What is a Second Price Auction and How Does It Work? [VIDEO]
Matt Kaplan Content Strategist
5 min read
Posted on October 24, 2018
Watch Our Whiteboard Video About Second Price Auctions
Among all of the mobile advertising auction mechanisms, perhaps few raise as many eyebrows as do second price auctions. Why is this price auction model used, and how does this type of auction differ from other options like an English auction?
To answer these questions, check out our latest Whiteboard Wednesday video featuring Ryan Gauss, InMobi’s Platform Product Manager. This video covers:
How, among all of the ad servers and ad exchanges, a winning bid is determined in a real time bidding-based second price bid auction.
The benefits of truthful bidding.
How advertisers and publishers view this bidding strategy.
How price floors impact the minimum price a bidder pays.
What happens when there are two winning bidders (i.e. two or more advertisers bidding the same price) and who pays the price of the ad in the end.
Welcome to another edition of Whiteboard Wednesday. My name is Ryan Gauss, and I’m the Platform Product Manager here at InMobi. And today we’re going to be discussing second price auctions, specifically what they are, how they work.
So before we get into that, we want to talk about the originations of second price auctions. And they were originally based on what was called a Vickrey auction. Now this concept was then taken by Google and Yahoo! and their advertising products, and it was tweaked a little bit to where we get to today, which is our modern day second price auction, which is used in our programmatic auctions.
Explaining the Second Price Auction Model
And basically what a second price auction is, is that the highest bidder in an auction will pay one cent higher than the second highest bidder. That’s important because what it does is it encourages bidders to bid as high or as high as they can for inventory that they really want.
And the reason that that is important is that because they’re only paying once cent higher than the second highest bidder, the risk to them that they will end up paying that amount that they bid is relatively low. The caveat to that, of course, is that if there’s two bidders that bid high, then the final bid price will end up being high. But that is not a typical situation.
So we’re going to run through a few examples of second price auctions, and show how the final price is settled upon. But before we do that, we want to talk about a couple of elements of second price auctions that are really important because they impact the transparency of the auction and the final outcome price.
So first off, we want to talk about the auction type. And today specifically, we’re going to be focusing on second price auctions. But the two main auction types that are used in programmatic auctions are first price and second price. Now with first price, it’s pretty simple. Whatever the bidder wins who wins the auction, they pay that amount. So they bid $10 and they win the auction, they pay $10. In a second price auction, as we’ve already talked about, the highest bidder who wins the auction will pay one cent higher than the second highest bidder.
Now the auction type is not a required element that has to be sent out in the bid request. But it’s really important that the bidder works with an SSP that always provides the auction type. The bidder wants to know exactly what auction mechanics they are functioning under, so they know how they should be bidding, so they use the correct algorithm. So, if you’re a DSP out there and you’re looking for an SSP to work with, make sure you work with one that always provides the auction type, so there’s no type of ambiguity there about what type of logistics they’re functioning under.
The other element we want to talk about before we get into our examples is the bid floor. Now the bid floor is also another element that is not required. But, without it, once again there’s a lack of transparency, and the bidder’s a little bit in the dark to try to determine how much they should actually bid. What the bid floor is is the minimal amount that a bidder must bid in order to be eligible to win the auction. So, if the bid floor is $2, the bidder must bid at least $2 or higher to be eligible to win the auction.
How a Second Price Auction Mechanism Works
So now that we’ve kind of defined some of our basic elements of a second price auction, let’s run through a few examples.
In our first example right here, we’re going to say that there are three different bidders who bid. So the first bidder will say has bid $7, the second bidder has bid $6, the third bidder has bid $5.50, and let’s say there’s a bid floor of $5. In this auction, bidder #1 is going to win the auction because they bid the highest. But, they’re not going to end up paying the $7 that they bid. They’re only going to pay one cent higher than the second highest bid, which would be $6.01.
In our next example, there’s only one bidder. So let’s say again bidder one bids $7, and there’s a floor of $5. In this example, the bid floor acts as the second highest bidder. So bidder #1 will win the auction again, but they will pay $5.01.
Now in our last example, we have two bidders that have bid, but they bid the exact same amount. So let’s say they both bid $7, and once again we have our bid floor of $5. Now the highest and the second highest bidder in this case have bid the same amount. So we cannot add one cent to the second highest bid because that would make it $7.01, which would we higher than either of these bidders had bid, and we can never charge a bidder higher than what they actually bid. So the final price in this auction will end up being $7.
Now in a case like this, where the highest bid is equal between two bidders, who wins the auction really depends upon the logic that is set at the SSP level. But the typical way that it’s resolved is that one of the two that bid the same amount is randomly chosen to be the winner.
So now that we’ve run through some examples, the last thing we want to touch on is bid depth. Bid depth is the amount of bidders that have actually placed a bid and are actually eligible to win the auction.
So bid depth can be seen as either a positive thing or a negative thing depending on the party that is viewing it. So it’s seen as a positive thing by publishers, who are the ones offering the inventory. They want to see greater bid depth because the more bidders that bid in an auction, it drives up the price and increases their revenue. And we can see that in example one right here, where there’s three bidders, and so the final price ends up being $6.01. If we compare that to our example #2, where there’s just one bidder, we have a much lower bid depth, we see the final price is $5.01. So from a publisher’s perspective, they definitely want to see example one, where there’s a greater bid depth.
Now on the opposite side of that, we have our bidders, who want to see a low bid depth because it’s less competitive and the price they end up paying ends up being much less. Once again from a bidder’s perspective, example two will be the better option for them because they’re the only ones that have bid and they will only pay one cent over the bid floor. Whereas in example one, where there is much greater bid depth and much more competition, they’re going to end up paying a higher price.
So that’s what we wanted to cover today with second price auctions. We hope this has given you a better idea of how they work, how they originated and where they’re going. And we’ll see you next time, in our next edition of Whiteboard Wednesday. Thank you very much.