Optimal Auction Design and Equilibrium Selection in Sponsored Search Auctions

by Benjamin G. Edelman & Michael Schwarz

Overview — Reserve prices may have an important impact on search advertising marketplaces. But the effect of reserve prices can be opaque, particularly because it is not always straightforward to compare "before" and "after" conditions. HBS professor Benjamin G. Edelman and Yahoo's Michael Schwarz use a pair of mathematical models to predict responses to reserve prices and understand which advertisers end up paying more. Key concepts include:

  • A search engine's optimal reserve price is independent of the number of bidders and also independent of the rate at which click-through rate declines over positions.
  • Most incremental revenue from setting reserve price optimally comes from the indirect effects on high bidders—not from the low bidder's direct effect, nor from indirect effects on other low bidders. This result may appear counter-intuitive because top bidders' large valuations place them, in an important sense, "furthest from" the reserve price.

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