The Internet and Business

1. The Internet and Business Lecture 9. Information Businesses; Industry Analysis Example: Newspapers

2. Only three more lectures from me! • Today: Industry Analysis Example: Newspapers • Learn about information goods • See an example of an industry analysis (for group projects) • Learn to analyze industry structure: Porter’s Five Forces • 4/13: Industry Analysis Example: Music • Another example of an information good • Also explain how startup ventures work (financing) • 4/20: The Internet and the Workplace • How the internet has changed the nature of work • 4/27 and 5/4: Group Presentations

3. Group Presentation Schedule • 4/27: Internet Banking, Movie Rentals, Social Networking • 5/4: Apparel, Internet Gambling, Television • Group wiki due 5/4 for all groups

4. Information Businesses Introduction to Information Goods

5. An information good is anything that can be digitized • Music • Movies • Newspapers • Book content, encyclopedias • Software • Blueprints • Address lists • These lecture notes…..

6. Information goods have a unique quality – they’re non-rivalrous • I can give my music to you and still keep it for myself! • But I can’t do that with my car; either I’m driving it or you are • Physical goods are rivalrous – only one person can get the benefit of it at a time (e.g. car, hamburger) • Information goods are non-rivalrous – many people can get the benefit of the same item at the same time

7. Information goods are also cheap to copy • The cost of producing the first copy of the song may be high • Weeks or months of composition • Time and cost of musicians • Editing, mixing etc • But once you’ve produced a song, the cost of producing one more copy is essentially zero • Information goods have high fixed costs and near-zero marginal costs

8. Before the internet, information goods were distributed the same way as physical goods • Milk distribution: • Truck delivers milk to the store • You drive to the store and buy the milk • Sometimes milk is delivered to your door • Music distribution • Truck delivers CDs to the store (e.g. Tower Records) • You drive to the store and buy the CD • News distribution • Truck delivers heavy bundles of paper with information printed on it • You drive to the store and buy the newspaper • Sometimes the newspaper is delivered to your door

9. Because information was treated as a “physical” good, firms could make money in the same way • Distribute it via retail stores • Charge per copy • Prevent theft

10. The internet has dramatically changed the economics of businesses that produce information goods • Lower production and distribution costs • Leads to much more competition  lower profits • International news organizations can easily reach New York customers • Anyone can blog about sports or local news • Small independent music producers can distribute internationally • Competitors (legal and illegal) provide free goods • Why pay for the New York Times when you can go to CNN.com for free? • New York Times and other papers forced to provide free information over the internet • Free music downloads and illegal copying have hit revenues both for record companies and artists, who receive smaller royalties

11. The impact of the internet on an industry depends on the product or service Type of industry Examples Impact of Internet Physical goods Steel, fruit, clothing ? Information goods ? Music, newspapers, television Services Gardening, travel agents, gambling, banking, social networking, movie rental ?

12. Industry Research Sources

13. Look at news and its sources, financial and business sites • Need to look at the news • www.nytimes.com and similar have good business info • Look at the dates • Google is a useful starting place, but to get up to date info you need to go to the source • Company and industry reports are a very valuable source of information • See financial sites such as www.bigcharts.com, www.yahoo.com/finance, www.finance.google.com • Industry reports such as Newspaper Association of America

14. Information sources • Industry associations • Newspaper Association of America • International Federation of the Phonographic Industry (IFPI) • Trade newspapers, magazines, web sites • Company annual reports • Market research organizations such as NPD, Nielsen and others • Use press and business magazines to find original sources • Occasionally can be original sources themselves

15. Research tips • Start “long lead time” data first • Company financials • Market size numerical data • Make sure you get the most recent news • If you base your project on data from 2002 you may find that it is now totally wrong • Internet business moves fast! You need 2008 or 2009 data • You can sometimes use older data if you are confident that little has changed • Business news sites are a good place to start • News sites try hard to be up to date with technology news • That’s because internet users are big consumers of that news • Many consumers attracts advertisers! • Include links to sources

16. A+ (hopefully!) Newspaper Industry See class wiki Video See New York Times web site Note: newspapers are an information good, so we expect the internet will have a big impact on the business

17. Executive Summary (put links to sections) • There are more than 1,400 newspapers in the US with total annual revenues of $55B • Advertising represents about 75% of revenue • Circulation has fallen about 15% in the last five years ; advertising revenue fell over 16% in 2008; newspaper stocks are underperforming the market • This was a fragmented industry with local monopolies (usually one paper per town) • Free news via the internet is a substitute for newspapers • Web sites have also siphoned off advertising revenue, especially classified ads • Newspapers have responded by setting up their own web sites, cannibalizing subscription revenue while trying to compete for advertising revenue. They are using more multimedia content. • However, top news sites are portals and blogs, not newspaper sites • Newspaper online ad revenue is not growing fast enough to offset falling newspaper ad revenue • Profits are falling across the industry • Newspapers are forming alliances with web sites to share local advertising revenue and to provide local content • Papers with strong brands – like the New York Times – are trying to use their brand to create partnerships e.g. with Monster.com • Some papers are advertising heavily to try to retain subscribers • Expect continued consolidation among smaller papers • Newspapers continuing to close, downsize or move to internet-only publication • Unlikely that newspaper companies in their current form will survive • Expect newspapers will not disappear – some advertising segments still strong

18. Elements of industry analysis • Size • Revenues and profits • Trends – growing? Contracting? • Structure • Who are the players? Are there a few big companies or many small ones? • What do they do? • Economics of industry participants • Who is making the money (profitability)? • Costs and cost “drivers” – what determines costs? • Revenue and revenue “drivers” – what affects revenue? • Impact of the internet – how does it affect cost and revenue? • Determinants of industry structure – what determines the amount of competition? • Business models • Who buys the product and why? How do the businesses make money? • Impact of the internet on business models • Examples of companies with different business models • Competitive strategy • Marketing strategy • Future developments • What’s happening now? To existing companies? To new companies? • What emerging new ways are there to use the internet in this industry?

19. Newspaper Industry Size

20. Get scope right The first thing to do in industry analysis is to get the scope right (this can be tricky!) • Are weekly papers included? • Are free newspapers? • What about news web sites like CNN.com? • What about news magazines? • What geographical scope? • International? • National? • Regional? Newspaper Industry Scope Questions

21. Here’s a working definition of an industry: • Group of firms • Serving the same customer needs • Using essentially the same technology

22. I’m choosing to use the definition used by the Newspaper Association of America • Paid circulation • Excludes free circulation • Daily and Sunday circulation • Printed on newsprint – tabloid or broadsheet • Excludes magazines • Excludes news web sites (in my definition news web sites are a substitute for newspapers) • United States • National, regional and local papers included

23. Quantitative data There were more than 1,400 daily newspapers in the USA in 2007 • 1,437 daily newspapers • A total daily circulation of 52.3 million • 907 Sunday newspapers • A total Sunday circulation of 53.2 million Source: Newspaper Association of America, http://www.naa.org/TrendsandNumbers/Total-Paid-Circulation.aspx, accessed 4/6/08

24. $ data important! Newspapers are a $55 billion industry in the US • Circulation expenditure $11 billion (2004) • Advertising revenue $45 billion (2007) • Totals a “$55 billion newspaper industry” Source: Newspaper Association of America http://www.naa.org/TrendsandNumbers/Advertising-Expenditures.aspx and http://www.naa.org/TrendsandNumbers/Circulation-Expenditures.aspx, accessed 4/7/08

25. Show trends over time Circulation has fallen sharply in the last four years

26. Newspaper ad revenue fell 16.6% in 2008 – online ad revenue not enough

27. Newspaper Industry Structure

28. Most cities and towns were served by a single local newspaper  fragmented industry with limited local competition! • Very large cities may have several newspapers, but they usually target different market segments e.g. • New York Times (targets educated, more affluent) • New York Post (less educated, less affluent, but more numerous!) • There are few nationally-distributed newspapers • New York Times, Wall Street Journal, USA Today, Washington Post, Christian Science Monitor (Source: http://www.abyznewslinks.com/unitena.htm ) • Most newspapers serve specific regions, cities, towns – e.g. Greenwich CT • Greenwich Time – paid circulation • Greenwich Citizen (Media News Group), Greenwich Post (Hersam Acorn)– free circulation • Industry is characterized by local markets with limited competition (Why is that? See economics)

29. Business names Many newspapers are owned by large publicly traded companies Publicly Traded Newspaper Publishers Ranked by Market Capitalization as of 4/6/08 Source: Google Finance, accessed 4/6/08

30. News Corp. is an integrated media company Sample of New Corp Media Assets Source: www.newscorp.com, accessed 4/6/08

31. The Media News Group is privately owned – it owns regional papers across the country Source: http://www.medianewsgroup.com/home/

32. According to MondoNewspapers.com, the top 100 US newspapers are owned by 40 different companies Source: Mondo Newspapers http://www.mondonewspapers.com/usa/owners.html, accessed 4/7/08

33. Membership of a recently-formed consortium indicates the fragmented nature of the newspaper industry • Belo Corp. • Calkins Media • Cox Newspapers (also owns Valpak) • The E.W. Scripps Company • Hearst Newspapers – division of Hearst Corporation • Journal Register Company • Lee Enterprises • McClatchy • Media General, Inc. • MediaNews Inc. • Morris Communications LLC – privately held • Paddock Publications Inc. – privately held Source: Media News Group press release 4/17/2007, http://www.medianewsgroup.com/Press/Releases/2007/NPC_Yahoo_Release_FINALfor41607.pdf?source=rv

34. There is almost always an economic reason for industry structure • Little local competition – why? – economies of scale • Cost of printing and distribution of paper means its rarely viable to have two printing plants in one place • Printing press is a fixed cost, so more circulation  lower unit cost • Time sensitive material and transportation cost makes it hard to truck in newspapers from (say) another state • Advertisers prefer the largest circulation, so bigger paper gets bigger (positive feedback), what Warren Buffett calls “survival of the fattest” • Companies own multiple newspapers in a region – why? – economies of scale again • 80% of news the same, just change front page and a few others • Advertisers like to reach everyone across a certain region

35. Explain economics Economies of scale example – one newspaper in a town make a profit because it can spread fixed costs over many papers (see also next page) One newspaper company, fixed costs of $1 million per year, market of 2 million papers per year Fixed cost $1 million/year to run Production cost per newspaper: 50c 2 million papers/year Printing press • Reporters • Editors If newspaper price is 60c  10c profit! With only one company the cost per paper is low as the fixed cost is spread out over 2 million papers. That’s economies of scale. The company makes a profit.

36. With two companies they both make a loss, so one goes out of business and you end up with one newspaper and a monopoly in the town! Two newspaper companies, split the market between them Production cost per newspaper: $1 Fixed cost $1 million/year to run 1 million papers/year Printing press • Reporters • Editors Newspaper price of 60c  40c loss! Production cost per newspaper: $1 Fixed cost $1 million/year to run 1 million papers/year Printing press • Reporters • Editors Newspaper price of 60c  40c loss!

37. Explain impact of internet The internet has radically altered the industry structure • Consumers now have many free substitutes • Portals: AOL, Yahoo! • TV: CNN.com • Newspapers responded by creating their own free web sites  cannibalization • Global reach of the internet means that the local monopoly of print news does not exist online  intense competition for audience • More competition, cannibalization  lower profits!

38. Industry competitors Rivalry among existing firms Porter’s five forces model of industry competition will help you define the players Potential Entrants Threat of new entrants Bargaining power of suppliers Bargaining power of buyers Suppliers Buyers Threat of substitute products or services Substitutes

39. 5 Forces analysis Free news web sites are a substitute for newspapers from a consumer’s perspective; from an advertiser’s perspective Google, Monster etc. are substitutes Potential Entrants • Aggregators? (like Google News) • Individual news consumers • Advertisers • Other news outlets (buy stories) Industry competitors Suppliers Buyers • The New York Times… • The Journal News… • Newsprint makers • News agencies • Technology vendors • Printing press vendors • News web sites • Job sites • Search engines • Craigslist Substitutes We’ll come back to this later

40. Multimedia Internet News Production and Distribution Freelancers Editing, Web Layout Customer Agencies: Reuters, AP, Bloomberg,.. WAY lower cost!! The internet changes news production and distribution economics – see video Traditional News Production and Distribution In-house reporters, photographers Editing, Layout Printing Distribution Customer Freelancers Agencies: Reuters, AP, Bloomberg,..

41. TV sites and internet portals dominate online news audiences News Site Audiences for February 2008 Source: Nielsen net ratings, reported on http://www.naa.org

42. The New York Times is the most visited newspaper web site

43. Political news blogs generate the most intense interest News Site Audiences for February 2008 Source: Nielsen net ratings, reported on http://www.naa.org

44. Newspapers are forming alliances with internet companies Example of Strategic Alliance Consortium of Local Newspapers Yahoo! • National reach • Advanced internet advertising technology • Unique local content • Local relationships • Membership • 12 newspaper companies • 264 newspapers • 44 states + • Enhanced newspaper online ad revenue using Yahoo!’s graphical ads, ad-serving technology, targeting, inventory management • Can provide national access to local advertisers • Yahoo! paid search on newspaper web sites • Yahoo! gets local news content to spread across its sites Source: Media News Group press release 4/17/2007, http://www.medianewsgroup.com/Press/Releases/2007/NPC_Yahoo_Release_FINALfor41607.pdf?source=rv

45. Industry Economics

46. Before internet Direct quote from Warren Buffett on newspaper economics: 1 of 2 “When Charlie and I were young, the newspaper business was as easy a way to make huge returns as existed in America. As one not-too-bright publisher famously said, “I owe my fortune to two great American institutions: monopoly and nepotism.” No paper in a one-paper city, however bad the product or however inept the management, could avoid gushing profits. The industry’s staggering returns could be simply explained. For most of the 20th Century, newspapers were the primary source of information for the American public. Whether the subject was sports, finance, or politics, newspapers reigned supreme. Just as important, their ads were the easiest way to find job opportunities or to learn the price of groceries at your town’s supermarkets. The great majority of families therefore felt the need for a paper every day, but understandably most didn’t wish to pay for two. Advertisers preferred the paper with the most circulation, and readers tended to want the paper with the most ads and news pages. This circularity led to a law of the newspaper jungle: Survival of the Fattest.” Source: Berkshire Hathaway letter to shareholders 2006: http://www.berkshirehathaway.com/letters/2006ltr.pdf

47. Direct quote from Warren Buffett: 2 of 2 “Thus, when two or more papers existed in a major city (which was almost universally the case a century ago), the one that pulled ahead usually emerged as the stand-alone winner. After competition disappeared, the paper’s pricing power in both advertising and circulation was unleashed. Typically, rates for both advertisers and readers would be raised annually – and the profits rolled in. For owners this was economic heaven. (Interestingly, though papers regularly – and often in a disapproving way – reported on the profitability of, say, the auto or steel industries, they never enlightened readers about their own Midas-like situation. Hmmm ...) Now, however, almost all newspaper owners realize that they are constantly losing ground in the battle for eyeballs. Simply put, if cable and satellite broadcasting, as well as the internet, had come along first, newspapers as we know them probably would never have existed…. …True, we have the leading online news operation in Buffalo, and it will continue to attract more viewers and ads. However, the economic potential of a newspaper internet site – given the many alternative sources of information and entertainment that are free and only a click away – is at best a small fraction of that existing in the past for a print newspaper facing no competition…. We hope that some combination of print and online will ward off economic doomsday for newspapers, and we will work hard in Buffalo to develop a sustainable business model. I think we will be successful. But the days of lush profits from our newspaper are over.”

48. Roughly 75% of newspaper revenues come from advertising • Industry advertising revenue $45B • Subscription revenue $11 B • Ad revenue/total revenue = 45/56 = 80%

49. Real estate, automotive and employment are the largest segments in classified advertising

50. Five forces analysis (1 of 2)