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Posted by on Feb 16, 2010 in Economy, Media, Science & Technology | 2 comments

Why Digital Editions (iPad, Kindle) Need Subscription Fees

I’ve been thinking about business models for online content (text and images), given Apple’s introduction of the iPad and Amazon’s infamous battle with Macmillan. I’ve argued that digital subscriptions should be less than their analog counterparts, basing my argument in large part on the fact that traditional print is vastly more expensive than digital distribution.

I’ve been wrong. At least in the short run.

Not wrong about the difference in distribution costs. That’s a no-brainer.

But I was wrong to expect an immediate drop in monthly (or annual) subscription fees. I was unconsciously holding constant the advertising revenue side of the equation. Let me explain.

Let’s imagine a (very simplified) budget for a newspaper that looks like this (roughly based on data from Media Economics):

  • Revenue: 70%, advertising; 30%, subscriptions
  • Costs: 40%, printing/distribution; 20%, overhead (administration, advertising, circulation); 30%, taxes, profit, interest; 10%, editorial

In this model, if subscription income went to zero and advertising income stayed constant, theoretically the shift from print to all-digital would result in savings that should mean the organization could break even. But in the interim — or maybe for the foreseeable future — there will be demand for a printed product. So we have to add costs — the web server, bandwidth, employees to manage the web. The ideal model might look like this:

  • Costs: 45%, printing/distribution/web; 17%, overhead (administration, advertising, circulation); 30%, taxes, profit, interest; 8%, editorial

But we know that operating margins are down. So a more realistic model might be:

  • Costs: 50%, printing/distribution/web; 20%, overhead (administration, advertising, circulation); 20%, taxes, profit, interest; 10%, editorial

We also know that advertising revenue is down-down-down. So today that revenue model might look like this:

  • Revenue: 40%, print advertising; 15%, online advertising; 45%, subscriptions

In other words, subscription income becomes more important as advertising revenue falls.

I’m pretty sure that the demand for core newspaper subscribers is inelastic: that means that a 1% increase in subscription prices will yield less than a 1% decline in subscribers*, but it will yield a decline. Each time there is a drop in print subscribers, the per unit cost of an individual newspaper rises, as the product is characterized by high fixed costs: the cost to create the content is the same for 100 as it is for 1 million copies. This model reflects what economists call public goods; it is a characteristic of any information good, from software to TV shows, from music to movies.

That’s why I think that traditional magazines or newspapers delivered via the iPad or Kindle must be more “costly” than they would be if they existed solely in a digital form. So don’t be surprised to see a digital subscription equal the print one. I don’t like it — especially since I hold a bias that a handful of executives drive up overhead costs and that the relatively modern goal of 20+% ROI is not only unsustainable, it’s unreasonable.

I am not saying that I believe the iPad and Kindle will “save” newspapers. I think a break up of the news media monopoly in the U.S. would be a good thing. I’m saying that I think I understand why subscription fees are going to be relatively high in the short-run. Remember, every time print subscriber numbers fall, the per unit price of the printed paper goes up for everyone else.

This back-of-the-envelope analysis also helps explain why small(ish) companies are able to launch successful online-only news products: limited overhead, limited distribution costs, and access to advertisers that were priced out of the daily newspaper market. Finally, this analysis could also be used to support various (generally unpopular) proposals that Congress throw a bone to the newspaper industry.

Somebody please show me that I’m wrong.

*It also means that a 1% drop in subscription rates will yield less than 1% increase in number of subscribers. See this paper from 1976 (pdf).

This post first appeared at WiredPen.