An Opportunity for Innovation

Approximately six months ago, I was contemplating making investments in the newspaper industry. Then I attended Berkshire Hathaway's (NYSE: BRK-A  ) shareholder meeting, and an audience member asked Warren Buffett (Berkshire owns The Buffalo News and a large stake in Washington Post (NYSE: WPO  ) ) what he thought about the newspaper industry. His reply implied that he was generally bearish and would remain so unless newspapers stocks declined substantially.

His reasoning seemed simple and infallible: Newspapers must now compete with the Internet as a source of information and entertainment, and because every person only has two eyeballs and 24 hours in a day, the pie is getting smaller. He also noted the fact that newspapers are failing to acquire young readers and face declining circulation every year.

When the burning bush speaks, I listen. The newspaper industry is still immensely profitable and throws off healthy free cash flows. However, in my humble opinion, I believe that the longer newspapers wait to go into crisis mode, the tougher the repercussions will be in the future.

I'm not by any stretch of the imagination a newspaper expert. I've never worked in the industry or had anything to do with newspapers besides read them. However, as a young professional, and more importantly, a consumer, I'm a member of the target demographic that the advertising industry salivates over. If newspapers can get more people like me to read, then they will replenish their subscriber base with a younger generation of readers and become much more attractive to advertisers.

Get in the trenches
A wise man once said, "He who getteth his fingernaileth most dirtyeth winneth the fighteth." OK, fine, it was me who said that minus the wise part, but I stand by my statement. I've read literally hundreds of business biographies, and I'd say the one defining characteristic of most great entrepreneurs is their penchant for doing the nitty-gritty things -- whether this is scrubbing the toilets themselves or personally dealing with upset customers.

I've read that some newspapers adamantly resist shifting coverage toward local news and the Internet because they're much less glamorous areas than international news and print media. However, newspapers exist to serve readers, just as hotels exist to serve guests, and restaurants exist to serve diners. If the reader wants local news, and Internet distribution, then the reader should get local news and Internet distribution.

A recent Fool article by John Reeves on disruptive innovation stated that upstarts in an industry get their toehold by focusing on low-end markets that the more powerful incumbents look down their noses at. Eventually, this low-end market serves as the power base from which it proceeds to take significant market share. Wal-Mart (NYSE: WMT  ) , IKEA, and Charles Schwab (Nasdaq: SCHW  ) are some examples of low-end disrupters. The newspaper industry needs to get down in the trenches, on the local scene, and on the Internet, where the next generation of market share wars will be fought.

Leverage Internet distribution
I read The Wall Street Journal (published by Dow Jones (NYSE: DJ  ) ) "cover to cover" every single day. I get violently ill if I don't have my daily news. Yet I don't pick up my newspaper every morning. Instead, I wake up and read the Journal on my computer.

The Internet is a far more efficient distribution mechanism. You don't have to flip between pages to read a story, you can quickly scan the list of articles for catchy titles, and you can do things like click on quotes and Google interesting things for further research.

Newspapers (that don't already) should offer free Internet subscriptions to print subscribers, aggressively advertise online subscriptions, and make their websites easier to read and less cluttered. Anecdotally, I feel that newspapers will bend over backwards to get you to sign up for a print subscription, but I can't seem to recall any newspapers pushing their online subscriptions. One exception is the Dow Jones, which has done a fabulous job of acquiring online subscribers. Its Wall Street Journal Online offering had 768,000 paying subscribers as of 2005, making it by itself the fifth-largest newspaper by circulation in America.

However, the newspaper industry at large has failed to monetize its online content. Of the $49 billion advertisers spent on newspapers in 2005, only $2 billion of this was from online ads. Newspapers also need to allow more third-party distribution. Although newspapers have strong distribution in the real world through newspaper stands and local vendors, I feel that many mediocre blogs have attained superior Web distribution than some of the most powerful newspapers simply because they try harder. Every day newspapers don't embrace the Internet and work to transfer their distribution advantage to the online world is an additional day the competition becomes more entrenched.

Fight fire with fire
We all know that classifieds, which make up 35% of the newspaper industry's $49 billion in advertising sales, according to the Newspaper Association of America, face a severe threat from competitors such as Craigslist and Monster (Nasdaq: MNST  ) . Although Gannett, Tribune (NYSE: TRB  ) , and McClatchy have done a good job with their joint venture, Careerbuilder, newspapers need to really focus on transferring classifieds online. I believe using print media for classifieds will suffer the same fate as card catalogues at libraries: The technology is irrelevant, obsolete, and inefficient. Personally, I would prefer to search through classifieds from my local newspaper rather than Craigslist or Monster because I feel the newspaper is a more authoritative source of relevant local jobs and classifieds. However, Craigslist and Monster continue to have websites that are easier to use, less cluttered, and provide more listings. If newspapers embraced the Internet and offered free Net subscriptions, they'd get more Internet readers, which would increase the number of listings and increase the value of their online classifieds offerings.

It ain't over
I read newspapers because the articles are well-researched and relevant, and they provide me with valuable knowledge. Newspaper journalists often have exclusive access and unique journalistic skills, and basically are able to provide me with information that I would have no way of getting on my own -- and all for the price of a quarter a day. The demand for these types of services won't go away. Some newspapers have expressed more of an inclination to extend into the digital world than others. However, I believe that if newspapers as an industry could more effectively transition their revenue-generating sources and distribution mechanisms online, then they could benefit readers and shareholders alike.

Wal-Mart is a Motley Fool Inside Value selection, while Charles Schwab is a Stock Advisor recommendation. Take the newsletter of your choice for a 30-day free trial.

Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above and appreciates your comments, concerns, and complaints. The Motley Fool has a disclosure policy.


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