“Data-Driven Thinking” is written by members of the media community and contains fresh ideas on the digital revolution in media.
Today’s column is written by Alexandre Cotarmanac’h, senior director of publisher products at Criteo.
There is a fundamental dynamic in any price negotiation: Both parties are trying to find out each other’s bottom line.
This haggling and bluffing can be very time-consuming and inefficient; some deals don’t get done just because the negotiators misjudged their challenger. So, finding a way to incentivize all parties to be transparent is very valuable.
One way this can work is when sellers commit to a set of rules that incentivize buyers to declare their true max prices. Second-price auctions are such a mechanism – the seller commits that he or she will charge you only slightly more than the next highest bidder was willing to pay.
Second-Price Auctions Were Always Far From Pure
Now, as soon as the buyer has started sharing his true valuation, the seller has a strong incentive to take advantage of the situation. To invent a second-highest bidder, sell-side platforms (SSPs) have created what they euphemistically call a dynamic floor. Until the buyer realizes what’s going on, this can be very effective at boosting revenues.
It didn’t take long for buyers to catch on. If you know that the price you pay depends, at least to some extent, on the price that you bid, then you stop declaring your true max price. Some buyers price-reduce their bids before they go into SSP auctions to correct for this and also set bids to equalize marginal costs across exchanges. SSPs with creative auction mechanics and low liquidity may be the most penalized in this scenario.
So, let’s be honest: Pure second-price auctions don’t really exist, regardless of whatever an SSP contract says. What we have is a spectrum of auction mechanics, where the platforms with the most real liquidity (Google) stick closest to the second price, and the main SSPs tend to charge a share of the bid price.
First-Price Auctions: The Latest Twist In The Same Story
In the world of ad tags and waterfalls, playing with auction mechanics was a nice way for SSPs to get some incremental yield for their clients.
In the world of header-bidding, being able to submit a higher clearing price to the ad server can be the difference between the SSP winning the impression or not. So, the incentives to squeeze more out of the auction got even bigger. That’s why we’re now seeing most SSPs move their auctions toward an explicit first-price auction, where buyers pay the price they bid.
Compared to the complexities of dynamic floors and impure second-price auctions, a first-price auction is refreshingly simple to understand. That much at least we can be happy with. But for a buyer, first-price auctions are really very complicated to optimize. If they submit their true max value to a first-price auction, they transfer all their economic value to the seller. How much should they bid, then? Well, just enough to win the auction, but no more.
Guessing that perfect bid is equivalent to estimating the next highest bid in the auction and bidding just higher. If they do this perfectly, buyers can have the same outcome as a pure second-price auction. But it is hard to do perfectly.
It’s Time For Buyers To Adapt To First-Price
SSPs are presently shifting to first prices faster than buyers are adapting their bidding strategies. This leads to some short-term yield gains for sellers.
But we have been here before; buyers will catch up and reduce their bids again to maintain their efficiency. Most buyers should be heavily reducing their bids now as the market shifts to pure first prices. The buyers that survive and prosper will be the ones who can make significant investments in the prediction models that are needed to bid effectively in a first-price world.
Buyers Look To Exchanges For Stability And Transparency
As we’ve seen, in the medium term, the amount of value that sellers capture is determined by the value they offer to buyers and the number of willing buyers in that market. Fiddling with auction mechanics can have a short-run impact on this, but it comes at the cost of noise and inefficiency.
Too often, SSPs have seen their role as agents for publishers, rather than neutral intermediaries – like stock exchanges – that help demand meet supply. Real ad exchanges have an important role to play in our market, but their place in the ecosystem depends on being disciplined, stable and transparent.