Further Thoughts on the Times' Paywall

There is an inescapable and very simple formula that describes the financial activity of all organizations that do business. It is the income statement for a given period of time:

Revenue - Expenses = Net Income

Most income generated in a given period fits under revenue, and most of the money spent for that same period fits under expenses. Complete the formula and you have a sense of the general capacity for an organization to create income. If net income is negative, then the organization obviously can't sustain that business model. If it is positive, then possibilities exist for growth.

Much has been made about notions of 'free' in the new internet economy, and it is certainly an important marketing component that plays to the strengths of digital distribution, but it cannot and should not in the long run be taken out of its context in a process that ultimately has to deliver a reliable revenue stream--a business model in which revenue ultimately exceeds expenses.

Anything given away for free costs money to create and distribute. Those costs go directly to the expense side of the formula. But they don't merely offset an equal amount of revenue. The cost of free comes directly out of the net profit of the company on a one to one basis. Here is how that works.

Let's say hypothetically that the New York Times has a net profit margin of 10% (for 2010 it's actually about 4.5%). That means that for every $100 it spends, it takes in $110 to make a profit of $10. Or we can say that every $110 worth of news sold by the New York Times cost it $100 to make. 

Now let's say that the New York Times decides to give away $100 in product. So they make $100 worth of news and give it away for free. Conventional logic says that the Times now has to make $100 in sales to make back that $100 loss. But because zero revenue comes in to offset that $100 expense, the New York Times is actually in the hole for $1000. Here's why. To get the money to make the $100 unit it gave away for free, the Times had to make and sell $1000 worth of news, bringing in with the 10% profit margin $100 in profit. So the $1000 dollars in operating expense brings in $1100 in revenue, and the profit, the $100 balance left over goes to pay for the $100 gift.

Now, the above theoretical example is based on the idea that the Times has a relatively stable operating business model. In this climate that is not the case, and technological advances in digital distribution have destabilized the model to the extent that there is little precedent to demonstrate the actual market value of the content recently being distributed for free.

What does all this have to do with the rollout of the New York Times paywall? 

Here is where it starts to get interesting.

Net income for the New York Times Company for the past five years is as follows:

2010: $108 million
2009: $20 million
2008: ($58 million)
2007: $209 million
2006: ($543 million)

Despite the recession that started in 2008, the Times' worst year was in 2006. If the recession bottomed out in mid 2008, then the Times has been making slow gains in its overall operating profitability, with a net income of $108 million in 2010.

What this is telling us is that its operations without the paywall are narrowly in the black, returning a modest net income in 2010 of $108 million on revenues of $2.4 billion, or a net profit margin of 4.5%. That is for the entire New York Times Company. The New York Times Media Group, publishers of the New York Times newspaper and NYTimes.com, makes up about 65% of that revenue.

According to the Times this improvement in profitability results from increasing online ad sales and cost cutting and increased efficiency in the print division.

Here's where I think the explanation for the current paywall system may reside. The Times is in the black, but barely. The industry is in flux. Change is already happening. Growth will happen online. The print division is cost cutting, but there are limits to how fast and how far that can go. The opportunity for an increase in net income comes mostly from NYTimes.com. But, whatever happens with NYTimes.com, online advertising needs to be sustained. Loss can come too. Make the paywall too tight and online advertising will drop off as readers fall away. Surges of readership through social media sharing will be constrained.

The middle spot? Make a paywall that is more of a nuisance than a real deterrent. This will keep advertising rates as high as possible through free readership and will begin to migrate concerned and conscientious readers over to a paying online model. Gradually the tightness of the paywall can be adjusted as its financial impacts become more known. 

If print revenues can be kept stable, the move to a loose paywall produces a powerful effect. Once the approximately $40 million invested in the paywall's implementation, plus the paywall operational costs are recovered, and any loss in online advertising is offset, online subscription revenues go nearly straight to net profit. Remember, NYTimes.com is already giving the news away for free. Their operations don't have to change for the paywall to take effect. They already produce and distribute the news. All things being equal, production costs don't rise.

It is one of the most unusual rollouts in business history. A company that is in full operational flow suddenly and somewhat loosely begins to charge for a product that it has been giving away for free.

A Little Bit of Free

In 2009 I made a series of predictions for the year, starting with the prediction that the New York Times would start to charge for it's online access. I was a little short on my time frame, but anyone who understands even the basics of the business of publishing could see the day coming. On March 28, the Times will initiate a pay for use system where users can access 20 pages per four week period for free and then have to pay, starting at $15.00/month.

The outcry against it indicates that the Times online is indeed worth paying for. People are upset because they recognize the value of the content and recognize the cost of being cut off from it. That right there says this will succeed at some level. If the announcement had been met with a collective yawn, it would have been a terrifying signal to the Times' executive team.

To demonstrate the value of the New York Times you can engage in a very simple experiment. Try life without the New York Times online. If it is worth the price, pay for it. If it isn't worth the price, don't.

Journalists and Photojournalists should be applauding this move. It signals an effort by the New York Times to uncouple content creation from direct dependence on online advertising. Without online subscription prices or online newsstand sales, there simply is no other way of generating a predictable online revenue stream. For online pieces there has been a direct one to one expense to advertising income ratio. That means that for every dollar spent on creating and distributing content one dollar has to come in from advertising to break even.

The publishing business model has always depended on three main sources of revenue; subscriptions, newsstand sales, and advertising. This created a more balanced and diverse method of allowing the readership to pay for content. Subscribers built a steady stream of predictable revenue, newsstand sales were driven by the content of individual issues, with sales surging for more popular--or valuable--content, and advertisers paying to pair advertising with the content. Subscription and newsstand sales provide a way for content creation to be recognized as both valuable and sustainable. It is a thing worth paying for, and requiring the audience to pay for it demonstrates its value.

If advertising is the only reliable mechanism for generating revenue, then the real value of content falls through the floor. The inevitable business conclusion in an online advertising only model is that content that is more conducive to advertising gets more lubricant in the system. A truly free model could only sustain itself over time if the content shaped itself around the advertising. In that case the reader is her or himself a product delivered by the publication to the advertisers. By paying for the content, the reader becomes the client again, shifting the scales back towards a balance between serving both the readers and the advertisers.

For that, just a little bit of free sounds about right.

Update: With early reports from the Times subscription rollout in Canada coming in, it seems that there are some very large holes in the paywall. Whether they are intentional or not, this certainly is not shaping up to be a black and white pay-or-don't-access situation. There's a good piece on Nieman Journalism Lab about how four lines of code are all that are needed to disable the content blocking system.