Online Advertising: "The Art of Eyeball Harvesting"

From Logic Magazine:

We’re told we’re living in an attention economy. Sites and platforms harvest our data, then use it to place targeted ads in our path. But how does this business model actually work? What are the processes and practices taking place behind the scenes that make this lucrative arrangement possible?
We spoke to Shengwu Li, an assistant professor of economics at Harvard, to learn more about the deep machinery of the attention economy.

Can you start by telling us a little bit about your area of expertise?
I work on behavioral economics and game theory, so I study insights from psychology and build them into mathematical models of human behavior. In particular, I’m interested in what we call market design.

For a lot of the history of economics, we've taken as given the way that market institutions work. Market design turns that on its head. It says that instead of taking the rules of the market as given, we should look at how those rules are written.

There are any number of times where the government or a private company needs to set up a market. For example, the Federal Communications Commission (FCC) might be selling the rights for companies to broadcast over a certain band of the wireless spectrum. The agency needs to come up with a set of rules that determines who pays them what for which portion of the spectrum. That's a market design question.

How are big tech companies engaged in market design?
Google and Facebook get most of their revenue from selling advertising. So they’ve had to design a system that enables advertisers to transact with them.

The evolution of that system has been very ad hoc. It started at Google. Early on, the company realized that it needed a way to allocate the different ad slots that appear next to its search results to different advertisers. So it started looking at something called a “second-price auction.” This is a kind of auction that gets invented by William Vickrey in the 1960s.

At the time, there were two standard auction formats: the first-price auction and the ascending auction. The first-price auction is where we all simultaneously submit bids and the highest bidder wins. The ascending auction is the one we generally think of when we picture an auction: there's somebody with a gavel and the price keeps going up and everybody drops out except the highest bidder and that person wins.

Vickrey recognized that both types of auctions have their advantages. One obvious virtue of the first-price auction is that everybody can participate asynchronously at a distance. We don’t all have to be in the room bidding at the same time. Logistically, it’s very efficient.

On the other hand, one virtue of the ascending auction is that it’s easy to know how to bid. You watch the price go up and once it's above your value, you quit. It’s simple: you keep bidding at all prices below your value, and you quit at all prices above your value.

Whereas in a first-price auction, you really need to strategize. You need to say, “Okay, I guess this object is worth $1000 to me, but if I get it for $1000 then I walk away no better off than I was before, so I should put in a bid somewhere below $1000.” But how much below $1000? That depends on what I think the other bidders are going to do—and what the other bidders do depend on what they think I’m going to do. It’s potentially a very complicated calculation.

So in 1961 Vickrey writes a paper where he proposes a new kind of auction that combines the benefits of both formats. In this new kind of auction, we can all submit bids asynchronously and we don’t need to strategize. Here’s how it works: everybody bids, the highest bidder wins, and then the winner pays the second-highest bid. Thus the second-price auction was born.

Why does that solve the problem of strategy? Why don't you have to strategize in a second-price auction?
The trick is to see that there is a neat isomorphism between the price you choose to quit at in an ascending auction and a bid that you place in a second-price auction. Instead of running an ascending auction and having everybody decide dynamically at the time when to quit, you can just ask everybody when they are going to quit in advance and call that their bid. The highest bidder will win and then pay the second-highest bid.


This encourages you to submit a bid at however much you value the object. So if you value the object at $1000, it is better to bid $1000 than to bid any other amount. And that's true regardless of the other players’ behavior....

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