I don't imagine Warren Buffett plays the online fantasy game World of Warcraft, as fun as that would be to watch. If he did, he might think differently about the pay-to-play model that he's advocated for online newspapers. In an interview earlier this year, Buffett said online newspapers were "giving away their product at the same time they're selling it." But the claim only captures half of how newspapers are failing, and what online monetization now looks like.
The real issue with newspapers
Taking Washington Post (NYSE: WPO) as an example, let's get a better understanding of the problem. In Q1 of 2012, the Post's newspaper revenue dropped 8% from 2011. Operating income was even worse, dropping from a $13 million loss in 2011 to a $23 million loss this year. The decline was due not to a subscription fall, but to a drop in advertising revenue.
In fact, increasing subscriptions isn't enough to raise advertising revenue. New York Times (NYSE: NYT) grew subscription revenue in Q1 and in its conference call claimed that much of the growth came from digital subscription revenue. However, even with subscription revenue growing, revenue from digital advertising fell 2%. Why wouldn't companies want to advertise to a growing base?
Advertisers aren't seeing the returns from online placements. If a company spends $1 on advertising, it wants to get $2 back, but this isn't happening. So advertisers are pulling out of the papers and leaving publishers with a revenue gap. To make up for the shortfall, Buffett's solution is to either charge folks for viewing content online or to offer different information online and in print.
Another model to consider
Activision Blizzard's (Nasdaq: ATVI) subscription model could be one way to solve the larger revenue problem. The video-game company has seen income from subscriptions increase 13% each year since 2009. In addition to subscription growth, the gamer earns extra revenue by allowing players to pay for items within its games. These small purchases add up and make each subscriber more valuable. Newspapers could use a similar system to gain incremental income from readers.
Instead of focusing on the Buffett-suggested paywall model, the Post should implement a news-based "freemium" service, which would offer a large swath of free content and then charge customers for premium services. While this looks similar to the subscription model that the Times uses, it has two important distinctions.
First, it allows customers to spend small amounts of money, which lowers the barrier to entry. No need to fork out up to $300 for a subscription; instead, pay $10 here and $5 there. Over the course of the year, you might spend $200 that you wouldn't have if you had to pay it in a lump sum.
Second, the freemium model gives room for more targeted advertising. If a customer pays for a yearlong subscription, the paper only knows that that customer likes the paper. There's no way to tell which parts of the paper are the most meaningful to a subscriber, since the subscriber is free to browse the whole thing. That system works great for Google, because it gets a view of your entire browsing life, but an online newspaper sees just a small window of activity. If instead you knew that a person was willing to pay for a specific topic -- like a live election-results tracker -- then you could bring in higher value ads and see a higher response rate for those ads.
Making it all make money
A higher response rate will give the newspaper more pricing power and will return more revenue to advertisers. A low barrier to entry will increase subscription-style revenue. The combined forces could make a significant impact on the Post's bottom line.
Online content providers continue to think subscriptions will save them. The industry is still living in the shadow of the first dot-com crash, when advertising rates plummeted, and is afraid to rely solely on advertising. But rates fell because the companies that had been advertising had no faith in the product, or in the returns they were seeing. A hybrid subscription-advertising approach could fill the void.
In short, Buffett is half right -- online newspapers are giving content away. What he doesn't understand is that giving away content can lead to advertising sales and reader income, if the publishers are smart about deployment. By focusing advertising and charging low entrance fees to users, content providers can have their cake and eat it, too.
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