How Can We Overcome Programmatic’s Principal-Agent Problem?

kirk-mcdonald-replaceData-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 Kirk McDonald, president at PubMatic.

Many in the programmatic world shamelessly borrow strategies, tactics and even language from the world of finance.

Some companies have “tickers” on their websites that scroll real-time eCPM data for all the verticals they serve in a way that wouldn’t look out of place on a Bloomberg terminal. Much of the industry’s technology and business innovation in recent years also mirrors the work that has made financial markets more transparent, efficient and effective.

But as the field matures and takes on even more characteristics of the financial industry, it also inherits many similar risks and challenges. One risk that I think is greatly underappreciated has its roots in what’s known as the “principal-agent” problem.

In programmatic, media buyers and sellers are “principals,” while exchanges, platforms and ad networks work as “agents.” The agents perform services on behalf of principals in return for some benefit, but the agents must balance their own interests against those of the principals they serve.

To some extent, these sorts of conflicts are inevitable because the goals of each party will always be different. This is as true in advertising as it is in negotiation, strategy or politics. But this frames a number of important questions.

When setting pricing, is the ad exchange acting in a way that benefits itself more than its customers? Does a platform’s decisions about how to configure and allocate inventory ultimately serve the needs of the platform more than those of its buyers or audience? Businesses can thrive or fail on how skillfully they negotiate this balance.

These problems are compounded when there is information asymmetry. Every side of the market has at least some incentive to hoard what it knows and draw a curtain over its strategy. This can lead to situations where pricing and process are hidden in a “black box,” giving agents greater ability to elevate their interests above principals, sometimes without principals ever knowing.

The result for the publishing industry is an erosion of trust. If media buyers don’t trust what they’re buying and bad actors take an unfair cut of the deals, publishers end up with less revenue to invest in compelling content.

We are fast moving toward a world where nearly all advertising can be bought and sold programmatically. The benefits to buyers and sellers are obvious, but the system will only work if there is mutual trust. And that trust comes largely from openness and transparency: If we just don’t know what’s going on, it’s harder to make rational and informed decisions about whether partners are fairly serving our interests.

As demonstrated in the financial industry, when principal-agent problems persist, regulation soon follows. If we want a truly open and interoperable programmatic industry, we have a responsibility to police ourselves and mindfully navigate the thicket of mutual and conflicting interests that is inherent in the business.

To this end, it’s possible to turn the challenges of a fast-moving field into advantages by tapping into our history of rapid innovation. The digital advertising industry is doing in a matter of years what the financial markets took decades to accomplish, in terms of fighting fraud and malfeasance, ensuring accuracy and transparency in pricing and streamlining manual processes into automated, real-time transactions.

Every day, we make decisions that can slowly nudge our businesseses in one direction or another. We have the choice between moving toward openness, transparency and fairness or retreating to closed systems and opaque processes.

I believe that it is in the industry’s best interest to err on the side of transparency. This will help build greater trust in our systems, increase the footprint of programmatic, ensure fair pricing and business practices and, ultimately, benefit all industry players over the long term.

Follow Kirk McDonald (@kirkm3), PubMatic (@PubMatic) and AdExchanger (@adexchanger) on Twitter.

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  1. Kirk, I couldn’t agree more. Transparency is the new black and never gets old. Information asymmetry is real and according to latest IAB document about this, in 2014 : “Ad networks can sit on the buy side as they can purchase programmatic digital inventory through ad exchanges or other ad networks by leveraging DSPs. Ad networks can also be on the sell side as they offer up their inventory through private market places. Ad networks typically add 30%-50% value-add mark-up fees with a few networks charging greater than 50%.” We all know, no Principals will be happy on the long term with agents getting 50% margins.

  2. Kirk’s article and Paris’ comment are both highly relevant and accurate in their hypotheses about the need for trust and fair margins. In the financial markets, trust exists because of total transparency and regulatory oversight, combined with what is perceived as very fair commissions or retainer fees for agents who facilitate the transaction. These fees are tiny per unit but ultimately rich because of the volume.

    What hasn’t happened yet in the digital ad marketplace … and I believe will … is disruption caused by a marketplace transaction service provider that is able to make a very healthy living with transaction fees in the <5% range, or subscription fees NOT tied to transactions, but rather to a basket of services whose value can be quantified in terms of results. The latter fully aligns the principal and agent. And doing so also solidifies the longevity of the programmatic marketplace dynamic that today is still finding its way.

  3. Mr. McDonald mentions that one potential outcome of the failure to be more open (the principal/agent problem) is the risk of government regulation, as in the financial industry. Perhaps the bigger risk is that if the parties getting benefits from the programmatic realm don’t solve this problem to their clients’ satisfaction, the clients will gradually abandon them and this industry will wither, then disappear. After all, we are not important enough to the global economy to require government regulation. But the marketplace will force discipline if the programmatic industry is seen as untrustworthy. We would be wise to keep in mind that many of the buyers and sellers don’t like the result of programmatic in the first place – that automation has slashed prices and profits. So they won’t complain too much if we have less of a role, or are gone completely.