What is programmatic advertising and how does it work?

Programmatic advertising terms and concepts

The programmatic advertising process has many terms associated with it, including the following:

• Ad exchange. This is an online marketplace where advertisers and publishers buy and sell ad inventory through real-time auctions. They connect programmatic advertising platforms like demand-side platforms (DSPs) and supply-side platforms (SSPs).
• Agency trading desk. This is a service an advertising agency uses to take advantage of DSPs and manual labor for programmatic media buying.
• Application programming interfaces (APIs). An API is code that enables different software systems to communicate and exchange data with each other.
• Cost-per-click. This is a pricing model where advertisers are paid each time their ad is clicked.
• DSP. This is the software advertisers use to automate the buying of ad inventory, or ad space. A DSP typically enables real-time bidding, audience targeting and buying ads across multiple platforms.
• First-party data. This is data primarily collected from a company's audience that can be used for targeted advertising.
• Header bidding. This programmatic technique enables publishers to request bids from multiple sources simultaneously. The bids are sent to an ad server to conduct the auction.
• In-stream video. These are ads played in video content. Examples include preroll, midroll and post-roll ads.
• Real-time bidding. Real-time bidding is a type of programmatic buying where ad impressions are bought and sold in real time when ad inventory becomes available. If a bid wins the auction, that ad is displayed on the publisher's webpage or app nearly instantly.
• Supply-side platform. This is the software that publishers use to manage, sell and optimize ad inventory. SSPs connect publishers with multiple ad exchanges and DSPs.
• Third-party data or third-party cookies. This is data collected by a third-party organization that doesn't have a direct relationship with the user. These third-party cookies are increasingly restricted and are typically used for targeted advertising.
• Video ad serving template. This template is used to serve video-based ads. It provides a universal format for ad servers to communicate with video players.
• Video completion rate. This is the percentage of users who watch a video ad to the end. It's a metric commonly used to determine the effectiveness of a video ad campaign.
• Viewability. Viewability measures if an ad is visible to users on a webpage.

How does programmatic advertising work?

Ads are placed through an auction system known as real-time bidding that manages transactions between the site or app publisher -- the supply side -- and the advertiser -- the demand side. The advertiser sets criteria for buying ads through a software interface, such as a DSP. When a publisher's software notifies the system that they have ad inventory, or spaces for ads available, those spaces are offered for real-time bidding.

Through automated processes, advertisers bid for the impression -- a single view of an ad by an individual -- based on its perceived value, according to established criteria. All these processes and the placement of the ad occur within the time it takes for the requested webpage to load. The entire process takes place between the time that a user requests a webpage and the time it takes for that page to load in the browser.

According to Emarketer's June 2024 forecast, programmatic advertising will make up 91.3% of U.S. display advertising in 2024.

Benefits of programmatic advertising

Programmatic advertising has been promoted due to its various benefits, including the following:

• Optimizes the advertiser's investment and the publisher's profit.
• Automates tasks, making it possible to serve consumers in real time.
• Enables targeted advertising, providing relevant purchase opportunities to users, which are more likely to result in sales.
• Cost-effective, so smaller companies with less budget can still maximize their online advertising.
• More efficient than traditional advertising methods, which require more time for making proposals, quotes and conducting negotiations.

Challenges and downsides of programmatic advertising

However, there are significant downsides to all this automation, including the following:

• Low bids on impressions can lead to ineffective ad purchases or placement on inappropriate websites, for example. It can even lead to ad fraud. Similarly, the publisher can end up with inappropriate ads appearing on their sites.
• From the customer's perspective, there are concerns about data privacy, as well as the annoyance of being targeted with ads that follow them from one site to another, possibly for something that someone has already purchased elsewhere or decided not to buy.
• Transparency might also be a concern for some, due to the process of going through DSPs, SSPs and ad exchanges. While programmatic advertising provides some level of visibility over where ads appear, transparency and brand safety are still concerns for advertisers.

How is programmatic advertising measured?

To measure the effectiveness of programmatic advertising, organizations can keep track of several different key performance indicators, including the following:

• Bounce rate. This is the percentage of users who click on an ad and then leave without viewing more than one page.
• Brand lift. This measures an increase in brand awareness or perception due to a particular ad campaign.
• Click-through rate. This is the ratio of users who click on an ad to the number of impressions.
• Conversions. This indicates the effectiveness of actions such as sales or downloads taken after a user clicks on an ad.
• Cost per click. This metric determines how much an ad costs based on the number of clicks it receives.
• Engagement rate. This is the rate of interactions -- outside of clicks -- such as shares, favorites and likes that users have with the ad.
• Frequency. This is the number of times an ad is shown to a single user.
• Impressions. This is the number of times an ad is shown to users.
• Return on investment. This measures the profitability of an ad relative to its cost.
• Viewability. This is the percentage of impressions that are viewable by users. Ads are considered viewable if half of the image is visible on the screen for a minimum of one second, or two seconds for video ads.

First-party data and third-party cookies play a major role in targeted advertising. Learn more about third-party cookies and how some companies, notably Google, are beginning to drop them.