What are Ad Auctions? The Definitive 2022 Guide

Sarah Wheeler
Sarah Wheeler
What are Ad Auctions? The Definitive 2022 Guide

As companies build out their ad businesses, many get lost in the myriad of available auction options, especially after Google’s publicized shift to first-price auctions. Publishers wonder: should they use second-price auction logic? Or first-price? Or, should they abandon auctions altogether and just rotate ads evenly?

To aid in these decisions, this article defines different auction methods, helping publishers decide which model works best for their ad business.

What are ad auctions?

Publishers run ad auctions in order to maximize their revenue. Auction logic is used by the ad decision engine to select the ad that is most likely to deliver the highest payout. If ten advertisers bid for one ad slot, the ad server would select the advertiser who is bidding the most.

Otherwise, the most common ad selection method is what we call “lottery” - aka, ads are picked randomly from the eligible candidates, regardless of what an advertiser is willing to bid. This could also be called “even rotation.” As part of this, each ad may also be assigned a dynamic “weight” to ensure it hits any predefined goals (impressions, clicks, etc.).

Google auctions

Should I run auctions over the lottery method?

Each publisher has different needs and commitments to their advertisers.

You might consider running auctions if:

  1. You have more advertisers than inventory. If you have, say, three advertisers all wanting the same ad slot, have them compete for it (driving more revenue for you). Similarly, if you have only three ad slots per page but nine advertisers, have them compete for those slots.
  2. Your advertisers are asking you how they can drive more impressions. Offering advertisers a way to compete for more impressions through the form of higher bidding allows them to take control of their impressions.
  3. You offer–or want to offer–a way for advertisers to set their own bids. With lottery selection, it’s odd to charge advertisers paying different amounts for the same inventory. Auctions allow advertisers to set their own bids.
  4. You are not guaranteeing impression volumes.

You might stick with lottery selection if:

  1. You guarantee volume. If you promise an advertiser 50M impressions for a fixed amount, you need to fill those. Lottery selection helps ensure they hit their targets versus being reliant on what others are bidding.
  2. You prefer fixed bids. Having advertisers set their own bids is complicated, especially for a fledgling ad platform. It’s simpler to launch with fixed bids (like $10 CPMs) that rotate evenly.
  3. You have more inventory than advertisers. Like how more demand than supply can lead to a bidding war, the flipside could lead to a race-to-the-bottom, where they know they can pick up inventory at low bids. Using lottery with fixed bids helps ensure there’s a “floor” amount you make.

Essentially, auctions are optimized to maximize your revenue when demand outpaces supply, whereas lotteries are better when your pricing model is simpler, with fixed bids or guaranteed volume amounts.

What types of auctions are there?

There are two main kinds:

1. First-price:

First-price auctions are straightforward: what you bid is what you pay. If three advertisers bid $2.00, $2.50, and $3.00 respectively, $3.00 is the winning bid, and the advertiser pays $3.00, as seen in this example. First price auction example

Publishers use first-price auctions because they:

  • Offer you a greater revenue potential. You make what the advertiser bids, even if the next highest bid was substantially lower.
  • Are becoming more popular. Google, for instance, recently migrated from second-price to first-price auctions.

2. Second-price:

In second-price auctions, the winning bid pays $0.01 more than the second-highest bid. If advertiser A bids $2.10, B bids bid $2.80, and C bids $2.50, B would win and pay just $2.51 ($2.50 + $0.01). Second price auction example

At first glance, this may seem inferior to first-price, but there are reasons to contemplate second-price.

Publishers use second-price auctions because they:

  • Are advertiser-friendly. Advertisers prefer second-price auctions because they won’t overpay for impressions. Lower prices will naturally lead to better downstream metrics too (cost per click, cost per action, etc.), which could keep them spending with you.
  • Ensure truthful bidding. If your advertisers know you do first-price, they may try to game the system via “bid shading,” where they estimate the market price of the impression, versus bidding what it’s actually worth to them. There’s a chance aggressive bid shading across the board could lead to less revenue than a second-price model (in response, publishers often implement bid floors). With second-price, however, there’s no reason to do bid shading; the auction will determine market value automatically.
  • Historically are more common. Advertisers are accustomed to second-price platforms, but as noted above, the industry is changing. With Google going to first-price, others will certainly follow.

Does pricing model impact whether you should do auctions?

Whether you want to do first or second price auctions, employing auction logic for selecting a winning advertiser can get tricky based on your pricing model.

The simplest method is to have all your advertisers bid via CPM (cost per thousand impressions). You’d then select the advertiser with the highest bid, maximizing your revenue.

But what happens if you want to offer CPC (cost per click) bidding, where advertisers set their desired CPCs? This adds a level of complexity, as the highest bidder doesn’t necessarily maximize your revenue. If someone is willing to pay $10 per click but nobody clicks on their ads, you make $0 from them. Meanwhile, if someone is willing to pay only $1 but gets clicks, you are better off selecting the $1 bidder.

With CPC bidding, therefore, the bid is important, but so is the expected click-through rate (CTR). And if you want to do cost-per-action bidding (CPA), you also have conversion rates to consider.

As you build your ad business, we don’t recommend writing a non-CPM auction algorithm yourself. It’s difficult and involves having to calculate an expected-cost-per-mille (eCPM) based on historical performance for every ad. Instead, we recommend working with a third-party ad server, or, if you want to build the ad platform in-house, integrating with Kevel to get all that logic instantly.

How do I get started?

If you work with a third-party ad server - or use Kevel’s ad infrastructure APIs - you get auction logic out-of-the-box. Depending on the tool, you should have the ability to toggle first or second-price, as well as set rules for auctions vs. lottery/even rotation.

If you want to build auction functionality yourself, we recommend working with a data scientist to develop the algorithm needed for more complex auction decisioning. Your tech team would then need to incorporate this logic into your ad selection engine.

Of course, that path could take months and countless engineering hours. It takes time to customize auction logic and ensure it’s up-to-date with current tech innovations.

That’s why companies like Ticketmaster, Klarna, and Yelp are increasingly turning to Kevel to easily incorporate auction logic into their in-house ad platforms. To learn more about how to do it too, contact us today.

Sarah Wheeler
Sarah Wheeler

Sarah is an experienced writer with a software background, allowing her to translate between ad tech experts and lay readers. As Kevel's Associate Product Marketing Manager, she helps broadcast new products and features.