I have been involved in managing clients online marketing accounts since 2003 when Google began it’s AdWords program.
A quick definition of what AdWords is:
Google AdWords is Google’s main advertising product and main source of revenue. Google’s total advertising revenues were USD$28 billion in 2010. AdWords offers pay-per-click (PPC) advertising, cost-per-thousand (CPM) advertising, and site-targeted advertising for text, banner, and rich-media ads. The AdWords program includes local, national, and international distribution. Google’s text advertisements are short, consisting of one headline consisting of 25 characters and two additional text lines consisting of 35 characters each. Image ads can be one of several different Interactive Advertising Bureau (IAB) standard sizes.
Advertisers select the words that should trigger their ads and the maximum amount they will pay per click. When a user searches on Google, ads (also known as creatives by Google) for relevant words are shown as “sponsored links” on the right side of the screen, and sometimes above the main search results. Click-through rates (CTR) for the ads are about 8% for the first ad, 5% for the second one, and 2.5% for the third one. Search results can return from 0 to 12 ads.
The ordering of the paid-for listings depends on other advertisers’ bids (PPC) and the “quality score” of all ads shown for a given search. The quality score is calculated by historical click-through rates, relevance of an advertiser’s ad text and keywords, an advertiser’s account history, and other relevance factors as determined by Google. The quality score is also used by Google to set the minimum bids for an advertiser’s keywords. The minimum bid takes into consideration the quality of the landing page as well, which includes the relevancy and originality of content, navigability, and transparency into the nature of the business. Though Google has released a list of full guidelines for sites, the precise formula and meaning of relevance and its definition is in part secret to Google and the parameters used can change dynamically.
The auction mechanism that determines the order of the ads is a generalized second-price auction. This is claimed to have the property that the participants do not necessarily fare best when they truthfully reveal any private information asked for by the auction mechanism (in this case, the value of the keyword to them, in the form of a “truthful” bid).