Bid shading is a term that’s suddenly showing up everywhere in ad tech as the industry-wide shift from second-price auctions to first-price auctions is taking place. So, what exactly is bid shading? And how does it work? How does it affect advertisers and publishers?
That’s what we’re going to discuss in this post.
Moving from the second-price auction world
Before we dive into what bid shading is, we first need to understand the reason it emerged. For a long time, second-price auction has been the industry standard in ad tech. Under second-price auctions, the buyer pays one cent more than the second-highest bid, while under first-price auctions, the buyer has to pay the exact bid they made.
So let’s say we have an auction with three bidders, who bid $10, $8, and $6 respectively for an impression. Under first-price auction, the winning buyer will have to pay the full $10, in comparison, under a second-price auction, they winning buyer will pay $8.01. Second-price auctions protect the buyers from overpaying for impressions.
However, the problem with second-price model is that it makes the auctions more complex and less transparent. Lately, major ad exchanges, including Google, have announced their intention of moving to a first-price model. Since most DSPs are optimized for reducing buyer cost in the second-price world, this shift to the first-price model presents a big problem for advertisers.
What is bid shading?
Bid shading is essentially a feature that enables DSPs and SSPs to reach a compromise when working under the first-price model. Recall the auction example from above, under first-price bidding, the buyer will have to pay $10 for the impressions. But buyers don’t want to pay that.
So the SSP and DSP reach an agreement with regard to the final payout for the winning bid, which is usually placed somewhere between what the buyer might have paid in a second-price auction and a first-price auction. So instead of paying $8.01 (second-price) or $10 (first-price), the buyer might pay $9—a compromise between both of those.
Bid shading was developed to retain buyers who aren’t happy having to pay significantly higher prices under the first-price model that has started gaining traction. “This is a product to soften the blow for buyers, especially DSPs, which aren’t yet configured to operate in a first-price world,” said Matt McIntyre, head of programmatic for EMEA, at Essence.
How does bid shading work?
How bid shading is implemented varies by ad tech vendors, the basic objective is to find and agree on a bid cost that lies somewhere between the first-price and second-price bid.
One way this is done is by taking the mathematical median between the first-price and second-price bid, this is a simple process, but not the most efficient in terms of estimating the best value for the bid. When using this method, in the above auction example, the final bid will be $9.
The other method is to look at previously recorded information such as bid-history, site stats, ad size, and win rates, and then determine the bid based on the estimated value of the impression.
According to figures released by The Trade Desk, Rubicon Project, and Pubmatic, bid shading can help buyers save about 20% in cost reductions with bid shading. Some vendors are offering bid shading as a free feature, while others are taking a cut from the money saved by using it.
How are publishers impacted?
Bid shading is primarily aimed at advertisers, it cushions them from the cost of paying the full amount as determined under the first-price auction model.
Ad tech is a zero sum game, so if advertisers are saving 20%, obviously the publishers are feeling the loss. Before bid shading, buyers did not know how to bid properly under first-price auctions and temporarily overpaid, which benefited publishers. Now publishers are seeing their CPMs fall back down, and this may continue if bid shading algorithms continue to improve.
That said, given that the mid-range bid determined by bid shading algorithms will still be significantly higher than second-price bids, publishers should still get a good payout.