A Beginners Guide to First-Price vs. Second-Price Auctions
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 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:
As header bidding transformed the system, auction dynamics followed suit. This “layering” of auctions is what’s creating major headache and confusion for the digital advertising industry on desktop and web. And as Google Ad Manager switches to first-price auction, the need to understand auction dynamics has never been more dire. 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.
Back To Basics
First price auction: A model wherein the buyer pays exactly the price they’ve bid on any given advertising impression.
Second-price auctions: A model wherein the buyer pays $0.01 more than the second highest bid for an ad impression.
Price Floor: The minimum price a publisher will accept for its inventory- ignoring all bids below that price.
Clearing Price: The final price paid for an impression.
Now, Let’s Walk Through An Auction
For example, There are 3 bidders:
- Bidder A 2.20$
- 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, though the winning bid still belongs to buyer B, their clearing price will be $0.01 + second-highest bid ($2.50) = $2.51.
The amount that the buyer saved on this impression, $0.29 is know 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 bid shading.
A unified auction scenario now looks like this:
Developed as a sweetener for buyers, bid shading is a technique buyers use in first-price auctions in an attempt to avoid overpaying. Essentially, bid shading takes a 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 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 second-price auctions 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, oftentimes publishers 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 instead requires publishers to rethink how they use floor prices.
When approaching floor strategy, publishers should switch focus and adapt their price floors against an expected aggressive bidding strategy from buyers.
Advantages of First-Price Auctions
- Reduces complexity in the ad tech environment
- Provides a fairer and simpler auction process
- More accurate evaluation of inventory value
- Ensures publishers receive a fair value for their inventory
Programmatic ad buying has come a long way from waterfalling and ultimately as the world may go first-price, it’s essential for publishers to understand the dynamics of both first-price 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 represents only one piece of the transparency puzzle.