The “real” value of a click

When you go to the store to buy a pizza, you can estimate the price based on the cost of the dough, cheese, onions, and tomato sauce etc. Usually, the final price of a pizza is determined on a ‘cost-plus’ basis, which means it is based on the cost of its components plus a markup. It is unlikely that you will find a pizza for $200 or $2 because these prices are much higher or lower than the cost of the ingredients. This same pricing model can also be applied to other items such as food, clothes, furniture, and cars. 

Determining the true value of a click can be challenging because it does not have physical components like a pizza. There is no dough to buy nor tomato sauce. How much does it cost to ‘manufacture’ a click? Is it the costs of the servers that runs it? The electricity? Determining the ‘real’ value of a click is hard, and that’s why publishers (like Google, Facebook, etc.) don’t try to use a cost-plus method but rather will let the demand derive a price for it. 

Instead of determining the price of a click based on its production costs and adding a markup, publishers use a (demand) auction-based pricing model, in which the click is sold to the person or company that offers the highest price. This demand-based pricing model recognizes that clicks have different values to different people and companies, and allows them to compete for the click by offering higher prices. In an auction-based pricing model, the item (in this case, a click) is sold to the highest bidder. 

In the past two decades, the use of an auction-based model for selling  advertising has been a major disruptor in the marketing industry. Companies like Google have been able to increase their revenues by using this model, in which the price of advertising is determined by an auction. The principles of auction theory, which is based on mathematical principles, help to explain why this model can be an effective strategy under certain conditions. If you have run a search marketing campaign, you are likely already familiar with the basics of this model. 

During COVID we noticed a decrease in market share for one of our travel clients. This is something that had happened in the past, and is often caused by bidding lower than competitors in the auction. However, when we looked into the data to see which competitor was willing to pay more for clicks during the pandemic, we were surprised to find that all of the competitors seemed to have also experienced a decline in market share around the same time. This raises the question of what could have caused the decline in market share for all of the competitors.

Upon further investigation, we noticed that some advertisers had stopped participating in auctions entirely since the COVID-19 outbreak began. As a result, the remaining bidders were able to increase their market share. This makes sense, as with fewer advertisers in the auction, the pie of available clicks is divided among a smaller number of bidders, resulting in a larger share for each bidder. However, since that time, the advertisers who had stopped participating have not returned, and the pie has continued to shrink for all the remaining bidders. This raises the question: How can the sum total of market share be dropping? 

After revisiting my old game theory math books, I remembered the concept of the reserve price. iIn second price auctions, like the ones in SEM, the reserve price  is the minimum price that the supplier (in this case, Google) will accept for a click. It is not disclosed to the public, but if a bid is lower than the reserve price, the click will not be sold to the highest bidder. In fact, it won’t be sold at all and less ads, or no ads at all, will show. To us, the only explanation that matched both auction theory and the data we analyzed was that Google was raising the minimum price and was thus content to reduce the total number of ads showing on the page. It was as if Google would rather not sell the click at all than sell it for a low price.  

This was especially surprising to notice as Google was de-facto increasing prices during one of the worst pandemics in the last 100 years and when travel businesses were desperate to attract customers and survive. There are situations where companies have increased prices during times of high demand, such as when Uber raised prices during a terrorist attack and many people wanted to escape the area or when Coca-Cola tested vending machines that increased the price of cold beverages on hot days. In these cases the supplier is attempting to maximize profits by taking advantage of the high demand. But here was a case of rising prices in low demand.

Before the pandemic, some advertisers were paying double the average cost per click (CPC) compared to what they paid during the pandemic, and yet they were still able to achieve similar or higher market share (albeit with a smaller absolute amount of traffic due to overall decreased travel demand). If it was not for this reserve price, all advertisers in an auction could bid down by half at any given moment of time, and everyone would still be buying the same traffic but for a much lower price.  

That reserve price is also used when there is only one advertiser in the auction and determines what price should be paid by that lonely advertiser. Our theory is that by increasing the minimum bid price, Google was not only aiming to increase their immediate revenue, but also protect itself from its own fear that after the pandemic is over, the price of clicks would remain low. Since the time we started monitoring the minimum price for auctions (by reverse engineering) and now, we have seen the average CPC’s in the travel market coming back to the same value as pre-COVID yet total advertiser market share is still below pre-pandemic levels  

Viewed from the present-day, this reserve price is similar to a central bank controlling the interest rate in the economy. The higher it is, the more it will prevent advertisers showing ads, as they will not pass the minimum. For the ones bidding higher than the minimum it will make them pay higher CPC’s. 

Figure 2. Average price of clicks (CPC’s) during 2020 to 2022. (averages for a selected travel market, not disclosed for privacy concerns) 

Conclusion

Understanding the reserve price in auctions is fundamental  to understanding performance during different time periods, geos and devices. Better monitoring and control of those minimums can help advertisers pay lower CPC’s without necessarily losing traffic. The pandemic taught us at Search Machines that if you understand Google’s Minimum CPC you can help a client in any market conditions

At Search Machines we utilize our AI platform ATLAS to gain insights and to optimize marketing performance on Google and Bing. To find out more about our data driven approach schedule a personalized demo call.