The AdWords Auction and Why Google's Automatic Bid Pushes are Risky

It's the height of the holiday shopping season and marketers are working feverishly to drive record levels of revenue while the getting's good.  In a timely move -- on Cyber Monday, no less -- Google introduced the ability to set Automated Rules in AdWords to push keyword bids to the CPC required to show on the top of the page.  Common sense and a quick review of top of page vs other segmentation stats tell us that click-through rates are significantly higher for ads above the natural listings -- compared to those on the right rail or bottom of the page -- so pushing bids in this manner will certainly drive more traffic. But does it make sense for advertisers to utilize this new feature? To help answer that question, let's back up a bit and review the mechanics of the AdWords auction.  In simple terms, where your ad ranks in the paid listings depends on your keyword's bid and it's Quality Score.  As Google states, "You always pay the lowest amount possible for the highest position you can get given your Quality Score and CPC bid." For example, let's say my only competitor bids $1.00 at a quality score of 5. Their Ad Rank is $1.00 X 5 = 5.  If I bid $2.00 with a QS of 10, my Ad Rank is 20 and I win the auction.  In order to beat my competitor's Ad Rank of 5, I actually only need a CPC of $0.51 per click, which is well below my bid and it's what I pay. Quality Score, by name, wasn't always part of the equation, but Google was smart to base Ad Rank on expected CTR from the beginning.  Consider a scenario where an advertiser has a very irrelevant ad, but at a very high bid.  As we'll show below, without consideration for probable CTR, that ad would show prominently, but generate few clicks, hurting Google's potential revenues and making for a poor user experience. While other factors influence QS, it is still largely a measure of an ad's expected CTR and, for our purposes here, we'll assume those other factors are equal.  With that in mind, let's get some assumptions out there before getting to some more detailed auction hypotheticals. From left to right, the first table simply lists the 10 advertisers in our auction, the Quality Score they have been given by Google, and their initial bids.  The second table gives the expected click-through rate for each position for the average advertiser.  This is not meant to represent CTRs for AdWords auctions universally, only to provide a reasonable baseline where top positions generate clicks at significantly higher rates than lower positions. The final, and likely most debatable, table provides an estimate of how much higher an ad's click-through rate will be in any position given its Quality Score.  Again this is not a universal law of AdWords, based on any insider information, nor is it how QS is really defined.  Instead, these are just levels that would make sense to Google given Quality Score's impact on CPC.  For example, a QS of 7 is generally considered average, so it's given a multiplier of 1.  Now, if I had a keyword with a QS of 10 that ranks just above a QS 7 keyword that has the same bid, I would get a 30% CPC "discount" on my bid, just by the auction mechanics described earlier.  In order for that to work for Google -- generate the same revenue -- my ad would need to generate clicks at 1.43 times the rate of the other ad (0.7 X 1.43 = 1). A Basic Ad Auction Alright, let's take those assumptions and drop them into a world where Quality Score/expected CTR is not considered.  Here's how it would play out: Ranking is determined solely by bid and each advertiser pays a penny more than the advertiser beneath them.  Advertiser A takes the top position, but only generates a CTR of 17.14%, lower than our expected average of 20%.  Assuming 1000 impressions for this auction, it generates 419 clicks and generates nearly $613 in revenue for Google. Enter Quality Score The same auction, but with Quality Score determining Ad Rank: Advertisers A and B have swapped positions due to B having a significantly higher QS than A, giving B a higher Ad Rank despite their lower bid.  None of the other advertisers change positions, but most end up with a different CPC -- some a bit higher, some a bit lower.  The average CPC across all advertisers only goes up 2.4%, but the auction generates 10% more clicks, resulting in 13% more revenue for Google. Top of Page Threshold It rarely seems to be discussed in full context, but as we explained last year, Google's 2007 change introducing an eligibility threshold for showing at the top of the page, effectively made Google a ghost bidder in many auctions.  In brief, if your ad is the last one shown above the natural listings, your CPC cost will be the amount of the CPC threshold, which varies with your Quality Score.  We can view the threshold as an Ad Rank threshold as we have below: This is the same auction as the one just above, only with the top of page threshold added.  I've made the threshold an Ad Rank of 9 for maximum impact.  Advertiser C pays the full amount of their bid and their contribution to Google's Revenue jumps from about $26 to $64 with zero additional clicks received.  The rest of the field goes unscathed. Automatic Bid Pushes Now we finally get back to the basis for this discussion -- Google's new Automated Rules option to push bids to the top of page CPC.  Let's say advertiser D has adopted the settings outlined in Google's blog post announcement:

Google raises D's bid so that their keyword reaches the top of the page.  To do this, advertiser D must beat out advertiser C who previously held the bottommost top of page or "promoted" position:

Advertiser D doubles their click volume, but pays three times as much per click.  The net effect on the overall auction is minimal, largely due to where the top of page threshold was initially set, but what happens when more than one advertiser chooses to adopt an automatic push strategy? Advertiser C wasn't happy about their clicks being cut in half, so they decide to push to reclaim a top of page position.  They go back and forth with advertiser D until both end up pushing advertiser A to the right rail: To do this, both C & D must beat advertiser A's Ad Rank of 18 by raising their own bids significantly.  Advertiser D's CPC is now 489% higher than it was before they decided to push to the top of the page and they have only doubled their clicks. A final hypothetical, what if there are more advertisers pushing to a promoted position than there are positions available?  Here's how that might look: Assuming C,D,E & F all adopt Google's example settings and allow their bids to be pushed to $10.00 and that the top of page Ad Rank threshold shifts with the actual competition in the auction, we see an explosion in click costs.  Advertiser E, with the lowest Quality Score at 6, sees their bid jump to the full $10.00, setting the Ad Rank threshold the other three must beat at 60. Google's revenue haul has risen 352% from the basic Quality Score auction above, while clicks delivered to advertisers have only increased 6%. Use With Caution It's difficult to think of an advertiser for whom or a scenario in which Google's example settings above -- increase bids to up to $10 on all but deleted keywords to reach the top of page -- will be a winning strategy.  Fortunately, Google does provide a number of segmentation options to limit the advertiser's exposure to runaway CPCs program-wide.  Google itself suggests that, "you might want to only raise bids for keywords that have a good quality score (for example, Quality score >= 6), so as not to bid up keywords that need to be optimized." Sure, that would help, but most will probably only want to consider using these rules on a handful of individual keywords that have special value for branding purposes. If Google wants to see greater adoption of push to top of page rules, they really need a lever that restricts the bid change to a certain percentage -- i.e. Don't push my bid by more than X%.  There's a certain margin of error in all bid calculations, so if we can generate a lot more clicks for a small CPC increase, it could be worth it.  Even then, problems would remain. The big one: Unlike the simplified hypotheticals above, a keyword can actually appear across a number of positions at the same bid due to differences in QS for individual auctions so the tradeoff between clicks and costs is a smooth curve rather than a discontinuous, staircase-like graph where a relatively small CPC change can result in one big and persistent increase in clicks.  Since Google isn't making push-to-top calculations for each auction -- the finest change is hourly based on that day's data -- they're really just moving you up the same click to cost curve you can see in Bid Simulator and you're probably better off doing that assessment on your own.
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