The high-frequency trading pioneered on Wall Street has come to Madison Avenue.
Arbitragers are buying millions of online ads and reselling them for a profit in the blink of an eye. They’re exploiting price discrepancies in a fast-evolving marketplace, where this year companies around the world will spend an estimated $9.33 billion on display and banner ads at auction.
Here’s how it works: Advertisers buy Internet spots in ad exchanges, where space is sold to the highest bidder. Even before ads reach the desired audience, they change hands in a complex volley of electronic trades between websites, ad space aggregators, exchanges, data analysts and ad agencies. That’s where the arbitragers come in. Using their own programs, they ferret out underpriced ads and resell them.
You see behavior like this all the time, said Ben Edelman, an associate professor at Harvard Business School in Cambridge, Massachusetts, who researches online advertising.
“I see a lot of guys who buy from one exchange and they sell to another exchange,” he said. “Some buy from an exchange and sell it right back to that very same exchange.”
Edelman, who sends out Web crawlers to detect click fraud and other schemes, picks up reselling activity in the results. Yet because the traders are anonymous, ad exchanges, online publishers and ad agencies can’t tell how big the field is.
However, it’s lucrative, according to two traders who work out of a nondescript building in New York’s Chinatown. The pair generate margins of as much as 60 percent and tens of thousands a day in revenue, they said. While there’s nothing illegal about what they do, critics say arbitragers are pumping up ad prices. The two traders, who asked to remain anonymous for fear of getting kicked off ad exchanges, say they’re agents of market efficiency, getting ads to the buyers who want them most.
Online display ads sold at auction are a growing percentage of Internet advertising, which also include search ads such as those that appear above Google Inc. search results. Display advertisements online, which include banner ads and short videos that pop up before YouTube videos play, are set to overtake search ads at $64.9 billion in sales next year, according to ZenithOptomedia. About a fifth of that will be sold in auctions, according to researcher Magna Global.
Computerized ad auctions have brought pricing transparency to a business that lacked central clearing houses. But it’s happening so quickly ad agencies are struggling to keep up, said Matt Seiler, Chief Executive Officer of IPG Mediabrands, a division of Interpublic Group of Cos.
In fact, arbitragers often understand the vagaries of the online advertising market better than industry veterans more comfortable with handshake deals than high-frequency trades, say the Chinatown traders. They said they routinely beat advertising holding companies.
Billions of ads are sold at auction every day on exchanges run by technology firms such as Rubicon Project Inc. and AppNexus Inc. When you open a web page, information such as age, sex, location and search history are zapped to buyers vying for your attention. Bundled with 999 other people, those eyeballs are offered to the highest bidder, usually ad agencies and their clients, which can range from big public companies such as Apple Inc. to local car dealerships.
Arbitragers win the first auction and resell the ad, finding exchanges where it’s more valuable and pocketing the difference. The process is over in a tenth of a second. On a typical day, the Chinatown traders’ 10-person company will arbitrage about 500 million advertisements, mostly banner ads, they said; about 30 billion ads are sold on AppNexus a day.
Traders’ programs trawl markets to find opportunities. What types of ads are cheap on Rubicon Project’s exchange? What’s pricey on Pubmatic Inc.? Like high-frequency trading firms arbitraging Microsoft Corp. stock between the New York Stock Exchange and Nasdaq, ad traders are wringing inefficiencies from the market -- for a price.
Agencies ignore exchanges with relevant ads or pay different rates based on which marketplace they’re bidding, the Chinatown traders said. Some agencies are poorly connected to exchanges and can’t respond to a first auction in time, allowing middlemen to buy and flip within the same market, they said.
Pat McCarthy, AppNexus’s marketing chief, says arbitrage has already peaked because exchanges are increasingly interconnected making it harder to find price inefficiencies.
“It definitely still happens,” McCarthy said. “I don’t really know offhand how prevalent that is at this time.”
Pubmatic President Kirk McDonald said his company doesn’t block the traders because it’s impossible to control their activity on other exchanges. Frank Addante, Rubicon’s founder and CEO, said last month that his company doesn’t “trade or arbitrage media like ad tech companies.”
Rubicon and AppNexus declined to comment specifically on efforts to halt arbitrage by traders.
Traders are having a noticeable effect on prices, said Jim Caruso, head of product strategy at Varick Media Management, the online campaign buyer for MDC Partners Inc.
“It’s not by any means a majority or anything like that,” he said. “But there’s enough of it that if you start to do a deep analysis of this type of thing you can pick up on these trends and work around them.”
Media buyers are beginning to notice the arbitrage and take steps to avoid it, according to Marcus Pratt, head of technology at Mediasmith Inc.
Traders buying and reselling at a higher rate “could be distorting the markets and removing the efficiency that we’re supposed to see through real-time bidding,” he said.
Pratt said he noticed that his firm was buying About.com Inc. ads for widely different prices on different exchanges, and was actually paying more for ads that were clicked on less.
“I can’t say for sure that any of that is guaranteed to be arbitrage,” Pratt said. Nevertheless, soon after, he negotiated a deal with About.com directly, avoiding public exchanges. “We’re getting better rates doing that than we were certainly just running on the open market previously.”
Though they’re prospering now, the Chinatown traders said the arbitrage opportunities won’t always be this good. Almost a third of auctioned display ads in the U.S. will be sold on private marketplaces by 2016, according to research firm eMarketer. To get out while the going is good, the pair is diversifying, with a staff of seven employees on the West Coast who are developing tools that help buyers navigate the murky world of online advertising.