Tuesday, May 26, 2009

Googlenomics and Auctions

Wired.com article about Hal Varian, Google's Chief Economist

Varian believes that a new era is dawning for what you might call the datarati—and it's all about harnessing supply and demand. "What's ubiquitous and cheap?" Varian asks. "Data." And what is scarce? The analytic ability to utilize that data. As a result, he believes that the kind of technical person who once would have wound up working for a hedge fund on Wall Street will now work at a firm whose business hinges on making smart, daring choices—decisions based on surprising results gleaned from algorithmic spelunking and executed with the confidence that comes from really doing the math.

This is an example of a disruptive innovation - a gutsy move for Google, but one that ultimately paid off.

The problem with an all-at-once auction, however, was that advertisers might be inclined to lowball their bids to avoid the sucker's trap of paying a huge amount more than the guy just below them on the page. So the Googlers decided that the winner of each auction would pay the amount (plus a penny) of the bid from the advertiser with the next-highest offer. (If Joe bids $10, Alice bids $9, and Sue bids $6, Joe gets the top slot and pays $9.01. Alice gets the next slot for $6.01, and so on.) Since competitors didn't have to worry about costly overbidding errors, the paradoxical result was that it encouraged higher bids.

By turning over its sales process entirely to an auction-based system, the company could similarly upend the world of advertising, removing human guesswork from the equation.

The move was risky. Going ahead with the phaseout—nicknamed Premium Sunset—meant giving up campaigns that were selling for hundreds of thousands of dollars, for the unproven possibility that the auction process would generate even bigger sums. "We were going to erase a huge part of the company's revenue," says Tim Armstrong, then head of direct sales in the US. (This March, Armstrong left Google to become AOL's new chair and CEO.) "Ninety-nine percent of companies would have said, 'Hold on, don't make that change.' But we had Larry, Sergey, and Eric saying, 'Let's go for it.'"

The article asks if we can imagine using auctions in our everyday lives? Does this make our free market economy much more agile, responsive, and transparent? Take game consoles, for example. An auction-based system would very quickly determine the value of consoles, creating a true free market economy, rather than our current system of retail price management (RPM) agreements (sometimes called vertical price-fixing).

Google even uses auctions for internal operations, like allocating servers among its various business units. Since moving a product's storage and computation to a new data center is disruptive, engineers often put it off. "I suggested we run an auction similar to what the airlines do when they oversell a flight. They keep offering bigger vouchers until enough customers give up their seats," Varian says. "In our case, we offer more machines in exchange for moving to new servers. One group might do it for 50 new ones, another for 100, and another won't move unless we give them 300. So we give them to the lowest bidder—they get their extra capacity, and we get computation shifted to the new data center."

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