In a session on the future of classifieds, McKinsey had some interesting original research to share. Despite the fact that most newspapers have seen their classified advertising revenue rebound over the past two years, McKinsey has determined that they have not only lost very significant market share in most classified ad categories, but they have suffered an extraordinary amount of "price destruction" at the same time. McKinsey estimates that Internet competitors like Craigslist have "destroyed" as much as 75% newspaper pricing in key categories such as employment and general merchandise. In other words, not only are newspapers losing business to the Internet, they are losing control of their rate cards too.

This second issue is the one that I think will be more troubling for newspapers over time. For the past two decades, most U.S. newspapers have not only faced very limited in-market competition for providing broad-reach advertising, but they have, almost without fault, controlled their rate cards unilaterally. They have raised prices as they have needed to, and with only limited concern for direct competitors.

Those days are over.

Google and its brethren are attacking their classified and display advertising franchises across a very broad front. In-market competition is back, and so are "two newspaper" town economics. But unfortunately for newspapers, these Internet companies are presenting a competitive profile that is much more threatening than just having another local newspaper to contend with. Google et al. have dramatically lower cost structures. They have larger and more attractive audiences. Their pricing models are more advertiser-friendly--selling qualified leads, not just space. And, they have nicer dispositions.

This dynamic, as it accelerates, will present a serious threat to the viability of a number of newspapers. Given the enormous cost structures attendant to newspaper publishing, from buying newsprint and operating printing presses to paying the salaries of editors and reporters, these companies can sustain price destruction for only so long. In the old days of two newspaper towns, once one got a significant upper hand in the rate card battle, it started pushing the other in a downward profit spiral that ended with either the shutting down of the weaker newspaper, or its consolidation into a government-sanctioned joint operating agreement with certain shared services. There have been few other outcomes. It didn't matter how popular the newspaper was with its readers. It was all about advertising.

That is what newspapers are facing today. The swarms of Internet competitors are creating the effect of a second newspaper when it comes to capturing local ad dollars.

What does this mean?

This means that local ad pricing will drop, and competitively driven pricing schemes, like performance-based pricing and auction-based sales, will take hold. Most likely, this means that newspapers' revenue from their current advertisers and ad products will drop... precipitously. This means trouble, because while revenue from existing operations will likely be cut, there is almost no way to make comparable cuts in cost structures. Too much of newspapers' cost structures are fixed.

Is this the end of newspapers? Does this mean that as low-cost Internet competitors take hold in local markets, newspapers will be inevitably pushed into a Death Spiral? No, but it does mean that newspapers can't just play defense if they want to survive. It will not be enough to just try to "defend the fortress" of their classified businesses. They will need to get aggressive. They will need to focus on growth strategies, both online and offline.

We are starting to see this. The New York Times Company bought About.com earlier this year. Scripps bought Shopzilla.com last week. Across the country, newspapers have been launching new print products, such as free tabloids and Hispanic editions, to find new readers and to serve new advertisers. Some are making the right moves. All will have to. The parallels to industries such as airlines are just too easy to make. Hopefully, it won't take the collapse of a major metro newspaper, akin to the collapse of Eastern Airlines or Pan Am, for everyone to wake up. I hope not--I like newspapers too much.

This commentary is insightful. I recommend it to others.