The Subtle Science Of Bidding Part 1: The Real Story

Regardless of how experienced you may be with AdWords, and with interpreting data that Google reports about your campaigns, you’ll occasionally see numbers that simply don’t make sense. What do you do when reported data flies in the face of both reason and experience?

As an example, look at this data for an exact match brand keyword. The data is normalized to eliminate day of week effects.

 
Do the numbers surprise you? They did when I first saw them. In fact, with my knowledge of the auction marketplace and information provided by Google’s AdWords help, I still couldn’t make sense of these numbers. Here is why I thought this data looked weird:

• Given that a bid of $23 got me an average position of 1.01 at a CPC $1.35 why did a $9.42 bid get me position 2.01? I should expect position 1 as my bid $9.42 bid is so much higher than the actual position 1 CPC.
• Why did my impression volume drop when I changed my bid from $23.38 to $17.80? Oddly enough, my click volume did not change much.
• Why did my CPC increase so much from position 1.09 to 1.01?
• Why the huge gap between bid and CPC?

In short: What gives?

As I analyzed this data and consulted with my company’s CTO Dr. Anil Kamath and Director of Research, Dr. Abhishek Pani, I learned so much about the nuances of Google’s auction marketplace that I thought it would be worth sharing.

In this post, I’ll focus on the details of search auction mechanism. Although I am using Google data to explain my point, all search engines employ a similar strategy to determine your CPC.

What AdWords tell you

The official Google AdWords help pages tell you that the CPC you pay is a function of your bid, quality score and of your competitors’ bid and quality score. The process for calculating the actual amount you pay works like this:

Step 1: Google calculates anAdRank for all advertisers in the auction in which AdRank = Quality Score * Bid.

Step 2: Advertisers are ordered in the descending order of their AdRank. This determines your rank in the auction process.

Step 3: Your CPC is calculated as:

CPC = (The next closest and lower AdRank to yours)/ Your Quality Score + $0.01

Let’s use the following dataset to understand how the auction mechanics work.

 
According to Google, you have the highest AdRank, so you win the auction and you get position 1. The CPC you pay is:

CPC = Ad Rank of B / 10 + $0.01 = 70/10 +0.01 =$7.01

However, this explanation is incomplete and in many ways incorrect for the following reasons:

AdRank is a product of a continuous variable thats strongly correlated to CTR and bid rather than quality score and bid. For the sake of convenience, I shall call this AdRank2 or ADR2 and assume that the quality score is the same as CTR. As CTR and Quality Score are very strongly correlated, this modified AdRank does not differ very much from Google’s explanation. However, while using QS or ADR2 will not affect your position in the above auction, it would affect the CPC calculation. For instance: In this example using ADR2 would give you an effective CPC of $5.33 (0.8/15%).

In addition, the explanation doesn’t answer the question posed by the first example—why bidding substantially higher than position 1 CPC could still get you position 2. It also doesn’t answer why a lower bid might get you the same position but a lot fewer impressions, especially on the brand words.

The actual auction mechanism

The actual mechanism by which CPC is determined is best understood in 3 steps:

• Your bid and your competitors’ bids determines the auction marketplace. Google uses your bid and your competitors’ bids to determine which keyword match type and bid combinations participate in an auction at the query level.
• Once Google determines which bidders can participate in the auction, AdRanks are calculated based on CTR or a CTR proxy and bids. Note that the CTR proxy that Google calculates is an estimate of CTR at position 1. So if your ad has never been in position 1, Google estimates it. As with any calculation, the estimates could be way off. This in turn could hurt your CPC.
• If you want your ad to display at the top of a result page (above the organic listings), Google has an artificial threshold you have to beat. So in a sense, Google’s organic results are competing with you for rank.

This “modified” auction mechanism explains the questions I posed about the first dataset I showed you above. We can draw a couple of conclusion from this.

First, the bid and CPC are more decoupled than we usually think. The bid determines the type of advertisers you are going to compete against. A very high bid on a broad match keyword means you participate in many auctions and this means more impressions and clicks. This explains why we saw a big drop in impressions even at the same position (1.01 to 1.09).

Second, the CPCs we observed for position 1 and position 2 are in a sense independent because the participants for those auctions were different. Hence, although you bid higher than the position 1 CPC, you could get position 2 because Google let another high bidding advertiser participate in your auctions when you were bidding low. I cannot calculate the CPC at position 2 just by looking at position 1 CPC. You have to look at the bid and the CPC. Note: We model CPCs by looking at the combination of bid, CPC, clicks and impressions to get a 90-95% model accuracy. So while it appears difficult to model, it is possible with sophisticated math.

If you are confused at this point, you are not alone. The auction marketplace is very opaque and complex where simple CPC and quality score explanations just do not explain trends we observe in real life. There are many, many more nuances that I’ll discuss in coming posts.

So what do we make of all this?

When making your bidding strategies and decisions keep the following in mind:

Your bid is far more important than is generally thought. Not only does it determine your CPC, it determines the competitors of your auction marketplace and the number of impressions you will get.

Position is only an artifact of the auction. It doesn’t determine anything. Aside from brand considerations, don’t pay undue attention to it. Instead pay attention to bid, CPC, clicks and ROI. They are your true performance metrics.

Dramatic bid changes can adversely affect CTR estimates. As said, search engines make CTR estimates about your keywords as they move positions. These changes can really hurt your CPCs.

Number 1 isn’t always best. For brand keywords, if your strategy is to bid really high to position 1 and subsequently leaving the bid alone, you might be setting yourself up for disaster. Google will charge you a higher CPC but you will not get many more clicks in return. Hence, you must watch performance of all keywords even if you just want to get them to the top position only.

I’ll illustrate the final two points in my next post with real life examples. Stay tuned!