The Dark Arts Of Second-Price Auctions

alexreinhold2Data-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 Alex Reinhold, head of solutions at Sociomantic.

The trusty second-price auction is a staple of the real-time bidding process. In the programmatic sphere, buyers bid on a publisher’s inventory and, in a perfect world, the buyer with the winning bid pays one cent higher than the second-highest bid, known as the clearing price.

To put this into perspective, let’s say that I’m participating in an eBay auction. I just bid the highest amount of $400 on a signed Metallica vinyl and won over the second-highest bid of $350. If the second-price rule applied at eBay, I would pay $350.01, one cent more than the second-highest bid, instead of the full $400.

With real-time bidding, this process happens on a much greater scale, and for each impression the bid is submitted in a matter of milliseconds. Seems straightforward enough, right? Yet, a lack of transparency around second-price auctions opens up the potential for price manipulation – another black eye for an industry already struggling to address ad fraud.

What actually takes place between the clearing price and the buyer’s winning bid? Unfortunately, only the exchanges can currently answer that, and they’re not very forthcoming.

Buyers can and should ask their ad exchange partners to explain their ad auction mechanisms in detail. Buyers can also look at the fine print in their contracts and to decipher how a second-price auction is defined.

But good luck: They will often learn that this seemingly clear concept means different things to different exchanges.

Black Box

Unfortunately, everything that takes place between a buyer’s bid and the clearing price happens in a black box. And with this lack of transparency, ad exchanges are free to do as they wish, which may include driving up clearing prices.

At a time where many industry players are so focused on “unified auctions” – yet another auction layer that uses clearing prices as first-price auction bids within the ad server – the complexities of ad exchanges are often not addressed, which in some cases may allow bad practices to breed.

Consider “dynamic floor pricing,” the most commonly used technique to inflate clearing prices. This enables publishers to adjust their floor price, the minimum amount they would sell an ad impression for, in real time to prevent buyers from deriving patterns in their bidding. Most exchanges do not provide the floor price in their bid request, so buyers don’t know the minimum amount they can bid.

While dynamic floor pricing benefits publishers by protecting their yield, it completely neglects the risks it creates for buyers in auctions with only one bidder, which occur more often than you might think. Dynamic floor pricing essentially pushes up the lower boundary between bid and second-highest bid in a way that cannot possibly be controlled by anyone. With billions of bid requests sent out hourly, just imagine how much money is at stake for exchanges.

Another prominent method to raise clearing prices is by using so-called “bidding fees” or “buyer fees” – when an arbitrary, undisclosed percentage set by the exchange is added to the second-highest bid. Some may consider these fees to be fair game, since they divide the cost of using the exchanges among both publishers and buyers.

However, while many would argue that the exchange fees should be paid by the publisher and not by the advertiser, the problem is more far-reaching. Exchanges claim the ability to add whatever they want to your bid as long as it doesn’t exceed the highest bid price. This means that if you bid $5 and the second-best bid is $3, the exchange has total contractual freedom to add as much as $1.99 in fees, charging anything between $3.01 and $5 as the final cost to the buyer. My experience suggests that this is happening on a large scale.

Obviously, most exchanges would claim that they don’t abuse this leeway, but how can a buyer be sure without contractual protections? Just try to ask an exchange how high those fees are, on average. Bueller?

In The Dark

The black box is the single most important lever that exchanges can pull to manipulate the amount of programmatic revenue that flows from advertisers to publishers. The only information that exchanges pass back to the buyers in an auction is a win notification that depicts the clearing price.

However, buyers have no way to find out whether the second price originates from the floor price, which, as previously mentioned, is often undisclosed, or from another bidder. Without transparency in second-price auctions, exchanges can potentially submit fake bids or deliberately manipulate clearing prices without getting caught, and neither buyers, the IAB nor similar third parties can do anything about it.

With all the fuss about transparency with ad fraud, viewability and unified auctions, it’s absurd that this topic is often neglected. It’s up to advertisers to either question the validity of the second-price auction altogether or to employ better control mechanisms while using it. Otherwise, the industry will continue trading vast amounts of money within black boxes that are subject to few controls.

Ultimately, such an arrangement isn’t good for anyone in the industry – well, except maybe the exchanges.

Follow Alex Reinhold (@alexreinhold_), Sociomantic (@sociomantic) and AdExchanger (@adexchanger).

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  1. Stephen

    ‘Ultimately, such an arrangement isn’t good for anyone in the industry – well, except maybe the exchanges.’ – And the DSP/SSP, particularly if it is the same platform managing both the sell and buy side, higher buy/sell prices = higher fees

  2. The eBay example referred to in this article is incorrect. eBay does in fact use a second price auction model and has always done so.

  3. Anton Daneyko

    What is a usual pricing model for DSPs and SSPs with respect to advertizers and publishers? Do they add a fixed price on top or is it a certain percentage of the bid price? In the second case both DSP and SSP benefit from higher prices.

  4. This is brilliant and obviously, if more people had been paying attention to this, maybe we wouldn’t have had the bid-caching scandal from Index Exchange nearly 27 months after this was published.

    I think it’s time for more folks to organize these types of manipulations and publicly discuss the properties/schema/processes that can provide transparency to the data supply chain, and lists of the “red flags” when certain fields are missing or when an exchange is taking an odd-industry-practice.

    It’s very challenging to keep up with what an exchange *shouldn’t* be doing — feature-blindness is creating more and more opportunities for subtle manipulations that have huge impacts on price at scale.

    Thanks for writing this, Alex.