The First Rule of Advertising Exchanges - There Are No Advertising Exchanges

  |  October 31, 2011   |  Comments

Today's advertising exchanges are a complete failure at efficiently disseminating price information. Here's why.

Welcome to Advertising Exchanges. The first rule of Advertising Exchanges you should all know is that there are no Advertising Exchanges. What? Please allow me to make the comparison to the financial markets and their exchanges to explain my point.

An "exchange," defined by Investopedia, is:

A marketplace in which securities, commodities, derivatives and other financial instruments are traded. The core function of an exchange - such as a stock exchange - is to ensure fair and orderly trading, as well as efficient dissemination of price information for any securities trading on that exchange. Exchanges give companies, governments and other groups a platform to sell securities to the investing public.

An "exchange" may be a physical location where traders meet to conduct business or an electronic platform.

Further:

The primary function of a stock exchange is to provide liquidity in listed securities. The effectiveness of a stock exchange in performing this function can be affected by many of its institutional characteristics, which we also refer to as exchange-design features. (Jain, 2003)

Now let us replace some of the terms in the above references.

An "exchange" becomes a marketplace in which advertising and other advertising related instruments are traded. And the core function of an exchange - such as an advertising exchange - is to ensure fair and orderly trading, as well as efficient dissemination of price information for any advertising unit trading on that exchange. Exchanges give companies, governments, and other groups a platform to sell advertising units to advertisers.

Now let's review how accurate this statement plays out against the backdrop of an "advertising exchange" in the real-time world and evaluate how accurately they fit against the definitions. (Please understand that this instance is representative of all the existing "ad exchanges.")

An Ad Exchange is a real-time marketplace that helps ad networks, agency holding companies, and emerging third-party technology providers maximize ROI across millions of sites. Buyers can increase return on investment through targeting, defined bids, defined budgets, and frequency caps on inventory purchases. You define your audience so you are only buying what you want and when you want it. A true, open real-time bidding system enables buyers to leverage their proprietary data and bidding algorithms for even more control over media spend.

The description provided seems to lack many of the defining characteristics we noted above. Focusing on the defined core function of an exchange to, "ensure fair and orderly trading, as well as efficient dissemination of price information for any securities trading on that exchange."

Exchanges should be credited with enabling biddable marketplaces and thus have enabled orderly trading, however one can question the fairness of the exchanges. Exchanges, to date, provide an information bias in favor of the supply side. In order to facilitate liquidity, the exchanges have created supply-side tools to assuage supplier/publisher fears that bid prices will not meet a minimum secondary market threshold. So a publisher can easily see transaction data but a buyer cannot (generally speaking). A buyer is permitted the knowledge of its bid data ("clearing price") or the price on its winning bids, but is not provided the clearing price on lost bids.

In other words, today's advertising exchanges are a complete failure at efficiently disseminating price information. Almost no "ask" (the price a seller is willing to accept) data exists. This information gap creates market inefficiency and imperfect information. Sellers know what buyers are bidding but the buyers don't really know what the sellers are willing to accept. Exchanges exaggerate this problem by enabling suppliers to create artificial prices with tools like floors or reserve pricing. As a result, the market is flooded with irrational behavior and random bid activity. The buy side attacks the information gap by attempting to predict price based on past performance but the pricing data is inherently biased by the original bid data and the "exchange" has failed to deliver the core premise of information dissemination and therefore creates illiquidity. Additionally, the exchange concept further fails because unlike the stock exchanges, the advertising exchange is nowhere close to the primary marketplace for the sale of advertising. Thus, rather than a rationale market reaction to bid-ask spreads, we simply get more illiquidity. The quantity of demand suffers and as a result the quality and supply falls when in fact the result should be market price adjustments.

The advances in today's advertising landscape have been in the programmatic purchase and sale of digital advertising with parties acting in a logical self-interested fashion to maximize their own financial potential. The evolution of the greater advertising market requires greater emphasis in the institutional design of the market itself and an understanding by all parties that more information will result in robust liquidity. The marketplace owners must also realize that dealing in market information is the key to increasing volume and that increased volume unlocks their profit potential.

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ABOUT THE AUTHOR

Edward Montes

As CEO and co-founder of Digilant, Ed is responsible for planning and implementing the company's strategic direction, overseeing international operations, and delivering on the company's vision. In 2010, Ed was awarded LatinTRENDS Magazine's Latino Trendsetter Award in the technology category. In 2011, he was named one of Boston Business Journal's Top 40 under 40.

Prior to becoming the CEO at Digilant, Ed served as the Manager Director for Havas Digital, North America where he was recognized with the Media All Star award by MediaWeek in early 2009.

Ed has also worked for Yahoo! Inc. and was a prosecutor in the Middlesex District Attorney's office of Massachusetts. He is a graduate of Boston University School of Law and the University of Massachusetts, Amherst.

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