The Economics of TV Advertising

Holly Sanders has found a TV paradox: as ratings fall, ad rates rise. Specifically, ad rates in both the fourth quarter and the first quarter are running 18% above their previous-year levels, even as ratings are 14% lower than they were a year ago. Sanders explains:

Although it seems counterintuitive, it's the law of supply and demand. As the TV audience shrinks, advertisers have to buy more ads to reach their target number of viewers. But that increased demand for ad slots creates scarcity, which in turn leads to rate hikes.

But if you read closely, it turns out that ad prices haven't really increased by very much at all. Says Sanders:

Advertisers use a measure known as cpm, or the cost to reach each 1,000 viewers, on which to base advertising rates.

If you're basing your advertising rates on cpm, then prices will naturally rise as ratings fall: it's got nothing to do with supply and demand at all. Simply keeping the cost of a 30-second slot constant in dollar terms would equate to a rise of 16% in cpm terms if ratings fall by 14%. If the cost of a slot merely goes up in line with inflation, then that's your 18% cpm rate hike right there.

In other words, what Sanders has discovered is not the price of ad slots going up, it's just the price of ad slots staying constant, even as the number of viewers they reach goes down.

This doesn't actually surprise me. Network TV is the last mass medium, and certain advertisers, like Procter & Gamble or McDonald's, need a mass medium for their ads. Jeff Jarvis says that they should "work a little harder and move past the one-stop-shopping of TV and upfront to put together networks online" - but the fact is that we're still a very, very, very long way from the point at which a FMCG manufacturer can achieve the requisite level of brand awareness with any kind of online campaign, no matter how expensive.

On a cpm basis, then, I reckon TV ad rates are going to continue to rise for the foreseeable future. In turn, that will be good for newspapers and websites, whose ad rates will look increasingly attractive in comparison. Everybody wins - except, maybe, the advertisers.