James D. Hess
The objective of this research is to identify the optimal pricing strategy for paid placements on search engines’ “search-results” listings. To accomplish this we develop a mathematical model incorporating a constellation of parameters that describe buyers’ online search intensity, competition among online sellers, and co-opetition between the online sellers and search engine. This model allows us to analyze three pricing strategies, namely pay-per-purchase (PPP), pay-per-click (PPC), and flat-fee (FF), for paid placement services. The paper then compares these pricing strategies in terms of their revenue potential for a search engine and identifies conditions when one pricing strategy is preferred over the other. Our analysis shows that PPC, the most popular pricing strategy, is not the optimal strategy to use when the proportion of buyers, who search online and end up buying online, is high. Instead the search engines would be better off by using PPP strategy. Another finding is that it is not always optimal to price paid-placements in proportion to their rank in the search results’ listings. For instance, our analysis shows that when the proportion of buyers with low search intensity is high and a search engine is following a PPC pricing strategy, then it is better off charging a higher price for a lower-ranked listing.