NEW YORK ( TheStreet) -- When Craigslist began to roll into metro areas in 2000, newspaper publishers responded with equal parts bewilderment and indignation: How could a Web site offer classified advertising without charging for its services? Within months, publishers reacted rationally enough, lowering their classified rates 20%, anxious to defend turf that accounted for 40% of revenue. About a year into the Craigslist invasion, publishers made another seemingly rational decision: they raised subscription prices to compensate for the loss of classified advertising. Yet higher subscription had the adverse effect of accelerating the decline in total subscribers, further damaging the "multi-sided" market that newspapers had long enjoyed, matching buyers and sellers of everything from cars and furniture to real estate and household services. In a new study that analyzes management reactions to Craigslist, a consummate "disruptive competitor," two professors analyze the actions of more than 1,000 U.S. newspapers from 2000 to 2007 to breakdown the response to an attack on a longstanding business model. The research by Robert Seamans of New York University's Stern School of Business and Feng Zhu of the Harvard Business School paints a picture of companies that tried to stop a cascading leak by moving around buckets. While the relatively comfy world of newspaper publishing was all but destroyed, consumers enjoyed a windfall; savings of about $5 billion they otherwise would have handed newspapers. "We were most surprised by how immediate and dramatic of an effect Craigslist's entry had on the classified ad side," Seamans said in a phone interview from Orlando earlier this week where he was attending a management conference. "It seems newspapers were pretty quick to realize the threat posed by Craigslist and responded by lowering classified ad rates." But Craigslist disrupted more than just classified advertising. As the three-year study shows, publishers' decision to raise subscription rates caused total circulation to tumble, a decline that only recently has showed signs of stabilizing. With fewer people receiving the newspaper hard copy, buyers of higher-priced display advertising began to clamor for lower rates, arguing that they were reaching fewer eyeballs. Which they were. So, they got those lower rates.
Typically, two years after Craigslist entered a metro area, newspapers were forced to lower display advertising rates, along with having already lowered classified ad rates. The drop in revenue only worsened. Seamans explains that Craig Newmark's creation applied the Google ( GOOG) model before Google had become a verb. Google, of course, figured out that it could offer search services for free on one side of its market in order to create as large a pool of users as possible on the other side of the market to appeal to advertisers. Google then charged advertisers for the opportunity to appeal to that gigantic user base. Craigslist did something similar. By not charging a fee, Craigslist's market platform became exponentially more attractive to both buyers and sellers. "Newspapers," Seamans said, "had historically underpriced on the subscription side because they more than made up for that on the advertising side." But Craigslist forever knocked over the business model, leaving newspapers scrambling to make up for lost revenue. Eventually, they had to cut employees. Newsrooms shrank and many went out of business, as this map shows. In retrospect, publishers' mistake was to try to compensate for lower classified advertising by raising subscription prices, and thereby sacrificing the size of their total user base. It's the main reason newspapers were largely hesitant to erect a paywall. But was it all their fault? Could newspapers have done something different to withstand the disruption caused by Craigslist? Rick Edmonds, a media business analyst at the Poynter Institute, argues that while new systems rarely emanate from within existing organizations, newspaper publishers tended to downplay Craigslist until it was too late. "It gets overstated that newspapers should have done this, they should have done that,'" Edmonds said. "That's kind of unrealistic about how innovation and especially disruptive innovation happens -- it doesn't very often come from inside. On the other hand, particularly in that early period, newspaper executives at top corporate level and at the local level were a little bit in denial saying things will get better.'' Only now, with the advent of paywalls, are newspapers beginning to see at least a way toward growth, though that future remains uncertain. Seamans, for one, is an optimist. ''Newspapers have been pretty resilient in the past, and I think they will be in the future," he said. "Newspapers withstood radio and then television, and then local television newscasts, and now it's the Internet. It's premature to say that the death of industry is at hand." Newspaper employees sure hope so. Written by Leon Lazaroff in New York >To contact the writer of this article, click here: LeonLazaroff.>.