Google determines quality scores by calculating multiple factors, including the relevance of the ad to the specific keyword or keywords, the quality of the landing page the ad is linked to, and, above all, the percentage of times users actually click on a given ad when it appears on a results page. (Other factors, Google won’t even discuss.) There’s also a penalty invoked when the ad quality is too low—in such cases, the company slaps a minimum bid on the advertiser. Google explains that this practice—reviled by many companies affected by it—protects users from being exposed to irrelevant or annoying ads that would sour people on sponsored links in general. Several lawsuits have been filed by would-be advertisers who claim that they are victims of an arbitrary process by a quasi monopoly.

What is the distortion?  One example would be an advertiser who is targeting a very select segment of the market and expects few to click through but expects a lot of money from those that do.  This advertiser is willing to pay a lot but may be excluded on quality score.  So one view is that Google is transferring value from high-paying niche consumers to the rest of the market.

However, for every set of keywords there is another market.  Google would optimally lower the quality penalty on searches using keywords that reveal that the searcher is really looking for a niche product. With this view the quality score is a mechanism for preventing unraveling of an efficient market segmentation.

The article is in Wired and it looks at Hal Varian, chief economist at Google.