How to Apply Game Theory in PPC Marketing

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I was blown away when I heard that the U.S. Federal Trade Commission is suing 1-800 Contacts for anticompetitive behavior. The contact lens company allegedly struck deals that prevented rivals from bidding on PPC ads on Google and Bing using their trademarked terms and variants.

According to the FTC complaint:

"Beginning in 2004, 1-800 Contacts secured agreements with at least fourteen competing online sellers of contact lenses providing that the parties would not bid against one another in certain search advertising auctions."

The FTC is concerned because these reciprocal agreements could have resulted in reduced price competition in search auctions, higher prices for consumers, and misleading search ads.

Basically, 1-800 Contacts is in trouble because they were applying game theory to improve their PPC results.

Game Theory 101

game theory 101

Imagine this scenario. You're at a bar with four of your friends. In walks a beautiful woman with blonde hair and four of her friends.

All eyes turn to the stunning blonde. The guys all want her. They are prepared to essentially go to war for the chance to win her.

That is, until Dr. John Forbes Nash Jr., played by Russell Crowe, has a revelation in one of the key scenes in A Beautiful Mind:

“If we all go for the blonde, we block each other and not a single one of us is going to get her. So then we go for her friends, but they will all give us the cold shoulder because nobody likes to be second choice. But what if no one goes to the blonde? We don’t get in each other’s way and we don’t insult the other girls. That’s the only way we win.”

Here's that scene:

What Does "A Beautiful Mind" Have To Do With PPC?

Companies often make deals with each other to avoid bidding on each other's terms. The result is lower costs and less competition.

Such agreements make a ton of sense for all parties involved.

Game theory is ultimately about how individual participants in a marketplace can cooperate to their mutual benefit.

how to apply game theory to ppc

In the Beautiful Mind scene, imagine the blonde is your trademarked keyword and that Nash's friends are actually your competitors.

Everyone chases the blonde. In doing so, the multiple competitors get in each other's way. In the end, nobody wins anything.

Ignore the blonde. Everyone wins (in theory).

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These Agreements Happen All The Time

None of this should be shocking. It's actually commonplace.

As long as I've been doing search marketing, there have been agreements between two or more larger competitors in a space, though perhaps not in writing.

While it sounds like 1-800 Contacts struck more formal deals, it's also easy to forge an informal understanding.

For example, let's say I notice someone is advertising using WordStream brand terms. I could call up that advertiser and say, "Hey, we're in the same industry, how about you knock this off? And, as a courtesy, I won't start poaching your brand terms."

Usually it's as simple as that. You come to a mutually beneficial arrangement.

Think of it like boxing. There are agreed-upon rules, such as no hitting below the belt. But if you go out and start punching your opponent in the crotch, you can bet he's going to hit you back with low blows!

game theory in adwords

AdWords & Game Theory

The branded search term is just another way to say "customers." Company A agrees it won't advertise on Company B's brand terms on AdWords, thus going after its customers. In exchange, Company B won't bid on Company A's brand terms and chase after its customers via paid search.

This is simplified game theory as applied to PPC marketing.

Over the last couple years, new ad technologies have made this type of collusion far more effective. I'm talking 10 to 100x more effective!

First: 3 Disclaimers

Before going forward, I need to make three things clear:

  1. Consult a lawyer: I am not a lawyer. If, for any reason, you feel the urge to go talk to competitors about any of this stuff, seek professional legal advice.
  2. Check the AdWords T&Cs: I’ve checked the AdWords terms and conditions and didn’t find anything I discuss here to be in violation of their policies. However, I'm not 100 percent sure on this point so, again, proceed at your own risk and consult a lawyer.
  3. This is all THEORETICAL. I've NEVER actually done any of what is discussed below myself. I just think it’s interesting to think about.

With that out of the way, let's look at two examples of applying game theory to the AdWords auction.

PPC Game Theory Strategy #1: Non-Competitive Audience Targeting

Customer match and RLSA (remarketing lists for search ads) enable more efficient ways to split up the pool of available search queries that are most interesting to competitors.

For example, let's take Verizon and AT&T. These tech rivals spent more than $6 billion on advertising in 2015.

Let's say Verizon targets AT&T's brand terms. Doing this wins them 100,000 AT&T customers. AT&T retaliates, targeting Verizon's brand terms. They convert 100,000 customers from Verizon.

This is kind of crazy, right? Neither company is any better off in such a scenario. Both AT&T and Verizon are out millions of dollars in ad spend only to end up back where they started.

adwords game theory

Imagine if these two tech behemoths could come to a deal where AT&T has an unlimited search keyword list and Verizon has an unlimited search keyword list. But AT&T will only go after people in its remarketing audience if Verizon only goes after people in their remarketing audience.

The power of RLSA lets brands cherry-pick their best people of the total pool of search queries – these are (a) the users that are 2-3x more likely to click:

rlsa vs non rlsa

And (b) 2-3x more likely to convert to a customer, too:

rlsa conversion rates

(Note: The data sources for the graphs above are three large WordStream clients advertising in the US for a 90-day period in Q2 and Q3 of 2016. We targeted the same keywords with and without RSLA, all other campaign elements remaining the same. We didn’t aggregate data across our client base because it’s hard to compared conversion rates across different industries with different offers.)

It’s the most efficient and fair way to split up the pie of available search queries. Sure, there might be some overlap between audiences, but it would be substantially less than 100 percent.

And that's exactly what brands are doing when they run vanilla (non-RLSA) search advertising campaigns. For example, when someone searches Google for "cell phone" that person may have a strong affinity for a certain provider – if that person isn't already biased toward your brand, then what could you hope to get from that ad impression?

Previously, I’ve advocated for advertisers in ridiculously competitive niches to dump vanilla search altogether and only do RLSA campaigns, then divert the “savings” towards cheaper, more leveraged remarketing cookie-pool growth strategies like social and display advertising.  If you can convince your competitors to do the same, you’ll both be better off.

Again, this is all just theoretical. I don't have an actual case study. But in theory, advertisers could greatly benefit by expanding the scope of non-competitive targeting schemes to include audiences.

PPC Game Theory Strategy #2: Customer Exclusionary Targeting

Another way to apply game theory to AdWords is with exclusionary targeting. All of the talk about customer match email targeting has been about how an advertiser can target their existing customers and prospects. This same technology could conversely be used by a competitor to exclude their campaigns from going after your existing clients.

customer match game theory

For this one you most certainly would want a third party to facilitate the transaction, such as when you have an escrow account for a transaction between two parties.

Continuing to use AT&T and Verizon as our theoretical example, AT&T agrees to upload its customer list of emails into Verizon's AdWords account. Verizon does the same with its customer list.

Both companies agree to exclude those people when targeting their AdWords campaigns.

By doing this, both AT&T and Verizon could avoid wasting so much money on these customers, while simultaneously substantially relieving upwards pressure on keyword bids for everyone else in the niche. Again, hitting each other below the belt is just so stupid and wasteful.

Theoretically, Game Theory Benefits Everyone

These are just two examples of how one might apply game theory to the AdWords auction.

Basically, this approach benefits everyone in the niche. Not only does it benefit the two (or more) parties that work together, but it also benefits everyone else in that niche because there will be substantially less pressure on auction dynamics. Remember, the price you pay per click is directly proportional to what other advertisers were willing to pay for that same keyword.

game theory in ppc marketing

Just as one advertiser can screw up a niche with irrational bidding, the reduction in bid pressure by splitting up inventory based on audiences through non-competitive or exclusionary targeting would have the opposite effect.

In the most competitive industries, if just the top two or three companies in a vertical agreed to such deals, they might all come out way ahead. Just like the friends at the bar in A Beautiful Mind.

What do you think?

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Comments

Maksim
Aug 15, 2016

Beautiful mind movie was just a great example for a wrong situation. it is OK when you have 3 good friends you can have an agreement. In bar full of great stallions and in rush hour time, the amount of competition will blow your plans of peaceful living in a dream world full of mutual happiness. some other lucky fellas would take your place in a bed with that blonde in 5 sec after you say "we all win". imagine how great this life would be, if we could provide every person with everything necessary for living. Imagine and forget - socialism failed many years ago. The system itself is perfect, but not the people and there will always be the bold one. anyway, if you decide to segment the cake - that is against the law nowadays. healthy competition is the only way you can develop this system naturally.

Larry Kim
Aug 16, 2016

one crazy advertiser can ruin an auction by bidding up prices. the reverse is also true.

Corey Zeimen
Aug 15, 2016

It will be interesting to see if this stops the others, if and when they do it or if its just too profitable to attempt it again.

tony
Aug 16, 2016

thanks for sharing the wonderful method of described through game.

This info will really work for me during working with PPC.

Robbet Bremer
Aug 16, 2016

Great to see you linking the ad auction and game theory, Larry! In a strange coincidence, we just published an article on this same topic (including the movie reference!) on our own blog. Different approach though. Check it out! http://blog.fairetail.be/hacking-the-adwords-auction-how-to-influence-competitors-and-lower-cpc

Larry Kim
Aug 16, 2016

good job robbet.

PC optimizer
Aug 16, 2016

This is a great insights for blog commenting. I really admire the person who wrote this. Very informative. Great job!

Larry Kim
Aug 16, 2016

lol thanks pc optimizer (if that really is your first and last name...)

pc optimizer
Sep 13, 2016

Thanks Larry Kim and yes this is my real name.

Jason Lancaster
Aug 16, 2016

Sorry to be "that guy", but this:

"Companies often make deals with each other to avoid bidding on each other's terms. The result is lower costs and less competition. Such agreements make a ton of sense for all fiestas involved."

Isn't correct. These agreements benefit everyone but the consumer, and in the long run they only hurt businesses. Competition is what keeps all of us on our toes.

I'm no pinnacle of ethical excellence myself, but I find it a bit disturbing that anyone would argue in favor of a practice that harms consumers. I'm disappointed to see someone argue in favor of a practice that is corrosive to business health.

Not to mention, some of our best campaigns are attacking our client's competitors (especially is competitors are foolish enough to operate without a trademark).

Larry Kim
Aug 16, 2016

i don't think competition goes away completely. companies still need to fight to acquire customers and retain them. it's just about doing it in a way that's theoretically more efficient from a cost perspective.

Louis
Aug 16, 2016

Thanks Larry, very informative read and good reference!

Ron Seigel5
Aug 17, 2016

Interesting read for sure (including the official complaint).

I have to agree with the FTC on this one Larry.

Part of what they were trying to do was to keep their pricing high as opposed to battling it out with their competition who were discounting significantly. These "agreements" were nothing more than "sign this or we'll sue you into the stone age".

IMO this goes against everything the web has been built on eCommerce wise. The web has been the great equalizer and monster companies don't necessarily have the upper hand over smaller, more nimble competitors who are willing to use price as their advantage (not that I would recommend that for long-term success).

Larry Kim
Aug 17, 2016

hi ron, just one idea here. if two companies spend hundreds of millions of dollars stealing each others customers, the customer still ends up paying for this in terms of inflated prices which take into consideration high marketing costs.

Ron Seigel345234
Aug 18, 2016

Well.....you had to go there. :)

That's actually a really valid point Larry. In a perfect world it makes sense. It falls apart when 1 competitor in the group decides to go rogue and screw everyone else. Give any arrangement like this enough time and it will be very likely to happen.

I could just be cynical right now though since I'm dealing with 2 competitors on AdWords with 6 accounts between them. And yes, WordStream is on the case with me. :)

Then again, I'm a take no prisoners, obliterate the competition, burn the boats kinda guy so I might not be the best judge here.

Paul Zubrinich
Aug 23, 2016


Haha. This is collusion and it's at least 2,000 years old. There's so much nudge nudge wink wink in this article, I wonder if Larry's fishing for someone to give him a call and say, "collude, bro?"

Yasmin Khan
Aug 29, 2016

Really interesting article, Larry! Definitely worth thinking about. Some of our clients work in industries with incredibly competitive and expensive "blonde" keywords. Can't help but wonder how that money could be otherwise spent, or how much more money they're going to spend as the ad prices continue to inflate.

Michael Webster
Sep 07, 2016

Larry;

1. Good ideas about collusion and advertising. I like the article.

2. Here is an interesting example of how real brand advertisers do silently cooperate -->

"The researchers found that in a span of a 52-week period, Coke and Pepsi ran non-overlapping price promotions for 26 of those weeks.

The odds of this happening by pure chance is very slim: a mere 1/495,918,532,948,104 (references below).

Statistically it seems that Coke and Pepsi, and these other brands, are involved in some type of silent cooperation. "

http://mindyourdecisions.com/blog/2011/09/06/why-are-coke-and-pepsi-never-on-sale-at-the-same-time-an-answer-from-game-theory/

3. There is a well known negotiation exercise, the Oil-Pricing game, which tests for the ability for two parties to "silently" collude -->

http://www.pon.harvard.edu/shop/oil-pricing-exercise-3/

4. The Oil Pricing game tends to be hard to solve & is a great exercise to run -- especially among competitive individuals.

5. The FTC action is not just about "silent collusion".

The claim is that the companies were bullied into signing an agreement not to bid as the result of unfair litigation.

I think that the FTC may have a hard time making this stick.

Rosie Tesmenitskaya
Oct 15, 2016

Thanks for such a Great Information here, really liked it I have read game theory in my CS class, didn’t knew we can use it this way also.

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