From negotiation to auction: The rise of real-time bidding

By — on / Dealmaking

Because of a technological innovation called real-time bidding, or RTB, more and more online-advertising transactions are being completed through auctions rather than negotiations. The transformation could foreshadow similar changes in other realms, as negotiations gain the potential to become more automated.

How RTB works
In the dark ages of the Internet, websites would negotiate individually with potential advertisers when they had display ad space to sell via meetings, phone calls, and e-mails. If one advertiser didn’t place an order, the seller would move on to the next one until the space was filled. Advertisers bought ad space based on a website’s general demographics, and site visitors all viewed the same ads, a practice known as “spray and pray,” writes Natasha Singer in the New York Times.

Through a more targeted, streamlined process, RTB companies help websites determine the value of their site visitors to advertisers by analyzing data about these visitors, collected through member-registration information, data-collecting “cookies” on browsers, and other sources.

Next, the RTB companies use their automated systems to auction off sales lots of “impressions,” or digital ad spaces, to the highest bidder. An impression’s value to advertisers depends on factors such as the size of the ad, the type of person who will be viewing it, and that person’s location (such as an urban or a rural area).

The auction occurs in less than 30 milliseconds, during the time a visitor waits for a website. Many ad agencies have created in-house “trading desks,” Wall Street–style, to monitor and alter their bids. Advertisers are expected to purchase about $2 billion in display ads through electronic auction-based exchanges in 2012, according to a Forrester Research report, an amount that could reach $8.3 billion by 2017.

Costs and benefits
Consumer advocates complain that RTB companies are gathering too much data about consumers, with little benefit to the consumers themselves, other than the ability to view more relevant ads. As such, RTB serves as a reminder of the importance of considering how peripheral parties will be affected by the outcomes of your transactions.

As for advertisers, the technology allows them to target customers with much more precision. One RTB company analyzed data for a sneaker company and discovered that Republicans in certain areas of Texas were less likely to exercise than Democrats in the same area. The RTB company helped the sneaker company adjust its advertising campaign to appeal more to Democrats, writes Singer.

As for websites, by switching from negotiations to auctions, they can more quickly and easily connect with the advertisers who are willing to pay the highest prices for their ad space.

Negotiate or hold an auction?
The rise of RTB raises the question of when it makes sense for sellers to hold an auction rather than negotiate. In his book Dealmaking: The New Strategy of Negotiauctions (Norton, 2011), Harvard Law School and Harvard Business School professor Guhan Subramanian suggests that auctions are generally a better choice under the following four conditions:

1. When you expect a large number of potential buyers. If you attract few buyers, you risk a “busted auction” that forces you to accept a lower bid than you might have negotiated.

2. When the item for sale has common value to bidders—that is, when they will use it in the same way (as is true of Internet ad space). By contrast, from the seller’s stance, a private value asset—such as a work of art that one bidder would resell and another would hang on the wall—may be better suited to negotiation.

3. When price is the only significant issue at stake and there is little opportunity to create value through in-depth discussion.

4. When you can tolerate the risks associated with a quick, open process that has clear winners and losers.

The Program on Negotiation at Harvard Law School
501 Pound Hall
1563 Massachusetts Avenue
Cambridge, Massachusetts 02138
tel 1-800-391-8629
tel (if calling from outside the U.S.) +1-301-528-2676
fax 617-495-7818