The complex nature of programmatic advertising has made it increasingly difficult for both the buy and sell-side to properly value inventory, and the accompanying confusion surrounding first price and second-price auctions has made it nearly impossible for publishers to optimize ad revenue.
Since the dawn of programmatic advertising, the ad tech market has been running on 2nd price auctions, as they were easier to navigate in a waterfall environment. The evolution of header bidding has flipped the script and allowed buyers to see and assess greater amounts of inventory at once.
And the common auction scenario today looks like this:
Image: Google
As header bidding transformed the system, auction dynamics followed suit. This “layering” of auctions is what’s creating major headaches and confusion for the digital advertising industry on the desktop and web. And as Google Ad Manager switches to first-price auction, the need to understand auction dynamics has never been direr. With this change, every offer from programmatic buyers will compete in the same unified auction, alongside inventory which is directly negotiated with advertisers
So why are first-price auctions gaining fame? In one word– transparency.
First-price auctions in programmatic advertising
Image: Google
What are first-price auctions?
In a first price auction model, the ad impression goes to the highest bidder, and the buyer pays exactly the price they bid on any given advertising impression.
A first-price auction model uses different auction rules than a second-price auction. Bidders submit their bids for ad inventory to the ad exchange simultaneously. The highest bidder wins and pays the exact price per thousand ad impressions that he or she bid during the auction. The amount paid by the winning bidder is known as the clearing price.
How does the first-price auction work (example)?
In a first price auction the highest bidder wins, and pays the exact amount that they bid for the impression.
Let’s look at a first-price auction example with three bidders. We’ll be looking at this example several times throughout this piece.
- Bidder A $2.20
- Bidder B $2.80
- Bidder C $2.50
As in any price auction, the winner is bidder B. In a first-price auction, bidder B pays the exact bidding price, $2.80, regardless of the amount the other players bid. There are usually no hard price floors in a first-price model.
What are the advantages of a first-price auction?
A first-price auction model reduces complexity in the auction process and reduces the revenue gap for publishers.
There are multiple advantages to first-price auctions. First and foremost, this auction model reduces complexity in the ad tech environment—the ad simply goes to the highest bid. In addition, they enable a more accurate evaluation of the market value of ad inventory, encourage competitive bids from demand partners, and ensure that publishers receive a fair value for their inventory. In general, publishers earn more revenue in first-price programmatic auctions than in a second-price model and many experts believe that they better reflect the true value of the ad impressions.
Second-price auctions in programmatic advertising
What are second-price auctions?
In the second-price auction model the winner pays a price that is $0.01 more than the second-highest bid for an impression.
In a second price auction model, the ad impression still goes to the highest bidder, just not at the cost of the initial bid in the real-time bidding. Instead, the highest bidder pays the amount that the second-highest bidder offered, plus $0.01, and therefore the final price is usually lower than the top bid.
How does a second-price auction work (example)?
In second-price auctions the highest bidder wins, but does not pay the amount that they bid. Instead, they pay the amount that the second-highest bidder offered plus $0.01.
For a second-price auction example, let’s return to the example we looked at in the previous section.
- Bidder A $2.20
- Bidder B $2.80
- Bidder C $2.50
In the first price and second price auction, B is the winning bid. However, instead of paying $2.80 for the impression, in a second-price auction they pay $2.51.
What are the advantages of second-price auctions?
A second-price auction reduces the risk of overspending which can lower the demand for a publisher’s inventory.
A second-price auction eliminates the risk overestimation of the value of the impression. Since buyers don’t overspend, there is a higher demand for the publisher’s inventory.
First-price vs. second-price auction dynamics comparison
Let’s go back to the price auction example presented above and look at the results of a first-price vs. second price auction.
- Bidder A $2.20
- Bidder B $2.80
- Bidder C $2.50
In the case of a first-price auction, the winning bid would be attributed to buyer B and the clearing price will be the same as the bid: $2.80.
In the case of a second price auction, although the winning bid still belongs to buyer B, the clearing price will be $0.01 + the second-highest bid ($2.50) = $2.51.
The amount that the buyer saved on this impression, $0.29, is known as the reduction. The reduction is simply the difference between the bid price and the clearing price.
With the switch toward first-price auctions, the fear of overpriced impressions has led to bidding shading.
A unified auction scenario now looks like this:
What is bid shading?
Bid shading is a technique buyers use in first-price auctions to avoid overpaying.
Developed as a sweetener for buyers given the challenges presented by header bidding, bid shading essentially takes the maximum possible bid and tries to forecast the market value for a given impression, in order to determine the actual bid price to submit.
Besides pricing data, bid shading algorithms look at factors like the site, ad size, exchange, and competitive dynamics to determine where to set the bid—if win rates decrease, the algorithm raises the price they pay.
One way publishers are counteracting bid shading is with intelligent price floors.
How has floor price strategy changed?
In a second-price auction, setting price floors on inventory was one of the main tools publishers implemented to combat the general reduction of bids. Floor prices are traditionally used by publishers to increase the closing price of their auctions.
When publishers notice that their auction closing prices are significantly lower than their highest bids, they often proactively raise their floor prices to increase their short-term revenue.
In a first-price auction, setting a floor can’t manipulate the clearing price, as the bid submitted by the buyer either wins or loses without reduction. The shift to first-price auctions and increase in header bidding instead requires publishers to rethink how they use floor prices.
When approaching floor strategy, publishers should switch focus and adapt their price floor against an expected aggressive bidding strategy from buyers.
The takeaway
Programmatic ad buying has come a long way from waterfalling. As header bidding becomes more prevalent and the world trends towards first-price, it’s essential for publishers to understand the dynamics of the various auction models including both first and second-price auctions.
First-price auctions may ultimately boost publishers’ revenue opportunities while simultaneously enabling advertisers to receive a clearer picture of auction dynamics.
As the industry seeks to create a level playing field that enables more transparent bidding, the transition to first-price auctions is a key piece of the transparency puzzle.
