In the online world today, advertisers are too often shooting in the dark, wasting bullets and missing their mark. The problem is that the online advertising market, especially the market for display advertising, is horribly inefficient. If one ad network cannot fulfill an advertiser’s campaign it passes the deal to another, who may pass it to another, until there are two or three or even four people in the middle, each taking a bite. The poor advertiser who paid a dollar, for example, might get inventory that the publisher sold for as little as a dime. Even worse, the advertiser doesn’t really know what he got for his money.

The current online ad market is just as bad for publishers, but in different ways. I’ll go into that in a later article.

The industry needs a new business model. It needs to outgrow the old broker model and evolve to an auction model. And that is happening, right now. My own company, AdECN, has launched an auction-based exchange, and we’re seeing similar efforts from other companies both online (RightMedia, AdBrite) and offline (Bid4Spots in radio, and the Walmart-led model for television). Twenty four stock brokers figured this out in 1792 when they met under a buttonwood tree in Manhattan and formed the New York Stock Exchange.

In the online world, the auction solution requires three elements: sophisticated targeting, auction-based pricing at the impression-level, and an exchange marketplace.

Sophisticated Targeting

Sophisticated targeting is essential because that is how an advertiser knows what he is buying — and you need to know that before you know what the opportunity is worth to you. In any market model, an advertiser should be able to use contextual, behavioral, or profile-based targeting strategies, or a combination of strategies.

For example, if you are selling sports cars, an ad on the front page of cardandriver.com, where every 15-year old boy can click on it, might be worth 25 cents CPM to you, but if you know that the ad will be shown only to males between the age of 30 and 60 with incomes over $100,000, the impression might be worth five dollars: more specific targeting yields a lower cost per acquisition despite the higher price of the ad.

But this sort of precision requires the ad to be priced not at the site, page, or location level, but at the impression level — when each view of a specific ad by a specific person at a specific instant is individually priced.

If you went to buy 1,000 shares of IBM from your stockbroker, but instead you got a basket of shares from different companies in “the tech sector,” would you be happy?

Auction-Based Pricing

Auction-based pricing is how the advertiser tells the market what a certain advertising impression is worth to him. Right away, this implies that there is sophisticated targeting so that he knows what he is bidding on.

Second, it implies that the highest bid wins.

This doesn’t always happen in “auctions,” but it is critical if a market is going to be fair and open to all participants. In some closed markets, like Google and RightMedia, the highest bid does not always win, because the market maker is “optimizing” the placements of ads for the greatest revenue — the greatest revenue for the market maker, that is, not necessarily the publisher. This backroom optimization means that as an advertiser you can bid the highest CPC or CPA and not even have your ad shown. That’s not really an auction at all.

Third, there has to be some guarantee that what the advertiser paid a fair price for what he gets. If buyers get ripped off, they don’t come back. Try to imagine eBay’s giant garage sale without its buyer protections?

Guaranteeing fairness in online advertising is trickier. The targeting may be detailed and completely accurate and the advertiser has determined what is worth to him. But every advertiser knows that not all ad spots are created equal. The same creative with the same targeting and the same price is going to perform better on some spots (front page, above the fold) than on others (buried at the bottom of a banner farm page). How to protect the advertiser?

AdECN protects the advertiser by tracking the performance of every ad spot on every page on every site in the exchange, by category and other factors (yes, that is a lot of data). At the moment of the auction, if the advertiser is bidding on a spot that performs about as well as other spots of its format and category, the bid goes just as the advertisers intended. But if the spot underperforms its peers, the advertiser’s bid is reduced accordingly, to reflect the relative value of that spot. Any fair auction needs a similar guarantee.

The New York Stock Exchange has it — it is the Securities and Exchange Commission.