From AJR,   September 2010

Broadband Blues   

The expansion of high-speed Internet access was bad news for newspaper advertising.

By John Morton
John Morton (mortoninc@msn.com), a former newspaper reporter, is president of a consulting firm that analyzes newspapers and other media properties.     

The great recession just past (if it truly has passed) was tough on all businesses, but it was particularly hard on the newspaper industry. It suffered more than most because changes in advertising patterns, chiefly a shift of advertisers to the Internet, started to hit newspapers hard almost two years before the onset of the recession in late 2007.

The severe economic slump in effect piled on an already deteriorating industry, leading to the sharpest declines in advertising revenue since World War II in 2008 (down 17 percent) and 2009 (down 27 percent). The worst advertising performance in all previous recessions was in 2001, down 9 percent, and 1991, down 6 percent.

The disturbing reality for newspapers is that as the economic recovery continues, they probably won't recapture all that they have lost, unlike in all previous recoveries. They did so after the 2001 downturn, even though there was an Internet then. So what has happened since to make this one so profoundly different?

The answer lies in the dramatic increase in the Internet's broadband coverage of national households. At the start of 2004, broadband coverage was about 25 percent. Two years later it reached 40 percent, by the end of 2007 it was 60 percent and now it's believed to be 90 percent or higher, making high-speed access available to households in all cities and towns except in remote rural areas.

That this upsurge has had a dramatic impact on newspaper advertising becomes clear on a bar chart, with one horizontal line plotting broadband growth and the other the percentage decline in newspaper advertising revenue. Since early 2004, the two lines are almost perfect reciprocals as one goes up dramatically, the other goes down dramatically.

Actually, the stage was set for this transformation decades ago, when total newspaper circulation began to decline. Weekday circulation peaked in 1987 at 62.8 million; Sunday circulation peaked in 1990 at 62.6 million. Each has been dropping since then, to most recently 46.3 million on weekdays and 46.9 million on Sunday. Despite the falloff, newspapers generally were able to retain a substantial, though declining, share of advertising spending until the broadband explosion began in earnest in 2004, chiefly because until then they remained a desirable and dominant vehicle for local advertising. There simply were not equally effective alternatives.

Broadband Internet changed that. Earlier, radio and television did not kill the newspaper industry, despite widespread predictions that they would, because neither medium is suited to detailed price-and-item advertising, the lifeblood of newspaper advertising. The Internet, though, can do price-and-item, perhaps even better than newspapers can, because it too is essentially a print medium.

One way to gauge how newspaper advertising has been affected by the rapid growth of broadband is to analyze its performance against aspects of the economy that historically have had some relationship with ad spending. One such factor is Gross Domestic Product (GDP). For many years, when GDP rose, newspaper advertising generally did as well. That relationship began to unravel in 2005 and fell apart completely two years later. In the four years leading up to the beginning of the recession in late 2007, GDP increased 2 to 4 percent, while newspaper advertising revenue dropped more than 10 percent. Once the recession set in, GDP also started to decline, but at a much slower rate than newspaper advertising.

Examining specific newspaper advertising categories reveals the same picture. Local retail advertising's relationship with total retail sales began to disconnect in 2005, with retail advertising beginning to plunge while retail sales increased right up to the recession. Similarly, the link between automotive advertising and the number of new and used cars sold began to fall apart in mid 2004; by the end of 2007, car sales had declined only slightly while auto advertising was down by more than 40 percent. And once the recession began, newspaper advertising revenue began to plunge at an even faster rate, far more quickly than any other economic indicator. Last year, total industry advertising revenue was only 56 percent of what it had been in 2005.

Does the advertising shift mean that the newspaper industry has been forever diminished? Probably. Despite signs of a modest recovery in the national economy this year, the best that can be said for newspapers is that conditions are deteriorating at a slower rate. In this year's first quarter, advertising revenue at the publicly reporting companies was down 6.3 percent; in the second quarter it was down 4.4 percent.

The industry remains profitable, albeit not nearly as profitable as in the past. The average operating profit margin at the public companies was more than 10 percent in the first quarter and improved to more than 13 percent in the second. But this largely was achieved by cutting costs into the bone at some companies.

That's not a reassuring strategy for the future.