Sponsored search advertising is ascendant---Jupiter Research reports expenditures rose 28% in 2007 to $8.9B and will continue to rise at a 15% CAGR, making it one of the major trends to affect the marketing landscape. Yet little, if any empirical research focuses upon search engine marketing strategy by integrating the behavior of various agents in sponsored search advertising (i.e., searchers, advertisers, and the search engine platform). The dynamic structural model we propose serves as a foundation to explore these and other sponsored search advertising phenomena. Fitting the model to a proprietary data set provided by an anonymous search engine, we conduct several policy simulations to illustrate the benefits of our approach. First, we explore how information asymmetries between search engines and advertisers can be exploited to enhance platform revenues. This has consequences for the pricing of market intelligence. Second, we assess the effect of allowing advertisers to bid not only on key words, but also by consumers searching histories and demographics thereby creating a more targeted model of advertising. Third, we explore several different auction pricing mechanisms and assess the role of each on engine and advertiser profits and revenues. Finally, we consider the role of consumer search tools such as sorting on consumer and advertiser behavior and engine revenues. One key finding is that the estimated advertiser value for a click on its sponsored link averages about 24 cents. Given the typical $22 retail price of the software products advertised on the considered search engine, this implies a conversion rate (sales per click) of about 1.1%, well within common estimates of 1-2% (gamedaily.com). Hence our approach appears to yield valid estimates of advertiser click valuations. Another finding is that customers appear to be segmented by their clicking frequency, with frequent clickers placing a greater emphasis on the position of the sponsored advertising link. Estimation of the policy simulations is in progress.
