Display Advertising Switched to First-price Auctions After Adoption of Header Bidding, New Study Finds

In its short lifespan, display advertising has employed several different selling mechanisms, which impact advertisers, publishers, and exchange platforms. Most recently, exchanges have moved from second-price auctions to first-price auctions, and one accepted explanation claims this is due to trust issues between advertisers and the exchange platforms they use to bid on digital ad space.

However, a new study has found that the move is more likely due to an industry-wide adoption of header bidding. Further, by using first-price auctions and header bidding, fees for exchange platforms equalize, leading to zero fees on the buyers’ side over time. The study also found that this shift in the marketplace ultimately benefits publishers by improving revenue.

The study, by researchers at Carnegie Mellon University (CMU), City University of Hong Kong, and University of Washington, appears in SSRN.

“The prevailing wisdom explaining the move was that first price auctions were more transparent since you pay what you bid,” says R. Ravi, Andris A. Zoltners Professor of Business and Professor of Operations Research and Computer Science at CMU’s Tepper School of Business, who coauthored the study with his two former doctoral advisees.

“Added to this was a lack of transparency in the fee structure and pricing rules of exchanges that aroused suspicion about reserve and second-price determination,” adds Stylianos Despotakis, Assistant Professor in the Department of Marketing at City University of Hong Kong and co-author of the study.

In the relatively short time that digital advertising has existed, its methods have changed several times. In the early days, advertisers targeted specific demographics via keyword searches. However, because the market moved from accessing the internet on a single device to using mobile devices, as well as online video content receiving more views than ever before, advertisers shifted to an auction system.

This system encouraged advertisers to partner with an advertising exchange to bid on available digital ad space in mere milliseconds. Over time, this form of real-time bidding evolved into a structure known as waterfalling, which organized advertising exchanges into a tiered sequence that publishers could quickly move through in order to immediately access the first available request to place an ad.

Though efficient, waterfalling ultimately hurt both advertisers and publishers since advertisers must be strategic about which exchange to partner with, and publishers often miss higher ad bids because the system values speed rather than purchasing power. Due to the inefficiencies produced by waterfalling, publishers introduced what they termed header bidding, which eliminates the sequential process and allows them to instead solicit bids from all potential advertisers at once, choosing the one they like best. This structure immediately caught on.

In this paper, the researchers study the recent rapid transition of exchanges moving from a second- to first-price auction format. In second-price bidding, advertises bid the highest amount they are willing to pay and pay one cent above the second-highest bid if they win. In first-price bidding, the winning advertiser pays exactly what they bid. The question the researchers sought to answer in this paper was why first-price bidding was not instituted immediately with the initial advent of display advertising. Additionally, what are the consequences of this late move and how will it affect the marketplace moving forward?

The researchers used a simple model involving one publisher selling an impression, two ad exchanges, and four advertisers who can bid for the impression through the exchanges. First, they analyzed a bidding system using waterfalling and second-price bidding, finding that in this model the revenue of the ad exchanges and the advertisers’ utilities are not affected by the auction format, meaning there is no incentive for the exchanges to move from the second-price format to first-price bidding.

“By using a parsimonious model incorporating all the stakeholders and their incentives, our study finds that there could be a simple economic explanation that was not apparent before, ” explains Amin Sayedi, Associate Professor of Marketing at the Foster School of Business, University of Washington and co-author of the study.

The researchers then demonstrated that revenues do increase for publishers when the bidding mechanism moves from waterfalling to header bidding. They show that when the publisher employed header bidding, both ad exchanges moved to first-price auctions. This suggests that the move to first-price auctions might be a direct economic consequence of the widespread adoption of header bidding by publishers. 

The move from second-price auctions to first-price auctions has been explained in the past as a result of trust issues between advertisers and exchanges. However, the researchers argue that the trust explanation is inconsistent with the timeline of display advertising and that it contradicts both Google’s and Facebook’s use of both first- and second-price bidding depending on their role as an exchange or as a consolidated publisher. Instead, the researchers believe that rather than trust issues forcing a market change, the move to first-price auctions is a result of improved revenue for publishers and increased competition for exchanges as a direct result of header bidding.

“The study is a true testament to the amalgam of technological and analytical skills that Tepper cultivates,” says Ravi. “Both my co-authors are trained in Computer Science, graduated from our interdisciplinary doctoral program and have become leading scholars in analytical marketing that explore technological change with deep institutional knowledge of modern business computing systems.”

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Summarized from an article in SSRN, First-price Auctions in Online Display Advertising by Ravi, R (Carnegie Mellon University), Despotakis, Stylianos (City University of Hong Kong) and Sayedi, Amin (University of Washington). Copyright 2019. All rights reserved