Thursday, April 12, 2007

Beyond magical thinking

In another example of the magical thinking that sometimes passes for the real thing in publishing, some people are embracing the idea that newspapers could continue in the future as break-even businesses subsidized by the profits of their online operations. Wrong.

If, heaven forbid, print profits were anywhere near being on a trajectory to nil, investors would bail out of publishing companies well before the distant theoretical point that new media operations reached sufficient critical mass to replace the revenues and profits of print.

Investors would be wise to flee, too, because online sales and profits – even though they are growing at robust double-digit rates – are not going to be anywhere near capable over the next 10 years of delivering a sufficient return to merit the substantial investment in big iron required to produce and deliver a print product.

If print sales and profits dried up to the point that newspapers truly were only breaking even, their managements would have to abandon the print product or risk being cashiered by their investors. So, break-even is not an option for print.

And the magical thinking that conjures such improbable scenarios is no substitute for objective analysis, realistic strategies and concrete action.

I’ll go through the math supporting my conclusions in a moment, but first some background:

My friend Peter Zollman raised the idea of break-even newspapering in his column in the March edition of Newspapers and Technology Magazine. Quoting an unidentified industry executive (without necessarily subscribing personally to the following dubious proposition), Peter said:
My friend’s theory is that the fixed costs of publishing the daily paper will remain, well, fixed – running the presses, buying newsprint and ink, operating delivery trucks and paying carriers, employing photographers and reporters and editors and so forth. Over time…those costs will essentially match the revenue of the daily print edition – so it will neither make nor lose money. The publisher…will remain profitable by generating healthy margins on all the related products it offers.
The chief problem with this economic fantasy is that print still delivers some 90% of the revenues at most newspapers. Even though online (and niche print products) may generate higher operating margins than the industry range of 20% to 30%, the profits coming from this relatively small volume of sales will not produce the absolute dollars necessary to make up for the absence of, or even a material decline in, print profitability.

Advisory: If you as math-averse as I am, you can TiVo through the technical stuff in the next three paragraphs and skip to “Conclusion.” If you proceed, please do not do so while operating heavy machinery.

The first of the two graphs below shows what would happen to the sales and profits of a hypothetical newspaper company whose print operations moved from a generous (but not unheard of) operating margin of nearly 29% today to negligible profits at the end of 10 years. In the same period, online operations would increase at hefty double-digit rates over the decade to deliver 50% of the company’s total sales and 100% of its operating profits.

Assuming a linear drop in print sales and profits each year on the way to break even, profits for the entire company would slip from $1.2 billion in Year 1 and continue falling annually until stabilizing at less than half that amount in Year 4 and thereafter. Once online sales grew to the point that they were delivering nearly a third of the revenues in Year 7, profitability would begin to improve slightly. But the consolidated earnings of $800 million in Year 10 still would be only two-thirds of where they started in Year 1.

Even though sales exceed the $4 billion level in the out-years, the company’s profitability of 17% in Year 10 is 41% lower than where it started in Year 1. That’s because the newspaper isn’t making any money.


So, what does it all mean? Glad you asked.

Like many big manufacturing businesses, newspapers require a huge investment in plant, fleet and other equipment to produce their print products. When investors put money into a company to help buy such assets, they require them to produce sufficiently high profits to merit the continued use of their money.

If the assets fail to produce adequately, the investors first pressure the management to improve the profitability of operations, then agitate for new management and, if still unsatisfied, demand the sale or liquidation of the business. Sound familiar?

If profits were to deteriorate as badly as discussed in the three above paragraphs you skipped, the return on assets (illustrated in the second graph below) would drop from 7.2% in Year 1 to an unacceptably low 2.8% by Year 6. No investor would sit still for that sort of deterioration.

Before that happened, investors either would demand a sharp improvement in print profitability or demand that the presses be stopped permanently. In other words, newspapers will go out of business before anyone ever lets them operate on a break-even basis.


Anonymous Anonymous said...

I'm a (union)delivery foreman for the NYT. I make 90k a year. My driver's make 60k before overtime. The paper we deliver costs one dollar at the newsstand. If you think that dollar covers the costs of delivering it (printing,warehouse,trucks,diesel fuel,drivers,insurance and on and on) I have a great bridge that i could sell you. The Sulzbergers of the newspaper world would be derelict if they weren't looking to get out of the hard copy end of it.

12:46 PM  
Anonymous Anonymous said...

Doesn't this analysis show the wisdom of an all-Internet news operation? That the real danger to the newspaper industry is a news media start-up with no capital intensive legacy of printing press, newsprint costs, delivery costs, etc?

In other words, the cost of most newsrooms (that is, the reporters, editors, copy editors) amounts to about 10% to 20% of newspaper revenue now. The rest of the revenue pays for the presses, etc.

So as soon as online revenues reach 10% to 20% of print revenue, which will happen in less than five years according to your graph, then you will be able to fund an online-only news operation that is making money, growing profits rapidly, and has the same robust editorial contingent of reporters and editors as today's print product.

Isn't this the real threat--and the real future--of the news business?

2:06 PM  

Post a Comment

<< Home