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

When they have to participate in first-price auctions, they should practice bid shading – where 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.

This post was syndicated from Ad Exchanger.