The Inner Workings of Ad Networks and Ad Exchanges

Every publisher knows ads are a known way to monetize their users as long as there are eye balls coming in. This post looks at the digital ad space and what you should be aware of when trying to understand the space.

Every publisher knows ads are a known way to monetize their users as long as there are eye balls coming in. This post looks at the digital ad space and what you should be aware of when trying to understand the space. More after the jump.

Most ad networks work based off a CPM model, where the publisher bills the ad network for every 1000 ad impressions they deliver. CPM stands for Cost-Per-Mille, which is Latin for ‘thousand’. This isn’t performance based, but rather inventory based as the publishers don’t have to deliver anything in addition to an impression in order to get paid.

The second model is CPC, which stands for Cost-Per-Click and is performance based. Advertisers pay publishers for every click they deliver to them, with impressions not having a bearing on the payment at all. You can deliver 1000 impressions and 1 click or 10,000 impressions and 1 click but you as a publisher would only get paid on that 1 click. This pricing structure favors marketers but can be difficult to negotiate as the uncertainty of delivery is a high opportunity cost to play. Although less prevalent, CPC market is still extremely popular and Google AdSense and AdWords work off of this model. It’s low risk for marketers as they only have to pay for performance.

A third often entertained model is CPA, or Cost Per Action, where advertisers only pay if a certain action such as a resultant sale or some other kind of conversion takes place (lead generated etc.). Many direct marketers calculate effective CPA, or eCPA as the metric to track their ROI. An eCPA is calculated by taking the total marketing cost and dividing by the number of resultant sales. So if you spent $100 in advertising for a product which led to 10 sales, your eCPA was $100 / 10 = $10 per sale. As long as you make more than $10 in profit per sale this works, otherwise it won’t.

Publishers and marketers (or advertisers) use ad servers to maintain their own reports and serve ads, using third party ad serving tools or ad exchanges (more on this later). When you see interactive ads being served on various sites you visit, there is a specific technical process taking place that enables such. Before we delve into the nuts and bolts of how ad servers work, let’s understand some of the history leading up to the rise of ad networks.

Major publishers in the early 2000s were gaining traffic as an increasing number of people were coming online. Using their sales force, selling a fraction of their available ad inventory, the space on their site they can put ads in order to make money, would be triumphant. Eventually publishers would opt for monetizing unsold space with performance-based advertising such as Google AdSense. Advertisers could nab up these spaces for cheap prices through companies called ‘ad networks’, whose sole purpose was to aggregate publishers in order to provide advertisers with low costing ad space that reached a lot of people. These were ideal for direct marketers who work based off of direct responses.

These low prices attracted agencies seeking more bang for their buck and fueled the growth of ad networks. Initially intentioned to monetize remaining inventory, these activities actually ended up cannibalizing sales team efforts. Ad networks grew in popularity as inventory rapidly increased and eventually competition induced specialization. Network fragmentation and ad ops problems ensued due to sluggish loading times and issues that arose when traffic spikes and network denials occurred. Ad server reports grew less accurate because the same impression could be counted multiple times as networks sent users back to the publisher, inflating the numbers and forecasted numbers. Such complex and inefficient setups in the publisher’s ad server caused page latency, bad UX and a billing nightmare.¬†Before we delve into network optimizers and SSPs, let’s understand how third party ad serving works.