James Hopson is a retired publisher of the Wisconsin State Journal in Madison and a former vice president for Lee Enterprises. He earned an MBA from Harvard University and served as a director to the Audit Bureau of Circulations board. Reach him via e-mail at james.hopson@news-jrnl.com.

A former vice president of Lee Enterprises looks at the fate of newspaper companies that diversified 10 years ago versus those that did not, and finds a stark contrast and a difficult path forward

With the clarity of hindsight we can now see that the strategic decisions of some newspaper companies have put them on the road to prosperity, while the decisions of others appear to be taking them over a cliff.

The industry reached the decisive fork in the road in the last 10 years. The crucial decision, the one that has made all the difference, was whether to diversify or to concentrate. The diversifiers are thriving, while the concentrators are sinking.

The diversifiers - Scripps, Washington Post, Cox - invested in high-growth businesses whose successes are more than compensating for the troubles in their newspapers. They continue to grow revenues and profits as their dependency on newspapers diminishes. Scripps invested in cable programming (HGTV, The Food Channel), Washington Post bought Kaplan Learning, and Cox diversified into cable TV and other businesses. Others, like Thomson got completely out of the U.S. newspaper business.

The concentrators made a big mistake. Companies like McClatchy, MediaNews and Lee increased their bets on newspapers, and newspapers are struggling with dwindling audiences, shrinking advertising revenues and market share, stubborn high-fixed costs and plummeting earnings. And borrowing lots of money to buy more newspapers at exactly the wrong time added a heavy debt burden to the concentrators' already long list of woes. The real question now is not whether they made a strategic mistake, but whether they made an irretrievably fatal strategic mistake.

I make no claims of infallibility as I write this. I was a Lee vice president during the time the company sold its television stations and bought the Howard and Pulitzer newspaper chains. I advocated and participated in the Howard and Pulitzer acquisitions. It was only later, as I began fully to understand newspapers' strategic peril, did I come to regard Lee's decisions as mistakes.

So what do the concentrators do now? They made their big bet on newspapers, and the bet looks like a bad one. What moves can they make now that might change the game for them and give their shareholders and employees some hope for a brighter future?

Before I try to answer the question, let's briefly review the elements of newspapers' strategic problems:

Declining audience. Since the early 1990s newspapers have been losing circulation. The absolute numbers fell even as households continued to grow, magnifying newspapers' loss of market coverage. The decline of readership has been most acute among younger adults. Time was, when a newspaper subscriber died, a young family would start a new subscription. That does not happen anymore.

Shrinking advertising revenues. Advertisers are pulling dollars out of their newspaper budgets to reach the growing audience of nonreaders. Classified advertising is fleeing to the Internet. Advertisers are abandoning inefficient mass media, like newspapers, for more efficient, more targeted media like the Internet, direct mail and cable television.

Powerful competition. Advancing technology has enabled the growth of highly effective alternatives to newspapers as content providers and advertising vehicles. As broadband penetration continues to grow, the Internet becomes an increasingly effective advertising medium, taking greater and greater chunks of U.S. ad spending from traditional media. Cable television is touting its new ability to deliver individualized messages to specific households. It seems like every middle-school kid has a cell phone and a laptop, and they have become incredibly facile at getting the information and entertainment they need without waiting for newspapers or other traditional media to deliver it to them.

Cost burdens. Newspaper companies are shedding people and other costs as fast as they can, but the demands of the legacy newspaper business - still the biggest part of their revenues and profits - make it impossible to cut costs as fast as revenues are falling. And the newsprint companies, newspapers' biggest suppliers, have found that by trimming manufacturing capacity they can artificially create supply shortages that keep paper prices high despite plummeting demand.

The problems are massive, and getting worse, exacerbated by the current slowdown in the economy. Revenue and profit numbers just keep deteriorating, and it is believed that a number of metro dailies are already losing money, and many more teeter on the brink.

The big newspaper companies have common strategies - cut costs, hang on to print readers and advertisers as best they can, and reach new audiences and tap new ad dollars with Internet and specialty print products.

The problem with those strategies is that they are insufficient to overcome the powerful market forces at work on their businesses. They haven't cut enough cost, they haven't been able to stem the ebbing tide of readers and advertisers, and their new ventures haven't generated enough revenue to make up for the print losses.

Particularly troublesome is the slowing of newspaper Internet revenues. We've all seen the models that show Internet ad revenues growing to become the dominant revenue stream for newspapers in a few years. Such models rely upon continuing the rapid rate at which Internet advertising had grown over the last few years. But the growth rates have slowed from 30 percent+ to 20 percent+ to less than 10 percent this year. Some of that slowdown is tied to the slump in classified advertising, but some of it is natural and predictable. Trees don't grow to the sky, and hot revenue categories rarely sustain high growth rates forever. If you rework the growth models and replace your assumption that Internet revenue will grow forever at 25 percent with a more reasonable and sustainable rate, you'll find that the date on which Internet revenues rescue the newspaper business has been pushed much farther into the future, and maybe never.

Newspapers had a great racket for a long time. They were essentially the only game in town for retail and classified advertisers and could charge high advertising prices consistent with their market dominance. But that dominance, and the pricing power it conferred upon newspapers, is fading fast. And newspapers' new ventures -Internet products and specialty publications - face lots of competitors that limit pricing power and the profitability of these new ventures. The new print and online products certainly help, but they are not big or profitable enough to plug the holes in the hull of the mother ship.

So, back to the question. What do the concentrators do now? McClatchy's CEO Gary Pruitt and Lee's Mary Junck are superb operators, but can they and the leaders of the other companies that have concentrated on the newspaper business devise a strategy that will put their companies on a path to prosperity?

Maybe.

I think they need to do two things:

First, take a huge chunk out of costs. The cuts made to date are much too timid. The layoffs and Web-width reductions and belt-tightening that they've executed thus far were done in hopes that things would eventually return to normal, so the fundamental structure of the business could and should be maintained. This incremental approach cannot work; but for the CEOs to take bolder action, they need to admit to themselves and their boards of directors that the business will not bounce back, that things have changed forever and that only big structural changes can get their costs down to a sustainable level. The big changes I envision involve outsourcing more and more of the operation, not just call centers and ad production. I would find somebody else to print and deliver my newspapers. Maybe I could partner with other publishers to create printing and distribution consortia. I would farm out everything I could with the exception of local news reporting and advertising sales. I would make the core of my business much, much smaller.

Second, diversify away from newspapers. No more incremental steps. No more little ideas. There are companies out there that have caught the wave of changes in audience and advertiser behavior. Buy some, and invest in their growth. They may be expensive, but what could be more expensive than watching the value of your company disappear? Lee and McClatchy stock prices have dropped almost 90 percent in the last three years. How bad do things have to get before the concentrators stop mincing around the edges of the problem and take meaningful action?

The one path to prosperity for the concentrators might be blocked by a mountain of debt. The already-heavy borrowing of companies like McClatchy, Lee,

MediaNews, Morris and others may stop lenders from financing their diversification. I hope not, because if they cannot diversify, I do not see a future for the newspaper companies.*