ads with more information are more relevant.

Google combines quality factors and ad format impact with maximum bid set by advertisers to derive a score for ads. This score is called the Ad Rank. Google uses ad rank to decide an ad’s Ad position (higher or lower).

Quality factors and ad format impact are clubbed into a Quality Score.  Google then multiplies the Quality Score with Maximum Bid to derive the Ad Rank.

Ad Rank = Quality Score x Maximum Bid

Note:

Google ranks Quality Score on a scale of 1 to 10, 1 being the lowest and 10 being the highest.

Following the example from above, all the four advertisers also have a Quality Score associated with their keywords now. Let’s see what their Ad Ranks come out to be. And how ad ranks are going to change the ad positioning.

Advertiser Max Bid Quality Score Ad Rank Ad Position (final)
Aman $2 9 18 3
Bob $3 5 15 4
Caity $4 7 28 1
Disha $5 4 20 2

From the two tables, we can very easily see a significant change in the ad position. Quality Score did play a crucial role. Disha, who bid the highest ($5) couldn’t secure the top position. Aman, who bid the lowest ($2) could still secure a better position than Bob who bid higher than him.

How much is an advertiser actually charged? What is the Actual Cost-Per-Click?

To calculate the actual CPC of any advertiser on Google AdWords, we can use the following formula.

Actual CPC = [(Ad Rank of the next highest bid)/(Quality Score of advertiser)] + 0.01

We can use this formula to calculate the actual cost-per-click that Google charges all the four advertisers. Caity holds the top position. Her actual CPC is $2.87. Disha holds the second spot. Her actual CPC is $4.51. Aman holds the third spot. His actual CPC is $1.67.

The gist of the blog –

Through auctions in Google AdWords, advertisers aim at getting a better Ad Rank. A good Ad Rank helps in retaining a higher ad position on SERP. Quality Score and Maximum Bid are the two key components of ad rank. In order to spend less and gain a good ad position, the Quality Score has to be optimized. Similarly, increasing the Maximum Bid to rank first is also a bad practice. Instead, you should optimize your Quality Score.

And not to forget, AdWords allows advertisers to adjust their bids not just based on keywords they pick. Advertisers can choose when their keywords should take part in an AdWords auction. Which means that they get to decide when, where and how to show their ads. Bids can be adjusted based on the time of the day, the location of the user, the device that the user is on when using Google search and more.

 

About the author

Mantha Sai Praveen

Content marketer by day, a poet by night.

By Mantha Sai Praveen

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