Interesting strategy. Focus on the only advantage local papers have -- the deep local connection -- and build the strategy around that. Might be a leaner newspaper with a smaller readership... but that will happen anyways.

Coupling this 'deep local' focus with a better social media strategy could help them survive. If you become THE source for all local news + provide an easy way for things to be shared / discussed via FB / Twitter, etc you can bring your competitive advantage to the digital realm.