Why should publishers care about bid shading?

Bid shading has once again become a hot topic in the programmatic advertising world. It’s a technique used by demand-side platforms (DSPs) to “bridge the gap” between the actual cost of ad impressions and what advertisers are willing to pay. This undoubtedly affects publishers’ overall ad revenue.

This technique is used in first-price auctions to make ad campaigns more cost-effective. However, it’s not all bad news for publishers. That’s why it’s important to understand how it works, so you can use it to your advantage.

What exactly is bid shading?

Bid shading is a predictive algorithm used by DSPs to locate and choose the best bidding price for ad impressions. Of course, that’s for the instance of first-price auctions, which we’ll get to in just a moment.

Bid shading prices are decided upon by DSPs. This is accomplished by studying the bid-history data to understand which bid rates would normally win on specific websites or in specific ad locations. It’s also done to figure out at what prices these bid ranges normally lost. In fact, this is another contributing factor in deciding what a bid should be.

Ultimately, the goal is to appease buyers that are unhappy with having to pay much higher prices in first-price auctions compared to second-price auctions.

Now let’s clarify the difference in second and first-price auctions to better understand the why behind bid shading:

Second-price auctions

In a second-price auction model, the highest bidder wins.

While this may sound like a no-brainer, the final price in second-price auctions is never equal to the initial bid. Instead, it ends up costing $0.01 more than the second-highest bid.

Google AdSense traditionally operated on a second-price auction model. The prices paid by advertisers in cost-per-click (CPC) campaigns ended up being less than their actual bid. However, since 2021, things have shifted to the first-price auction model.

This is because real-time bidding (RTB) and header bidding have come to the forefront of the programmatic ad bidding ecosystem. Allowing publishers to open up their ad inventories for bidding to multiple SSPs and ad exchanges at once.

Unfortunately, this has also created complex operational inefficiencies within second-price auctions. Not to mention, they tend to carry hidden fees that are taken by the DSPs or buyers.

Here’s an example:

Let’s say there are three bidders participating in a second-price auction. We’ll call them bidders A, B, and C. Bidder A offers $3, bidder B offers $5, and bidder C offers $4 — all for the same ad inventory.

The highest bid here is obviously $5, but bidder B wins the auction and only has to pay $4.01 for every 1,000 ad impressions. The difference that comes up in the winning bid is called reduction, and in this case, it saved bidder B $0.99 per 1,000 ad impressions on their campaign.

First-price auctions

In a first-price auction, bidders participate simultaneously with the highest bidder being the winner. This winning bid is referred to as the clearing price. The bidder will pay the exact price per 1,000 ad impressions as they bid during the auction.

Unlike second-price auctions, first-price auctions tend to lean more in favor of the publisher. 78% of publishers said they transitioned from second-price to first-price auctions as it helped them to optimize their revenues.

Publishers and advertisers are able to assess the real value of each 1,000 ad impressions to accurately measure their return on investments (ROIs). This also provides a clear and concise outlook in each auction as it lets both parties know how much an ad inventory is worth and exactly how much is being bid.

Here’s an example:

Using bidders A, B, and C again, let’s say they set a price of how much they’re willing to pay for 1,000 ad impressions of a particular inventory. Bidder A offers $3, bidder B offers $5, and bidder C offers $4.

With the highest bid being $5, bidder B wins the auction and pays the publishers $5 per 1,000 ad impressions. And this is before any relevant stakeholders like SSPs and DSPs take their cut for helping out with the sale.

As you can see, the primary differences between first and second-price auctions are transparency and pricing. Publishers tend to lose out in second-price auctions due to bid reductions.

It should be noted that different exchanges will manage auctions differently. However, first-price auctions will always offer greater transparency and fair competition among buyers.

Who participates in bid shading?

In 2018, Google’s DV360 provided the ad tech ecosystem with a free tool to optimize fixed CPM bidding. Around that same time, The Trade Desk not only offered bid shading, but charged DSPs for its algorithm (Koa). MediaMath was another major player that started providing bid shading capabilities, following Rubicon Project (now Magnite) and PubMatic.

Generally speaking, both publishers and advertisers have had an increasingly difficult time figuring out how to handle ad inventories accurately ever since programmatic advertising was introduced to the ecosystem.

Because of this, major ad exchanges such as Index Exchange, OpenX, and Magnite switched to first-price auctions. With Google Ad Manager joining the crowd as recently as 2019.

Ultimately, it’s the advertisers and their DSPs who participate in bid shading. These techniques put more power in their hands in regards to advertising spend while stabilizing demand for publishers’ ad inventory.

Why should publishers care about bid shading?

By now it’s probably obvious that bid shading can negatively impact your ad revenue as a publisher. In second-price auctions, advertisers were not obliged to pay the full bid price. As a result, publishers took a monetary hit due to the “discount.”

For a while, you would’ve been able to secure higher CPMs through first-price auctions. But with bid shading, your CPMs may have taken a hit.

Bid shading also comes up when the sell-side attempts to implement supply-path optimization (SPO). SPO attempts to solve the following question, “What is the best and most direct source for an advertiser to buy an impression from?” Every additional platform or vendor involved in buying and selling an impression comes with their own fee for their services.

In a straight path scenario, fewer middle people between the advertiser and publisher may result in fewer cuts. However, given bid shading, the buy-side aims to buy the impression for as low as possible, which isn’t great news for publishers.

One way to combat bid shading is to implement price floors. This prevents advertisers from lowering their bids to the lowest possible winning price.