In the world of programmatic ad buying, bid shading is having a bit of a moment. This long-standing auction practice, in which a bidder “shades,” or lowers, a bid to ensure he or she isn’t paying more than an item is worth, has been updated for the ad tech world: Supply-side platforms (SSP) and demand-side platforms (DSP) alike are increasingly providing users with bid shading services that are powered by algorithms.
To understand why bid shading is suddenly a hot topic, you need only look to recent shifts in how ad inventory is sold. Once dominated by second-price auctions, the industry is now turning to a first-price model — and with that change has come widespread concern about the cost of impressions.
A Tale of Two Auctions
In early March, Google announced that it was “simplifying programmatic” by switching to first-price auctions for Google Ad Manager by the end of 2019. In a first-price auction, the price of an ad impression is set by the highest bidder, meaning that the highest bidder pays exactly what they said they would pay for the impression. Or, as Google puts it, “An advertising buyer’s bid will not be shared with another buyer before the auction or be able to set the price for another buyer. The buyer that wins the auction pays the price they bid.”
First-price auctions may sound straightforward, but they can result in an advertiser overpaying for an impression: The highest bid might be much higher than the second, for instance, and the winner would have no way of knowing. In fact, first-price auctions result in a 59% higher cost per impression (CPM) than second-price auctions.
In a second-price auction, prices are determined by the second-highest bidder. The highest bidder wins the auction, but pays the price submitted by the runner-up — plus one cent — for an impression. Second-price auctions — also called Vickrey auctions for the Columbia University professor who first wrote about them in 1961 — have long been used in programmatic ad buying. However, hidden costs like buyer fees can be added unnoticed to the price of impression, since the auction winner doesn’t know the amount of the second-highest bid.
The Bid Shading Compromise
Google’s move to first-price auctions reflects an industry-wide trend: 43.3% of impressions were sold through first-price auctions last year. Consequently, the fear of overpriced impressions has led to a compromise of sorts called bid shading.
Bid shading is a price-reduction measure employed by ad technology providers. Data related to bid history, the website an ad is placed on, ad size, etc.,are used to determine a bid that beats the competition, while ensuring that an ad buyer isn’t paying more than the impression is worth. Ideally, the resulting bid falls somewhere between what would have been paid in a second-price auction and a first-price auction.
Of course, the resulting bid isn’t the perfect bid. As marketing agency Hearts & Science pointed out in a recent study of first-price auctions, no one platform in the programmatic advertising supply chain has all the data needed to flawlessly execute bid shading. For example, DSPs do not have access to bid data from other DSPs, and SSPs similarly do not have information about bids received by other SSPs.
Currently, many DSPs and SSPs offer bid shading as a free service, including Google’s own DV360. But as demand increases, this is likely to change.
Cost-Saving Solution — Or Another Problem?
Google’s promise to simplify the programmatic ad buying experience seems at odds with the measures advertisers will have to take to keep costs down. Even if first-price auctions provide clarity around impression price, bid shading will muddy the waters again: Buyers will have to rely on a platform’s bid calculations, which come in many forms and live in a black box.
However you feel about bid shading, it appears to be performing as intended. The practice has reportedly saved advertisers up to 20% on CPMs. This could offset a trend that Pathmatics data shows: This year, average daily CPM for Google ads has risen 9%, and CPM for Amazon ads is up more than 20%. As the programmatic landscape continues to move to first-price auctions, advertisers who don’t adjust their bidding strategies to this new reality will end up paying the price.