What are First Price Auctions, and how do they compare to other programmatic in-app advertising auction mechanisms? As an ad tech bidding strategy, what are the advantages and disadvantages of the first price auction bidding model?
In this latest Whiteboard Wednesdays video, Ryan Gauss, InMobi’s Platform Product Manager, highlights the unique attributes of this type of auction in which the highest bidder wins. In the video, he also covers how this compares to other price models in which initial bid prices aren’t always what advertisers pay out, and why switching to real-time initial bid auctions is not always so easy.
Hi, and welcome to another edition of Whiteboard Wednesday. My name is Ryan Gauss, and I’m the Platform Product Manager here at InMobi. And today we’re going to be discussing First Price Auctions, why they’re becoming more common and what the advantages and disadvantages of them are.
So first off, why are First Price Auctions becoming more common? And the reason is, is that there is more transparency with them, and also it allows the DSP or the buyer or even bidder, depending on which term you want to use, to be able to compete more competitively in multiple auctions.
So first off, let’s take a step back and just describe what a First Price Auction is as compared to a Second Price Auction. So in a First Price Auction, the highest bidder who wins the auction will pay what they bid. So if they bid $10 and they win, they will pay $10.
In a Second Price Auction, the highest bidder who wins the auction will pay one cent higher than the second highest bidder. So if the highest bidder pays $10 and the second highest bid $8, the first bidder will end up winning and will pay one cent more, which is $8.01.
So before we get into the real disadvantages and advantages of a First Price Auction, we want to start off by saying that it’s really important that every auction that is sent out by the auction platform should specifically say if it is a First Price or a Second Price Auction. If the auction type is not listed, then there really is no transparency to begin with in the auction.
So let’s take a look at the advantages. So we know that in a First Price Auction, that the highest bidder ends up paying what they bid. So because of that, there is greater transparency. There’s no way for the auction final price to be manipulated because, as with a Second Price Auction the final price is dependent on someone else’s bid. That doesn’t happen with a First Price, and so there’s less chance of manipulation there.
The other benefit or advantage is there are no fees when it comes to a First Price Auction. And what I mean by no fees is, because the winning bidder is paying what they bid, there’s no way to tack on any undisclosed fees. That’s something that sometimes can happen in a Second Price Auction.
The third advantage that we want to point out here for a DSP is that if a DSP must win multiple auctions in order to serve an ad for an ad opportunity, then they’re at a real disadvantage if any of those previous auctions before the final one is not a First Price Auction. So we’re going to go through an example right now, but we wanted to make sure that we pointed out that multiple auctions is another one of those advantages.
So let’s go through an example right here. In one common scenario — one of the common scenarios — in the industry right now, where you would see multiple auctions, is with header bidding. So typically with header bidding, you will see an initial header bidding auction, and then the winner of that auction — their price — will be passed into a second auction that they must also win in order to serve the ad.
So for example right here, we’re going to start off and say we have an initial header bidding auction. We have two DSPs, DSP 1 and DSP 2, who are going to bid, and this is a Second Price Auction. So let’s say DSP one bids $10, and DSP bids $5. So now, in a typical Second Price Auction, DSP one is going to win and they’re going to pay one cent higher than the Second Price Auction so they’re going to pay — DSP one is the winner here — they’re going to pay $5.01.
So you can probably already see the disadvantage here. DSP one was willing to bid $10, but now this price of $5.01 is what is going to be passed into the second auction. So now that we have our second auction in the ad server, DSP one will be competing at a price of $5.01, whereas a new DSP — let’s say DSP 3 — is going to bid $7. So in our auction here, the second one — we’re going to say it’s a First Price Auction. So now, DSP 3 is going to win the auction. They’re going to be the DSP that going to serve the ad. But they won the auction at a price of $7.
So the outcome of this is that we now have a DSP who didn’t bid the highest who ends up winning, and the publisher ends up getting less revenue that they would if this initial $10 bid had been passed in. So you can see if this original header bidding auction had been First Price, and the price of $10 would have won, then that would have been passed into the second auction, the price of $10, which would have resulted in the actual highest bidder across both auctions winning and the publisher ending up with more revenue.
So switching to a First Price Auction is becoming more common because of scenarios like this. But it’s not that simple for a DSP to all of a sudden just start bidding within a First Price Auction. Typically in a First Price Auction what you will see is the DSPs bid a little bit lower than they would in a Second Price Auction. The reason being is in a First Price, the DSP is going to pay what they bid, whereas in a Second Price, they’re not going to, the chances of them paying that amount is very unlikely. They’re going to pay a lot less.
So because of that, DSPs need to have a different bidding algorithm in a First Price Auction as opposed to a Second Price Auction. And because of that, they have to reformulate their algorithm and a lot of these DSPs have not been able to do that yet. They’re still kind of behind the times a little bit. So if they want to compete in a First Price Auction, they end up having to use a Second Price algorithm, bidding algorithm, and they end up paying a lot more than what they should be.
So because of this, the practice of Bid Shading has come about. And what Bid Shading is in a nutshell is that it allows a DSP to bid in a First Price Auction, and if they win not necessarily have to pay that full amount. It will be discounted a certain percentage. What that discount is really depends on the auction platform and how they calculate that. Two of the more common calculations that are used to apply that discount are A) splitting the difference between the First Price Auction and Second Price Auction price or B) looking at the historical price that was paid for that inventory — that site or that app or that user — and then doing that.
So you can see that Bid Shading is a positive for a DSP because it does allow them to pay a little bit less price than a typical First Price Auction, but there is a disadvantage to Bid Shading, and that disadvantage is that there is now less transparency. And one of the things that First Price Auctions were trying to do all along is they were trying to add more transparency to the auction. So even though Bid Shading does benefit a DSP, it kind of takes a step backwards because now there’s less transparency back into it again.
So from a publisher’s standpoint, how do they view this? What are the advantages? What are they seeing as the positives to that? So from a publisher’s standpoint, they will end up getting more revenue because a First Price Auction will end up paying more than a Second Price Auction typically.
And also, the other advantage from a publisher’s standpoint is that in a First Price Auction, because a bidder is going to pay what they bid, it’s a truer indication of how they value, how they want to price that inventory. So from a publisher’s standpoint, they’re going to get a more true valuation of what their inventory is worth.
And so as we look at these advantages right here, we want to just point out that the first three are advantages for the DSP; the last two are advantages for the publisher.
Now before we close this one, we want to take a look at the disadvantages. We already mentioned that there can be less transparency produced through Bid Shading. The other two disadvantages are that a buyer now has to create a new algorithm for First Price bidding. And then overall, because it’s a First Price Auction, the DSP ends up paying a higher price. So that’s something that they are’nt necessarily happy about, even though there are some other advantages with regards to transparency in competing across multiple auctions that are something that comes with it.
So looking at First Price Auction’s disadvantages and advantages, there are more advantages. So it really does benefit a publisher and a DSP in the long run. What we would recommend to publishers out there is if they do plan to run a combination of First Price and Second Price Auctions, they do a couple of things. First off, make sure that they are always indicating clearly in the bid request whether it’s a First Price or Second Price Auction, so the DSP knows what algorithm they should use for bidding.
And the second thing is, if they are going to work with DSPs, that those DSPs have both a First Price and a Second Price algorithm for bidding, or that they offer some type of Bid Shading discount. If they do that, that will increase the amount of trust and decrease the amount of confusion that comes about with a combination of First Price and Second Price Auctions.
So that’s it for this edition of Whiteboard Wednesdays. We look forward to seeing you in our next one. Thank you.
Interested in learning more about auction dynamics and different bid auction price models? Want to know how a soft floor differs from a hard price floor? Then be sure to check out these other Whiteboard Wednesday videos streaming in real time.