Editor's Note

03/29/2007 12:00 am EST

Focus:

Howard Gold

Founder & President, GoldenEgg Investing

March 29, 2007

Last week, while everyone was worrying about what the Federal Reserve would do next and how deep the housing market's problems are, two interesting news items slipped in under the radar.

The first was that so far in 2007, sales of compact disks had plummeted 20% from last year's figures at this time, and music downloads weren't making up for the decline.

Second, famed analyst John Morton closed his 30-year-old newsletter on the newspaper industry, declaring that many publishers had probably passed the point of no return.

How are these seemingly disparate events related? They both show how painful the transition to the digital world can be, but that entire industries' survival-and investors' fortunes-depend on whether they can make the change successfully.

Of course, record companies have been having problems for years as the Internet allowed easy sharing and reproduction of their product-sometimes legally, often not. For years the industry responded by stonewalling, especially through lobbying and litigation. It succeeded in shutting down file-sharing service Napster (which later reopened as a commercial service), but that turned out to be a pyrrhic victory.

Since Apple launched the iPod in 2001, it has sold 90 million devices and users have downloaded more than two billion songs (at about a buck a pop) from its iTunes Music Store. The record companies get a nice cut of each song sold, but notice I said "songs," not "albums."

The emergence of the iPod has sped a transition away from long-form albums and towards single songs. Now, The New York Times reports, "buyers of digital music are purchasing singles over albums by a margin of 19 to 1." And who needs a whole CD to listen to just one song?

Maybe it's just cyclical: Kids are listening to individual songs now the way Baby Boomers used to lug a bunch of 45 rpm hit singles to dance parties. But it is different in one crucial sense: The technology has given the user more control over his or her music-not record company suits, MTV veejays or radio personalities.

That has upended the entire music industry's distribution chain from the recording studio to the retail store. In a sign of the times, the iconic Tower Records closed down 89 of its stores when it went out of business last year. Meanwhile, the industry's costs, The Times reported ominously, "are still built on blockbuster albums."

Newspapers have the same problem. While people are clamoring for news and information, print newspapers' circulation is falling off a cliff. The Audit Bureau of Circulations reported a 2.8 percent decline in weekday newspaper circulation during the six months ended last September 30. The beleaguered Los Angeles Times lost 8% of its paying customers during that time, while almost 7% of The Boston Globe's daily readers abandoned ship.

Advertising is also dropping as new media outlets like Craigslist and eBay siphon off lucrative classified ads and media buyers increasingly move display ads to where the eyeballs are. Result: Total newspaper advertising revenue was down 1.3 percent in 2006, estimates the Morton-Groves Newspaper Newsletter.

It's hard to work up much sympathy for newspaper publishers, many of whom have watched the Internet explode over the last decade and gotten serious about it only when it was almost too late.

"Instead of making the technology, personnel, marketing, and product investments critical for success, industry leaders have accepted that circulation declines are inevitable," the last issue of the Morton-Groves newsletter writes.

Meanwhile, too many newsrooms were ruled by troglodytes who viewed the Internet as a threat to their product, which they narrowly defined as what appeared in print on paper. 

Like record companies, newspapers have huge legacy costs: printing plants, presses, paper, delivery trucks, computers, and of course huge numbers of people to sell ads, manage circulation, and report and edit the news.

Can their fledgling Web operations pay the freight? Superstar investor-and newspaper owner-Warren Buffett doesn't think so.

"The economic potential of a newspaper Internet site-given the many alternative sources of information and entertainment that are free and only a click away-is at best a small fraction of that existing in the past for a print newspaper facing no competition," he wrote in this year's annual letter to Berkshire Hathaway's shareholders.

What we're living through, quite simply, is a technological revolution. The world is moving from an analog/industrial paradigm to a virtual/digital one. The ability to transmit words, sound, and images in digital zeros and ones has demolished most of the physical barriers to where people can get information or entertainment.

"We are becoming digital nomads," writes futurist Richard Watson. "We read, listen and watch what we want when we want. Readers are shifting their eyes and ears to online sources of information delivered via everything from mobile phones to iPods. What used to be a passive one-way conversation is thus turning into an active relationship."

Investors need to pay close attention to these trends. It's too late to avoid the problems of newspapers and recorded music. If you own stock in companies exposed to those industries, you should probably either sell or bank your dividend payments and pray for Blackstone or Carlyle to bail you out. (Full disclosure: I own Dow Jones stock and my wife holds shares of Tribune.)

But you also should be on the lookout for where the digital revolution will spread next. And here's a hint on what to avoid:

Cable and telephone companies are investing billions of dollars to upgrade their pipes to provide even faster Internet access to customers, allowing them to download massive files, especially video. Semiconductor manufacturers are developing chips that have even greater capacity to process graphics and videos, and consumer electronics manufacturers are working on more ways to integrate television and the Internet.

So, you may very well see this ad in, say, 2010, and it won't be in a newspaper:

"Coming soon to an iPod near you-Spiderman IV."

Are you listening, theater owners and studio executives?

Comments? Please E-mail us at TopProsTopPicks@intershow.com.

Howard R. Gold is editor-in-chief of MoneyShow.com. The opinions stated in this column are his own and not those of InterShow.

Related Articles on