SPECIAL REPORT: The Web Tightens — What’s Behind the Slowdown in Online Revenue Growth

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By: Jennifer Saba

(From November’s print edition) Amidst the plague-like conditions newspapers are facing ? the locusts eating up print ad revenue, a flood of ill will from Wall Street, the arid credit markets, and crushing loads of debt ? publishers could once at least find relief in the steady, often strong growth of online ad revenue. For several years, executives touted the double-digit rise in online dollars as the reason to keep believing in newspapers.

At the start of summer, that comfort vanished.

The Newspaper Association of America (NAA) released its quarterly numbers for the industry in September ? and for the first time since the association started tracking and breaking out online ad revenue five years ago, the category dipped into negative territory. In Q2, online ad revenue fell 2.4% year over year to $776 million. Online ad revenue had grown 7.2% to $804 million in the previous quarter. “The only good news, other than cost reduction, was largely the growth in digital that newspapers have had,” observes Christopher Vollmer, a partner and practice leader for the U.S. media and entertainment group at consulting firm Booz & Co. “Now it appears to have stalled.”

One quarter does not a trend make, and growth abates as revenue rises. But online revenue is still a very small piece of the total ad pie ? in Q2 it represented only 8% ? and too little to excuse a slowdown. As Harry Hawkes, a vice president at Booz & Co. who leads the firm’s newspaper work, quips, “When it was growing, they were still trading nickels for dollars. The increase wasn’t that great when it was good.”

Nevertheless, newspaper publishers have been counting on double-digit advances in online revenue to help make up for the loss of print ads. It was the last tool they could use for positive spin. So are the latest results only a small jolt? Or are newspapers in for a real shock in quarters to come?

The problem? It’s classified
“Alarming?” Gordon Borrell of Borrell Associates asks about the downturn in online ad dollars. “We have been telling people this fire has been coming in this direction for years.”

For Borrell and several other sources interviewed for this report, one of the main reasons for the downturn is an over-reliance on classified advertising and combo sales packages. About 60% to 70% of online revenue for the industry as a whole comes from classified, confirms Randy Bennett, the NAA’s senior vice president of business development. He believes Q2 declining results are “primarily tied to classifieds and the dramatic drop in classifieds overall, and newspapers’ reliance on classified dollars to drive online.” Adds Wachovia senior analyst John Janedis: “Even online, these companies in the industry have too much exposure to classifieds.”

The technique practiced for years is to upsell classified print ads by tacking on an online ad for additional dollars. For a long time, it worked.

Display advertising, not listings, is where the growth is, at least in the first half of 2008: The IAB reported it rose 19% to $3.8 billion.

“To get the big numbers and big increases as they were touting this as a panacea of print decline, they were riding up the escalator of classified sales,” says Ken Doctor, an affiliate analyst with Outsell Research and author of the Content Bridges blog.

The problems with this strategy is: One, when print ad revenue drops off a cliff, so does online classified revenue when it’s tied to the former. Two, classifieds, even those sold purely on the Web, are exposed to the elements of the economy no matter where the listing appears. The Internet offers no more protection than print.

“Now we are descending,” says Doctor. “Newspapers have had their own volume problems for various reasons, and the overall economy has been going down. That has reduced the volume of print ads ? and that has brought down online volume and taken down bundled growth rate to zero and below.”

If companies aren’t hiring, they aren’t placing help-wanted ads in print or online. Take the pure-play, job-recruitment site Monster.com, as an example. Janedis lowered the company’s North America Career revenue growth estimates in 2009 from -8% to -14.7%. “At this point, all things considered, it’s cyclical, even online,” he says.

McClatchy made that point when it released its August results, which actually showed online growth. The publisher helpfully breaks out online and print revenue in monthly statistics. Total online advertising in August grew 7.4% in every category except classifieds. Remarkably, McClatchy managed to make gains in real estate and auto, up 18.1% and 31.3%, respectively. Employment sank 32.7%. The company’s management has been very vocal over the past several months about moving away from bundled ads, instead focusing on online-only ads.

Pat Talamantes, McClatchy’s CFO, remarked about the results in a statement: “In fact, when employment advertising, which has declined both in print and online as a result of the nationwide slowdown in hiring, is excluded, our online advertising revenue was up 51.5% in August and was up 55.3% in the first eight months of 2008.” The company gained ground with online revenue by limiting its inventory and its reliance on ad networks.

Some observers point to an even bigger issue than the addiction to classifieds and bundled packages. “We have felt for the longest time that most newspapers have not gone to market with an appropriate value proposition,” says Sammy Papert, chairman/CEO of Belden Associates. “They leveraged their existing relationship. ‘Hey, we have a Web site now, don’t you want to advertise on it for an extra $100 a month?'”

He believes that newspapers hamstring their selling efforts when they rely on metrics, such as “uniques,” to entice advertisers to place a buy. “Newspapers are going to have to deliver more than just aggregate eyeballs,” he explains, since local advertisers are getting more sophisticated in channeling dollars to search-engine marketing.

In Papert’s opinion, newspapers should offer local advertisers other services such as search-engine optimization or conducting surveys on behalf of the advertiser ? something that brings value to the table. According to research firm Magna and the NAA, search-related advertising is expected to grow 24% to more than $13.5 billion in 2009 ? the biggest gain, and spend, for emerging online advertising.

Not only is the growth of online ad dollars reversing, but newspapers have been losing local advertising share to other media ? particularly pure-plays like Google ? since 2005, Gordon Borrell notes. “It’s not a trend that just popped up on the radar,” he says. “It’s been out there if you look at share versus total revenue growth.” Local online advertising in general grew 50% this year, he adds.

Booz & Co.’s Vollmer thinks the bad rap that newspapers have received over the past several months is tainting their online properties. “The print product has been in a pretty steady decline. That decline has been so significant and persuasive, it’s having spillover effects to the online [edition] as well,” he says. “It’s affecting the confidence level that advertisers want to allocate to newspapers as brands in general.”

Making a better ‘impression’
Even if advertisers want to spend money with newspaper Web sites, Vollmer, like Belden’s Papert, notices a worrisome trend in Web metrics. He observes that time spent per session on newspaper Web sites is actually quite short ? implying that people are dashing in and out in order to check the weather or the latest baseball score. “There is an expectation that you are going to spend time with the newspaper,” says Vollmer. “The reality is people use these newspapers very differently online. The value of that impression is a lot less.”

Traditionally, newspapers tend to undercharge for the cost per thousand (CPM) ? when they sell it, that is. According to the IAB, in 2007 about 53% of ad space on newspaper Web sites of seven publishers went unsold, compared with 50% in 2006, The New York Times reported.

To boost the cost per thousand, Vollmer contradicts industry wisdom in the direction online newspapers should take. Guess what? It’s not just hyperlocal. If newspapers want to attract local online advertising for an attractive price, he says, a distinguishing set of factors is required. “I think newspapers have to think through what is fundamentally their proposition as a local regional company,” he says. “I’m not sure that local is enough, given the amount of competition there is in digital.”

The New York Times, he says, brands itself as upscale and sophisticated. It’s a specific, tailored focus ? much more so than, say, the generic distinction of covering the city of Chicago. Advertisers are inter-ested in psychographics, otherwise it becomes a commodity game.

All is not lost. While many sources told E&P that newspapers have relied too long on bundled upsells and classified advertising, almost everyone thinks that newspapers are in a position to turn in a positive direction.

Outsell’s Doctor explained that once a newspaper can garner at least 50% of its online revenue from online-only sales and pull back from classifieds, it will jump-start growth engines. Says Gregory Springs, a senior associate in Booz & Co.’s media practice: “I don’t think we see this downturn in online advertising growth as anything other than a short-term issue. It will return to positive growth.”

The NAA is forecasting that online revenue will increase roughly 1.8% to $3.2 billion this year. In 2009, it expects that figure to rise 9% to $3.5 billion. “I think newspapers for a while have been trying to ramp up and diversify and find new revenue sources,” says the NAA’s Bennett. “As that continues, we will see a difference, maybe not in third or fourth quarter, but in 2009.”

Wachovia’s Janedis notes that publishers see the “need” and “urgency” to divest out of classified online advertising. “The good news is that they are on it. The bad news is that the numbers are not where they would like to see them.”

Borrell echoes that sentiment. The newspaper industry anticipated the downturn, and has been making efforts to return online ad revenue on a northward trajectory. He draws a parallel between aircraft carriers and newspapers: behemoths that take time to shift course. “We think they will turn the corner,” he adds.

Something for the pain
The Yahoo alliance is a big part of the plan. Yahoo’s new ad platform management system, APT (as E&P explored last month) puts several critical tools within the reach of newspapers.

The alliance opens up the newspaper’s inventory, making it more valuable by greatly expanding its reach within a market. APT’s main driver is that it allows for behavioral targeting, letting newspapers sell advertisers on more psychographic data. Increased reach and the capacity to hit targets more precisely increases the newspaper’s ability to raise CPMs.

When Yahoo unveiled APT in late September in New York, Dean Singleton, CEO of MediaNews Group and one of the first newspaper chains to rollout the platform, said his group of newspapers expects CPMs to triple.

Singleton acknowledges the recent slowdown in online ad revenue, and MediaNews Group’s decline in online ad revenue growth this year so far. The reason? He points to upsells in the classified category. In the same breath he says that MediaNews Group is on track to diversify away from that, thanks to Yahoo.

APT is “already beginning to ease our pain,” says Singleton. The San Jose (Calif.) Mercury News, one of the first test sites for APT, is already garnering attention from advertisers who normally wouldn’t touch newspapers.

Currently, 22% of MediaNews Group’s operating cash flow comes from online revenue. In five years, Singleton expects that figure to rise to 50%.

Rusty Coats, the vice president of interactive for the newspaper division at E.W. Scripps, doesn’t even count online ads upsold from print, calling such ads a “false positive.” Classifieds have to be stripped out to get an accurate picture of online ad revenue, he contends. “We have been victims of our own success,” he says of newspapers gorging on online classifieds for too long. “We haven’t developed those muscles that we should have been developing. Fat cats don’t chase rats.”

At Scripps, pure-play online revenue is advancing in 40% to 50% clips, Coats adds. He expects that rate to accelerate even more with the implementation of APT.

Instead of selling online “sections” mimicking how print sales are structured, E.W. Scripps is putting forth a concerted effort to sell audience.

In certain markets, Coats says, the Yahoo partnership will boost the reach of an online newspaper from 25% to 80%. That opens up a lot more people to target. Ultimately, that will help Scripps flip the ratio of total online revenue, with about 70% coming from online-only display advertising and 30% coming from verticals ? “I don’t mean upsells,” he adds.

Coats is so optimistic about online ad revenue that he sounds like he’s just stepped out of the year 2004. Once bundled ads and classifieds are separated out, the potential is enormous. There’s “an incredible story of online revenue ? a powerful source of income for all of us,” he adds. He forecasts that by 2012, online revenue will pay for all the company’s newspaper journalism.

When asked if that means a newsroom with a total of 10 employees, Coats responds, “We set that goal on the newsroom we have now, and adjusted up for inflation. That is what we have at our disposal right now.”

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