With header bidding the norm at all top publishers, first-price auctions should be a matter of course, argues Kay Schneider (pictured below), general manager, SmartX Platform, smartclip, in this exclusive byline for ExchangeWire, and explains why a change from second-price auctions is needed, now!

Game theory suggests that a buyer might allocate a higher max bid price to a purchase item if there is a chance to settle a transaction with a final price that is significantly lower than his bid. As a result, the transactions may – on average - settle with higher prices which makes second-price auction as a transaction model for ad trading attractive for suppliers. A valid proof for the above, however, has never been provided. Another very important characteristic of second-price auction is that it doesn’t allow for market price discovery. Some SSPs even have been suspected to manipulate second-price auctions by allocating floor prices after receiving bids.

However, second-price auction became the standard; and optimisation algorithms of DSPs and SSPs have been built and improved accordingly over the years. Still, most platforms have been technically able to run first-price auctions ever since, it’s just been unused.

Why change now?

Kay Schneider, GM SmartX Platform, smartclip

Predominantly because the second-price auction model does not harmonise with header bidding, which is based on first price. To unveil the disharmony, both SSP and header wrapper would have to follow the same logic.

Standard ad servers work with a fixed price per line item, so that each potential settlement price has to be linked to a specific line item carrying this price. Thus, the amount of possible settlement prices is limited, which conflicts with the second-price auction concept. Therefore, both would have to use the first price.

If the DSP is unable to determine whether an impression is being auctioned on first price, and hence does not adjust bidding behaviour accordingly, the buyer is very likely to lose a lot of money by bidding – and clearing – for a much too high CPM. We have witnessed some (smaller) DSPs claiming that publishers practise auction type abuse and buyers lose money.

DSPs can protect their buyers by insisting in two easy rules following the openRTB protocol: every bid request should contain 1) the information on which auction type applies and 2) the floor CPM for the respective transaction.

Assuming that first-price auctions will become more relevant in the future, here is some advice:

As a buyer, make sure your DSP secures you from any auction-type abuse. If you have lost money, change your DSP. This shouldn’t have hit your vendor by surprise in the first place.

When buying on public auctions, set a filter (if provided) to your line items so that your buying strategy fits with the auction type in place. For private buying, talk to your supply partners to have both sides aligned.

As a seller, understand your options for keeping control and transparency on the selected auction types. If you use header bidding, you might consider a change from second- to first-price auction, run tests before you switch big. For selling publicly: do not change auction type settings and don’t let your SSP do it on your behalf. For selling privately: as always, transparency is key. Talk to your buyers first, don’t jeopardise the relationship.

There are good arguments for replacing second-price auctions with first-price, especially since this would grant price transparency that buyers so often postulate nowadays. But be aware of potential short-term conflicts between supply and demand. Conduct this shift in thoughtful steps, accompanied by a transparent dialogue with your partners.