Newspaper executives know that online classified-advertising services are taking a bite out of industry revenues. Recent announcements by Google and Microsoft suggesting their interest in the classifieds business only add to the newspapers' concerns, which also include rising costs and declining circulation. Our analysis shows the extent of the damage to revenues by online competitors and suggests what publishers can do to defend their turf.

From 2001 to 2004, online players such as craigslist, Monster, and Realtor.com captured approximately 5 percent of the newspapers' US market share—resulting in a loss of $2 billion of the $34 billion classifieds market. In some categories of classifieds, the loss was far greater: 40 percent or more. Lost market share is only part of the story. Newspapers are having difficulty raising advertising rates to make up for sagging volume, since online competitors offer advertisers an inexpensive (and inexhaustible) supply of ad space in local and national markets. In some cities, newspapers find that they must offer small advertisers general classified ads free of charge.

Newspaper publishers cannot afford to give ground, because classified ads make up more than one-third of their advertising revenues; display ads account for most of the rest. Some leading papers...