Pitching to America at 3 a.m.

The ads for PedEgg and ShamWow may be shlocky, said Jon Nathanson, but they’re a very serious business.

NOTHING GOOD IS on TV between 1 a.m. and 6 a.m., and for good reason. Nobody’s trying. It’s the time period known euphemistically in the media business as the “Post Late Fringe,” and less euphemistically as the “Graveyard Slot.” It’s when networks and local TV affiliates sign off. They give up. They stop pretending that anyone important is watching and sell off their airtime—not just 30-second commercial spots, but entire 30-minute programming blocks—to sponsors. Those sponsors fill the left-for-dead airwaves with direct-response television (DRTV), better known as infomercials.

For certain companies—the kinds of companies that make Snuggies and ShamWows—the Graveyard is prime time. It’s dirt-cheap media space. It’s highly efficient for testing products and messaging against targeted consumer segments. It’s the perfect perch for Perfect Polly, the plastic parakeet with a swiveling head and a chirp like a 1980s car alarm. It’s the choicest real estate for the Snap’n Pump, a vacuum sealer for sandwich bags. And it’s pretty much the only time slot socially acceptable for the UroClub, a 9-iron golf club that doubles as a portable urinal.

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These products certainly put the “fringe” in Post Late Fringe. It boggles the mind that anyone would want to buy them. But they’re serious business. Collectively, the U.S. market for infomercial products stood at $170 billion in 2009 and could exceed $250 billion by 2015. In fact, with the worth of the entire U.S. network and cable industry estimated at $97 billion as of 2013, DRTV is much bigger than TV itself.

To put that into perspective: $250 billion will represent at least an entire percentage point of the U.S. gross domestic product in 2015. Infomercials may be uniquely American, but how can they account for such a giant slice of America?

Consider some of the biggest brands in the DRTV business. Proactiv, a celebrity-shilled skin-care line made famous on the infomercial circuit, generates a little over $1.7 billion a year in revenue. The PedEgg, a heel-scraping callus remover, has earned over $450 million since 2007. These products, like many others in the DRTV space, are not one-hit wonders, spawned in a garage by a couple of wackos with a pipe dream. Rather, they are bets in the portfolios of much larger, highly capitalized intellectual property holding companies.

Telebrands, maker of the PedEgg, is one such company. With revenues exceeding $500 million a year, it’s one of the major players in the DRTV products business. It’s the firm that brought you the Slice-O-Matic, the Pocket Hose, the Hurricane Spin Mop, and at least several hundred more pieces of single-purpose shlock.

The infomercials themselves are just appetizers; getting stocked at Walmart is the main course. That’s where the real money is made. (Retail sales account for approximately 90 percent of Telebrands’ revenues.)

And companies like Telebrands aren’t the only players in the space anymore. Much of the recent growth in the DRTV business isn’t coming from some explosive takeoff in Snuggie sales. It’s the result of some of America’s largest corporations, like Procter & Gamble and Johnson & Johnson, jumping into the fray.

Infomercials, it turns out, make a great deal of sense as a product marketing channel—provided the marketer can maintain super-high margins, spread risk across a number of bets, and master the intricacies of late-night/early-morning media planning. For every impressionable Graveyard viewer who buys a Showtime rotisserie grill at home, hundreds more buy them at Home Depot.

THE VITA-MIX CORP. aired the world’s first infomercial in 1949. The spot featured founder and former boardwalk salesman William G. Barnard as a self-proclaimed “author, lecturer, and food specialist.” Barnard spared no hyperbole in pitching “one of the most wonderful machines that was ever invented,” his company’s new blender. Sales took off, and a new commercial medium was born.

But buying half-hour blocks of television in daytime and prime time was a cost--prohibitive exercise for startups like Vita-Mix. Over time, many of them would strike bargains with local TV stations to purchase time in the wee hours of the morning. The airtime would otherwise go to waste, and it sold for a song. Stations were happy to get anything for the time, and advertisers were happy to purchase time at fire-sale prices.

In the ensuing decades, most infomercials came from the Vita-Mixes of the world: fledgling companies, often founded by former door-to-door salesmen and garage inventors, trying their hand at pitching viewers through TV. Their success rates were modest. A product introduced through early infomercials stood about a 50 percent chance of success. The medium was a coin toss, but it was a very inexpensive one.

These infomercials made up about 75 percent of the DRTV landscape through the late 1980s and early 1990s. At that point, outsourcing and internationalization made bringing new products to market cheaper than ever, which flooded the Graveyard with new entrants. Success rates on one-step infomercial campaigns—ones with no retail sales—plummeted to 10 percent or less. Response rates—the number of viewers who actually bought something while watching an infomercial—dropped into the 1 percent range, where they mostly remain to this day.

As a result, the DRTV landscape experienced a seismic shift away from mom ’n’ pop advertisers and toward big companies. Firms like Telebrands, which had consolidated their power after a string of early hits in the medium, began to dominate the space. Big consumer-product brands, like P&G and even Apple, followed soon thereafter.

WE KNOW THAT infomercial marketers want to make things cheaply and sell them expensively. That’s true of any business. But the infomercial industry has to take that mantra to the extreme. Let’s start with the expensive, i.e., the product margins. A 400 percent markup (80 percent margin) isn’t unusual in this business. It’s actually something of an industry-standard minimum.

Think a four-pack of ShamWows at $20 is the once-in-a-lifetime steal the pitchman says it is? Think again. You’re paying a 1,500 percent markup for some scraps of cast-off industrial rayon and polypropylene. The wholesale cost of a comparable product is about 1 to 30 cents apiece. But put some funky branding on them, give them a cool pitch, and those shammies soak up cash as easily as spills.

Producing a half-hour infomercial can cost anywhere from $25,000 to $250,000, depending on the production values and the host or talent involved in the shoot. For the sake of comparison: The average cost of producing a 30-second national TV commercial is about $350,000.

That means a national spot costs about $11,000–$12,000 per second in production costs (not including the media buy, which costs millions more). By contrast, a $25,000 infomercial at 30 minutes in length runs $13.89 per second. The higher end of the spectrum is still quite a bargain at $138.89 per second.

The use of well-known spokespeople like the late Billy Mays, or celebrities like George Foreman, runs the cost of production into the higher end ($250,000 or so for the half hour). But the investment can pay off: A 1999 study found that the use of celebrities in DRTV spots could result in a 20 percent lift in response rates. And celebrity partnership deals can be struck inexpensively if the brand uses a deferred payment structure. Companies often pay celebrities in equity and/or royalties on unit sales, avoiding up-front costs at the possible expense of long-term margins.

George Foreman estimates that he made $200 million from the sale of the grills bearing his name, which he neither invented nor initially wanted anything to do with. The “Lean, Mean, Fat-Reducing Grilling Machine” was the brainchild of Salton, Inc., an appliance-maker that didn’t expect its grill to be much of a hit. It offered Foreman a hefty royalty on sales, and when his charming personality helped the grill take off, Salton bought out the perpetual rights to his name through a combination of cash and equity.

The George Foreman Grill happened to run at a successful and profitable response rate before securing lucrative distribution deals at major retailers. But that is not the intent of most of today’s infomercials. In fact, many of them aren’t necessarily designed to sell products at all; they’re designed to test the salability of those products in a mass-market environment like Walmart. Producing compelling spots is a means to an end. And what holds true of production in terms of controlling costs holds even truer of media buying.

Graveyard spots are incredibly cheap, especially when compared with prevailing rates for daytime and prime time. The average cost of a 30-second spot on network daytime is $9,200. The average cost of a prime-time spot is $110,200. These are national network buys, and purchasing individual spots (as opposed to larger flights in bulk) is almost unheard-of.

Infomercial spots, on the other hand, are usually bought through local TV stations in half-hour blocks. One-off buys, or buys in small handfuls, are not uncommon. There are approximately 212 local markets offering these blocks, giving the buyer the ability to target specific regions and defray the risk of a national network buy.

BUT THE POINT of an infomercial campaign isn’t to maximize reach. It’s to test products and pitches. More accurately, it’s to test a lot of products simultaneously, or the same product in a lot of different ways. A savvy marketer can A/B test the same campaign in different markets in real time. Because buys can be made in a much more ad hoc fashion than on network TV, the marketer can swap in and out different messages at almost any time in a campaign.

An infomercial buyer can produce and air a small test campaign for about $100,000. Any sales generated by the infomercials in the testing phase are almost incidental. If the response rates are decent (and remember, the bar is set pretty low: about 1 percent on average), the campaign can recoup a small fraction of its investment while still running a modest loss.

At this point, the marketer buys more test spots, perhaps in different markets. If he doesn’t have a deal in place with a local re-tailer on a trial basis, he moves quickly to secure one, usually in his highest--performing test market. From there, he’ll double down on that market to drive demand.

This strategy is known as the “retail-driving” infomercial: a campaign designed either to sell to retailers, or to promote awareness of, and drive traffic to, a product already stocked in stores. The economics of the strategy make it speculative at best for first-time product manufacturers and marketers without retail presence. On the other hand, big companies can leverage existing retail relationships and shelf space.

Increasingly, these big companies are making bigger spends in the DRTV space. J&J spent $22 million on infomercials in 2009 to test-launch and lead-generate its Neutrogena SkinID line. SC Johnson, another giant, spent $21.7 million on infomercials to support its Ziploc and Oust products. P&G has made infomercials a cornerstone of its Olay-brand moisturizer campaigns.

As for the little guys? DRTV is now a pretty hostile medium for them, due to the high failure rate of releasing new products to market through late-night ads.

©2013 by Jon Nathanson. Excerpted with permission from a longer article that originally appeared in Priceonomics.com.