Where Is the Bottom?

By: Mark Fitzgerald And Jennifer Saba From the moment newspapers set up shop on these shores ? the first one promptly shut down by Colonial authorities, its copies hunted down and burned ? America's dailies have faced no end of near-apocalyptic challenges to their freedom and finances. The Alien & Sedition Act, the Civil War, the Great Depression, the mass hypnosis of the Boob Tube, the extinction of the big-city evening paper: In the face of all this and more, the industry not only endured, it prospered.

Yet now that newspapers are again sliding toward the trough of another of the countless advertising slumps in their long history, something feels ... different. "It's more than shocking ? it's terrifying," says newspaper veteran Alan Mutter. "I don't think anybody wants to get too far out and predict what's happening next."

That's the question that increasingly alarms those in and outside the industry: Is this just another sharp turn of the newspaper advertising cycle ? or is it a mortal wound created by so-called "secular" changes afflicting print? Are the lucrative print ad dollars going away permanently, and so quickly that online revenues will never catch up?

How worried should newspapers be?

If, as Mutter says, no one wants to predict what will happen next, it's because what's happened already is disquieting enough: five straight quarters of falling print advertising revenue, which seemed to accelerate through a long, hot summer of bad news from the balance sheets. It was, for instance, a July unworthy of fireworks, with real estate classified revenues down 20% year-to-year at Gannett Co., 24% at Tribune Co., and 26% at the McClatchy Co. As if Dow Jones & Co. did not have enough on its plate with Rupert Murdoch's takeover, it had to cope with a 75% collapse in the volume of technology- related ads.

The losing streak continued in August. Ad revenue plunged 9.2% at McClatchy, 6% at Gannett, 4.6% at The New York Times Co., 7.2% at Tribune, and 9.6% at Journal Register Co.

Save the bad news for a Friday afternoon, any media consultant will tell a corporation or a politician. So well past lunch on the getaway day for Labor Day weekend, the Newspaper Association of America (NAA) let slip that advertising revenue for the industry as a whole sank 8.6% in the second quarter of the year.

But NAA buried the lede: strip out online revenue and it plummeted 10.2% ? the worst drop since the third quarter (the Sept. 11 quarter) of 2001.

Online ad revenue grew, sure, but its 19.3% increase was just further evidence that the truly big percentage jumps ? such as the 33.2% leap in the second quarter of 2006 ? are likely all in the past. And while online is growing in share of total dollars, print still accounts for 93% of newspaper ad revenue.

The online deceleration recorded by the NAA caught the eye of Alexia Quadrani, a research analyst with Bear Stearns. Newspapers need every bit of revenue they get "when faced with severe print ad declines," she wrote in a note to investors. Her kicker is not reassuring: "We do not expect any large positive swings in newspaper revenues (and for that matter, margins) as a result any time soon."

There's one more worrying thing about the industry's current sputtering: It happened while the nation's economy in general was in reasonably good shape, and a recession seemed unlikely. Now, with the possibility of a recession looming ? due to a slowdown in job growth and home sales ? are newspapers in for more, and perhaps worse, contractions of ad revenues ahead? "I think it's too soon to call this the bottom," offers Wachovia Equity Research senior analyst John Janedis. "I think the major reason is the macroenvironment. It could go into a recession, and there would be another leg down in terms of declines."

Goldman Sachs analyst Peter Appert doesn't see a hard stop either. "My first takeaway is there is no sign of the bottom," he says. "It's unprecedented to see the rates of decline in ad revenue that we are seeing this year in a non-recession environment. To define the bottom is next to impossible." His best guess of when the industry will hit the ground: "When Internet-based ad revenue will offset what I think will be a permanent decline in print."

The problem is, there's no sign ahead of anything that will reverse the declines, argues Mike Simonton, an analyst with Fitch Ratings Services. Moving advertisers to online sites is unlikely to be a panacea, he adds, because newspapers, which have operated effectively as local monopolies in print, have no advantage in the crowded Web.

Wall Street once believed that newspaper sites could seize great opportunities in national advertising to buttress its natural advantage in local print. No longer. "We have seen massive declines in national," says Janedis. "But national revenue is still twice as large as online revenue, so we won't see any real impact of online until the early to middle part of the next decade," he estimates.

"And that is making the assumption that solid growth there will continue."

When will online begin churning out the kind of revenue that print provided newspapers? "Not for a very long time," Janedis adds bluntly.

At current projections (see chart, p. 28) by Goldman Sachs, online ad revenue would need to increase 20% for each of the next five years to produce total newspaper ad revenue gains by 2011 ? and then, only because of easier year-over-year comparisons.

One thing analysts know for sure, though, is that newspapers so far are doing worse than even their low expectations. "We did expect it to be bad," Fitch's Simonton says. "We did not expect the declines would be this pronounced."

A fear of fear itself
Not everyone is so pessimistic. Asked to comment on the ad plunge, a publisher in a growing Sun Belt market replied, "Off the record? It sucks, it's horrible. But we know it's going to be short-lived, because we have growth, we have people moving here. If I were in a place where housing was collapsing and the local plant was shutting down, it would be of Steinbeck proportions."

Still, the publisher says, things are not "dire," and it's annoying to hear the ubiquitous industry observers say it is: "There is nothing about this downturn that is unusual. I don't have one advertiser who isn't in [my paper] because he's on the Internet. They just don't have the money to advertise anywhere."

Jay Smith, president of Cox Newspapers and former chairman of the NAA, is just as philosophical. Smith acknowledges he hasn't seen a downturn "quite this severe" in his 40-year career, but adds: "It's a fascinating time to be in this business. We are reinventing ourselves. It would be nice to reinvent ourselves at a calmer pace but you have to play the speed of the game, and right now the game is pretty frenetic."

According to Toronto-based consultant Len Kubas, the industry's dismay over recent newspaper performance is degenerating into hysteria. "We tend to use exaggerated words to describe the plight we're in," he says. "There's a loss of momentum, no doubt about it, but ad revenues aren't 'cratering.' I personally believe newspapers have a terrific future."

Newspaper executives ? especially advertising directors ? should cut out their public keening about their current difficulties, and start implementing "a few, moderate tweaks" to get sales back on track, Kubas urges. "The biggest fear that I have," he says, "is not that papers will go out of business, but the people who are running newspapers will lose their confidence in their ability to change the future."

Yet for an optimist, Kubas offers a doleful assessment of how long newspaper revenues have been stuck. According to a chart created by Kubas Consultants, newspaper revenues reached a tipping point in 2000, well before the 9/11 terror attacks (see chart below). And just as they're saying on Wall Street, Kubas doesn't believe that online revenues will be sufficient to make up the lost print revenue ? especially with the kind of declines newspapers are experiencing now. "For every 1% decline in print, you have to have something like a 12% or 13% increase in online revenue," he says, "so once you see 2% or 3% declines in print revenue in a month, it really takes big increases in online to make it up."

Marginal solutions
Kubas offers several fixes ? and one harsh prescription publishers may find hard to swallow.

One of the first things newspapers can do, he says, is simplify their ad sales approach, adopting modular advertising that sells size, not inches. Newspapers must realize they are selling visual impact, Kubas says, not column inches, and they should reduce the barriers to color advertising: "Newspapers still price color like it's 1955."

Papers should also resize, and listen to consumers who clearly prefer tabloids, Berliners, and A4s over broadsheets. But Kubas' most controversial call is for a change in the fundamental part of the newspaper business model: high margins. Newspapers must get out of the "margin management game," he says. "If you're locked into an operating model that says you have to deliver high operating margins, you have to cut costs, and you have to be pretty Draconian about cutting costs. Given the weak ad momentums now, you have to cut costs even more dramatically than in the past, and sooner or later, advertisers and readers are going to figure it out."

Wall Street was initially attracted to newspapers because of those high operating margins and the abundant cash flow. But now, analysts are concluding that Kubas is right to see high margins as a problem.

"The industry has done yeoman-like work in protecting profitability by cutting costs," says Goldman Sachs' Appert. "The challenge and the reality is that can only take you so far. You can't be cutting 7% of your staff every year and expect to stay in business."

But Appert says the good old days of consistent 20% to 25% margins are over, and that newspapers are going to have a harder and harder time keeping them even in the high teens in the next three or four years. "Investors and the companies, frankly, need to rethink their expectations," he says. "It's still a great business ? it's just going to be less profitable."

Even with their intense cost-cutting, newspapers are seeing margins erode. Appert figures that Tribune's operating margin, for instance, will fall to 16.7% this year, down from 18.9% last year, 19.8% the year before, and 21.9% in 2004. "That is emblematic of what is happening broadly," Appert says. "This was a low-20s margin business; it's now in the low teens."

The fix is ... in?
Newspapers themselves, though, are vowing not to go gentle into that good night.

Is the newspaper industry in something like a death spiral, Tribune Publishing Co. President Scott C. Smith is asked? "No, absolutely not, but we do have really tough revenue trends, tougher than we expected in 2007 ? but it is this combination of cyclical and secular factors," says Smith, who heads up Tribune Co.'s newspaper and print division and is publisher of the flagship Chicago Tribune.

Tribune, which is going private at the end of the year in an $8 billion deal engineered by Chicago real estate baron Sam Zell, probably has been hammered a little harder by the cyclical aspect of this revenue crisis because it owns big dailies in Los Angeles and Florida that have watched their real estate ad revenues evaporate during the regional housing collapses. "But we're not just waiting for the cycle to turn," Smith adds. Tribune has a lot invested in print, and just last year fired up a new inserter system in Chicago to allow the kind of sub-ZIP code distribution marketers long demanded of newspapers.

Now, it's going after national in a big way. Tribune has reorganized its national sales group, Tribune Media Net (TMN). When TMN was created in the heady days after the chain's acquisition of Times Mirror with its Los Angeles and New York papers, it was, in the language of the times, intended to offer "cross-platform" opportunities that would monetize the "synergies" of Tribune's new "national footprint."

It didn't work out. "National spending hasn't grown in newspapers as we hoped, but we're focused on those clients more intently with this new structure," Smith says.

This time around, TMN is taking a handful of big national advertisers away from its local papers, and concentrating all its sales efforts on them. It's nearly the advertising equivalent of focusing the newsroom on "local, local, local." Another similarity to what's happening in newsrooms: At Tribune newspapers, about 100 ad jobs are going away through a combination of layoffs and attrition.

The hope is that cozying up to decision makers will work out as it has with auto giant GM, which publishes its highly coveted special sections (called GM Showroom in the Chicago market) in its three Chicago dailies.

But Tribune recognizes that some print isn't coming back. "Take recruitment, that was a structural change that changed several years ago, and continues on the online path," TMN President Ken DePaola says, noting that Tribune is a principal owner of help-wanted job board CareerBuilder. Travel and entertainment, he believes, are probably going that way, too.

"But real estate, I think, will come back, and we're already seeing a little bit of that in Chicago," he adds. "Big-box retailers, I see that as more cyclical. And [that segment] hasn't really gone away for us. They use a preprint strategy, and we're still a lot more efficient than putting an insert in the mailbox."

And newspapers still have the audience, grayer perhaps but far more active than past generations, DePaola argues: "Regardless of circulation and readership declines, we still have the biggest audience, with the best incomes, who trust us, who engage with us, who have a kind of emotional attachment."

No 'charge' for consumers
But does another secular change threaten newspapers' enviable hold on its audience?

Alan Mutter ? whose blog "Reflections of a Newsosaur" often punctures the news- paper industry's self-image with ruthless analysis of its performance ? thinks that dailies may be losing their longtime cachet as a marketing tool that can deliver a smart, sophisticated audience. He's been hearing from media buyers that clients just don't want to advertise in newspapers.

Why? If you're an advertiser, and a lot of people "think it's dumb to read a newspaper, it would be dumb to advertise in them," he says. Media buyers are worried that it has become "unfashionable" to advertise in the paper. "That word of mouth is difficult to combat," he says. "It's like John Kerry and the Swift Boat thing. I'm afraid the newspaper industry is letting it happen," partly because of cuts in coverage and staffing and physical size being implemented to protect margins.

The dailies are afterthoughts for image campaigns, says retail consultant Ed Nakfoor. That's not encouraging given the merger and acquisition activity in the retail sector, most notably Federated and May, where new nameplates usually mean big branding pushes. Nakfoor offers his assessment of his local market in Detroit: "On Sunday, there is no wonderful image advertising of hot trends of what is in the stores. You are not seeing full-color, full-page ads here. Generally speaking, the newspapers are becoming more thin and reedy on a regular basis."

When the dailies are used as vehicles, the department stores rely on sale ads and coupons. For the high-end retailers like Nieman Marcus and Saks Fifth Avenue, branding advertising in most dailies is virtually non-existent, save for the occasional cosmetic "bonus" ad. "It's pretty much a maintenance kind of thing ? another sale," notes Nakfoor. "You are not seeing anything to get folks really charged."

Tender talks tough
In Nakfoor's town of Birmingham, Mich., Karen Daskas makes his point.

The decidedly fashionable Daskas is co-owner of the ultra-high end retail store Tender, located in the tony Detroit suburb. Michigan is going through what locals call a "one-state recession" that has hammered newspaper owners, particularly the Journal Register Co. Yet you wouldn't know about hard times looking at Tender. Its inventory wears labels such as Jimmy Choo, Derek Lam, Mui Mui and Zac Posen ? designers that attract discriminating shoppers willing to shell out thousands of dollars for the latest collections.

Just don't expect to see a Tender ad in Detroit's daily newspapers. Why bother? Daskas asks. Her customers sure aren't looking there. She says dailies disappoint for two reasons: For one, her customers don't subscribe. For another, the newspapers don't cover her market ? they're not relevant.

"They will write about a $350,000 Bentley or Rolls, but they don't want to write about a $2,000 sweater or a $1,200 pair of shoes, or a $3,000 handbag," Daskas complains. "Everything you read says the luxury market is on fire. Not everyone in Michigan is eating pork and beans."

Daskas isn't a snob. Well, maybe a little. She flat doesn't like the ad environment of the dailies. All those lucrative ? and store traffic-generating ? coupons? Ugh, they're ... d?class?. So for results, Daskas and her co-owner sister turn to the glossy city mags and neighborhood weeklies, like Detroit Jewish News and Grosse Pointe News. They are pleased with Signature ? a lifestyle magazine from Detroit Newspapers ? and are happy to advertise in it because it's "upscale and people connect with it."

It's not that newspapers aren't courting Tender. Daskas says that an executive with the dailies (which sell under a joint operating agreement) came calling, and he wanted her opinion. She gave it. Daskas recommended when the newspapers feature products in layouts, instead of listing Web sites, maybe they should consider local stores.

Daskas understands that the business side can't dictate what reporters write. But then she framed it in another way: Newspapers at least have a shot of getting ads from local stores ? they'll never get ads from Web sites.

The domino effect
The two big categories for newspapers, retail and classified ? never mind national, which has always been touch-and-go ? are experiencing their own transformations, too.

Newspapers are capturing part of the stream of recruitment advertising to the Web with CareerBuilder and partnerships with Yahoo's HotJobs and Monster.com, but the return is a far cry from what papers once netted from print classified help-wanted ads.

Real estate is suffering from the downturn which was anticipated, just not at the current levels. Mary Jacobus, president and COO of The New York Times Regional Media Group, says papers in Alabama and Louisiana are holding their own, but acknowledges their California and Florida markets have been sideswiped by the collapsing housing market. They forecasted a crunch, just not its ferocity.

When real estate ? and subsequently the credit market ? sinks, it pulls other categories down with it. Suddenly, people stop refinancing mortgages for extra cash once used to remodel an outdated kitchen, purchase home furnishings, or buy a new car.

Analysts too have been busy whittling down revenue projections for the remainder of the year. Goldman Sach's Appert forecasts that print advertising revenue will be down around 6% in 2007. Wachovia's Janedis cut his ad revenue estimates for the second half of 2007. The third quarter is expected to decline 7.4% versus a predicted decline of 6.9%; Q4 ? a quarter where the industry typically pulls in the most revenue ? should be down 6.2%, versus a previous estimate of -4.7%.

This, of course, assumes the economy doesn't hit a recession. Says Fitch's Simonton: "With consumer confidence waning, job growth slowing, high energy prices, and housing difficulties, we could certainly face an economic slowdown. We believe that newspapers' revenue streams would be under even more pressure in a cyclical downturn than they are facing now."

No one is calling a recession yet, but already it is creeping into newspapers' business doings. The Minnesota Vikings, for example, were set to close a deal with Avista Capital Partners to buy up the Minneapolis Star Tribune's land. They pulled out of the estimated $45 million transaction partly because of the credit market.

How long, baby, how long?
Clearly, the Web is something newspapers need to get right every bit as much as print. But so far they are stuck in a business model that some analysts say just cannot possibly save the day.

Mutter, for one, says cheap Web banner ads simply can never sell at the kind of rates newspapers can charge for its display and classified: "They are chasing their tails producing expensive content ? and [selling] the cheapest advertising."

Tribune Media Net's DePaola says the disparity between Web and print revenue is already lessening. "We've finally balanced print with online," he says. "By definition, for every dollar we were losing on print, we were making just a dime on online. But that's a lot more in balance now."

Newspapers will have to keep at that balancing act for longer than they would like, according to most analysts. Goldman Sachs' Appert, for instance, predicts newspapers won't reach the bottom ? or, as they say on The Street, hit its "inflection point" ? for another half-decade or so (see chart above).

The rate of decline will subside when classified revenue, which accounts for approximately one-third of newspaper ad revenue, becomes a smaller and smaller piece of the pie. "I wouldn't spin that as a positive," Appert says with a mordant laugh. "The business is going to get better," he adds, "because we lost much of it."