How do First Price and Second Price Auctions differ?

There is a lot of talk in online advertising about First Price and Second Price auctions. The difference between the two is simple, but there is more to know about the two auction formats than just understanding the mechanics. Given that almost half of all digital advertising buyers and sellers don’t understand the difference between First Price and Second Price auctions (source), we’ve produced this guide to explain the difference and the impact that each has on publisher earnings.

How First Price auctions work

First price auctions work exactly how we intuitively expect an auction to work.  One or more potential buyers make a bid, the highest wins and they pay the price that they bid.

How Second Price auctions differ

Second price auctions are designed to give buyers confidence to bid their best price without overpaying. If we re-run the above auction using a second price approach then the outcome is slightly different. Bidder B still wins, which makes sense as they submitted the highest bid. However, their price is set by the next highest bidder. The winner pays one penny more than the next highest bid. In this case Bidder B wins and pays $2.51.

Are Second Price auctions worse for publishers?

In the above example, the publisher lost out on $0.49. That was a 16% drop in revenue from the same three bids, and no such comparison will show the first price auction being better for the publisher. Such auction-specific examples do miss a key point though. Google AdSense is famously a second price auction. The theory is that advertisers can set their bids to the highest value that works for them, knowing that they will only pay that price if it is absolutely necessary to secure the impression. This supposedly pushes bids higher, satisfying publishers whilst ensuring that advertisers never overpay.

What is driving the change in auction dynamics?

Currently, Google Ad Manager primarily runs the Second Price auction model, which enables buyers to bid to their true maximum without the worry of overpaying. Because of this, bidders tend to submit higher bids which benefits the publisher. This model was initially implemented by Google as they believed that it provided a better overall reflection of the market value of publishers’ inventory. However, Google announced earlier this year that they will be transitioning to First Price auctions by the year end.

The change in auction dynamics has been driven by emerging practices inside the digital ad space, which have led to an unfair playing field. According to Google, this transition will simplify the programmatic ecosystem, creating a more fair and transparent environment for both buyers and sellers. On the buyer-side, First Price auction models enable advertisers to equally compete for publishers’ inventory. On the sell-side, publishers benefit from First Price auction models because buyers are bidding fair value that is reflective of the true value of publishers’ inventory.