John Chew over at CSInvesting.com recently challenged his readers to advise Jeff Bezos on his purchase of the Washington Post and numerous local newspapers from the Washington Post Company (WPO). We decided to take the bait. What follows is our memo to Mr. Bezos.
To: Jeff Bezos
From: Punchcard Investing
Re: Strategy for Improving the Washington Post
Congratulations on your recent purchase of the Washington Post!
We have put together this memo to aid you in turning around the Post. This memo assumes that your principal motive for purchasing the assets is to make money. In other words, it is not merely a vanity purchase like buying expensive art to hang on your wall. Nor is it a charitable endeavor.
Our approach to business analysis turns on the existence of a “moat” or lack thereof. A “moat,” also known as “durable competitive advantages” or “barriers to entry,” is what keeps competitors away and customers in. A company with a moat can expect to earn outsized returns while a company without a moat is doomed to earn its cost of capital or less. The principal forms of durable competitive advantages are customer captivity and economies of scale, with economies of scale having outsized importance.
We’re sure these concepts are not new to you. Your approach at Amazon seems to take the moat concept to its logical extreme. You are willing to sacrifice years and years of cash flow by pouring capex into building the widest moat anyone has ever seen. Starting with books, you have disrupted one retail sector after another. But, you have never generated much cash earnings. We assume that at some point, having vanquished all of your enemies from the field, you will turn off the reinvestment of earnings and generate a flood of free cash flow. Until and unless that happens, we won’t buy your stock but we will respect and admire your efforts.
As you know, your lack of interest in profits will serve you well in the newspaper industry. The reasons for this have been described elsewhere but a couple of data points tell the story. The Washington Post’s operating revenue has dropped 44% in the past 6 years. Its operating margin was -9.2% in 2012. How can you turn this around, even with loads of patient capital?
Your guiding principal should be that intensely local media businesses are inherently more likely to develop and sustain competitive advantages. This runs completely counter to your grand ambitions for Amazon, but you need to ignore the allure that online publications can be “infinitely broad and infinitely deep”.
By contrast, its actually specialization and localization that are the key. “At the end of the day, superior returns are made possible only by barriers to entry, and barriers to entry are easier to defend within tightly defined boundaries, “ write Knee, Greenwald and Seave in their book on media company strategy, The Curse of the Mogul. “Within media, this typically means either narrow geographical scope or, more likely, product niche. Specialized media have the double benefit of increasing the likelihood that scale can be accepted quickly and decisively and that the nature of the audience – by virtue of whatever shared activity, inclination, or demographic defines the niche – will lend itself to developing customer captivity.” Thus, a specialized or localized niche media property can build the reinforcing barriers to entry of economies of scale and customer captivity.
With these broad principals in mind, let’s look at the three principal models for running a newspaper in this era: (1) the hyper local approach, (2) the hyper specialized approach, and (3) trial and error.
Model #1 – The Hyper-Local Approach
The Hyper-Local Approach is founded on the principal that people love to read about themselves and their friends and neighbors. A favorite high school journalism teacher used to urge us to have as many names as possible in the newspaper because names were the biggest driver of readership. The Hyper Local Approach rests on this principal. As Warren Buffet wrote in his 2012 letter to shareholders, “A reader’s eyes may glaze over after they take in a couple of paragraphs about Canadian tariffs or political developments in Pakistan; a story about the reader himself or his neighbors will be read to the end.”
In fact, Buffet has been investing in newspapers, spending $344 million to buy 28 local newspapers in 2012-13. In the 2012 letter, Buffet lays out the 4 criteria he uses to evaluate a newspaper acquisition: (1) comprehensive and reliable information, (2) tight-bound community, (3) sensible Internet strategy, and (4) available at a reasonable price. Essentially, Buffet figures that if he gets in at a low enough price and concentrates on small-market papers with a monopoly on local news, he’ll make money even in a declining industry.
The concept of the local monopoly is key here. In a tight-bound community, the local newspaper will have enough people interested in the local gossip to drive customer captivity and it is relatively easy to reach scale. Fixed costs such as marketing, assembled workforce, and management overhead can be spread more effectively over more customers.
The problem for you is that DC is not a tight-bound community. As the size of the market grows, the interest in this type of news declines. Buffet points out that his two largest newspaper, the Buffalo News and the Omaha World-Herald suffered revenue declines while the 6 small dailies he owned for all of 2012 were flat.
The second problem is that the Post is a general interest newspaper with a national readership. It is unlikely that you bought it to shrink the size and cover high school sports and the raccoon living in Mrs. Johnson’s garage.
Further, the Graham family is famously close with Buffet and Berkshire owns 23.27% of the Washington Post Company. It is more than likely that Buffet was offered the same deal to purchase the paper that you were. The fact that he passed probably means that he didn’t think this model was appropriate – a fact not to be taken lightly.
Model #2 – The Hyper-Specialized Approach
The other type of approach working in the current era is the Hyper-Specialized Approach. A publication goes into great detail on a specific subject to satisfy a hardcore, highly-concentrated audience. This model closely resembles Buffet’s but instead of being bounded by geography it is limited by subject matter.
In our view, adopting this model would build on the Post’s Capitol Hill expertise but transform it into a trade paper for politics. The obvious analogy here is to Politico. Politico was started by 2 former Washington Post staffers and backed financially by the Alliburtion family, former rivals to the Grahams who owned the Washington Star until its demise in 1978. Politico’s focus is Washington-centric and it is aimed at the politics-obsessed. Politico makes the most of the Internet. Its minute-to-minute coverage is habit forming for the target audience. Counter-intuitively though, half of Politico’s revenue comes from the print version. The results so far have been modest. The closely held parent company, Alliburton Media, does not release financial information, but we did find that revenue in 2009 was $15 million
The obvious problem with this approach is that Politico already exists and it gives most of its products away for free. We’re not sure how 2 competitors could survive in this rather limited area.
An alternative to Models #1 and #2 is a hybrid approach where the Post is split into a local paper covering DC events and a trade paper for people in politics. The question then becomes whether this is big enough to hold your interest. This approach doesn’t seem particularly scalable. If you were next going to purchase a newspaper in, say, St. Louis, we don’t see a lot of synergies between operating the 2 papers because of the intensely local focus other than knowhow.
Model #3 – Trial and Error
Its quite possible that the best model for running a newspaper in the Internet Era is unknown at this time. In Buffet’s analysis of the newspaper industry, he was quick to point out that the best pay arrangement for newspapers on the Internet is not yet clear. He cites the Wall Street Journal and the Arkansas Democrat-Gazette that went to pay formats early and it seems to have worked out, but experimentation in this area has been rather limited to-date.
Perhaps you bought the Post with the expectation that it would give you the opportunity to learn the newspaper business from the inside. With this experience, you could then work on formulating the correct pay format. If its out there to be discovered, you are certainly the right guy to uncover it. We never would have thought of offering free shipping for $75 per year as a method for increasing customer captivity, but it certainly seems to work. Perhaps you will bring this kind of imaginative thinking to the newspaper world.
Thus, you will have to unlearn everything that has made Amazon great as you enter the world of newspapers. Forget the allure of growth, going global and no boundaries. The media properties most likely to succeed in the Internet era are intensely local. But given the low barriers to entry, where anyone can instantly set up a local blog, it is hard to be sanguine about the business. Your vision, imagination and patience will be put to the test.