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Ad exchanges and ad networks work best together: here’s why

Digital advertising

Web publishers have myriad ways of profiting from users coming to their sites. Display, or banner, advertising has been around since particular web pages became popular and needed to monetise.

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How these things work

Advertisers needed to buy inventory but internet audiences are increasingly fragmented according to their demographics and interests — so ad networks aggregated inventory across many sites in order to provide the size of audience that traditional avenues like television had previously offered. Inventory would be sold on a cost-per-thousand impressions (views) or, as it termed, CPM basis.

For a more technical explanation of how ad networks work, let’s refer to our friends at Advertising Perspectives:

“In the ad network model, the building blocks are the traditional components of web advertising: web content servers, publisher ad servers, advertiser (third party) ad servers, database providers, cookies, tracking Pixels and content delivery networks (CDN).

The process generally works as follows (simplified for clarity):

  • User begins to load a web page.
  • Web page issues a request for an advertisement from the publisher’s ad server which logs the request and returns a “NET TAG”.
  • Web page issues request to the ad network server, which processes its pixel, reads and/or drops its cookie, queries its database and applies targeting (demographic, geographic, contextual, behavioural or all of the above) algorithms. It then applies the rules set in the contract with the advertiser. If it finds a profitable match it issues an ADV TAG and logs the transaction. If it does not find a match, the ad network may pass the request on to a partner network, which repeats the process to determine if it has a profitable ad to display and so on until a network claims the impression. This processes typically involves multiple http requests and redirects, which impact load time negatively.
  • Web page processes the ADV TAG resulting in the advertiser ad server either serving the ad or handing off the request to a Content Delivery Network (CDN).
  • The browser loads the ad, if the user hasn’t already moved on to another page.”

As with most things related to the internet these days, Google has played a major part in the ad network side of things with its Google Display Network which covers roughly 80% of all internet properties from sites including Gmail, to apps and video like YouTube.

Obviously all this buying and selling of inventory can get really complicated, especially when one network sells a particular slice of inventory to another network who might pass on the same inventory (at an inflated price — we all need to be profitable) to a third network.

This also leads to a similar level of complication when it comes to reporting as reports are then generated from three different networks, which almost certainly have differences in the way they measure and report on the inventory.

Enter the ad exchange — a place where unsold inventory from sites and networks is auctioned off to the highest bidder among agencies, advertisers and networks. Typically, the inventory sold on these exchanges can be bought at a steal: think of it as a factory shop for inventory — it’s great value, if you know how to find it.

The thing to remember here, is that this relies on “liquidity”: where the amount of impressions, buyers and sellers are enough to fuel the supply and demand basis. It is then, essentially, a stock exchange for unsold inventory.

Let’s use a real life example here: a short-term loans company might need to get potential client leads at a cost of US$10 per lead. In order to achieve this kind of performance, it needs to get impressions (views of their banner adverts) at a steal so it goes onto Jimmy’s Ad Exchange and sees people bidding on his inventory for under US$1 CPM. Jimmy’s inventory also fits the demographic profile of the client that the short-term loans company wants to target.

It knows that for every 1 000 impressions (1 CPM) it will get a click on its banner. It also knows that it takes 10 clicks for one lead to fill in its form. So they bid on 10 000 impressions (10 CPM) in order to get the 10 clicks in order to achieve the one lead at US$10/lead. Obviously it’s entitled to bid on it what it feels it is worth to the business and if it gets the CPM lower than US$1, it can drive its margins up.

The main players

Obviously this sounds like quite a technical operation: store-bought code doth not an effective ad exchange make.

These things require a massive engineering input to create the tools to handle this as well as the scale that enterprise clients demand, so naturally your big internet players like Google, Microsoft and Yahoo! are the leaders in ad exchange land.

Google, arguably, has the best opportunity to make this work as it has vast experience in the Real Time Bidding (RTB) arena with its flagship money-spinner: Adwords. Google’s display acquisition, DoubleClick, also helps in terms of tracking the post-impression click and their dearth of coding talent makes their technology some of the most sophisticated when it comes to ad exchanges.

There are also a couple of smaller players, but overall there aren’t that many companies active in the space. Here’s a list of the biggest ad exchanges currently operating:

Common questions

Can networks and exchanges co-exist? The simple answer is yes. Historically they’ve existed together and continue to exist.

Think about it this way: the stock exchange didn’t put stockbrokers out of business — it actually heightened the demand for them as they knew where the get the stock at the right price.

In the online world, agencies exist which act like a stockbroker: they know where to find the inventory and are driven by a certain price of performance parameter that they need to achieve.

But, doesn’t this kind of activity drive down the CPMs for advertisers, you ask. It sure does. Think about it this way: if you were desperate to make money, would you rather sell something that’s worth US$1 for US$0.10 than not at all? Absolutely! As is the case with most auctions, you bid what you think the item is worth to you, which means that naturally some publishers will cry foul and say that the system doesn’t appropriately value the inventory.

So the exchange acts like the Remora fish on the shark: picking up the unsold inventory and making it available at a bargain, creating immense value for advertisers who ordinarily wouldn’t have bought the inventory.

On a more positive note, the more targeting capabilities and aspects like real time bidding increase, the more valuable this kind of mechanism can be for advertisers as they can act on the data they receive and turn more users into customers.

The overarching theme here is that online advertising inventory can now, even more than ever, be targeted accurately and bought at a price that is in line with advertising expectations — ad networks and ad exchanges work together to create this effect in the industry.

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