First-price auction or second-price auction – what is the difference, which is most common, and why does it matter?
These are questions that continue to challenge marketers in the programmatic space. If you thought media transacting in a matter of milliseconds was complex, consider the notion of advertisers participating in programmatic auctions that use different pricing models and favor different bidding strategies. Believe it or not, this is the reality in which programmatic marketers currently live.
What’s the Difference?
Before we dive in, it’s important to understand the different types of programmatic auctions. The two most widely accepted types are first-price and second-price. The dynamics of the auctions determine the price at which an impression is sold. In a first-price auction, the highest bidder determines how much an impression is sold for. In a second-price auction, the second-highest bidder determines how much an impression is sold for. Still not following? Let’s break it down further.
Many liken a programmatic auction to buying an item off eBay. In a typical eBay auction, a winner pays the second highest bid rather than their own. For example, if there is an auction on a pair of shoes and user A bids $2.00, user B bids $5.00 and user C bids $10.00 – user C will win the shoes but will not pay $10.00. They will pay $5.01 – one cent higher than the second highest bid in the auction (User B’s bid). The concept of paying slightly higher than the second highest bid rather than your own is the definition of a second-price auction.
If the same scenario were to happen in a first-price auction, user C would still win the shoes, but would pay what they bid – $10.00 – nearly $5.00 more than what they would have paid had it been a second-price auction. User C’s bid was the same in both scenarios, but the dynamics of each auction ultimately affected the final price of the shoes.
Which is Most Common?
For years, second-price auctions have been the norm in the programmatic world. According to eMarketer, in December 2017, only 5.8% of programmatic impressions were sold via first-price auctions. Four months later in March of 2018, eMarketer ran the same analysis and found that 43.3% of programmatic impressions were being sold through first-price auctions.
Though second-price still was the majority at the time, it is clear that significant shifts towards first-price auctions were happening, and happening quickly, throughout the industry. Fast forward to April of 2019, and most of the major exchanges have transitioned to a first-price model. Google, the largest player in the space, was the most recent exchange to announce its plans to shift models by end of year.
Yes, changes are happening, but it’s also important to discuss why they are happening. The main reasons cited for the shifts have been header bidding and transparency – a topic that has haunted programmatic since the beginning. With first-price auctions there is inherently more transparency as both buyers and sellers can see the actual cost of the impression, allowing buyers the ability to infer additional costs or fees taken by the exchanges. On the contrary, second-price auctions leave buyers a bit more in the dark. If someone bids $10.00 in a second-price auction and wins the bid at $5.01, they can assume the second highest bid was $5.00 and no additional fees or markups were taken but will never know for sure.
Why Does It Matter?
It’s imperative for programmatic advertisers to understand the changes happening to auction pricing because different pricing models require different bidding strategies. Historically, demand-side platforms (DSPs) built their algorithms to facilitate advertisers bidding high enough to win impressions, but ultimately paying no more than the value of the next highest bidder. Now, advertisers are paying exactly what they bid, which can get expensive. How do we know what is a fair price to pay?
Fortunately, there are solutions available to help avoid overpaying. One of the most common tactics is “bid shading”. Bid shading is a technology solution that utilizes an algorithm to calculate the right bid regardless of the auction model used. Most of the DSPs, including Google, have enabled automated bidding solutions such as this in their platform. At Harmelin, our trading desk is utilizing automated bidding solutions whenever and wherever possible. Other best practices we’ve deployed include setting fixed bids no higher than 2x the value of the targeted inventory, working via private deals rather than open exchange, and most importantly, asking questions.
Especially amidst transition, it is imperative for buyers to hold themselves, DSPs, and exchanges accountable. We need to continue to press for transparency, we need to understand what types of auctions we are competing in and we need to know what tactics are available to help mitigate costs. Ultimately, we need to understand the rules of the game before we start playing.