First-Price vs. Second-Price Auctions

First-Price vs. Second-Price auctions

Have you ever made a purchase on eBay? If yes, you are no stranger to the rules of second-price auctions, the bidding technique that enables the winner to pay the price bid by the second-highest bidder instead of their own. 

The second-price auction model has been widely used in the landscape of programmatic advertising. For years, it has enabled advertisers to bid high amounts for impressions while ultimately paying a much lower price. However, recent trends in the AdTech industry reveal a steady shift toward a first-price auction model. Before exploring the reasons behind this change, let’s first understand the first- and second-price auction and the key difference between the two. 

 

What Is A First-Price Auction?

A first-price auction is a model for purchasing ad impressions where the winning bid is paid in full by the advertiser who placed the bid. The transparency of this model allows both publishers and advertisers to see the true cost of the impression and know about the fees accepted by Ad Exchanges or SSPs.

Publishers’ primary advantage in such auctions is the potential for higher revenue. With advertisers bidding as much as possible for valuable ad inventory, publishers can benefit from receiving the highest possible bid.

Brands, by using the first-price auction, can get premium inventory, which may not be affordable in a second-price auction due to competitive bidding. Thus, brands pay precisely for targeted value — certain audiences and sites, to whom and where they wish to place their ads. But, this can sometimes lead to inflated bids and lower demand for the publishers’ inventory. That is why it is important to observe the fair market value of the impressions and understand the auction’s mechanics. 

Also, the first-price auction mechanics are still evolving and being implemented, which means most DSPs do not have the technology to differentiate first-price from second-price auction. It can lead to missing essential and valuable ad inventory for buyers.

 

What Is A Second-Price Auction?

In this type of programmatic media buying, if the winning bidder wins, they end up paying the price bid by the second-highest bidder, plus $0.01. Second-price auction models were designed to allow advertisers to purchase ad impressions at an optimal price without having to overpay. And even more — it allows brands to potentially pay less than their initial bid. But these aren’t the only benefits for advertisers.

These are the main advantages of this auction type:

  • Cost Savings: Advertisers can save money and further reinvest in their campaigns for greater reach.
  • Competitive Insights: They can gather data on competitors’ bids to optimise their offers and campaigns.
  • Established Platforms: Many platforms already use this auction model so it is a guaranteed positive user experience for brands.
  • Real-time Optimization: DSP platforms can adjust to marketplace changes and other real-time factors to select optimal bids. This is crucial for advertisers since auctions occur in milliseconds, which is too quick for manual adjustments.

However, brands should be aware that they might miss out on valuable inventory if their bids are too low. They may also remain unaware of the exact clearing prices — the winning bids in the auction.

Despite features like pricing floors and minimum price settings, publishers can lose revenue in a second-price auction. Therefore, the programmatic advertising world is gradually shifting towards a balance that benefits both publishers and brands, leading to the increasing adoption of first-price auctions.

 

First Price Vs Second Price Auction

In real-time bidding (RTB), the second-price auction gives the winner an opportunity to pay slightly less than their original bid. Rather than paying the full amount, the winning bidder pays the second-highest bid plus $0.01, known as the clearing price.

 

Consider this second-price auction example, similar to how it works on eBay:

Bidder A: $4

Bidder B: $4.50

Bidder C: $4.20

Outcome:

Bidder B wins and gets the impression for the clearing price of $4.21 (second-highest bid + $0.01). The reduction, or consumer surplus, is the $0.29 that the winning bidder “saved” on the impression.

This reduction offers bidders an advantage and an opportunity to save when they overestimate the value of the impression. However, due to various floor optimizations and other factors, the pure second-price auction model is rarely seen in programmatic media buying.

 

For comparison, consider this first-price auction example:

Bidder A: $4.00

Bidder B: $4.50

Bidder C: $4.20

Outcome:

Bidder B wins and pays $4.50. In a first-price auction, the winner pays the exact amount of their bid.

 

In the first-price auction model, also known as an English auction, bidders pay exactly what they bid. While this method provides publishers with the highest eCPMs for their inventory, it can result in inflated prices as buyers “guesstimate” their competitors’ bids. This can lead to overpaying and decreased demand for the publisher’s inventory.

Aspect First-Price Auction Second-Price Auction
Mechanism Bidders pay the exact amount of their bid. The winning bidder pays the amount bid by the second-highest bidder plus a minimal increment (e.g., $0.01).
Benefits Gain a first look at valuable inventory through header bidding.

Pay the actual value for specific sites or audiences.

Potential for higher eCPMs for publishers.

Savings from paying less than the highest bid.

Access to data on competitors’ bids to optimise future bidding

Established infrastructure for smooth operations.

Utilisation of DSP technology for real-time bidding adjustments.

Limitations Difficulty in determining true market value due to publisher price floors.

Potential for overpaying or missing out on inventory due to bid estimation.

Slower site load times and compromised user experience.

DSPs lack the technology to differentiate auction types or combat SSP price floors.

Lack of transparency if bid does not win (no visibility into clearing price).

Risk of missing valuable inventory with static bidding approaches.

 Dependency on bidding algorithms and market conditions

Example Advertiser A bids $2.00

Advertiser B bids $3.00

Advertiser C bids $4.00 (Winner = pays $4.0)

Advertiser A bids $2.00

Advertiser B bids $3.00

Advertiser C bids $4.00 (Winner = pays $3.00)

Bid Shading

Bid shading is a widely used strategy by buyers in first-price auctions to prevent overpaying.

This technique, developed to address the complexities of header bidding, takes the highest possible bid and forecasts the market value of an impression to determine the appropriate bid price to submit.

Bid shading algorithms consider various factors besides pricing data, including the site, ad size, exchange, and competitive dynamics. When win rates drop, the algorithm increases the bid price.

Publishers are responding to bid shading by implementing intelligent price floors (the lowest price a publisher will take for its inventory).

 

First Price Or Second Price Auction For Advertisers?

Advertisers face trade-offs in transparency and cost-effectiveness when deciding between a first-price or second-price auction in programmatic ad buying. The first-price auction offers transparency by revealing the true cost of impressions and fees, but it may lead to overpayment if advertisers bid higher than the actual value of the impressions. 

Contrary to that, second-price auctions involve paying slightly above the bid of the second-highest bidder. Potentially, this saves money but lacks transparency in some cases. 

Advertisers should carefully consider their priorities: transparency and knowing costs upfront (first-price) or potentially lower costs with less visibility into final prices (second-price). 

 

First Price Or Second Price Auction For Publishers?

First-price and second-price auction models offer distinct advantages and challenges for publishers in programmatic advertising. 

The first-price auction allows publishers to earn higher revenue without bid reduction, offering transparency and compatibility with header bidding for competitive bids. But, it may incentivise buyers to shade their bids lower to save costs, potentially reducing overall revenue. 

While the second-price auction initially appears simpler, it can lead to unpredictable bid outcomes and reduced revenue clarity for publishers.

Publishers must weigh the benefits of higher upfront revenue against potential bid shading and bid density issues when choosing between auction models.

 

Conclusion

This guide provides you with a comprehensive overview of First-price and second-price from top to bottom. With these key insights, you will be able to easily navigate through the complexities of digital advertising. Remember to stay alert with market trends and  you may find it easier to boost your sales or invest in the right advertising.