First price auction, Second price auction and the one in the middle
Updated: Oct 16 2021
For years second best bids model (aka second price auctions or Vickrey auction) rules the online media market. It means that when advertisers win an auction for an ad space they don’t pay the bid they actually offered but the 2nd best bid (plus one cent).
If Google is doing it and Yahoo is doing it and Amazon is doing it then it’s probably right.
The reason we are talking about it now is that Google just announced that they are about to change their Adsense auction from 2nd best bid to first and this might start a snowball effect. Oh, advertising on Google, including product listing ads, remains with the 2nd best bid model. For now.
Regardless of Google’s announcement, in the last 2 years as ecommerce media is booming (especially Sponsored Product Ads) the model’s absolute sovereignty is being challenged.
This is a good opportunity to give it a deeper look.
Walmart goes first
Trying to catch up with Amazon’s advertising success, Walmart offers a first price auction model to it’s sellers who want to promote their products.
Target is also selling ads on first bid auction and so are many other big retailers.
eBay who is already generating $1 billion a year from promoted listings offered sellers until recently a CPA model where the sellers pay their selected ad rate when their promoted products are being purchased but now started to offer also CPC campaigns (using a second-price auction for now). Kroger, Instacart and Ubereats are also using 2nd best bid auction.
First time Second
The founder of the 2nd best bid auction was not a Google analyst nor a mathematician. He was a German poet and his name was Johann Wolfgang von Goethe.
In January 16. 1797 he tried to sell a poem he wrote to a local publisher.
“I will write down the price that I want for the poem and seal it in an envelope”, wrote Johann to the publisher.
“Then you will write down the price that you are willing to pay for my poem. If the price is lower than the price I quoted and sealed in the envelope you will not get my poem and we will say our goodbyes but if it is higher than my quote you will get the poem and you will only pay the quote that I have written in the envelope.”
And thus the 2nd best bid auction was invented.
100 years later it was adopted by stamp collectors and 100 years later it was adopted also by Google.
The advantage of the 2nd best bid auction is that in theory there is one dominant strategy for winning it and that is to bid the true value of the item that you bid for. Following this strategy will ensure the bidder that they will get the best possible result (regardless of what the other bidders do).
There is no case in which you could get a better result if you offer a bid that is higher or lower than your actual value. This is a nice exercise. Try it.
First price auction does not have a dominant strategy and that is why Google and the others adopted this type of auction.
Nice theory but …
The thing is that we are talking about real time bidding (for advertising) in scale where hundreds or thousands of advertisers and sellers are bidding in order to promote their products.
It’s not obvious that this game theory applies in this case and that the sellers are following the dominant strategy for this type of auction.
In a study we conducted during the first week of July we examined 20 different eCommerce sites that sell Sponsored Product Ads and looked at the total highest bids and the total 2nd best bids of all the ads that were clicked on during that week.
We found that the average winning bids were 20% higher than the average actual price that was paid by the sellers (the 2nd best bids).
In some stores the number was much higher, especially in those that didnt have a lot of active sellers and campaigns to fill in all the ad slots in all the categories. In many cases the advertisers had no competition (especially in the long tail categories) so they paid the min bid that the store defined (which could be as low as one cent).
Who wants to go first?
It means that the stores could have theoretically gained 20% more revenue from their Sponsored Product Ads if they used first bid auction instead of 2nd best bid.
However if they do move to 1st bid auction and charge their sellers and advertisers 20% more (on average) it will effect the ROAS (return on ad spend) and might drive some sellers and advertisers to change their bidding strategy or limit their monthly budget.
Since the average ROAS of Sponsored Product Ads (for promoting products) is still way above the average ROAS of other advertising channels, moving to 1st bid might have a positive effect on the stores even if some sellers pause or limit their campaigns.
Does that mean your store should switch to 1st bids auction?
The best of both worlds
The answer to the last question is No.
The safe decision would be to follow the market – As long as Amazon and Google are using 2nd best bids for their product ads there should be no rush to switch your store’s offering to a model that is worse for the sellers and advertisers.
However if you are interested in maximizing your short term revenue (knowing that it would hurt your sellers ROAS and effect their satisfaction) you should consider it.
There is also a third option that enables your store to maximize the ad revenue without hurting the sellers ROAS!
Mabaya offers another bidding model – Match ACoS auction. In this auction type we look at the 2nd best bid and the CPC (cost per click) that is required to reach the store’s average desired ACoS (Advertising cost of sale which is the opposite of the ROAS – a figure that the store defines in the settings) and then charge the highest of these 2 numbers.
Here are 3 examples –
- Seller A bids $1
- Seller B bids $2
- The store avg desired ACoS is 10% and in order for the seller to reach it when selling this type of product the CPC should be $1.2.
In this case seller B would win and he pay $1.2. This is way below what he is willing to pay ($2), it will get him a good ACoS (10%) and the store would get more than $1.
- Seller A bids $1
- Seller B bids $2
- The store avg desired ACoS is 10% and in order for the seller to reach it when selling this type of product the CPC should be $0.8.
In this case seller B would win and he pay $1.
- Seller A bids $1
- Seller B bids $2
- The store avg desired ACoS is 10% and in order for the seller to reach it when selling this type of product the CPC should be $3.
In this case seller B would win and he pay $2.
Johann Wolfgang von Goethe was not only a smart trader but also a smart poet with good observations.
Therefor until you decide whether to offer a 1st bid auction, 2nd bid auction or the Match ACoS auction we recommend to follow his old advice: “One ought, every day at least, to hear a little song, read a good poem, see a fine picture, and, if it were possible, to speak a few reasonable words”.
Sounds reasonable 🙂
Mabaya offers a white-label self-service Sponsored Products Ads platform for online retailers and marketplaces that enables sellers and brands to bid in order to ensure their products are listed in premium locations in the online store.
The platform is integrated in more than 50 ecommerce sites around the globe (such as Bol.com, Jumia, Manomano, Kaufland, Hepsiburada, Falabella etc.), serving more than 60,000 advertisers and sellers.