By Jonathan A. Knee, Barrons.com
RECENT HYSTERIA OVER THE IMMINENT demise of daily newspapers is misplaced. As an economic matter, most newspapers still are far more profitable than other, higher-profile consumer media. As a policy matter, those calling for government subsidies or other protections ignore the true state of the marketplace of ideas: It has never been so vibrant.
Newspapers do face a genuine crisis, but the nature of this crisis is misunderstood. Formulating a coherent response -- for operators, investors and policymakers -- requires a clear-eyed view of the state of the industry.
Doing worse doesn't mean doing badly. Until recently, many newspapers had profit margins exceeding 30%. By 2008, the industry's average margin had fallen to the mid-teens. The speed and magnitude of this decline have resulted in wrenching changes in the way these historically stable businesses must operate.
The continuing drama shouldn't distract from real earnings power. Many newspapers still have almost double the profitability of other media sectors, such as movies, music and books -- which have long struggled to achieve margins of even 10%.
EVEN GOOD BUSINESSES can have bad capital structures. Many newspaper companies took on debt that could have been easily supported if profitability had been maintained. The problem is that current earnings, even if superior relative to those of other media businesses, are far below what anyone had anticipated.
For instance, McClatchy put much of its $2 billion of debt in place in early 2006, when margins still approached 30%. In 2008, it had 20% margins on almost $2 billion of revenue, but debt service consumed its profit. As a result, while its recent share price at $3. 65 is well above its July all-time-low of 40 cents, McClatchy's stock-market value is still barely $300 million -- down from a high of more than $3 billion as recently as 2005.
One way or another, the capital-structure crises at newspaper companies will be resolved, by paying back the debt over time, negotiating with creditors or by bankruptcy. The underlying businesses will go forward.
There are many newspaper industries. The handful of national newspapers that garner the most attention represent a tiny subindustry (about 10% of daily circulation) within the overall sector. These papers, which include the New York Times, the Wall Street Journal (published by News Corp., which also owns Barron's) and USA Today, have long been among the industry's least profitable.
USA Today, for example, took a decade to attain profitability, and has continued to maintain much lower margins than the small market local papers that filled parent company Gannett's coffers with the cash it spent on USA Today. With daily circulation under 100,000, local "monopoly" papers represent the backbone of the industry, and continue to be highly profitable -- although not as profitable as they once were.
Some major-market local papers have become unprofitable under the combined burden of antiquated cost structures (including union contracts that severely limit operating flexibility) and new market entrants -- both off- and online. Some of these papers might seek bankruptcy protection or even shut temporarily, in order to address anachronistic legacy-cost issues. But there are few markets that shouldn't be able to support a healthy newspaper.
OBVIOUSLY, THE INTERNET ISN'T the newspaper industry's friend.
Large, fixed-cost printing machinery and distribution infrastructure are required to produce a daily local paper and represent the industry's biggest barrier to entry. Unfortunately for the newspapers, efficient delivery of classified advertising -- which represented barely a quarter of newspaper revenue but more than half of profit -- turned out to be the Internet's "killer app." Monster.com, Craigslist, realestate.com, cars.com and dozens of other sites emerged to capture an increasing share of this once wildly profitable and proprietary domain.
Newspapers continue to have advantages of scale in certain aspects of their business, such as sales and local-news collection. And cooperating with adjacent competitors or outsourcing certain functions altogether can ensure that the newspapers capture some continuing benefits of lost scale, even if these must now be shared.
Smart operators have begun to apply these principles to everything from printing and distribution to certain aspects of news collection and even the editorial process. Industry strategies should focus on reinforcing competitive advantages, not trying to reestablish dominance in areas where that is now structurally impossible.
The Internet should be part of these strategies, but blindly embracing this medium, which has few barriers to entry, will only accelerate the already ominous financial trends.
Bad for shareholders doesn't mean bad for consumers. Even the savviest newspaper operator won't be able to return its business to the level of profitability it once had. The Internet has increased competition for the attention of many audiences, not just the audience for classified ads.
Although this heightened competition has led newspapers to cut their costly original national and international coverage and investigative journalism, consumers have multiple new sources to replace what is missing from their local papers.
The Internet provides timely access to other local, national and international news outlets. Blogs, citizen journalists and social and experts' networks also make available a deeper, more textured collection of viewpoints on news events than local newspapers provided to their once captive audience -- no matter how much more the papers used to invest in coverage.
The Internet has created information overload. Media entrepreneurs surely will develop compelling products to guide consumers through the cacophony. But they may not be the third- and fourth-generation descendants of the entrepreneurs who founded mass-market newspapers.
THE NEWSPAPER OF TOMORROW will indeed be very different in terms of how it is produced and delivered, what is in it, and how profitable it is. It will be part of a much more crowded and complex news and information ecosystem.
Operators must aggressively focus on cost and cooperation, designing truly distinctive offerings that leverage their advantages in this newly competitive landscape.
Policymakers currently have plenty of legitimate targets of their attention without worrying about the fate of newspapers or trying to keep change from happening. If they keep out of the way, news junkies in particular should anticipate an era of unprecedented plenty. And investors will be well-rewarded by backing managers who appreciate the continuing, if diminished, profit potential of this new environment.
JONATHAN A. KNEE is director of the Media Program at Columbia Business School and coauthor of The Curse of the Mogul: What's Wrong With The World's Leading Media Companies (Portfolio: 2009).
