With the increasing importance of online marketing as a tool for firms to gain visibility vis-a-vis competitors, new dimensions of competition have been gaining predominance in the last decades. One of them is sponsored search auctions. This might have, perhaps inadvertently for consumers, anti-competitive effects. In BSE Working Paper Nº 1356, “Market Effects of Sponsored Search Auctions,” Massimo Motta and Antonio Penta explore the implications of competitive bidding for visibility in online sponsored search between firms.
What happens when we look at brands or branded products online?
We all look for items online from time to time. Sometimes we know exactly which brand we are interested in, but at other times we may also be open to considering competing brands we may not entirely be aware of. In general, when we enter a keyword in a search engine, there is a real-time auction in which firms try to outbid each other to appear first in the search results and gain visibility to attract customers. (Links which are displayed on top of the search engine page, typically are clicked by users in a much higher proportion.)
This auctioning process when customers look for specific brands or branded products has been at the center of legal arguments, and the competitive consequences of allocating links in a search engine through this method have not been well studied so far.
Counterbalancing effects on competition
One can think that this bidding process and its outcome can help lower search costs for consumers, thus enhancing competition and reducing prices. Also, because it might give visibility to firms that may otherwise be unknown to consumers, market power by larger firms might be reduced.
On the other hand, facing these auctions may increase firms’ costs that are then passed through to consumers. This creates upward pressure on prices. Perhaps less visible is the negative effect which takes place when a firm wins the bidding for its brand. When this happens, firms which are potentially visible (when the search engine lists organic results, rather than sponsored links) may be crowded out and appear fewer times. This increases market concentration.
How can we think about these auctions?
To rationalize these interactions, the authors think of a model where two competing firms set prices and bids to secure a sponsored link in a search engine whenever consumers look for a brand name.
Consumers are thought of as being of two types: naïve and sophisticated. The former just considers the first link that appears on the search engine. The latter instead looks at both links, provided they are visible, and then compares prices.
Auctioning leads to a reduction in competition and consumer welfare
Once they have their model at hand, the authors compare cases with respect to a no-ads benchmark where both links are always available. In that case, the first link any consumer finds is the one corresponding to the firm they searched for, followed by the link of the other firm. Firms will set prices knowing they have to compete for the sophisticated consumers who compare their prices.
Once an auction is introduced to allocate the first link in the search page, when firms are symmetric (that is, they have similar costs and qualities, and an equal share of consumers searching for their brands) the result is that the price faced by consumers will be higher than in the no-auction setting. This is because each firm wins the auction for its brand name, thereby displacing the link of the other. Consumers initially aware of and searching for a given brand will only see that brand, so even sophisticated consumers will not be able to compare offers. Effectively, brand auctions eliminate competition, thereby increasing prices and reducing variety. A further detrimental effect for consumers arises because of the higher marginal cost due to the auctioning process, which will translate into higher prices.
What seems to be the net effects of bidding in these markets?
The authors extend their baseline model and examine different specifications. All in all, auctioning links in a brand search has detrimental effects on consumer welfare. One case in which this mechanism may have a positive role to play is when there is a new entrant in the market that is completely unknown to customers, so the search engine at first does not provide a link to it. Under certain circumstances, the entrant might be able to win the auction for the brand name of the incumbent. When this happens, it will obtain the visibility that otherwise it would not have. In other less extreme asymmetric situations, though, brand auctions turn out to have again anti-competitive effects.
These results seem to suggest that legislation that prohibits bidding for sponsored links in brand searches might well be pro-competitive, since costs for consumers seem to outweigh potential gains. More generally, this paper points to the importance of having more research on the market effects of online search advertising, which is so pervasive but whose impact has so far been largely unexplored.