I’ve been thinking about business models for online content (text and images), given Apple’s introduction of the iPad and Amazon’s infamous battle with Macmillan. I’ve argued that digital subscriptions should be less than their analog counterparts, basing my argument in large part on the fact that traditional print is vastly more expensive than digital distribution.
I’ve been wrong. At least in the short run.
Not wrong about the difference in distribution costs. That’s a no-brainer.
But I was wrong to expect an immediate drop in monthly (or annual) subscription fees. I was unconsciously holding constant the advertising revenue side of the equation. Let me explain.
Let’s imagine a (very simplified) budget for a newspaper that looks like this (roughly based on data from Media Economics):
- Revenue: 70%, advertising; 30%, subscriptions
- Costs: 40%, printing/distribution; 20%, overhead (administration, advertising, circulation); 30%, taxes, profit, interest; 10%, editorial
In this model, if subscription income went to zero and advertising income stayed constant, theoretically the shift from print to all-digital would result in savings that should mean the organization could break even. But in the interim — or maybe for the foreseeable future — there will be demand for a printed product. So we have to add costs — the web server, bandwidth, employees to manage the web. The ideal model might look like this:
- Costs: 45%, printing/distribution/web; 17%, overhead (administration, advertising, circulation); 30%, taxes, profit, interest; 8%, editorial
But we know that operating margins are down. So a more realistic model might be:
- Costs: 50%, printing/distribution/web; 20%, overhead (administration, advertising, circulation); 20%, taxes, profit, interest; 10%, editorial
We also know that advertising revenue is down-down-down. So today that revenue model might look like this:
- Revenue: 40%, print advertising; 15%, online advertising; 45%, subscriptions
In other words, subscription income becomes more important as advertising revenue falls.
I’m pretty sure that the demand for core newspaper subscribers is inelastic: that means that a 1% increase in subscription prices will yield less than a 1% decline in subscribers*, but it will yield a decline. Each time there is a drop in print subscribers, the per unit cost of an individual newspaper rises, as the product is characterized by high fixed costs: the cost to create the content is the same for 100 as it is for 1 million copies. This model reflects what economists call public goods; it is a characteristic of any information good, from software to TV shows, from music to movies.
That’s why I think that traditional magazines or newspapers delivered via the iPad or Kindle must be more “costly” than they would be if they existed solely in a digital form. So don’t be surprised to see a digital subscription equal the print one. I don’t like it — especially since I hold a bias that a handful of executives drive up overhead costs and that the relatively modern goal of 20+% ROI is not only unsustainable, it’s unreasonable.
I am not saying that I believe the iPad and Kindle will “save” newspapers. I think a break up of the news media monopoly in the U.S. would be a good thing. I’m saying that I think I understand why subscription fees are going to be relatively high in the short-run. Remember, every time print subscriber numbers fall, the per unit price of the printed paper goes up for everyone else.
This back-of-the-envelope analysis also helps explain why small(ish) companies are able to launch successful online-only news products: limited overhead, limited distribution costs, and access to advertisers that were priced out of the daily newspaper market. Finally, this analysis could also be used to support various (generally unpopular) proposals that Congress throw a bone to the newspaper industry.
Somebody please show me that I’m wrong.
*It also means that a 1% drop in subscription rates will yield less than 1% increase in number of subscribers. See this paper from 1976 (pdf).
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7 Comments, Comment or Ping
Kathy Gill
My hypothesis about digital subscriptions is that they are elastic. This means that they are price sensitive: a 1% decrease in price yields more than a 1% increase in subscribers.
Elasticity of demand for digital subscriptions is not part of this analysis and would play a large part in per unit pricing, but not in the need for subscription income in the wake of declining advertising income.
Feb 16th, 2010
Jim Hong
You’ve missed one big variable in the digital subscription cost structure: Cost of inclusion into the walled garden. Apple and others are charging a 30% cut of the revenue for digital subscriptions (the same as individual item purchases). At least one of the things this means is that publisher cannot achieve any economies of scale for volume, and this fee is recurring indefinitely. Let’s call it the “Walled Garden Tax”. According to the following article, this may be economically prohibitive in the subscription model:
http://www.ft.com/cms/s/0/6530db6e-1a70-11df-a2e3-00144feab49a.html
I suspect one of the reasons why (the article doesn’t specifically call it out) is that subscription publishers operate on considerably lower margins than book publishers do. But since they generate new content far more regularly, they “make it up in volume”. And even some of what is traditionally considered Variable Overhead really isn’t (e.g. Reporter staff) because you can’t dip under the threshold of what would be normally acceptable content. If you could automagically wave a wand and make all that warehouse space, printing presses, trucks, drivers, operators, etc. go away, maybe the margin could accommodate the Walled Garden Tax better.
Feb 16th, 2010
Kathy Gill
Hi, Jim – thanks.
Hopefully, the cost of converting the “daily paper” from its newspaper zeros-and-ones to its iPad zeros-and-ones will be nominal. From that perspective, each subscription sold after those nominal costs are covered is “icing”.
The trick in pricing any information good is estimating how many units you will will sell, since all the costs are bound in the production of the /first/ unit. You need to set a price that will recover those costs — once you pass that N, you’re looking at close to 100% profit (except i the case of iTunes sales, where you are looking at 70% profit — but there is also a cost reduction: the iTunes 30% is in the ballpark for my estimate of overhead associated with administration, promotion and circulation). For a “middle man”– that 30% is pretty darn low.
There’s also additional advertising revenue that might be made via these digital editions.
The budget I outlined above — based on expense info from Media Economics — is not a traditional “variable v fixed cost” model. It was actual expenses. Reporters are in the 10% not the overhead. All the things you list are not overhead in this budget – it’s the 50% that is printing/distribution. If you could stop publishing a print version tomorrow, you’d be in a much better place as far as costs …. but you would also have just lost the bulk of your revenue. It’s a serious catch-22.
Feb 16th, 2010
Greg Rasa
Kathy, a couple of items in the news that add some wrinkles to the formula. There’s a debate now at NYT over how to price the monthly subscription via iPad — $10 a month, a la the Kindle subscription, or $30. The thinking on the higher amount: Price it too cheap, and you’ll pass the tipping point at which people drop their print subscription. Since there is often some overlap between digital and analog versions of a product (if I like an album I’ve downloaded, I’ll often go buy it on CD for the superior sound quality), that’s one more factor in the complex pricing formula:
http://www.electronista.com/articles/10/02/16/nyt.print.digital.staff.argue.on.price/
Meanwhile, ad revenue continues to fall. Though not as steeply as in the worst of the recession, it’ll continue to be a moving target going forward (and you can figure the movement’s more or less in one direction):
http://seattletimes.nwsource.com/html/businesstechnology/2011029030_apusearnsnewyorktimes.html
And worst of all, there’s the challenge of overcoming the public’s “something-for-nothing” expectations …
http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2010/02/17/BU591C2C99.DTL&type=business
Feb 17th, 2010
Jim Hong
Hey Kathy,
I think we may be in violent agreement.
I think we both agree that taken by themselves, it costs less to publish a digital edition (any kind of digital) of a newspaper/magazine than the very same print version. NOTE: There are some cumulative publishing costs if you’re publishing to different digital endpoints as feed structures, DRM, rendering technologies, etc. aren’t standardized across the different endpoints yet, but that’s still primarily setup cost though it’s an expensive one for the papers as they typically don’t have this expertise in-house.
I think we also both agree that you can’t just wish away the sunk costs around printing, since even if you stop printing you still have these capital expenditures hitting your G/L.
What I *think* you’re saying is that subscribership is essentially a zero-sum proposition, and that’s why digital subscription costs must be kept artificially high so that regardless of whether someone is a print or digital subscriber, they’re still cover the cost of printing the physical paper. Is that right? That’s what I was saying above, which is why the Walled Garden Tax is such a big hit to the publishers because you can’t wish away the costs of printing the physical paper and (I contend) that subscribership *is* essentially a zero-sum game right now because a lot of people are used to getting “good enough” news for free and they opt to spend their entertainment/edutainment dollars elsewhere. So people inclined to subscribe to the paper/magazine will do one or the other, whichever is cheaper.
Feb 17th, 2010
Toni Delrio
The media market is in a transition stage and this stage that will not be brief. In this transition the media market (Movies, Books, Newspapers, Magazines) is migrating from the business of “physical” to the business of “content”. A key factor that media companies tend to ignore is that the shift from “physical” to “content” is demand-led, that is, consumer and their consumption habits are pushing the industry to adapt. Unfortunately, the media industry has been fighting this market trend and has had trouble adapting. As in any other industry, fighting a trend is the worst business strategy. Instead, the media industry should play to win in the new market context.
For perspective, today, most newspapers keep their printed publication, additionally have an online version, most likely with less quality content that the printed version. Today, most of their distribution efforts are still behind the printed version. This strategy is totally against the market trend, and it is usually driven by the fear of cannibalizing print with online. Obviously, newspapers stakeholders don’t what their current cash-cow, print, to die.
The big challenge comes when the business’ cash-cow is not longer relevant for the market. Then, new strategies should arise. Media companies need to think of new bold strategies. Playing in the middle ground is not efficient, the organization has not focus on where to play, cost structure is not efficient, consumers start disengaging, etc. At the end, as in any economic model, inefficient players are eventually kicked out of the market.
The strategy is simple: Listen, listen, listen… to the market trends and play to win with the trend.
Mar 5th, 2010
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