Auction mechanics 101

Note: Verizon Media is now known as Yahoo.

You've probably heard a lot of talk about recent shifts and trends around auction mechanics, along with differing opinions on what they mean to your bottom line. While it's true that the rise in header bidding has been a game changer for many publishers, now that it's become an industry norm, let's take a look at how the auction landscape has changed in this first part of our two-part series on auction mechanics.

First, let's refresh your memory on common programmatic auction mechanics:

Second-price auctions collect real-time sealed bids from all buyers. The highest bidder wins the auction, but typically only pays one cent higher than the second highest bidder (thus the second-price name). This was long seen as an efficient way to determine the true value of an impression, satisfying both the advertiser and publisher.

Second Price Auction

In first-price auctions, the bidders pay exactly what they bid, with the highest bid setting the clearing price for the impression.

First Price Auction

The programmatic advertising marketplace has seen major changes over the last few years, with nearly half of all impressions sold on a first-price basis. This shift from second-price auctions by many SSPs was initially intended to bring more transparency to both buyers and sellers as well as increased CPMs and revenue for publishers. However, the reality may not be so clear-cut.

Although first-price auctions are cited as a way for publishers to increase their yields, it forces buyers to guess the true value of the impression, and thus they may end up overpaying. This, in turn, could drive down demand for a publisher's inventory if buyers are repeatedly overpaying for that inventory. Since many buyers' bidding strategies were based on second price models, they were not initially equipped to the shift in auction mechanics. They sometimes did not have transparency into the auction mechanics or price floors implemented.

We're seeing buyers make the following adjustments in a first-price scenario:

  • Enhanced Bidding Algorithms: New technology offerings and services are now giving buyers deeper insight into the bids needed to win the impression without overpaying. Many DSPs have created bid price optimization algorithms that use machine learning to determine the optimal bid.

  • Bid Shading: Many SSPs offer bid shading as a compromise between first and second-price auctions where technology looks at historical bidding trends and uses this data to set a bid somewhere in between the 1st and 2nd price. DSPs are starting to offer similar technology as a tool for buyers to avoid overpaying in a first-price auction.

    For publishers, it raises the price from what would normally win in a second-price auction and also may help retain a healthy buyer competition and bid density by eliminating advertiser feelings that they overpaid.

  • Testing for the absolute minimum price: First-price auctions encourage buyers to bid as low as possible to determine the clearing price of the auction. This continual testing of lower bids will naturally bring down all the bids in the auction. In a second-price auction, this isn't necessary as the clearing price is transparent.

  • Shifting to Direct Programmatic and PMPs: Many buyers moved out of open marketplace first price auctions as they saw their costs rise along with uncertainty about what bids would succeed in the auction. Direct premium guaranteed deals and fixed-price PMPs offer a price-controlled alternative coupled with a brand-safe environment. This reduces bid density on the open exchange and could result in lower eCPMs with less competition.

So now that you have the auction basics down, what do programmatic auction models mean to publishers and, more importantly, do they matter? Find out in part two of our series, "The shift to first-price auctions: 3 factors publishers should know".

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