The price of television advertising continues to skyrocket, even though audiences have dwindled as viewers have moved onto alternative, web-based video platforms.

There are up to 17% fewer TV watchers in some demographics this year, compared to previous seasons.

How, you ask, is this even possible?

The prices stay high because the TV networks act like a cartel and create the illusion of scarcity.

Imagine this scenario: Every year, a few dozen of the world’s top oil buyers and their clients — five major petroleum suppliers — gather in Midtown New York, enter a room that’s closed to the public, and agree on the aggregate price of oil for much of the rest of the year.

They don’t really know how much oil will be needed, but they can make a good guess. At least 15% of the U.S. oil supply gets priced in for the rest of the year in a series of gigantic contracts worth billions of dollars. Each buyer represents millions of American customers. The prices at which each buyer is getting his oil aren’t disclosed. And sometimes the suppliers aren’t even sure they can deliver enough oil to fulfill their part of the bargain.

If you were told that this is how oil gets bought and sold — through an opaque cartel that meets in secret — you’d be angry, and for good reason. There would be Congressional inquiries, antitrust prosecutions. Executives might even go to prison.

Oil isn’t sold like this, of course. Oil is traded on exchanges, and buyers and sellers can see the price of oil per barrel moving up and down in a fairly transparent manner.

But television advertising is, pretty much, traded like this, in what the industry calls the “upfronts.”

The upfront compresses what ought to be a yearlong buying season into just a few days. Advertisers are told “Buy now!” or face a severe disadvantage later in the season when all the good airtime is gone. All the networks agree to use the same week to make their pitch, even though they compete.

Last year, CBS kept the price of its upfront inventory high by refusing to sell some of it until later in the year — making its time even more scarce, and even more expensive for latecomers.

How upfronts work

Right now, ABC, CBS, NBC, Fox, and some of the major cable channels, are holding their “upfront” buying events in Midtown New York. They do this every year: The networks put on crazy shows, featuring their big stars, trying to build as much buzz as possible.

The shows are for ad-buyers, not the public. Last year, Jimmy Kimmel did a set for ABC in which he mocked the NBC show “Animal Practice,” which featured a monkey. “This is the first time that NBC has had a star that throws its own feces since Gary Busey on ‘Celebrity Apprentice,'” he said. Then he added, “We know that you have 9 billion to spend this week, so don’t get all cheap-o, Secret Service on us” (a reference to the scandal in which a presidential security officer short-changed a prostitute).

Once the shows are over, the buyers and the networks literally enter a secret room, or at least a room that no one else is allowed into, and do their deals. About $10 billion will get spent this month. Ad Age describes it this way:

This is the time of year when the most powerful ad execs in the nation stand in line — line! — to get into Carnegie Hall and Lincoln Center to hear the pitch, see the clips and laugh along with the stars.

… after these big parties are over, possibly as few as 40 people from the networks, agencies and brands will go into backrooms and decide how $9 billion of the $62 billion U.S. TV ad market will be spent next year.

This is madness. No other billion-dollar commodity exchanges hands with this lack of transparency.

“Clients do not share their rates, and if they found out an agency was sharing their rates, that would be it,” said one ad agency CEO.

TV airtime is sold in chunks of 30-second units. At base, it’s a commodity. Some of it is more valuable, due to shows with larger audiences, or skewed demographics. But 30 seconds inside “Two And A Half Men” is mostly the same as 30 seconds inside “Big Bang Theory.”

Yet advertisers never really know the “true” price of any 30-second slot. Via their media-buying agencies, they must cut their deals with networks without knowing what other advertisers are paying. The system hurts new advertisers with smaller budgets. Big clients like Ford and McDonald’s have been advertising for decades and know all the tricks. They can build in long-term discounts. New advertisers lack that leverage, and don’t know how deep the discounts are that other buyers are getting on the same airtime.

Levi’s once had the boldness to ask what prices other clients represented by its own ad agency were paying — and people freaked out:

“That kind of thing is not done, and it’s because of the cloak-and-dagger nature of how rates are decided in this industry,” one agency CEO told Ad Age. “Clients do not share their rates, and if they found out an agency was sharing their rates, that would be it.”

Imagine trying to buy stocks, or flights, or concert tickets on the same basis — the vendor would tell you the price you can buy stock at, but not what price everyone else was paying.

The networks have actively resisted reform

And they’ve been successful doing it: 

• In August 2012, Google’s TV Ads experiment, an online exchange for airtime, was closed. None of the networks gave Google any significant inventory to sell.
• NBC offered Google only its worst niche inventory, on obscure channels like Sleuth and Chiller.
• A company called Spot Runner died after failing to sign a single client or network to its online TV marketplace, and Microsoft gave up on its attempt to do the same thing.
• The cable networks also resisted an attempt by Wal-mart to form an online TV ad exchange with eBay — and Wal-mart is one of the biggest buyers of TV in the U.S.

It’s not that Google and Wal-mart were defeated by superior competition from NBC et al. This is a business where as late as 2009, Tracey Scheppach of Starcom Media Group (one of the larger ad buyers) complained that some TV deals were still conducted by fax. MediaPost noted that “hundreds of millions of dollars can get spent literally over a lunch and with no more contractual requirement than a handshake.”

The inefficiencies are built in for a reason. Networks aren’t about to make their own market more efficient if that would mean lower prices for buyers.

And the buyers themselves have a conflict, too. The big media agencies pool billions of dollars of their clients’ money to cut upfront deals, in hopes of driving down the aggregate price through sheer volume. If that job was done instead via an online trading exchange, someone might ask the awkward question of why media agencies exist at all.

Clients are trapped because TV buying is genuinely complicated, and companies need specialists to do it for them. It’s almost a classic rent-seeking scenario from economics.

I’ll give the last word to MediaPost’s Joe Mandese, who compares the upfront to a Vegas casino where the odds are structured in favor of the house:

… it could well be the only marketplace where the sellers ask the buyers to “register their budgets” with them beforehand so that they can price their inventory most efficiently. The networks say they do this, and media buyers comply with the request, under the auspices that it is the only way to ensure that all the advertisers and agencies will get all the commercial time in the shows they want. Not because it is a method for the networks to “count the house,” model demand, and optimize their yield based on it — as observers in most any other market might conclude from such practices.