Second Price Auction

What is second price auction

In programmatic advertising, advertisers (or buyers) purchase inventories from publishers (or sellers) through bidding. The most commonly practiced bidding in this scenario is the second-price auction.

The second price auction is when the highest bid (the winner) has to pay only one cent more than the second-highest bid. The winning bid need not pay the total price that they bid on.

How does the second price auction work

Let us examine the workings of this bidding method with a second price auction example.

There are three major bids for an inventory. They are as follows.

• Bid A: $120
• Bid B: $160
• Bid C: $140

Here, the winning bid is Bid B. The ad inventory will be sold to Bidder B. They will not pay $160. They will only pay a cent more than the second-highest bid. Bidder B will pay $140.01 in total to the publisher.

Let’s examine the case of a second price auction when there is only one bidder. If the bidder makes a bid of $10 and the floor price is just $8, then the bidder will only have to pay $8.01 for the inventory.

First price auction vs. Second price auction

We examined how second-price auctions work. First-price auctions are slightly different from second-price auctions on many accounts. They are:

1. Pricing Model: The first price auction will require the bidder to pay the exact amount, regardless of what the other participants bid. Second-price auctions require the winner to pay 1 cent more than the second-highest bid.
2. Incentives for bidding: In the first price auction, biddes can shade their bids below their true value. Advertisers can submit bids lower than they are willing to pay to secure a lower price and maximize profits. Bidders are encouraged to bid their true value in the second price auction. Since the winner will only pay a cent more than the second-highest bid, they can confidently submit their maximum bid.
3. Transparency: Bidders opting for first-price auction must assess market conditions, predict participants' behavior, and adjust their bids to maximize their chances of winning. In the second price auction, the focal point is submitting the true values, as shading bids are not beneficial.
4. Revenue generation: The first price auction generates higher revenue for publishers since winners pay the full bid amount. But some bidders can offset this by shading bids and reducing the overall competition. In a second-price auction, publishers might receive lower revenues and can since the winning bidder pays a cent more than the second-highest bid. But the transparent nature of the auction can attract more bidders and encourage strategic bidding.

Advantages of second price auction

• Simplicity: It is relatively straightforward to implement a second-price auction. This makes it easier for advertisers and ad exchanges to understand and participate in the auction process.
• Strategic bidding: The second price auction encourages advertisers to bid their actual ad placement value strategically. This helps ensure that the winning advertiser is ready to pay more than other bidders, thus providing the ad placements a fair deal.
• Cost efficient: Second price auctions are cost-efficient. The winning bid reflects the actual market value of the ad placement, which can lead to fair pricing and efficient allocation of ad inventory. This will, in turn, benefit both advertisers and publishers.
• No shading of bids: In the second price auction, the incentive to shade bids (submitting lower bids than the true value of the inventory) is less. Advertisers are more likely to submit the true values leading to higher revenue for publishers.

Disadvantages of second price auction

• No revenue certainty: In second-price auctions, publishers can experience uncertainty in revenue collection. The winning bid determines the price, and publishers cannot accurately predict the revenue they will receive from each ad placement.
• Inefficient auction dynamics: Bidders will strategically adjust their bids based on market knowledge, participants, and more. It can distort the auction outcomes and lead to subpar results.
• Complexities in bidding strategies: Second-price auctions are problematic for advertisers since optimizing bidding requires understanding other bidders' behavior and adjusting one's bids accordingly. So this will prove difficult for advertisers aiming to maximize their return on investment.
• Bid sniping: In second-price auctions, "bid sniping" or placing last-minute high bids to win the auction by a narrow margin can be practiced. It can discourage fair competition among bidders.