How do advertisers compete in sponsored search auctions? Evidence from the digital camera industry

This paper examines how advertisers react to the complex competitive environment in sponsored search auctions considering two salient competitive features: rank externality where the payoff of a rank position to an advertiser depends on which specific advertisers are located in other ranks, and competitor heterogeneity where diverse advertisers of different types may be competing for the same search keyword. We examine advertisers' behaviors from the lens of the strategic group theory. We first develop an approach to cluster participating advertisers into strategic groups and then empirically examine whether these groups manifest themselves in sponsored search auctions. Further, we examine whether advertisers in the same strategic group choose to appear closer to (or farther away from) each other, as opposed to advertisers from other strategic groups participating in the same auction. Our empirical analysis, based on data collected at Google, lends support to the existence of strategic groups in sponsored search auctions. We find that advertisers tend to obtain ranks in the sponsored search listings that are similar to competing advertisers from the same strategic group, regardless of whether they participate in all the auctions for the same keyword or not. Our findings contribute to the sponsored search literature by theorizing and empirically verifying advertisers' competitive behavior from the strategic group perspective.