Effects of the Presence of Organic Listing in Search Advertising

This paper analyzes how the presence of organic listing as a competing information source affects advertisers' sponsored bidding and the equilibrium outcomes in search advertising. We consider a game-theoretic model in which two firms bid for sponsored advertising slots provided by a monopolistic search engine and then compete for consumers in price in the product market. Firms are asymmetrically differentiated in market preference and are given different exposure in organic listing aligned with their market appeal. We identify two aspects of a firm's sponsored bidding incentive, namely, the promotive and the preventive incentives. The presence of organic listing alters firms' sponsored bidding incentives such that the stronger firm has primarily preventive incentive, whereas the weaker has mainly promotive incentive. We show that the preventive incentive decreases and the promotive incentive increases as the difference in firms' market appeal decreases, and as a result, even the weaker firm may outbid the stronger competitor under such a co-listing setting. We further examine how the presence of organic listing affects the equilibrium outcomes by comparing it with a benchmark case in which there is only a sponsored list. We show that the differentiated exposure in the organic list gives the weaker advertiser chances to win a better sponsored position, which improves the overall information structure the search engine provides. As a result, the equilibrium social welfare, sales diversity, and consumer surplus increase. Although the presence of the free exposure from the organic list may reduce advertisers' sponsored bidding incentive per se, the overall effect benefits the search engine's growth in the long run.