How to price an Ad to its true value by using Ad Auctions

Michael Ostrovsky, Co-Founder and Chief Scientist

June 22, 2022
5 min read
Auction Based Ads

Pricing at true market value

Do you run out of ads to show to your users? Or, conversely, run out of space on your website or app to satisfy all of the demand from advertisers that you have? You are not alone. Fixed-price guaranteed delivery ads are rarely priced right: to do so would require a magic 8-ball that could foresee all the changes in demand, supply, market conditions (and everything else under the sun). Fortunately, there is a solution to this problem.

Ad auctions have sufficient flexibility to adjust to changing market conditions, and most importantly, adjust to reveal the true market value of your advertising space. Hint: it may be much higher than you think.

Dell’s acquisition of 3PAR

On August 16, 2010, Dell announced an acquisition of data storage company 3PAR, for $1.15billion, representing an 87% premium over 3PAR’s latest market price ($18 per share vs. $9.65 at market closing). This initially looked like a fairly standard acquisition, with a very nice premium going to 3PAR’s shareholders, who were very happy with the price that, if anything, exceeded the company’s value to them. However, things were about to take an unexpected turn.

A week later, on August 23, Hewlett-Packard entered the picture and made an offer to acquire 3PAR for $1.5 billion ($24 per share)—a 30% markup relative to the already-high price offered by Dell.

Three days later, on August 26, Dell responded with $24.30 per share. It took a day for HP to respond with $27.00—only for Dell to immediately match it. HP came back in 90 minutes with an offer of $30 per share.

On September 2, after much deliberation, Dell increased its offer to $32 per share and HP responded with $33, valuing 3PAR at $2.4 billion—much higher than the initial price offered for the company (and happily accepted by shareholders)!

From M&A to Internet Advertising

There is no doubt that if 3PAR’s management tried to price the company in advance, or tried to negotiate with just one potential customer, there is no way they would come even close to that value. Of course, the reason why they were able to ultimately receive it is very clear—the bidding war between Dell and HP led them to make the best offers they could, in the process uncovering the true value of 3PAR. That is the magic and power of auctions: they help sellers uncover the true value of the items they have for sale.

Internet advertising is no different. Search engines like Google and Bing and top e-commerce marketplaces like Amazon and Alibaba have generated tens and hundreds of billions of dollars by running ad auctions for ad slots, uncovering the true value of their inventory in the process.

Remarkably, ad auctions allowed them to achieve these results without having to explicitly price that space. While flat-rate, fixed-pricing advertising is also present on the Web (and was in fact the original way online advertising was sold), it is overshadowed by auction-based systems.

The reason is simple: pricing is very hard.

Justifying a 2.4Billion Price Tag

Put yourself in the shoes of the management of 3PAR before the bidding war between HP and Dell started. Would you be able to price the company correctly? Would you be able to ask, with a straight face, that HP pay you $2.4 billion for the company—several times the company’s value at market closing? In fact, HP probably wouldn’t be able to justify paying such a high price to its board!

It is the auction between HP and its competitor that helped uncover the company’s true value and made the deal happen at such a high price.

Selling advertising at fixed prices is no different. You have to make all kinds of guesses to figure out the price—and then buyers will try to negotiate the price down. You will find yourself having to justify the prices all the time: buyers may claim that they are too high, your management may push that they are too low, etc. And in the end, you are bound to set the price incorrectly, simply because the world is complex and always changing.

How Ad Auctions Price Ads

If your prices end up being too high, you will find yourself with unsold inventory, wishing that you charged less. If your prices end up being too low, you will find too much demand from advertisers, resulting in suboptimal revenue and annoyed partners who cannot get ad space at published prices. The problem is compounded by the fact that the true value of that space may vary by geography of the user, time of day and day of the week, the exact location of the ad, and a bunch of other factors. All of this results in an astronomical number of possible combinations (and thus possible prices)—each of which is hard to get right.

By contrast, ad auctions resolve all of these issues naturally and organically. Advertisers submit their objectives and valuations to the auction system. These objectives and valuations can be changed at any time, giving advertisers a lot of flexibility.

The auction system then sells ad impressions in real time, to those who value them the most. Most importantly, the price at which ad space will be sold will be automatically set by the auction—it will be determined by market competition, with the auction serving as a powerful and accurate price discovery mechanism. In some cases, demand from advertisers will be low, and the price will naturally below as well. In others, demand will be high, and advertisers may naturally increase the price given there are limited eyeballs. In both cases, prices will accurately reflect the true value of the ad space—without the platform having to rely on the magic 8-ball to predict them.

Ad auctions work incredibly well in a variety of settings, have an almost-magical ability to adjust to market conditions, and automatically discover prices that reflect the items’ true market value.

Online advertising is no exception: auctions in such settings work remarkably well and are responsible for some of the most notable business successes of the past two decades. Topsort is here to offer the exact transition or solution you need to deploy an auction-based advertising model and price right at the market’s true value.

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