Hearts & Science Calls To Replace First-Price Auction With Reformed Second-Price Model

The switch to first-price auctions last year is causing programmatic buyers to pay more, according to research from media agency Hearts & Science.

In one test, a first-price auction drove CPMs up by more than 50%.

The Omnicom agency wants programmatic to create “clean” second-price auctions to remove the premium that buyers pay. It doesn’t want to revert back to the previous second-price model, which suffers from problems around transparency and bid density, along with a multi-stage auction.

Ben Hovaness, executive director of digital activation for Hearts & Science, said a reimagined second-price auction must meet two conditions.

First, those who run the auctions must be audited to ensure they’re not artificially boosting the clearing price. Second, the industry must resolve the reason why first-price auctions proliferated: header bidding has created an inefficient two-stage auction, where the highest bidder doesn’t always win.

A second-price auction where SSPs pass through all bids and the publisher conducts the auction could solve those problems, Hovaness proposed.

Transformation will take time and collaboration. As a stopgap, Hearts & Science proposes that brands invest in second-price auctions when possible and negotiate private marketplaces with key publishers.

When they have to participate in first-price auctions, they should practice bid shadingwhere an algorithm reduces the bid to lower prices for the advertiser – to reduce CPMs, Hovaness said.

Hearts & Sciences hopes its study gets more marketers to think about how auction mechanics affect their programmatic investments.

“We have discussed the concept of cleaning up the auction system with our clients, Hovaness said. “We want to get marketers thinking about what’s going on in the auction and what it means for their interests.”

Hearts & Science said the agency and its clients don’t stand to gain from the switch. As an agency for large, well-resourced clients, it can ensure they aren’t victimized by auction mechanics.

Instead, Hovaness insists all marketers, especially smaller ones, would benefit: “If we make the marketplace as fair and transparent as possible, marketers can channel their resources into more fruitful areas.”

Behind the research

Hearts & Science’s test involved buying impressions in both first- and second-price auctions. Hearts & Science created a third test group for situations where the DSP used an auto-bidder to enable bid shading for clients. It spent thousands of dollars across millions of impressions.

CPMs were 59% higher in first-price auctions than in second-price auctions. Using an auto-bidder to try to reduce prices didn’t help much. CPMs in that group were still 54% higher than in second-price auctions.

The results contradict the claim made by some SSPs and DSPs that the switch to first-price auctions is a wash once buyers adjust their bidding strategies. The problem? Even bid shading can’t reduce bids with the same precision that a second-price auction can, where a buyer pays just a penny more than the second-highest bid.

“Auction theory predicts that this cost-neutrality claim is inaccurate, and our real-world testing bears this prediction out,” Hovaness said.

To date, much of the uproar over the switch from second-price auctions to first-price auctions has been over how the auction type switch was conducted. Some exchanges notified buyers after the fact or not at all, a scenario where the buyers ended up paying more. But the buyers who were aware of the switch also paid more.

“The [change to first-price auctions] was not friendly for the buy side. But even if there was a perfect rollout, it would still be a net negative,” Hovaness said.

Reforming the auction

Hearts & Science is rethinking the auction structure and how to optimize spend for first-price auctions.

Getting a third-party to referee the auction should be a first step. “Until we get some transparency and third-party oversight, it’s hard to look at what reforms should be made around restructuring the auction,” Hovaness said.

Auction restructuring must also protect publisher yield from artificial bid scarcity, where DSPs only submit one client bid to an exchange. Each exchange conducts an auction and passes one bid to the publisher, whose ad server picks the highest bid from all the exchanges.

“One proposal is to pass all the bids through, so it’s not an auction running in a DSP or SSP. They function as bid conduits, and the publisher can conduct a clean second-price auction,” Hovaness said.

DSPs can still submit a single bid, but exchanges will simply aggregate all those bids and submit them to the publisher, who will decide what ad to serve.

“It’s important to get all the bids to the auction … otherwise publisher yields would collapse,” Hovaness said.

The setup makes open programmatic auctions more similar to “unintermediated” auction systems, like Facebook, Snapchat, Pinterest, Bing and Google search, which all run second-price auctions.

“The key outcome we should try to secure is a classic second-price auction,” Hovaness said. “Hearts & Science looks forward to working with its clients and partners to make this a reality.”

Read the full report here.

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1 Comment

  1. Bob Smith

    It is promising to see P&G pushing for some reform here.

    One key point that is raised here is the problem of low bid density. While the point is raised, a good solution is not proposed. This article states that “DSPs can still submit a single bid, but exchanges will simply aggregate all those bids and submit them to the publisher, who will decide what ad to serve.” That will not cut it, as it does not address the key reason for lack of bid density: an increasingly large % of demand sits in just a few DSPs.

    To ensure there is full and fair competition in a second price auction, DSPs need to submit at least their top two bids, which will be eligible to second-price each other (e.g. if DV 360 has the top two bids in the auction, its higher bidder will win and close at the other bidder’s bid price). DSPs similarly will need to be audited to ensure they are doing this, and not sending a second price that is artificially low. DSPs historically have pushed back on this idea, thinking their larger market share is a competitive advantage that allows them to keep prices lower for their clients.

    The result, however, is publishers began to seek out different ways to find the true value a bidder was willing to pay, leading to waterfalls of SSPs, dynamic price floors, header bidding and first-priced auctions. And yet here we are 7 years on and neither side is satisfied.

    There needs to be a solution that feels fair for all. Advertisers and publishers should agree on what that means, and then have their respective tech vendors build to that spec, rather than having the tech in the middle dictate it.