SEM Irrationality: Now with Proof!

Kevin (at ClickZ) has a story about the discovery of irrationality in search. A collection of economists have analyzed search auctions and determined that advertisers are paying more than they need to, under the current auction model. The comments from the authors of the paper seem to place the responsibility for this price gap on the engines, and suggests that the engines don't want to change their system because they would lose revenue.

While I'm sure that the engines are not in a rush to make a change that would cost them cash, I also don't think this tells the whole story. OK, advertisers who focus on top spots are likely to get fleeced, but that's not a big deal. Top spots for key terms are just like ads during the Super Bowl and billboards in Times Square: the cost doesn't make regular sense, but companies just want to do it, anyhow.

But, the article states that, under the system they recommend, advertisers would pay only what the click was really worth. The problem with this, is that many advertisers don't really have any idea what the value of a click is. They have a sense of what they'd like to pay, but an actual value (ie: how much revenue a click will bring) is often obscure.

The other point, that seems to be left out here, is that cost and rank isn't always determined by bid alone. Google, of course, factors bid with number of clicks, as does Jeeves. Yahoo! will eventually follow suit, as well. I haven't read the paper, but that is a wildcard that can have a significant effect on costs.