Why bad newspapers can still make good profits

The strange success of the Independent Group SA explained - by Warren Buffett

JOHANNESBURG - The possibility that the imminent fall of the Independent News & Media Empire, might lead to the liberation of its colonial possessions has been met with some ill-disguised glee in South Africa. As Gill Moodie wrote on Moneyweb a couple of weeks ago, "the mere thought of the Irish leaving our shores has got hacks across the land shivering in anticipation and please forgive us if we take to the streets like grateful Munchkins, singing: ‘Ding-dong the witch is dead'."

The sentiment here seems to be that anyone - even businessmen acting as a front for the ruling ANC - would be preferable owners of much of the South African press than Tony O'Reilly & Co. The plunder of - or, to put it more politely, ‘lack of investment' in - the South African assets by their Irish owners has become a source of some rather morbid humour.

In an article first published on his weblog Professor Anton Harber stated that O'Reilly had made no real recent investment in infrastructure: "The headquarters in Sauer Street, Central Johannesburg, are so run-down they look like something from an Afghan village recently visited by an American bomber."

This outrageous comparison provoked Jeremy Gordin - ex of the Independent - into writing: "let me say that I have seen countless pictures of Afghan villages recently visited by American bombers - and it is deeply insulting to these places, and the people who live in them, to claim they are more run-down than the Indy's Sauer Street HQ. Just who does this Harber think he is?"

Fortunately perhaps, given the fraught state of South African - Afghani relations, another ex-Independent hack, John Matisonn, was able to settle what could have developed into a rather ugly international controversy. In a comment on Gordin's article he wrote:

"As one of the few people -- perhaps the only one -- to have had the privilege of working in both the Independent's Sauer Street Johannesburg offices and an Afghan village recently visited by an American bomber, I feel uniquely qualified to comment on the dispute between my two colleagues, Anton Harber and Jeremy Gordin. A dispute this serious between two eminent professionals cannot be allowed to lie unresolved.

I am writing this from the capital, Kabul, where I currently work, but last week I visited several Afghan villages. With great regret at disagreeing with a professor of Anton's standing, I am obliged to report a significant number of differences:

1. An Afghan village recently bombed usually retains most of its residents, since the bombs usually miss their targets.

2. Despite ever-increasing insecurity, I was proudly shown a new street of shops that were left untouched, showing that the bombs did not prevent a growth in employment.

3. In one of those streets I was provided with a succulent meal of a quality not seen in the Sauer street canteen, at a cost of 100 Afghanis (US$2).

4. Village rooms, no matter how poor the owner, are covered in Afghan carpets in deep rich reds unseen in the Johannesburg office.

I trust this settles the matter."

The version of Harber's article published in Business Day toned down the analogy somewhat, noting only that the "Sauer Street headquarters are like an office squatter camp." This comparison did not go unchallenged either. Moegsien Williams, group editorial director of Independent News & Media SA wrote in to Business Day objecting to the comparison. "Only those liberals pontificating from ivory towers," he stated, "would use the phrase ‘squatter camp' as a way to denigrate us and in the process insult the millions who are forced to live in them." As Harber commented on his blog in reply "It seems I insulted everyone except the Independent group."

On the editorial side of things the Independent has long practised Piranha management. By now all the flesh of the old, somewhat bovine, Argus Group has gone. The skeletal remains are held together only by the dedicated efforts of a few sinewy hacks. Yet despite the great fall in quality of editorial content, the newspapers have continued to generate massive profits for the parent company. The pips may have squeaked but the Independent News & Media was still able to squeeze 69,1m Euros (some R800m) out of its South African operations over the last financial year. As has been noted elsewhere, this is not how things are usually supposed to work in a free market. In theory, if the quality of a product declines so should (eventually) the profitability of the company producing it.

The answer to this apparent paradox lies in an observation made by the legendary American investor Warren Buffett many years ago. His company, Berkshire Hathaway, has owned the Buffalo News since 1977. In the section of his 1984 letter to investors, dealing with the newspaper, Buffett wrote:

"The economics of a dominant newspaper are excellent, among the very best in the business world. Owners, naturally, would like to believe that their wonderful profitability is achieved only because they unfailingly turn out a wonderful product. That comfortable theory wilts before an uncomfortable fact. While first-class newspapers make excellent profits, the profits of third-rate papers are as good or better - as long as either class of paper is dominant within its community. Of course, product quality may have been crucial to the paper in achieving dominance....

Once dominant, the newspaper itself, not the marketplace, determines just how good or how bad the paper will be. Good or bad, it will prosper. That is not true of most businesses: inferior quality generally produces inferior economics. But even a poor newspaper is a bargain to most citizens simply because of its ‘bulletin board' value.  Other things being equal, a poor product will not achieve quite the level of readership achieved by a first-class product. A poor product, however, will still remain essential to most citizens, and what commands their attention will command the attention of advertisers. Since high standards are not imposed by the marketplace, management must impose its own."

The Independent group SA has provided an object lesson in the truth of this observation. The newspapers have been transformed from good to bad, and yet they have remained a source of prosperity for their owners. Given that it is up to management on whether high standards are imposed, or not, the next question is why O'Reilly allowed such a decline? Many other owners, such as Buffett, have taken great pride in the quality of their newspapers. But presumably, as a foreign owner, O'Reilly did not have to subject himself to reading the ever dimming Johannesburg Star every morning. His prestige, and knighthood, came from owning and supporting the loss making Independent of London. Not from running the kind of newspapers in South Africa which could have kept the ANC government honest and shored up our fragile new democracy.

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