Common Problems with Second Price Auctions [VIDEO]

Is there a problem with second price auctions? While it has some good things going for it, it can - and has been - manipulated.

In this latest Whiteboard Wednesday video, Ryan Gauss, the Platform Product Manager here at InMobi, explains how the highest bid can be secretly tweaked, alternatives to the second price auctioning model and what demand-side platforms (DSPs) need to know before selecting a supply-side platform (SSP) to work with.

Transcript:

Hello, and 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 talk about flaws of second price auctions.

In our previous Whiteboard Wednesday, we talked about second price auctions, what they are and how they work. And today we’re going to talk about different flaws in them, what some of the benefits are and weaknesses, and how they can be manipulated.

So first off, let’s focus on the benefits of second price auctions. As we mentioned previously in our Whiteboard Wednesday, the main benefit of them is it allows bidders to bid high for the inventory they really want, with relatively low risk that they will end up paying that amount, because they’re only going to end up paying one cent over the second highest bidder. So what ends up happening the majority of the time is they pay a much lower amount than they originally bid.

Now let’s take a look at the weaknesses. So there’s two main weaknesses that are typically mentioned when we talk about second price auctions. The first one is that bidders do not know what the other bidders or bids are that are coming into the auction. There’s no transparency. There’s no insight. And the problem with this is it really opens up the auction for manipulation. We’re going to go through a couple of examples and show how it can be manipulated.

The other potential downside and weakness of second price auctions, and we’re not going to spend really much time discussing this today, is that if a second price auction bidder must compete in multiple auctions, they really are at a disadvantage. And typically we see this come into play often when we’re talking about header bidding. So in header bidding, a bidder might have to go ahead and compete in multiple auctions, and in that case, they’re at a big disadvantage. So we’ll leave that for a future Whiteboard Wednesday that show how that functions, but that’s just one other potential weakness that we want to point out.

So let’s go through a couple of examples of how a second price auction can be manipulated. So the first example we’re going to do is we have an auction, and let’s say there are three bidders. So bidder one bids $7, bidder two bids $6, bidder three bids $5.50 and the bid floor is $5. Now, bidder one is the highest bidder, but they have no knowledge of what these other bidders have actually bid, so they don’t know that bidder two has bid $6. There’s no transparency, there’s no insight.

So what can happen is, the SSP can submit an artificial - or a fake or a dummy - bid. So what I mean by that is once all these bids have come in, if the SSP wants to drive up the price so they gain more revenue for themselves, they can go ahead and submit a fake bid at, say, $6.50. So this becomes the new second highest bidder, and so it inflates the price that bidder one will end up needing to pay.

So before this fake bid was submitted, bidder one would win the auction and pay $6.01. But now that this fake and dummy bid has been submitted, the final price for bidder one becomes $6.51. So you can see right there that this auction has been manipulated. Bidder one ends up paying more than there’s supposed to have to pay, but because bidder one has no insight on to the other bids and who else is bidding, this is virtually impossible to detect. So this is a very, very difficult thing for bidder one to figure out, but it is definitely a way that it can be manipulated.

Now let’s look at another example of how a second price auction can be manipulated. In this example, bidder one is going to bid $7. But, in this case, the bid floor is not actually sent out in the bid request. It’s not a required field, but if it’s not there, obviously there’s a lack of transparency and it opens it up to this other possible way of manipulation. So what can happen in this case without a bid floor being sent out is when bidder one submits their bid at $7, the SSP can now artificially raise the bid floor and end up getting more revenue.

So to put a more concrete example to our scenario right here, let’s say bidder one submits $7, and initially the bid floor was $5. The auction is held. Only one bidder sends in a price of $7, and now the SSP says, I’m going to raise that floor say, all of a sudden, $6. Now bidder one has no knowledge that the bid floor has been raised, because they never received the initial bid floor. So now, instead of the original closing price being $5.01, which would have been one cent over the original bid floor, the final price now becomes $6.01. Now, once again, bidder one is paying more than they should have to pay, but because they have no insight into what is happening within this auction, it is virtually impossible for them to detect what is actually happening.

So because of the different ways that a second price auction can be manipulated, more and more DSPs are starting to move towards first price auctions. And in a first price auction, a DSP, if they win the auction, will end up paying exactly what they bid. They may end up paying a little more that they would in a typical second price auction, but they know exactly what they’re going to pay if they win.

Another possible auction type that’s starting to come into play is what’s called bid shading. And we’re not going to go into an explanation of that, but basically what bid shading is, it attempts to split the difference between a first price auction price and a second price auction price. But once again there’s still some lack of transparency in that because when that price is split in between that, that’s decided by the SSP, and once again the DSP really has no insight into that and what else is happening as far as other bidders in the auction.

So because of all these potential weaknesses and manipulation that can happen in a second price auction, it’s really important that DSPs have trust, and know and have a lot of transparency into what is actually happening in the auction. So we would encourage all DSPs out there: before you start working with an SSP, to make sure that they’re always providing the auction type, a bid floor, and that they know and trust the SSP they’re working with.

That’s all for today. Thank you very much. We’ll see you next time.