The Inexorable Decline of Traditional Media
January 30, 2008
By
Bill Grimes
I have just
read a sentence in the current issue of the ECONOMIST
that as much as anything I know or have heard spells the growing doom for
traditional media. I define traditional media as those companies which create,
produce and distribute information and entertainment content and which pre-date
the commercial content businesses of the Internet. The future of these
companies as financially sound purveyors of content in consumer demand is
exclusively or highly dependent on profits of newspapers, magazines, yellow
pages, outdoor, radio and TV stations and broadcast networks
assets--traditional media.
The
sentence: "There is still a gap between the time people spend online as a
fraction of their media consumption (about a fifth) and the fraction of
marketing budgets spent on the internet (about 7.5%)."
First, that
such a gap or variance exists between a media property’s audience share and
share of ad expenditures is neither new nor surprising. Previous new or
emerging media have experienced similar significant gaps in their early days of
entry into a content market replete with entrenched competitors. At CBS Radio,
I remember in the early 70's that as FM stations' combined share of listening
was nearing 40 percent, their share of ad expenditures
was in the low 20's. When I left ESPN in 1988, the major basic ad supported
cable networks such as ESPN, USA,CNN, MTV and more had been in existence for
eight or nine years. That year, 1988, the combined viewing share of all basic
cable nets was about 20 percent. Yet cable nets’ total ad revenues were
approximately $400 million or four percent of the $10 billion spent by
advertisers on national TV networks then. For the year 2006 (latest information),
total network ad revenues were $25 billion and the cable networks generated $11
billion or 44 percent of this spending. Total viewing to basic cable networks
is 48 percent according to the Cable Advertising Bureau.
These
market gaps narrow over time and I know of nothing that can change that
reality. After all, a media property should receive about the same share of the
revenue that its audience represents. I call that market equilibrium the
medium's entitled share (of market), even though the top-rated station, network
or the leading magazine in its market segments usually enjoys a
slightly higher share of revenues than its audience share for a number of
reasons that include buyer loyalty and lethargy, perceived industry prestige
and seller confidence exhibited in aggressive pricing.
The
continual narrowing of the gap as Internet sites march inexorably toward their
entitled share is what trumpets the gloom and doom for traditional media. To
illustrate quantitatively, let's assume that in ten years from now time
spent with Internet media (websites that accept advertising) represents 25
percent of all media consumption. That would assume an increase of only five
percentages points from today’s share of 20 percent (above). Given the growing
increase and availability of broadband Internet access and the explosive growth
in Internet-produced video, this growth estimate ten years out seems highly
achievable and even conservative. Now, let's assume that in ten years
Internet's share of advertising advances to 18 percent of media ad
expenditures. This assumption holds that the Internet share of total ad spend
is still seven percentage points less than its share of media
consumption (18 percent to 25 percent), or its entitled share. The argument is
stronger that the share will be higher than 18 percent than less than that, but
let’s proceed with this analysis using the lower revenue market share number.
(One could argue that the Internet share could possibly be as much as five
percentage points higher and not be accused of reckless forecasting--see cable
networks’ performance above.)
Now let's
assume that over this period of time
An
important metric to focus on is that today (2006 to be specific) traditional
media generates $277.5 billion (92.5 percent) of all ad revenues (ECONOMIST). In this scenario traditional
media’s share of market will decrease to 82 percent in year ten or $334
billion. At first, to mention a $50 billion increase in revenues for
traditional media seems a generous amount. However, it would for traditional
media be an annualized growth of only about three percent. Remember the
assumption is that all spending is growing at four percent annually and with
Internet gaining ten total market share percentage points by year ten the
annual revenue increase for traditional media would be reduced by one
percentage point or three percent. Obviously some traditional media properties
will fare better and some will fare worse.
However,
with three percent annual revenue growth how can media companies expect any
profit growth? A company could achieve profit growth with revenue growth of
three percent but only if two conditions exist: First is that its annual
operating expense increases must be less than five percent--a considerable
challenge even if inflation remains around
three percent, which could be difficult to achieve. Added to that
macro-economic unknown is the well-known fact that traditional media companies
have been earnestly reducing operating expenses for several years. That
industry reality suggests that additional reductions will be more difficult to
make and will likely be more injurious to the quality and quantity of any media
property’s most important asset, its content. The second condition that must
exist for a company’s profit to increase with these revenue/expense assumptions
(let’s call it the 3/5 percent scenario) is that the company would have to have
a profit margin of 21 percent or higher the year before the 3/ 5 percent
scenario occurs.
To
illustrate, let’s assume a company today has $100 in revenue (that 100 can be
any amount in actual dollars providing the following ratio of revenue-to-profit
exists) and operating expenses of $80. Its operating profit that year would
therefore be $20. If revenues increase three percent and expenses five percent,
the following year the company’s revenues will be $103 and its expenses will be
$84. Its profit would be $19, or a $5 and a five percent reduction versus the
previous year. Such a performance would occur with many traditional media
companies because in the last five years many have experienced profit margins
declines and are operating with margins less than 20 percent.
One of the
worst possible media company performances has been The New York Times Company.
Last year this company had zero profit margins. It reported an operating loss
of $534 million on $3.289 billion of revenue. This was a substantial slide from
2005 actual profit of $319 million on virtually the same revenues: $3.231.
Something particularly untoward happened to expenses this past year, which I assume
was related to the new corporate headquarters, one-time severance, write-offs
and basic increases above five percent in customary operating expenses. A more
important observation is that despite growing revenues from About.com, a
relatively recent Internet acquisition, the company’s revenues were unchanged from the previous year--no
three percent growth here. Virtually every newspaper, particularly its second
largest property, The Boston Globe,
suffered revenue declines. Again, importantly, the company’s operating margin
in the much better year of 2005 was just under 10 percent., not the 21 percent
needed to grow profits in the 3/5 percent scenario. I use NYT as a surrogate
for the traditional media industry and while acknowledging that its plummeting financials
have degenerated more severely and more rapidly than most traditional media
companies, the reason may be that NYT, because of exceptionally incompetent
management and an over-reliance on print assets, is just among the first of
these companies to experience the bitter taste of market medicine, or “creative
destruction” as the eminent economist, Joseph Schumpeter, wrote in 1975. Before
leaving the battered NYT it should be noted that in mid-2002 NYT’s shares were trading at $52. Yesterday’s closing price
was $16.06.
Assuming
that declining profit growth is the norm and not the exception for most
traditional media companies, what are the additional impacts (beside further
headcount reductions and the weakening of content)? Company credit ratings will
be downgraded meaning that their cost of capital will increase. The result of
this is higher interest payments on debt and an increasing inability to make
acquisition because the company’s other capital component, its equity (often
essential in making acquisitions), has decreased. Lower profits and lower
margins equal a lower share (equity) price. We will likely then see further
industry consolidation but consolidation is only a short-term fix for an
industry that has endemic deterioration in its business fundamentals. This
tactic has never been a remedy to the ills of a business; witness the
performance of these traditional media today after decades of mergers and
acquisitions.
What’s a NY
Times Company or a CBS to name just two companies to do? Can expenses be reduced much further? Maybe,
but I cannot envision that happening without a concomitant decrease in content
quality. Can some technological breakthrough such as low-cost animated actors
for movies and television or the elimination of paper-based newspapers and
magazines be upon the horizon? And if so, will the hidebound management of many
of these companies be willing to adapt real change? And, of course, such
changes would be fraught with the risk of diminishing consumer satisfaction
which if so would result in continued decrease in share of media consumption.
That in turn which would more rapidly reduce traditional media’s share of ad
revenue dampening any profit growth. None of the above addresses an almost
equally nasty problem of the deleterious impact on the loss of subscriber
revenues upon which some media rely heavily upon.
We all talk
about traditional media’s deteriorating future and its increasingly competitive
media marketplace, but I believe, and hopefully I have demonstrated, that everything
we have heard to date is understated and that the severity of the problem has
not been fully realized. There is no silver bullet solution but the best
thinking I have heard on future strategies for these companies was in a recent
talk at an investor conference by Peter Chernin,
President of News Corp. This is the traditional media company that really does
get it. It knows what today younger generations want in electronic and mobile
content. Chernin articulates a strategic path that I
would think so many other traditional media companies would want to
follow. But there is little evidence that most of these
companies’ CEO’s will not or cannot (for fears of change, risk, failure,
lethargy and more) follow the News Corp. strategies. What we will increasingly
see as we view the media horizon is fewer traditional media, particularly fewer
newspapers, magazines, radio and TV stations. The good
news is that the Internet, like a fertile field blessed with the best mix of
soil, sunshine and rain, will sprout an ever-widening array of rich flowering
content of all genres and forms. Just as the time has come to say goodbye to
old politicians and to welcome in the new, it’s time to say goodbye to many old
traditional media, those once surviving perennials which today find themselves
in an overgrown garden that they insufficiently tended, their gray petals
wilting as the last signs of life are now evident.