Last week, Google announced that it will transition Google Ad Manager (formerly Adx), its ad exchange, from a second-price to a first-price auction model by the end of 2019. Google is actually late in bringing the first price auction mechanic to Adx; most other large ad exchanges started their transition to first price auctions in 2017.
In a nutshell, a second-price auction model awards the auction to the highest bid at a price only slightly above the second-highest bid. This contrasts with a first-price auction model, which awards the auction to whoever submitted the highest bid.
The second-price auction model preserves some elements of the Vickrey auction, which is meant to incentivize bidders to submit a bid on an item that best matches their interpretation of that item’s worth. Second-price auctions were de rigueur for digital advertising for a very long time because they also helped to alleviate the winner’s curse, whereby it is likely that the winner of an auction is simply the person who most overestimated the value of the item being bid on. This presentation does a very good job of explaining the difference between first- and second-price auctions.
The impetus of the major exchanges in transitioning from the second-price to the first-price auction model in 2017 was lack of transparency from SSPs around fees and hidden costs, mis-labeled auction types, and undisclosed price floors. The rise to ubiquity of header bidding in desktop ad inventory auctions precipitated much of this unseemly behavior on the part of SSPs; header bidding essentially removed any SSP’s claim of unique access to inventory. Without unique inventory, SSPs needed to compete exclusively on the basis of the yield they deliver to publishers and thus began to manipulate price floors unscrupulously. Note that most of these concepts only obliquely apply to mobile; for a background on unified auctions in mobile, read this piece by Tapdaq’s Dom Bracher.
Google is obviously a gargantuan presence in digital advertising, and the fact that it is transitioning Adx (but not the advertising auction environments which operate completely under its control, such as Adsense for search and YouTube) to a first-price model is significant. It’s important to consider the repercussions of this change: in the short term, it’s likely that CPMs and effective CPMs will increase as advertisers’ bid models are tuned to the new environment. In a second-price model, the highest bid isn’t paid, and as those high bids become the winners under the first-price model, the price paid for inventory will increase to the highest bid. According to this DigiDay survey, 78% of publishers saw an increase in revenue after the initial transition to the first-price model in 2017.
Of course, advertisers will adapt to this change over time by modifying their bid logic, but another consequence will be harder to accommodate: increased volatility in CPM prices as they are no longer effectively anchored by the second-price mechanism.
The idea here is that any given range of bids is bounded at the bottom by $0 but can be theoretically unbounded at the top; it is the same driving logic behind the Pareto principle and why median values, not averages, are used in conveying income levels. If true values decide auction winners, then high bids, which can be unbounded, could not only price other bidders out of the market as prices increase, but the non-monotonic nature of those price increases will create uncertainty for publishers. These are changes that publishers should attempt to acclimate themselves to as Google transitions Adx over the course of this year to the first-price model.