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Google and its sibling companies at Alphabet collectively bid on thousands of keywords in AdWords. That has been going on for years. The search giant has said its ad buying does not “directly inflate” pricing for other advertisers because “advertisers are charged as if it wasn’t bidding.” However, that’s not quite accurate.

Participating in its own ad auctions has long raised conflict of interest objections. A report from The Wall Street Journal last month put a spotlight on the practice again with some eye-popping stats and renewed our questions about how these ads affect other advertisers.

Analysis by SEMrush, in early December, featured in the WSJ report, found that ads for Google and its sister companies appeared in the top ad spot on Google search in 91 percent of 25,000 results for broad non-brand queries — like “laptops” and “phones” — related to the products.

How do all those ads affect the CPCs Google customers pay in those auctions? From the The Wall Sreet Journal (bolding added):

“Google said that when it competes for ads, other advertisers are charged as if it wasn’t bidding, meaning its participation doesn’t directly inflate prices. That is one of a series of house ad rules set by an internal Google committee designed to minimize conflict.”

Let’s break that down and look at why that first sentence doesn’t paint the whole picture.

How Google deals with pricing when it competes

The committee overseeing Google’s house ad rules determined that when a Google ad competes in an auction, the AdRank of its ads will be taken out of the mix before calculating the CPCs of the other advertisers. That’s what “advertisers are charged as if it wasn’t bidding” refers to.

What it really means is advertisers are charged as if Google didn’t win its ad position.

First, a quick refresher. AdRank is the quality score of an ad times the maximum price an advertiser is willing to pay for an ad click. AdRank is what informs the price an advertiser pays for an ad click. The basic CPC calculation is:

AdRank of Advertiser Below You/Your Quality Score + $0.01 = Your CPC

Because pricing is based in part on the AdRank of the next competitor, actual prices can vary pretty widely. A typical auction looks something like this:

google-auction-adrank

Based on conversations with Google and what we already know, this is how an AdWords auction works when Google (or another Alphabet company) advertises:

  • Google enters the auction, essentially like any other advertiser.
  • Just as with any other auction, all ad positions are based on the AdRank of each participant in the auction. The best AdRank gets the top position.
  • The CPCs that advertisers end up paying are determined only after Google’s AdRank is taken out of the mix. For example, if Google wins position 2, then the advertiser in position 1 ends up paying just enough to have beaten the AdRank of the advertiser in position 3.

Using the same information from the auction above, here’s an illustration of how CPCs are calculated when Google entered and won position 2.

google-auction-adrank-scenario-1

By skipping over Google’s AdRank and calculating Advertiser 1’s CPC based on the AdRank of Advertiser 2, the prices stay the same as when Google wasn’t participating in the first auction scenario above.

This is why Google maintains that its participation doesn’t directly inflate prices.

What happens when Google wins the auction?

SEMrush found that Google was in the top ad position in 91 percent of the results it looked at. If we consider that data directional, the scenario above in which Google won the number two spot and not the first position, is less typical.

When Google wins the auction, it is also technically true that its AdRank has no effect on the prices advertisers in the positions below pay. In fact, Google doesn’t factor into the pricing at all when it wins the top spot.

google-auction-adrank-scenario-2

The CPCs of the other advertisers aren’t affected by removing Google’s Ad Rank from the calculation. The advertiser in position 2 is already paying just over what it needed to beat out the Ad Rank of the advertiser in position 3 — assuming all the bids stay the same.

But it’s an auction. Competition affects bidding in an auction.

The simple scenarios above ignore the likelihood that advertisers — particularly those using any type of bid automation rules — will adjust bids in response to more competition entering the auction.

As marketers told the WSJ, “[A]dvertising slots on many pages are limited, so Google’s ads can prompt others to increase their bids to compete with the remaining slots.”

When Google scores the top ad position most of the time, the other advertisers are left to fight among themselves for the remaining slots. If the other advertisers raise their bids to fight for those top spots when Google comes into the mix, all of their CPCs will go up.

google-auction-adrank-scenario-3

Even if just one advertiser, Advertiser 3 in the example below, raises its bid to try to stay visible at the top of the page, everyone’s CPCs go up from where they were in Scenario 2.

google-auction-adrank-scenario-4

To be absolutely clear, the two scenarios above can happen whether it’s Google or some other high AdRank competitor in the mix. The difference in this case is that the competitor is both the auctioneer and the bidder.

A lack of transparency

There are also questions about how much Google really bids and how high its quality scores must be to keep winning the top spot so often. Per The Wall Street Journal’s report:

“Google said that its ads only appear atop results because of the ad’s quality and the price Google is willing to pay. Google said its house ads are also subject to marketing budgets.”

Google is saying its ads are treated just like everyone else’s in terms of quality scores and bids. Adding that their ad buying teams are beholden to marketing budgets is a way of saying its teams don’t just drastically outbid everyone. A Google spokesperson reiterated to Search Engine Land that internal teams are held accountable for their AdWords budgets like other marketers. Still, to outsiders this can look like money just moving around the same pot.

There is also no transparency into whether a Google ad’s quality is determined the same way as a typical advertiser.

Marty Weintraub of AimClear analyzed SpyFu data that showed Google may be spending millions to promote AdWords on SEO-related keywords, for example.

“We wonder what the quality score is tendering Ads about AdWords for SEO KWs?,” Weintraub asked.

There is no way of knowing this because Google hasn’t said publicly whether its ads are held to the same, higher or lower quality thresholds as other advertisers.

What else could Google do?

Looking back at the first two auction examples shown above, one can see Google’s argument that the pricing measures it takes, plus the fact that it appears to win most of the auctions it enters, means its participation does not “directly” impact advertisers’ pricing. Removing the AdRank of its own ads is when calculating pricing for others is good practice. Yet the last two scenarios illustrate that fix only plays an absolute role if the auctions occur in a vacuum and advertisers’ bids aren’t influenced by Google as competitor. The company has been clear that that’s not what happens.

So what else could Google do?

One can argue Google shouldn’t act as both auctioneer and bidder at all. However, it’s harder to argue that Nest shouldn’t be allowed to advertise its thermostats on Google, for example. Either way, there are steps Google could take to be clearer about its role and better inform its customers of steps it takes to address conflicts of interest.

For starters, it could clarify whether its ads are held to different quality score thresholds and explicitly acknowledge that advertisers pay as if Google didn’t win its position, not as if Google didn’t bid. That’s easy.

Some more involved ideas: Google could provide competing advertisers with more transparency into its performance in the auction. Envision a type of Auction Insights report for those competitors, but one that shows the Quality Scores (external), ad positions and actual CPCs. Going even further, the company could provide master read-only access to its AdWords accounts. Use them as teaching tools and show how the company uses its own auction-based system. It sounds far fetched, but not completely crazy, right?

That Google and Alphabet’s expanding hardware businesses want to use the search engine to promote their products makes sense given its enormous reach and ability to convert. Google is also not the only digital company to use its own auction to buy advertising. But it is the biggest and most profitable digital media company on the planet, and participating in its own marketplace has implications for an increasing number of its customers.

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