Competition between demand-side intermediaries in ad exchanges (2014)

Online advertising constitutes one of the main sources of revenue for the majority of businesses on the web. Online advertising inventory was traditionally traded via bilateral contracts between publishers and advertisers, vastly through a number of intermediaries. However, what caused an explosion in the volume and, consequently, the revenue of online ads was the incorporation of auctions as the major mechanism for trading sponsored search ads in all major search engines. This reduced transaction costs and allowed for the advertisement of small websites which constitute the majority of Internet traffic. Auction-based markets were harder to establish in the display advertising industry due to the higher volume of inventory and the pre-existence of traditional intermediaries, often leading to inefficiencies and lack of transparency. Nevertheless, this has recently changed with the introduction of the ad exchanges, centralized marketplaces for the allocation of display advertising inventory that support auctions and real-time bidding. The appearance of ad exchanges has also altered the market structure of both demand-side and supply side intermediaries which increasingly adopt auctions to perform their business operations. Hence, each time a user enters a publisher's website, the contracted ad exchange runs an auction among a number of demand-side intermediaries, each of which represents their interested advertisers and typically submits a bid by running a local auction among these advertisers.<br/><br/>Against this background, within this thesis, we look both at the auction design problem of the ad exchange and the demand-side intermediaries as well as at the strategies to be adopted by advertisers. Specifically, we study the revenue and efficiency effects of the introduction and competition of the demand-side intermediaries in a single-item auction setting with independent private valuations. The introduction of these intermediaries constitutes a major issue for ad exchanges since they hide some of the demand from the ad exchange and hence can make a profit by pocketing the difference between what they receive from their advertisers and what they pay at the exchange. Ad exchanges were created to offer transparency to both sides of the market, so it is important to study the share of the revenue that intermediaries receive to justify their services offered given the competition they face by other such intermediaries. The existence of mediators is a well-known problem in other settings. For this reason, our formulation is general enough to encompass other areas where two levels of auctions arise, such as procurement auctions with subcontracting and auctions with colluding bidders.<br/><br/>In more detail, we study the effects of the demand-side intermediaries' choice of auction for three widely used mechanisms, two variations of the second-price sealed-bid (known as Vickrey) auction, termed PRE and POST, and first-price sealed-bid (FPSB) auctions. We first look at a scenario with a finite number of intermediaries, each implementing the same mechanism, where we compare the profits attained for all stakeholders. We find that there cannot be a complete profit ranking of the three auctions: FPSB auctions yield higher expected profit for a small number of competing intermediaries, otherwise PRE auctions are better for the intermediaries. We also find that the ad exchange benefits from intermediaries implementing POST auctions. We then let demand-side intermediaries set reserve (or floor) prices, that are known to increase an auctioneer's expected revenue. For issues of analytical tractability, we only consider scenarios with two intermediaries but we also compare the two Vickrey variations in heterogeneous settings where one intermediary implements the first whereas the other implements the second variation. We find that intermediaries, in general, follow mixed reserve-price-setting strategies whose distributions are difficult to derive analytically. For this reason, we use the fictitious play algorithm to calculate approximate equilibria and numerically compare the revenue and efficiency of the three mechanisms for specific instances. We find that PRE seems to perform best in terms of attained profit but is less efficient than POST. Hence, the latter might be a better option for intermediaries in the long term.<br/><br/>Finally, we extend the previous setting by letting advertisers strategically select one of the two intermediaries when the latter implement each of the two Vickrey variations. We analytically derive the advertisers' intermediary selection strategies in equilibrium. Given that, in some cases, these strategies are rather complex, we use again the fictitious play algorithm to numerically calculate the intermediaries' and the ad exchange's best responses for the same instances as before. We find that, when both intermediaries implement POST auctions, advertisers always select the low-reserve intermediary, otherwise they generally follow randomized strategies. Last, we find that the ad exchange benefits from intermediaries implementing the pre-award Vickrey variation compared to a setting with two heterogeneous Vickrey intermediary auctioneers, whereas the opposite is true for the intermediaries.<br/>