A winner's curse is a phenomenon in which the winner of an auction overpays for the goods or services won. This usually happens when there is incomplete information regarding the true value of the item. The lack of knowledge is usually not a deliberate attempt from the auctioneer, but rather the nature of the auctioned item itself.
One of the best examples of winner's curse in practical auctions is in oil field explorations. The true value of an oil field is very hard to determine and so companies bid on oil fields without accurate information. Companies that maximize the value of an oil field for development will bid higher and consequentially win the auction. This becomes the winner's curse because the value of the oil field could be less than the money paid for it.
Winner's Curse in PPC Advertising
Winner's curse is a dangerous phenomenon for PPC advertisers that not many are aware of. The simple reason is that accounting for this is quite complicated and it requires a deliberate effort to understand its true effects. However, the winner's curse is very real in PPC advertising because the true value of placing an advertisement is impossible to determine.
To understand winner's curse for PPC advertising, it is first important to look at how Google AdWords ranks ads through its auction.
Understanding How Google AdWords are ranked
Google AdWords ranks advertisements based on the maximum Cost Per Click (CPC) and its Click Through Rate (CTR). The higher the CPC, the higher the advertisement will be placed. Also, higher CTR shows that the advertisement is more relevant to people and then will be placed higher. At this stage, it is important to mention that the CPC used in calculation is not the actual CPC but the maximum CPC. This is the value that you specify is the highest your ad will be worth.
Marketing Mistake of Inflated CPC
Since the maximum CPC is usually much lower than the actual CPC, advertisers tend to push up their maximum CPC values. This is done in anticipation of a lower actual CPC but a higher ad position. These inflated CPCs are advised by a number of so called AdWord experts and agencies that promise you a higher ad position for niche keywords. However, the folly is all too obvious.
Calculating your Money's Worth
The winner's curse happens in inflated CPCs when you actually end up with a higher position. This paradoxical situation means that you will achieve what you aim for, but overall it is a mistake because you will not get your money's worth. The main problem with the winner's curse in this case is that it is not immediately obvious and usually you will only know about this problem after spending a lot of money. In the end, it is important to remember that what matters is whether or not you get your money's worth through PPC advertising and not about getting the top advertising spots.
The reason why winner's curse is common in the PPC advertising world is because more than one advertiser uses CPC inflation. So when an advertiser inflates the maximum CPC from $ 1 to $ 2, there are half a dozen other advertisers who would have inflated their price in the range of $ 1.5. In this case, you will have to pay higher than $ 1 for each ad.
Protecting Yourself from the Winner's Curse
It is there before important that when you calculate your maximum CPC, you take relevant data from your previous marketing strategies and do not inflate the price. To understand why a non-inflated CPC is ideal for your advertising goals, it should be stated that Google AdWords and indeed most advertising CPC programs use a Vickrey Auction model. It is mathematically shown that the best strategy in a Vickrey auction is to bid at the exact value that you think the product is worth. Bidding higher or lower is simply sub-optimal. Keeping this in mind, advertisers can succeed better at managing their CPC campaigns.