Follow the Money
By: Peter Winter
Tags: Management, Business, Life, Newspapers, Disruption

In ancient Greece there was an official called the “Remembrancer.” His job was to remind people of what they would have liked to forget. Usually he told them unpleasant tales of hubris and greed. Now that I’ve hit the age of 70, I like to think that’s my job, at least as far as the newspaper business is concerned, and I do it not merely to pile on, and not merely because there are good stories to be found there. No, I do it in the hope that lessons might perhaps be learned. So let me just say, on this the 13th day of February, 2020, the day of the McClatchy newspaper company’s bankruptcy announcement, that a gentleman by the name of Tony Ridder is the luckiest guy on the planet.

Here’s why.

In 1999, the daily newspaper industry hit peak profitability. Advertising revenues were $46.2 billion and circulation revenues were $10.4 billion. At that point 1,600 dailies owned mainly by 25 holding companies constituted the largest advertising medium in the country. By far. The consumer internet was in its infancy — the Netscape IPO had occurred just four years before. Newspaper revenues were bigger even than broadcast and cable television, combined. And the newspaper industry was absurdly profitable. Average pre-tax profit margins peaked at 28.5% that year. The delicious irony was that newspaper profitability was built on hiking advertising rates year after year on local retailers with razor-thin margins of less than 1%.

Gleefully exploiting distribution monopolies defined by how far their trucks could get by sunrise, newspapers saw no end to a world where advertising rates could be hiked on a whim. The high fixed cost of printing newspapers, building a home delivery channel and maintaining a large sales force provided a steep barrier to entry for any potential competitor. Newspapers were the only game in town. They had a license to steal. And steal, they did.

One evening I got a call from one of our classified advertising managers. He wanted to know what I thought about the idea of hiking his paper’s help-wanted rates by 33%. His rationale? It was a recession. Nobody was hiring. But when it was over, and hiring resumed, his clients would have forgotten what they used to pay and would happily pay the new rate. It worked. They did.

That’s how good it was. How easy it was.

Now then, where do you think all the money went? Taxes? Okay. Debt repayment? Sure. Capital equipment? Hardly. Research and Development? Nah, no need for that. The industry spent a mere 0.2% of gross sales on R&D each year. So where did it go? Come on, you know where it went. It went into the pockets of majority shareholders — and their families.

In the 25 years leading up to 1999, the newspaper industry consolidated. Many newspaper companies transitioned from private to public ownership to get cash to expand by buying other papers. For this we can thank our friends on Wall Street and their lunatic clamor for eternal growth.

Journalists hated it. In the kind of dexterous intellectual migration for which they are famous, they flipped from distrusting family ownership — with echoes of Balzac’s “behind every great fortune lies a crime” — to begging them not to sell to philistine bean-counters with no respect for the grand traditions of newspapering. There was indeed a difference in the way private owners ran their newspapers. They didn’t run them like public companies, maximized for profit. No way. They ran them even harder. They used them as personal cash machines.

And they wanted to keep doing so even as they went public. So they needed access to public capital without surrendering control. The solution they came up with was worthy of them. They pioneered dual-class stock structures that established uneven voting rights to ensure they stayed in charge. The Grahams of the Washington Post, the Ochs-Sulzbergers of the New York Times, the Bancrofts, former owners of Dow Jones & Company, the Dechards of Dallas, and yes, the McClatchys and many others all secured continuing control through super-voting Class B shares. Maybe it’s because I’m an immigrant, but to me there’s something un-American about gerrymandering public ownership so that general investors who’ve put up their own hard-earned scratch don’t have any say in the direction of their company.

The descendants of founders have proven over and over again that they are not up to the challenges of leadership. Usually an emotional association with the past impedes resolution — and often they just don’t have the stomach for the fight. Mainly, they want to husband what they have. The pressure to avoid risk grows over the years as the group of secondary stock-holders eating at the trough continues to expand, from generation to generation, from first cousins to second, from the family of the first spouse to the family of the second and perhaps even the third. If the founding family is smart, they bring in professional management. If they’re even smarter, they’ll listen to them, if they’re any good. They hardly ever do. This is why you go from shirt sleeves to shirt sleeves in just three generations.

“Not for love, honor or fame, but for Cash”

The masthead of the Marble Hill (Indiana) Era newspaper, 1894

Executives operating within a family-dominated company, private or public, find themselves caught between a capricious group of majority shareholders accustomed to unremitting genuflection and a frustrated group of employees unable to get anything of significance done. So they settle. Managing up becomes much more important than managing down. Protecting shareholder value becomes protecting the value of the majority shareholder’s stake. And running the formula to ensure that the expected financial return is achieved year after year becomes the most important objective. Everything slows down. Every eye looks inwards.

When a business model is tuned to drive reliable profit-taking and husbanding is the only strategy, then the dividend, the bonus and the reliable annual increase become the only things that matter. Everyone, everyone, becomes a co-conspirator in protecting the comfortable status quo. Stewards rule. Innovation is reduced to a game of incremental process improvement rather than anything that might seriously challenge the status quo, until process after process is tuned and re-tuned and accreted like concrete — and that’s just the way we do things around here.

Wall Street never looks too hard under the hood, especially if the numbers look okay. If they had in this case, they might have found that newspapers, while stable and profitable, had a serious problem that they were keeping to themselves; Newspaper readers were turning gray — and since the mid-90s, fewer younger readers were coming on board to replace them.

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That meant extinction was a simple matter of actuarial certainty. The only question was, when. Well that, and also the one that asked why editors and their newsrooms never bothered to figure out what to do about it.

The final stage of consolidation was taking place as the new millennium approached. Some of the remaining independent newspaper company owners had come to realize the jig was up. They always were very well advised. Cash now looked better than dividends. Time to find a newspaper company that was keen to expand. Time to sell and run. Time to find a mark.

Every seller has a good reason to sell. Every buyer is a hero with a great idea, at least until it’s proven wrong. Even the Tribune Company, far and away the industry leader in anticipating the impact of the internet and developing new digital products to exploit it, mistimed the scale and velocity of the print contraction when it bought the Times-Mirror Company from the Chandler family in 2000. $8 billion in cash and stock and assumed debt, the largest newspaper transaction, ever. Off to Chicago went eight newspapers, including the L.A. Times, Long Island Newsday, the Baltimore Sun and the oldest newspaper in the United States, the Hartford Courant. The dotcom bust was just coming to a close. Fortunes had been lost in the correction. Compared to first-round internet companies, newspaper profits looked real and reliable. Increased scale would translate well into digital presence. And naturally, asset prices would keep on climbing, forever.

Credit for such deals was not hard to get and it was cheap. But just five or six years later the debt assumed by companies intent on bulking up in newspapers would break their backs. Under the weight of the Great Recession and unprecedented competition from digital insurgents, they began to totter. By 2007, the retail slowdown and circulation losses put newspaper ad pricing up against a ceiling for the very first time. And cost-cutting could no longer preserve margin and disguise decay.

In desperation they sold everything, the big downtown buildings, parking lots, everything they could, in a madcap plan to sell the furniture in order to save the house. And every subsequent reporting cycle, they soft-shoe shuffled their way through a “look over here, not over there” sales pitch that promised Wall Street they were “reducing reliance on print by diversifying revenue.” The early results were always “promising” and achieved in parallel with “laser-focused” expense management in the core business designed to buy more time for “our transformation into a digital media company.” It was remarkable, the performance, not the achievements. It was legerdemain, with a straight face.

Depleted earnings were diverted to repay what debt they could. The rest was refinanced on increasingly onerous terms. In the end, most surrendered to private equity. Deleveragers talk a good game, they have to, if only for their own self-respect, but the only differentiating plan they ever seem to have is a less encumbered approach to asset-stripping than everybody else. Any and all free cash flow is going to be applied first to servicing that debt. Private equity is doing what private equity does. It’s riding a legacy business down, taking costs out as quickly as possible to recoup the money as quickly as possible. It’s corporate hospice and it never ends well.

Nobody at Tribune Company in 2000 had the faintest idea they were standing on this precipice.

No-one at the McClatchy Company realized it either. They too could not resist the lure of expansion.

McClatchy got its start in 1857, as a four-page newspaper for residents of Sacramento in the wake of the gold rush. The company focused for more than a century on the newspaper business in California’s Sacramento and San Joaquin Valleys. The Sacramento Bee. The Modesto Bee. The Fresno Bee. What is it about McClatchy and anthophila?

Suddenly, they decided to jump in, before they missed out. In 1998 McClatchy bought the Minneapolis Star-Tribune from the Cowles family for $1.2 billion. In cash. It whetted their appetite for buying more. They picked up a few small newspapers in South Carolina. And they acquired the Raleigh News & Observer from the Daniels family. But they wanted something bigger.

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Out in San Jose, Tony Ridder was loving life as the new millennium began. In 1998 he had moved his company, Knight-Ridder Newspapers, from the offices of the Miami Herald in Florida to a brand-new building in the heart of San Jose, home to another of his papers, the Mercury News. “A visionary move to Silicon Valley,” said the industry trade magazine, “Editor & Publisher.” Nobody seemed to notice he had gotten his Pebble Beach membership a year before.

With 32 newspapers, including famous brands like the Miami Herald, the Philadelphia Inquirer, the Detroit Free Press, the Fort Worth Star-Telegram, the Kansas City Star and the San Jose Mercury News, Knight-Ridder was the second-largest U.S. newspaper publisher at the time. Ridder the visionary had all the leverage in the world in a set of big, important markets. He had journalists, advertiser relationships, content, everything he would need if the internet did turn out to be more than a passing fancy.

But by 2003 the newspaper slide was picking up momentum. Despite the dotcom bust, the Internet was proving not to be a passing fancy after all. The monopoly walls disintegrated. Newspapers suddenly had to compete for audience and attention with revolutionary digital products that promised new ways to consume the news, to find things, buy things, do things and interact. The content bundle was cherry picked — the classifieds, typically 35% of a newspaper’s revenues and 50% of its profit — were an irresistible economic target and they went first, but everything was up for grabs and it wasn’t long before the stock tables were seized, and the sports scores, the weather forecast, political coverage, news commentary, restaurant reviews, the retail advertising base, even the comics. The broad product offering was unbundled and hollowed out, readers became users and fled, advertisers were seduced away to faster, better vertical alternatives.

Ridder, amazingly, seemed unfazed. As he made the round of newspaper meetings people congratulated him for the great work he was doing in adapting his company to the digital age. The San Jose Mercury News was in the vanguard of the movement, out there in the heart of Silicon Valley; the first newspaper on AOL, then the first newspaper with a website, why, now the whole paper was available online.

It’s human nature to relate the unfamiliar to the familiar. The automobile was the “horseless carriage.” Radio was once the “wireless.” Personal computers look like typewriters. For newspapers, the Internet meant simply their newspaper, online. Their newsrooms could not imagine any other response. It wasn’t just that they were unskilled in the tricky business of new product development — remove the masthead and you couldn’t tell one newspaper apart from any other — they also flaunted their innumeracy and floated high above the grubby business of marketing. They were imprisoned in the prism of print and monopoly return.

In business, every threat masks an opportunity that should have been obvious. The Internet offered newspaper companies the rare prospect of product reinvention and economic revival. But all they could see was a chance to throw away the ink and paper and sell the trucks, the same product delivered at less cost and sold as if the age of targeted and measurable advertising had never arrived. They followed the Mercury News and put their newspapers “up on the Internet” — and that’s all they did. No search, no social, no new relationship with users, not even a user database, no original engineering, no disciplined, marketing-led process of new product development, not a single trace of digital sensibility — just a continuing belief that the best way to deliver journalism, even in the digital world, was via the newspaper bundle. It was an error compounded by the self-important belief that national and international news could be bottled up in one place, and made still worse by the religious belief that their “quality,” “credible” local news made a defining difference. It didn’t. It never did.

From the start, not one online newspaper performed well enough to make the top 20 in digital share — in its own market.

Many say one of the reasons for the catastrophic collapse of newspapers is that, in their desperation for audience, they handed over their content to digital distributors. But the bigger reason was their willingness to hand over the customer relationship as well. It guaranteed they would thereafter be blind to what kind of news products and digital services their former subscriber-customers were craving.

Google won search. Facebook won social. Newspapers won nothing. The failure to build new digital media products, born on the web, is the singular failing of newspapers. It has led to the same financial horror story everywhere you look. Zombie newspapers staggering around without a plan, the death-throes of an industry going down.

By 2005, revenue growth was slowing quickly across the industry. Circulation declines were happening across the subscriber base now, and the loss of younger readers had picked up speed. Digital results offered no compensating relief, in audience or in revenue. Still Ridder didn’t see it. At a private meeting in Dallas to discuss the formation of a national digital news network owned by newspapers, someone noticed that no company present owned a newspaper in Boston. “That’s not a problem,” said Ridder, ever the monopolist. “We’ll just flip a coin for it.” That’s all it would take. Thanks to the flip of a coin, someone in the room would own the digital future of Boston.

His investors could read the writing on the wall. They saw the digital results and began to question his leadership. Some sensed the recession coming. Ridder tried to convince them that newspapers would bounce back better than ever should a recession come. After all, they always had. But a group owning 35% of the KNR stock said they were tired of waiting for management to turn around a share price that had tumbled from almost $80 in 2003 to a three-year low of $52.58.

In public filings that year, they urged the board to consider putting the company up for sale. The biggest investor, Private Capital Management, agreed, and said it would even support a hostile takeover of the company. For the first time ever, Ridder began to feel the heat. He didn’t like it one bit. But had he left it too late? Or was there a print patsy left out there who might buy his company?

Enter our friends from Sacramento, led now by a guy by the name of Gary Pruitt, a man so eager to join the exalted ranks of newspaper industry leaders that he convinced the McClatchys they should pay $40 a share for Knight-Ridder — by borrowing $3.75 billion. The Knight Ridder board jumped at the chance. In 2006 it happily sold the 32 newspapers to McClatchy for $4.5 billion plus the assumption of $2 billion in debt. It was the last great financial deal in newspapering, 9.5 times cash flow.

Pruitt promptly sold off eleven papers to work down the total acquisition cost. It made no difference. The long slide out had begun. It accelerated as the Great Recession hit the following year. Newspapers never did bounce back. Managed decline was all McClatchy had left, no matter the legerdemain. Pruitt, having artfully positioned himself as the ultimate believer, now runs the Associated Press. His former company finally went bankrupt today. He did just fine, and in the great tradition of newspaper ownership, the McClatchy family themselves will be just fine, too. Those on the McClatchy pension plan, not so much.

Ridder took the money and ran over the mountain to Pebble Beach. He had sold off his grandfather’s company just as newspapers finally tumbled into the Grand Canyon.

That’s why he’s the luckiest guy on the planet.

He was forced out in the nick of time.