The Unraveling of Newspaper Economics

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 |  Includes: AHC, GCI, GHC, JRN, LEE, MEG, MNI, NYT, SSP
by: Robert H. Heath

Major newspaper publishers met last week in Chicago in a not-exactly-secret, but definitely closed-to-the-public meeting to discuss the future of the newspaper business. More specifically, it seems, the meeting was convened to share ideas about how to more effectively monetize newspaper content on the web as traditional print subscription and advertising revenue plummet.

(As an aside, since most newspaper content on the web today is free, "monetize" must mean a price increase. Imagine if any other industry convened a closed meeting to discuss a price increase. What would the press have to say about that?)

As an avid reader (and paying subscriber) of several newspapers, I'm hoping they'll figure out how to survive. Sadly, I think the meeting must've been terribly disappointing.

A copy of "Paid Content - Newspaper Economic Action Plan" produced for the meeting by the American Press Institute has been published on the web in several place including here. A quick read of the document cannot inspire confidence. The action plan recommends that newspaper publishers experiment with micropayments, subscriptions, and more ominously, industry and maybe government pressure on companies like Google (NASDAQ:GOOG), Yahoo (NASDAQ:YHOO) and Microsoft (NASDAQ:MSFT) to share search-related ad revenue. This last bit is called the "Fair Share Doctrine" described as "Negotiate for money, a lot more, from Google and online news aggregators for a 'fairer' share of the profits from linking and ad sales."

These ideas are neither novel nor untested. And they haven't worked so far. One gets a vague and uncomfortable sense that when the API recommends, "... [using] technology, news-industry production protocols, influence and public policy to thwart piracy" what they really mean is "maybe some government intervention can help us survive in our current form."

The 31-page API report goes wrong in its second paragraph when it asserts, "The problem is that the online business model does not yet come close to compensating for the steep slide in the print business model that it is replacing." Guess what, it probably never will.

For well over a century the newspaper industry has enjoyed handsome economics supported by bundling economics and enviably low marginal distribution costs. These returns became even more attractive as many cities (in the U.S. at least) became one-newspaper towns. Bundled pricing, low marginal costs and monopolistic (or at least oligopolistic) market structure is a wonderful way to make a living. It is, however, not a birthright. And the government has no role helping the newspaper industry compensate for its loosening grip on its historical monopoly.

Here's Warren Buffett, whose Berkshire Hathaway (NYSE:BRK.A) has owned the Buffalo Evening News since 1977 and is major investor in the Washington Post Company (WPO), writing in his annual letter 25 years ago:

The economics of a dominant newspaper are excellent, among the very best in the business world. Owners, naturally, would like to believe that their wonderful profitability is achieved only because they unfailingly turn out a wonderful product. That comfortable theory wilts before an uncomfortable fact. While first-class newspapers make excellent profits, the profits of third-rate papers are as good or better - as long as either class of paper is dominant within its community. [Emphasis added.]

Twenty-five years on, Mr. Buffett has changed his view of the newspaper business. During Berkshire Hathaway's latest annual meeting, he said, “For most newspapers in the United states, we would not buy them at any price...They have the possibility of going to just unending losses.”

What's Changed?

The structure of any market in equilibrium is determined in a complex interplay of technology, economics, inertia (in the form of pre-existing relationships) and sometimes regulation. In the short term, the last three factors are paramount; in the long-term, technology dominates.

Traditional Newspaper Economics
The Virtuous Circle

Click to enlargeHistorically, the market structure of the newspaper business enjoyed a virtuous circle as depicted above. Once the costly reporting and editorial staff is on the payroll, the printing press paid for and the distribution system in place (representing yesterday's technology), the incremental cost of including an additional classified ad (or any other feature) in the daily newspaper is negligible. Hence, newspapers had incentives to bundle many forms of content in addition to their own editorial content: TV listings, horoscopes, movie schedules, stock listings, comic strips, classified ads, etc. A subscriber paid for the bundled product even if he used the classified ads maybe once a year, or never read the horoscope or used the TV listings. The high fixed costs, surplus economics from bundling and low marginal distribution costs gave rise to something akin to a natural monopoly. And in most U.S. cities, the market leader has seen its competitors fade away in the past three decades.

Now imagine you're a newspaper subscriber (maybe you still are). If you could disaggregate the horoscopes from the weather from the sports from the local news from the international news from the business news from the TV listings from the almost non-existent stock price listings, how much would you pay for the parts of the paper you actually intend to read? Probably less than the $10-$15 per week it currently costs at the newsstand. Probably less than the $6-$8 per week it costs for a subscription.

Probably a lot less.

This is the problem faced by the newspapers. Bundling is a pricing strategy that delivers surplus economics to the supplier by enticing customers to buy more than they would if the bundled products were sold separately. By weight, much of your local newspaper (and its website) is information sourced from third parties (stock listings, classified ads, lightly edited excerpts of corporate news releases, etc.) now readily available elsewhere on the internet (see note 1). By disaggregating the newspaper's traditional bundle of content, the internet may be exposing the market value, or to use the API's term "true value" of the original editorial content produced by the publisher itself.

As publishers experiment with new or revamped online pricing models they may find that the true value of their original content will give real meaning to the term micro-payment. No newspaper has a monopoly on "the news". It certainly has no monopoly on the third-party information it republishes. The newspaper industry suffers from a notion that it should enjoy monopoly economics on content (hey, that's copyrighted!) when in reality the historical monopoly was based on distribution and much of the profit was based on aggregating other people's content. And in the internet age, that distribution monopoly is over; and others, like Google, do a pretty good job of aggregating content.

Copyright should be respected. But if a reader can get his daily dose of international news as readily from the Washington Post, the New York Times (NYSE:NYT) or a foreign newspaper, copyright on a particular rendition of the news will not give rise to monopoly economics.

Like the music industry did before it, the API's view of the newspaper industry confuses the surplus economics arising from bundling and distribution monopolies for the natural economics of their copyrighted content. Copyright does provide a monopoly right in a particular form of expression but it does not guarantee that consumers will pay handsomely for it, if at all. The music industry has spent the past ten years battling piracy when the real problem has been the unbundling of the album format. It turns out that customers prefer to pay a $1.29 for the one song they really want rather than $14.99 for the twelve songs that the label bundled on the CD. Losing the additional $13.70 really hits the music label's revenue line. A twelve-year old kid downloading thousands of songs he can't otherwise afford does not.

When new technologies completely undermine an industry's market structure, that industry needs to be rebuilt from the ground up. The newspaper industry will fumble along (much like the music industry) if it starts from the premise that its historical economics represent some kind of natural order.

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Note 1. This morning's complimentary San Francisco Examiner landed on my front porch despite my wife's repeated attempts to discourage them from delivering it; I guess they need the circulation numbers to support their advertising rate base. The paper, including ad inserts, totals 54 pages. A quick inspection shows the content is allocated as follows:

Third-party content

Ads: 34.5 pages

Classifieds 4.0 pages

Movie listings 2.0 pages

Weather 1.0 pages

Games 1.0 pages

subtotal 42.5 pages

This leaves 11.5 pages of news content, but of course the "World", "Nation" and "California" sections (one page apiece) appear to be entirely made up of syndicated pieces by the Associated Press or others. So the actual original content produced by the Examiner comes to about eight pages, or about 15% of the total newspaper.

Disclosure: Currently short GCI