High-Frequency Traders Turn to the Online Ad Market

High-frequency trading comes to Madison Avenue
Photograph by Terence Kawaja/Luma Partners

In a red brick building in New York’s Chinatown filled with startups, a company uses custom computer programs to scout for opportunities, making millions of trades each day that generate tens of thousands of dollars in revenue. This company is not buying and selling stocks, bonds, or commodities: Its specialty is online ads.

High-frequency traders have found a new market to exploit. A growing percentage of the billions of display ads that pop up on computer screens are sold to the highest bidder at online marketplaces such as AppNexus, Microsoft Ad Exchange, PubMatic, Rubicon Project, and Yahoo! Ad Exchange. Before the ads appear, they change hands in a complex volley of electronic trades among websites, ad space aggregators, exchanges, data analysts, and ad agencies. Real-time bidding “tends to be fabulously complicated,” says Ben Edelman, an associate professor at Harvard Business School who studies online advertising. “The number of intermediaries in a single ad placement can be just extreme.”

That web of transactions creates opportunities for arbitrageurs. Using computer algorithms, traders can scan the markets for price discrepancies, buying and reselling ads for small profits in a fraction of a second. “I see a lot of guys who buy from one exchange, and they sell to another exchange,” says Edelman. “Some buy from an exchange and sell it right back to that very same exchange.”

Here’s a simplified version of how the process works. Let’s say Ford Motor wants to advertise to consumers who had shown they were in the market for a luxury car—women age 35-60 who searched for Mercedes on Google, “liked” a story about BMWs on Facebook, or looked on About.com’s luxury car page. In each of those cases, Ford or an ad agency it hired, such as Omnicom Group, could create profiles of the people it was looking for and connect to an online exchange where advertisers buy spots. Websites send information on available space and audiences to the exchange. When Ford sees the audience it is looking for, it can bid for the space. If it wins, the carmaker’s luxury sedan ad immediately pops up on the website spot. The whole transaction takes place in 100 milliseconds or less.

That’s still plenty of time for arbitrageurs to squeeze in. Maybe Ford isn’t looking at one exchange that has a lot of its desired targets. Or it isn’t bidding fast enough. Either way, traders can buy available website space at a cheaper price and flip it to Ford, taking a nice profit for their trouble.

The two traders who run the Chinatown operation say that on a typical day their 10-person outfit will arbitrage about 500 million spots, mostly banner ads. While there’s nothing illegal about what they do, some in the advertising industry say the buying and selling by arbitrageurs pumps up ad prices. The two say they’re simply agents of market efficiency, getting ad slots to the advertisers who want them most. The duo asked to remain anonymous so they wouldn’t be barred from ad exchanges. While Google’s marketplace restricts participation to advertisers and their representatives, some other exchanges permit middlemen to bid. Asked if they tried to bar arbs from their exchanges, AppNexus, Microsoft, and Rubicon declined to comment. PubMatic President Kirk McDonald says his company doesn’t block the traders because it’s impossible to control their activity on other exchanges.

This year companies around the world will spend an estimated $9.33 billion on online display ads at auction, according to Magna Global, a research and media buying unit of Interpublic Group. While auctions have brought pricing efficiency to the business, computerization is happening so quickly that ad agencies are struggling to keep up, says Matt Seiler, chief executive officer of IPG Mediabrands.

Arbitrageurs “could be distorting the markets and removing the efficiency that we’re supposed to see through real-time bidding,” says Marcus Pratt, head of technology at ad buyer Mediasmith. After Pratt noticed that his firm was buying About.com ads for widely different prices on different exchanges, 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,” he says.

Although they’re prospering now, the Chinatown traders say the arbitrage opportunities won’t always be as rich as they are today. By 2016 almost a third of auctioned display ads in the U.S. will be sold on private marketplaces that connect buyers and sellers directly, according to research firm EMarketer. So the pair is diversifying, with a staff on the West Coast who are developing tools that help advertisers navigate the murky online world and buy space more efficiently.

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