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.

Conclusion

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.