How long can publishers afford to print?

Second of two parts. The first part is here.

Unless advertising pulls out of its spectacular nosedive and rapidly begins to grow again, publishers may find within a matter of years that they cannot afford to keep printing newspapers.

While there may be a sufficiently large audience of people interested in buying newspapers for a decade or longer (see prior post) , the high fixed costs associated with producing and delivering newspapers suggest that some publishers may not be able to sustain print products for as long as demand holds out.

I arrived at this sobering conclusion by trying to project the profitability of print newspaper publishing for the next 15 years. The projections, which involved several moving parts, necessarily depended on a number of arbitrary assumptions, as detailed below.

But the projections clearly indicate that publishers pursuing a business-as-usual approach to the newspaper business may find their print operations, in the worst case, to be unsustainably unprofitable within five years. Any number of factors, as we soon will see, could ameliorate or accelerate those outcomes.

Without question, the key variable in predicting the future for print is whether, and how much, advertising sales will recover from the unprecedented 40% drop they have suffered since hitting an all-time peak of $49 billion in 2005. Here’s why the ad outlook matters:

:: If you believe print advertising will stop falling and start growing as the economy recovers in the next few years, then you can make the case that print has a future for as far as the eye can see.

:: If you believe the decline in advertising will taper off to a slow but steadily continuing rate of decay, then print has a few more good years before unavoidably high fixed costs consume what’s left of industry profits, thereby making the business economically unsustainable.

:: If you believe the drop in advertising we have seen in the last four years will accelerate in the future, then stock up on newsprint as fast as you can, if you have fish to wrap or puppies to train.

In an effort to illustrate how each of the above scenarios might play out, I built a model to gauge the future profitability of print in each of three cases through 2025. I used identical assumptions in every case, varying only how much advertising would rise or fall in each scenario.

I started each case with these assumptions for 2009, the first year of the model: Advertising sales were $28 billion; publishers spent $16.8 billion (60% of revenues) on print production and distribution, and pre-tax profit was $4.2 billion (15% of revenues).

Because production and distribution costs for the most part are fixed, I kept production costs constant in every year across all three cases. In reality, of course, production and distribution costs do vary from year to year, with costs falling if papers are leaner, fewer copies are sold and circulation declines. On the other hand, I made no effort adjust for inflation in payroll, benefits, paper, ink, fuel and other costs that are likely to increase over time.

Further, I did not attempt to take into account the sort of savings publishers could achieve through such extraordinary measures as eliminating print editions on certain days of the week, shifting their revenue models to favor subscription fees instead of ad sales, outsourcing operations formerly handled in house or consolidating the production of multiple papers in the same plant.

The only variables, therefore, were assumptions regarding future advertising sales. They are as follows:

:: Optimistic Case – Ad sales drop 10% in 2010, are unchanged in 2011 and then grow at 2% a year in 2012 and each subsequent year.

:: Middle Case – Ad sales fall 15% in 2011, slide 5% in 2012 and then decline 2% in 2012 and each subsequent year.

:: Pessimistic Case – Ad sales plunge 20% in 2010, drop 15% in 2011 and then decline 5% in 2012 and each subsequent year.

The effect on advertising sales is shown below in Figure 1 and the impact on pre-tax profitability is shown in Figure 2.

As you can see in the Optimistic Case, the newspaper industry pulls out of its advertising power dive in Figure 1 and returns to comfortable profitability in Figure 2.

In the Middle and Pessimistic Cases, however, print profitability erodes in a matter of years. All other things being equal, print would be marginally unprofitable within five years in the Middle Case and profoundly unprofitable in a shorter time in the Pessimistic Case.

But all other things aren’t likely to be equal. Apart from the few newspaper executives stubborn enough to hew to the industry’s traditional course in hopes of being rescued by a rapid and robust economic turnaround, it is reasonable to assume that most publishers are going to start doing something different in an attempt alter the deteriorating economics that are threatening their core business.

I don’t know what the new innovations might be. The scary part is that I am afraid the publishers don’t, either.