Clueless in Chicago --Unraveling Newspaper Economics

Major newspaper publishers met last month 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 (API) 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, coordinated industry and maybe government pressure on companies like Google, Yahoo and Microsoft 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 never will.

For well over a century the newspaper industry has enjoyed handsome returns from the economics of bundling combined with 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 Buffet, whose Berkshire Hathaway has owned the Buffalo Evening News since 1977 and is a major investor in the Washington Post Company, 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. Buffet 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 by a complex and recursive interplay of technology, economics, inertia (in the form of pre-existing business 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


Historically, the market structure of the newspaper business enjoyed a virtuous circle as depicted above. Once the sunk cost of the editorial staff is incurred, the printing press paid for, and the distribution system in place (collectively 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 reader 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 (note 1). The high fixed costs, offset by the 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 post-war years (note 2).

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 to subscribe.

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, the majority of your local newspaper (and its website) is information sourced from third parties (ads, stock listings, classifieds, lightly edited excerpts of corporate news releases, etc.) readily available elsewhere on the internet (note 3). By allowing readers to disaggregate 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 revamped online pricing models they may find that the true value of their original content will give horrifying 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 its historical monopoly was control of a distribution channel and much of the profit was based on aggregating and organizing other people's content. In the internet age, that distribution monopoly no longer exists and others, like Google, do a pretty good job of aggregating third-party 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 or a foreign newspaper, copyright on a particular rendition of the news will not give rise to monopoly economics.

Like the music industry 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 indeed confer a monopoly right to a particular form of expression, but in no way guarantees that consumers will pay handsomely for it, if at all. The music industry has spent the past ten years battling piracy when the larger economic problem has been the unbundling of the album format. It turns out that customers prefer to pay $1.29 for one song they really want rather than $14.99 for the twelve songs the label bundled on a CD album. Losing the additional $13.70 per transaction really hits the music label's revenue line. A twelve-year old kid downloading thousands of songs he can't otherwise afford does not.

If newspapers no longer command a monopoly on distribution and can expect no surplus economics from bundling third-party content -- including ads -- they may find that the ratio of the "true value" of their editorial content to their historical revenue approximates the 20% of the average paper that is made up of original content.

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.


--------------------

Note 1. It should be noted that subscribers to print newspapers generally pay less than the actual cost of writing, editing, printing and delivering the newspaper... often a lot less. What drove newspaper profitability in the past was advertising sales, but that requires the aggregation of a large audience, which requires aggregation of diverse content to appeal to a large, diverse audience to attract the advertisers.  Another virtuous circle... or vicious cycle if it starts running in the wrong direction.

Note 2. Noam, Eli M., "Media Ownership and Concentration in America"

Note 3. 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.