Dive into the intricate world of Google ad auctions and uncover the mechanisms that determine ad placements and costs. Discover why focusing on cost per click (CPC) might not be the best approach to evaluating your advertising success.

In the ever-evolving landscape of search marketing, understanding the dynamics of ad auctions is crucial for maximising ad placements and managing costs effectively. Recent visibility into these mechanisms, partly due to the DOJ trial against Google, has shed light on some aspects of the ad auction process, often misunderstood as primarily driving up ad costs.

The Case Against CPC

Despite common scepticism towards higher CPCs, it’s essential to shift focus from CPC to more impactful metrics such as cost per action (CPA), return on ad spend (ROAS), or return on investment (ROI). These metrics provide a clearer picture of business outcomes and the true value of your advertising efforts. If you can adopt this perspective, you’ll be better equipped to explain to stakeholders why a higher CPC isn’t necessarily detrimental.

Key Components of Ad Auctions

The Importance Of Ad Rank

Ad Rank is a foundational element in ad auctions, balancing bid amounts with ad quality to determine ad placement. The basic formula is:

Ad Rank = Max CPC × predicted CTR

This ensures that both the bid amount and the quality of the ad are considered. Predicted CTR (pCTR) is a critical metric, estimating the likelihood of an ad being clicked for a given search query. It reflects the relevance and expected performance of the ad.

pCTR and Its Impact on Actual CPC

The actual CPC paid by advertisers is significantly influenced by the pCTR of their ads. Ads with higher pCTR can secure better positions at lower actual CPCs, encouraging advertisers to create highly relevant and engaging content. This alignment with user intent not only improves ad placements but also leads to more efficient spending.

Google’s CPM-Based Ranking System

Interestingly, Google ranks ads based on CPM (cost-per-thousand-impressions), not CPC. Advertisers bid a maximum CPC, which, when combined with pCTR, results in an estimated CPM (eCPM). The ad with the highest eCPM wins the auction. This system incentivises maximising CPM, aligning Google’s interests with those of publishers and ensuring the best utilisation of ad space.

The Role Of pCTR

pCTR is a dynamic metric calculated for each auction based on the search query’s context. Advertisers with higher pCTR benefit from lower CPCs and better ad positions. This dynamic nature drives continuous improvement in ad quality, benefiting both users and advertisers.

Distinguishing Quality Score from pCTR

While both Quality Score (QS) and pCTR are crucial, they serve different purposes. QS is a broad indicator of ad quality, encompassing ad relevance, landing page experience, and historical performance, whereas pCTR is a real-time estimate of an ad’s click likelihood for specific queries. Understanding both metrics helps advertisers optimise their campaigns effectively.

Nuanced Aspects of Ad Auctions

The DOJ trial has brought to light several nuanced aspects of Google ad auctions, such as ad rank thresholds, reserve prices, out-of-order promotions, and Randomized Generalized Second-Price (RGSP) mechanisms. These elements collectively ensure a more effective advertising ecosystem, promoting high-quality, relevant ads that enhance user experience.

In summary, while higher CPCs might seem concerning at first glance, they are often a byproduct of more effective, higher-quality advertising. By focusing on CPA, ROAS, or ROI, advertisers can better assess the true value of their campaigns. Understanding and optimising the various components of Google ad auctions can lead to more efficient ad spending and improved outcomes for both advertisers and users.

Understanding Thresholds And Reserve Prices

The ad auction process is more complex than simply ranking ads and displaying them from highest to lowest rank. There are specific thresholds that determine various factors, including an ad’s eligibility for prominent positions on the page and the reserve price necessary for it to be displayed at all.

These thresholds fluctuate based on numerous elements such as ad quality, position, user signals, and the specific search topic. Google views ads as informational tools that should help answer user queries. Consequently, there is a quality threshold that an ad must surpass to be shown above organic results.

This explains why many searches display fewer than four ads above the organic results. According to Google’s internal data, as of 2020, less than 2% of all searches on Google had four or more ads, regardless of their page position.

Impact of Thresholds And Reserve Prices on Costs

To delve into this, we need to understand the concept of an ad’s long-term value (LTV), which measures the economic benefit of displaying the ad minus the expected cost of showing it. The economic benefit equates to the ad rank, calculated as pCTR × Max CPC—essentially, how much Google predicts they will earn from displaying the ad.

The cost of showing the ad includes the potential negative impact on user experience, such as causing ad blindness or making users avoid future ads. The predicted negative impact is the threshold or reserve price for an ad. Only if its economic benefit exceeds the expected cost can the ad be shown. In other words, if LTV > 0, the ad may appear.

This means that ads often need to pay more than $0.01 (or the equivalent in other currencies) to be displayed, raising overall prices.

Benefits of Thresholds And Reserve Prices for Advertisers

If all second-price auction prices were determined by the next competitor, many advertisers would fall below the LTV > 0 thresholds, even if they have a MaxCPC capable of surpassing the threshold. Google respects the advertiser’s intention to display their ad by collecting the CPC necessary to offset the predicted negative value of showing the ad.

Think of the threshold as a hidden participant in the ad auction, whose ad position aligns with the threshold. Surpassing this threshold increases the effective CPC an advertiser pays, but it also allows the advertiser to display their ads in scenarios where they might not have shown otherwise, without exceeding their maximum bid.

For instance, in a scenario where your ad is the only eligible contender, you may be required to pay the reserve price, influenced by the thresholds. In cases without strong competition, a highly relevant ad with a high MaxCPC might still struggle to meet the threshold. To ensure the advertiser gets the desired exposure, Google adjusts their effective CPC to meet the threshold, allowing the ad to be shown (LTV > 0).

Out-Of-Order Ad Promotion

Now that we’ve covered reserve prices and thresholds, let’s explore a specific example involving the threshold for ads to be shown at the top of the page.

What Is Out-Of-Order Ad Promotion?

Out-of-order ad promotion occurs when an ad with a lower Ad Rank is promoted above an ad with a higher Ad Rank. This is possible because thresholds have a relevance component; for instance, Google might only promote an ad to the top of the page if it meets a certain level of relevance (pCTR).

Since Ad Rank is composed of MaxCPC and pCTR, it’s possible for a lower-ranked ad (Ad B) with a better pCTR to be stuck behind a higher-ranked ad (Ad A) with a lower pCTR.

Example:

Ad	MaxCPC	pCTR	Ad Rank
A	10	3	30
B	2	10	20

In out-of-order promotion, ad B can be allowed to jump over ad A.

Impact on Costs

When advertiser A’s low-quality ad doesn’t meet the promotion threshold but advertiser B’s ad does, rather than pushing both ads to the bottom of the page, advertiser B’s ad is promoted above advertiser A’s. Advertiser B then pays the CPC required to surpass the top-of-page threshold (reserve price), which can be higher than if they had to beat Ad A’s Ad Rank.

Benefits of Out-Of-Order Ad Promotion for Advertisers

Out-of-order ad promotion benefits advertisers by considering factors beyond just the bid amount. This approach takes various thresholds into account, including ad relevance, ensuring that high-quality ads can appear in top positions even if their Ad Ranks are lower.

This helps smaller advertisers with highly relevant ads to compete effectively against larger competitors with bigger budgets. By promoting ads based on relevance and quality, advertisers are incentivised to create more engaging and useful ads, ultimately leading to better user experiences and higher conversion rates.

Thresholds and reserve prices are pivotal in the ad auction process, ensuring that only ads meeting certain quality and relevance standards are displayed. This system not only maintains a high standard of ads but also allows advertisers to achieve better placements through quality and relevance rather than sheer bid amounts. Understanding these mechanisms can help advertisers optimise their strategies for more effective and efficient advertising outcomes.

Randomized Generalized Second-Price (RGSP) Auctions in Google Ads

Understanding RGSP

In a traditional second-price auction, the highest bidder wins the ad spot but pays the price of the second-highest bid. However, in Google’s ad auctions, the process incorporates predictions made by machine learning, particularly the predicted click-through rate (pCTR). These predictions aren’t always precise, which can create discrepancies, especially when multiple advertisers are competing closely with only minor differences in their ML-generated pCTR setting them apart.

To mitigate the risk of inaccurate predictions becoming self-reinforcing truths, Google uses a mechanism called Randomized Generalized Second-Price (RGSP). This system occasionally re-orders ads randomly to introduce variability, allowing the machine learning algorithm to better evaluate its predictions and improve future accuracy. This ensures that ad performance data is not skewed by fixed positions, helping to discern an ad’s true quality from external factors like its placement.

How RGSP Impacts Costs

RGSP adds an element of unpredictability, encouraging advertisers to bid their true value rather than underbidding strategically. When ads are re-ordered, deviating from the strict ranking mechanism, it can alter the CPCs, potentially raising prices for some advertisers. This randomness prevents high-pCTR ads from consistently occupying top positions, thereby fostering a more diverse and competitive ad environment.

Benefits of RGSP for Advertisers

By preventing ads with high predicted relevance from monopolising top positions, RGSP promotes a diverse range of ads. This mechanism helps avoid scenarios where ads with inaccurately high pCTRs remain in top spots unfairly, thus allowing newer or lower-bid ads with potentially higher actual relevance to get visibility. This fosters a competitive environment where ad quality and relevance are prioritised, leading to better performance and higher ROI for advertisers.

Normalisation Techniques

What Are Normalisation Techniques?

Google employs normalisation techniques to ensure that ad rankings reflect true relevance rather than being influenced by external factors like ad format or page position. Metrics such as pCTR are adjusted to account for these factors, levelling the playing field for all advertisers. For instance, ads in higher positions naturally get higher CTRs, and ads with more visible lines of text perform better. Project Momiji works to normalise pCTRs by removing these biases, ensuring that the ad’s performance is attributed to its inherent quality.

How Normalisation Techniques Impact Costs

Normalising pCTR for ad formats and page positions means some advertisers with high pCTRs may see a downward adjustment. This adjustment ensures that the high pCTR is not merely a result of a more appealing ad format or better page position. Consequently, advertisers might pay more than they would without normalisation. For example, an ad shown in position 1 with a pCTR of 10% may have had only 8% if shown in position 2. By estimating the underlying ad relevance pCTR and normalising for all external factors, Google ensures fair pricing based on true relevance.

Benefits of Normalisation Techniques for Advertisers

Normalisation prevents unfair advantages arising from superior positions or ad treatments, ensuring ad pricing reflects true relevance. This promotes fair competition and encourages investment in high-quality, user-relevant ads. Advertisers benefit from a system that rewards genuine ad quality, leading to better user experiences and higher conversion rates.

Conclusion: Focusing Beyond CPC

Understanding the intricacies of ad auction dynamics is essential for advertisers aiming to optimise their campaigns and achieve superior outcomes. Higher CPCs often result from mechanisms designed to promote ad quality, relevance, and better user experiences. By focusing on metrics like CPA, ROAS, and ROI, advertisers can appreciate the benefits of these dynamics more fully.

The components of the ad auction, from ad rank thresholds to RGSP mechanisms and normalisation techniques, work together to create a fair and competitive environment. This encourages continuous improvement in ad quality, ultimately benefiting both advertisers and users. By embracing these complexities and striving for high-quality, relevant ads, advertisers can navigate the ad auction landscape more effectively and achieve greater success in their digital marketing efforts. If you’d like to take your Google Ads account performance to the next level, contact us today.