Search Advertising

Search engines enable advertisers to target consumers based on the query they have entered. In a framework with horizontal product differentiation, imperfect product information and in which consumers incur search costs, I study the equilibrium of a game in which firms who advertise on a search engine have to choose their pricing and targeting strategies. The main results of the paper are the following: (1) in equilibrium, the targeting mechanism endogenously minimizes search costs, and improves the quality of the matching between consumers and firms. (2) Giving firms the opportunity to target queries fosters price competition, by improving the value of search for consumers. (3) The per-click fee chosen by a monopolistic search engine is too high with respect to the social optimum, and competition between search engines further increases the distortions if firms cannot price-discriminate consumers based on the search engine they use. (4) While designing its platform, a monopolistic search engine must solve a trade-off between attracting many users by offering them a high utility, and softening price-competition between advertisers in order to extract profit. A monopolisic search engine will thus choose a suboptimal matching quality, but competition between search engines eliminates this distortion.