What will the news media of the future cost?

(This post is a translated version of an article that I wrote for netzwertig.com, the leading German tech blog)

The media industry is in the middle of a deep transformation, and nobody knows what the successful business models of the future will look like. Sometimes it’s useful to look at this kind of situation from the perspective of good old-fashioned economic laws, because they apply even in the digital age.

The current discussion about the future of media is shaped to a large part by ideology and wishful thinking instead of rational analysis. There seems to be little common ground between Internet prophets (“Information wants to be free”) and traditionalists (“Good journalism deserves good money”). Some online pundits seem to think that media companies should never, ever charge for their products again, while many managers of traditional media businesses would love to see the Internet shut down altogether.

Unfortunately, this whole discussion typically doesn’t address the heart of the matter. The future of media business models will not be decided by ideology and idealistic visions, but by simple market laws. And to understand these, a bit of economic analysis typically works much better than idealism.

Obviously, most traditional media companies, newspapers in particular, currently have a revenue problem. Print circulations (and ad sales) are falling rapidly, and users seem to be unwilling to pay for online media.

Broadly speaking, this trend reflects a change in the supply situation. To use a bit of Economics 101: The price that can be achieved for a certain product is a result of the relationship between supply and demand. Economists like to illustrate this with supply and demand curves:

Supplydemand1-1

The supply curve S shows that suppliers will produce more units of a product (x) if prices (p) are higher. On the opposite site, customers will buy more of a product if prices are lower. The demand curve D therefore is sloped in the opposite direction. Since we’re talking about media here, the demand curve is pretty steep. This reflects the fact that people can’t consume much more media even if prices fall. There are only so many hours in a day, and attention is limited. The point where the supply and demand curve intersect is the market equilibrium that determines the market price and the volume of product sold.

The increasing popularity of the Internet as a news medium has pretty severe consequences for this equilibrium. Since Internet-based media have a much lower cost of distribution, suppliers can provide much more of their product at the same price. The supply curve shifts down (from S to S2). As a result, the volume of media products sold increases a bit, but prices fall pretty dramatically. That’s exactly what we’re currently experiencing in reality, although reality is of course more complex than this very simple model.

Supplydemand2-1

Now for the important question: Is this new position of the supply curve (and therefore the much lower price level) sustainable, i.e. can it remain at this point in the long run? That’s not obvious, because supply behavior often overshoots a sustainable point in technological revolutions — just think back to the dot com era. Business models need some time to find a stable new point.

But the way to a new long-term equilibrium is not linear and depends on a lot of factors, not least of all the interaction with traditional market segment. In news media, it is currently rational behavior for newspaper companies to offer their content on the web for free. But that’s only true as long as the traditional print business is healthy. Let’s play a bit with some numbers to show the idea behind this claim.

Each supplier obviously has to consider at which price he wants to offer a certain amount of his product. Without going into theoretical details: roughly speaking, the supplier has to consider his marginal costs, i.e. the costs that are caused by producing another unit of a product, and the average costs that in the end have to be covered by revenue.

And now we see the fundamental difference between traditional media that are bound to physical distribution, and the digital world: Each information product initially creates costs for the production of the actual content (for instance, salaries for journalists). But when it comes to the costs per unit — the marginal costs — analog and digital media are fundamentally different. The costs for the production and distribution of a printed newspaper are substantial. But serving an additional reader on a newspaper website costs almost nothing.
Now let’s look at a simplified model case for a hypothetical newspaper company. Let’s assume that the production of content costs $250,000 every day (not unrealistic for a major newspaper). Let’s further assume that the printing and distribution of a newspaper costs 50 cents per copy, but serving another reader on the newspaper’s website costs only 5 cents (caused by the need for additional bandwidth and server capacity).

If we look at average costs for different audience sizes, we’ll see the following picture:

Avcosts

The first unit of a newspaper is incredibly expensive, but the more copies you produce, the better initial content production costs are distributed over all readers. The more circulation grows, the more the average costs per print copy (red curve) approaches marginal costs.

But what happens if the company publishes the same content both in print and on the web? Since the additional costs for the web channel are low, the total average costs for both media taken together (green curve) rise only slightly. If we assume that revenue from the print business already covers the costs of the newspaper, the Internet can potentially be very profitable for the media company. Even if online ad sales are relatively low, they can easily cover the small additional costs, and the rest is pure profit.

But: If the print business starts to fail — because readers migrate to the online edition — and the web channel has to carry initial costs alone (blue curve), we get a different picture:
Avcostsweb
Of course, costs for a pure web offering are much lower, but they are way higher than zero, particularly if the number of readers is relatively small. As soon as the cross-subsidy from the print side falls, the Internet channel has to provide much higher revenue to finance the initial costs of content production. And in many cases, it could be difficult to achieve this from ad sales alone.

Some Internet prophets seem to think that media companies should never again charge for content. That’s a pretty naive view. This approach only works as long as there is a healthy traditional (print) business. And obviously, this traditional business is eroding.

So what can be expected if the print business fails altogether? The harsh reality is that many media companies will not survive it. That’s why overall supply of news will start to decrease, and prices for news will rise.

Supplydemand3-1

More specifically: The phase in the development of the news business that we are currently experiencing is not sustainable. I’m convinced that the era of a huge oversupply of free news will come to an end sooner or later.

Media companies with a well differentiated product will start to charge for their content again, and users will pay if they can’t get the same quality content elsewhere — and that will increasingly be the case with shrinking supply. Online news subscriptions will be much cheaper than their paper equivalent, but they will cost something, probably around 10-40% of a newspaper subscription.

The economic characteristics of online media have another important consequence: The big players will have a huge advantage, since it’s economically crucial to distribute initial costs over as many readers as possible. Print media experience scalability problems at some point due to their physical production. But the Internet is largely free of these concerns.

The world of digital news will almost certainly be bi-polar. On one side there will be a few giant media conglomerates that will produce news for global markets. Almost certainly, they will offer their products in different versions for different price points. The freemium model, which is already popular in the software market, could very well be the model of the future in media. And these media conglomerates will make sure that the oversupply of news will be kept in check.

Next to this, there will be plenty of space for small, often semi-professional providers that can publish their content for free, thanks to low production costs. Advertising will be the typical business model, driven by an increased selectiveness of advertisers who want to reach certain interesting target groups in focused way. There will be a few segments where small media companies can established paid content franchises, but this will be a niche phenomenon.

The situation will be tough for the group in between: The medium-sized publishers that have to carry a substantial cost base from the print era, but don’t have the scale to reach a huge audience. Realistically, the model of the medium sized regional publishing house will very likely vanish. The economic structure of digital media doesn’t leave much room for this type of company.

Again: The current situation of the media industry is an anomaly that is not sustainable in the long run. This conclusion is not about ideology, but about market forces. We all will have to get used to paying for high quality news, probably pretty soon. It will be cheaper than the good old newspaper, but not free forever.