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26 posts from March 2005

Returns and Returns Reserves

In an earlier post I noted that unsold product returns from bookstores make royalty calculations a bit more complex than you might think. There are actually two components to this: returns from the accounts and the returns reserve.

Let’s use the simple numbers from the example yesterday: a book with a $30 cover price, an average bookstore discount of 50%, an author royalty rate of 10% and the publisher shipped 12,000 copies of the book in its life. That resulted in total payments to the author of $18,000 (see yesterday’s post for the details).

Unfortunately, 2,000 of those 12,000 never sold through to customers and remained on bookstore shelves for a couple of years. The stores returned all of the 2,000 unsold copies to the publisher and the publisher gives the stores a full credit for their return. What just happened to the author’s royalties? As calculated in the earlier post, the sale of each copy of the book represents a $1.50 royalty for the author. The returns reduce the royalties by that much, or $3,000 for the 2,000 copies returned. That means the author really only earned $15,000 on the project, not the $18,000 stated earlier.

The publisher overpaid the author by $3,000. How does the publisher adjust the author’s account? The book stopped selling long ago and the publisher didn’t receive the returns until well past the point where the author was overpaid. Unless the author’s agreement calls for “cross-accounting” or “cross-collateralization”, the subject of a future post, there appears to be no simple way for the publisher to correct the situation. Actually, there is a solution and it’s called a returns reserve.

A returns reserve is a portion of the author’s royalties that is set aside by the publisher until some future date. In essence, the publisher hangs onto these funds until a reasonable estimate of returns can be gauged. Let’s say the publisher uses a returns reserve rate of 20%. In our example, this changes the original total author royalty payment from $18,000 to 20% less, or $14,400; the publisher hangs onto the other $3,600 until it can determine the likelihood of future returns.

The publisher withheld 20% of the author’s royalties under the assumption that 1 out of every 5 copies shipped to the stores might come back as a future return. How does the 20% returns reserve rate compare to the actual returns rate realized by the publisher? 2,000 of the original 12,000 copies came back, producing an actual returns rate of 16.7%. Since the actual returns rate is less than the returns reserve rate, the publisher owes the author the difference. As noted in the previous paragraph, the publisher withheld $3,600. The effect of the actual returns was $3,000 (2,000 copies returned times $1.50 per copy royalty to the author). Therefore, in order to reconcile the author’s account, the publisher should pay the author the $600 difference ($3,600 withheld minus the royalty effect of the actual returns: $3,000).

As you can imagine, the actual returns rate is sometimes considerably different from the returns reserve rate. If the actual rate is well under the reserve rate, the publisher might release some of the reserves before all the returns net out. If the actual returns rate is higher, the publisher might be able to recoup some of the author overpayment by netting down future author payments on the project. For example, during one royalty period, if the publisher shipped out 500 copies and also got 500 copies in returns, the sales net is zero for the period and the author’s royalty payment is probably zero as well.

Returns are an unfortunate reality of the publishing business. Very few sales are made to accounts on a non-returnable basis. When they are non-returnable, the discount the account receives from the publisher tends to go up considerably, which might make for another interesting future post.

Basic Royalty Calculations

“How will my royalties be calculated?” That’s typically one of the first questions an author asks. At the risk of oversimplifying things, here’s a quick explanation:

Let’s assume we’re talking about a book with a $30 cover price. That’s not how much the publisher receives, however (unless they sell it direct to the consumer). The bookstore typically gets a 50% discount from the publisher, more or less. In other words, the bookstore paid about $15 to stock one copy of this $30 book.

To keep the math simple, let’s further assume the author is being paid on a flat 10% royalty rate. The 10% rate is multiplied against the net proceeds received by the publisher, in this case, $15. The result is a single-copy royalty payment of $1.50. If 10,000 copies of the book sell during its life, the author earns $15,000 in royalties (10,000 copies times $1.50 per copy).

It would be great if everything were this simple. In reality, there are two key factors I’ve glossed over: the author’s advance and copies that may get returned from the bookstore. First, the advance…

Most authoring agreements state that the publisher will pay the author an advance against future royalties. The assumption is that the author needs this money to take the time out of their schedule and write the manuscript. For the sake of argument, let’s assume the author was paid a $7,500 advance against future royalties for the book discussed above. That means the publisher has to sell 5,000 copies before the author’s advance “earns out”. (Remember, each copy generates $1.50 of income for the author, but the publisher has already paid out $7,500 as an advance – divide the advance ($7,500) by the per unit royalty contribution ($1.50) and you get the number of copies that have to be sold for the author’s advance to earn out (5,000).) In this model, the author doesn’t see any payment beyond the $7,500 advance until the 5,001st copy is sold. To sum up, let’s say this book sold a total of 12,000 copies in its life. How much did the author make in royalties? The author received a $7,500 advance, which essentially covered any author payment for the first 5,000 units, as noted above. For the other 7,000 units sold (12,000 minus 5,000), the author is paid at that same 10% (or $1.50 per copy) rate, or $10,500. Add that amount to the original advance ($7,500), and you have a total payout to the author of $18,000 for the life of the book.

Did you know that the vast majority of books sitting on shelves at your local bookstore are fully returnable to the publisher? If the publisher ships 100 copies of our example book to the bookstore and the bookstore doesn’t sell a single copy, they can return them to the publisher for a complete refund. Sounds like a consignment business, doesn’t it? Not quite, but returns make the royalty calculation much more complex. In fact, it’s so complex that I’m not going to try and cover it in this post… I’ll save those details for a follow-up post tomorrow.

Author and Publisher Wish Lists

I spent most of the last week at a series of meetings at Microsoft in Redmond, WA. During one of these sessions, we brought a roomful of authors and publishers together to discuss ways to improve the business. OK, it was really a chance for authors to air their top 10 complaints about publishers and for publishers to do the same regarding authors. Believe it or not, it was an extremely upbeat meeting.

Our original intention was to have a discussion on the top 3 or 4 issues from each camp, but we only managed to develop the wish lists and ran out of time for the discussion. Rather than staying up all night trying to fix one or two of these items, we decided to think bigger: we’re starting a new blog with the goal of expanding the discussion and hopefully developing some solutions.

One-line summaries of the top issues are posted and ready for review. Be sure to weigh in with your opinions. More importantly, see if you can help us develop some viable solutions.

Great New Products: Mitnick and Make:

Robert Scoble recently asked me “what books are you most excited about seeing customers react to?” I’ll do my best to highlight these in the coming months, including products from Wiley as well as other publishers.

The first book I’d like to feature here is the new one from Kevin Mitnick: The Art of Intrusion. My group was fortunate enough to publish Kevin’s previous book, The Art of Deception, a couple of years ago. This new title (published last month) is off to a great start and is currently on the bestseller lists at both Amazon and Barnes & Noble.

Why am I so anxious to see customer reaction to this one? Kevin Mitnick has a large fan base and his first book was an enormous hit. The Art of Deception explained how to gain someone’s trust through the use of social engineering. The Art of Intrusion goes behind the scenes covering the exploits of other hackers over the last several years. These hackers were willing to share the details of their stories with Mitnick, primarily because of who he is and their respect for him.

I’m about halfway through the book and have found it to be one of those page-turners you don’t want to put down. My favorite story so far is one about a couple of convicts in Texas who not only managed to secretly network a series of computers inside a prison, but also obtained dial-up access to the Internet. I couldn’t help but picture the bumbling guards from one of my favorite movies, The Shawshank Redemption

Sure, I’m biased. After all, it’s one of the high visibility books published by my group this year. To balance things out, I’d also like to highlight a great new product from O’Reilly: Make: magazine.

Make: is an interesting experiment aimed at the hobbyist or technology do-it-yourself crowd. I took at look at their premiere issue a couple of weeks ago and loved it. It’s chock full of step-by-step projects and hacks for all sorts of gadgets. As you may have read in one of my earlier posts, I see a lot of opportunities with the hobbyist crowd. Make: magazine will undoubtedly be a hit in this segment.

It’s available either direct from O'Reilly or exclusively on Amazon (till 3/15) and it appears that they plan to start off with 4 issues per year. I’m assuming that if the subscription base builds they’ll look at turning it into a monthly product. At $34.95 for a one-year subscription it’s not exactly cheap. But, I was impressed with how rich the content was in the first issue – if they deliver the same quality in the future it’s worth every penny. Congratulations to O’Reilly for creating yet another new and exciting product!

If you’ve read some of my earlier posts, you’ll see that I enjoy exploring new ways to distribute content. Audio books are an interesting option due to the fact that I tend to be a slow reader. Being a gadget freak, I also like to make use of my PocketPC whenever possible.

“Books-on-tape/CD” have been around for years, of course. Rather than lugging around an extra CD, or worse, a bunch of tapes and a cassette player, I decided to give a test drive and see whether “Books-on-PDA” is a viable option. I’m pleased to report that the experience so far has been outstanding.

I downloaded my first book from over the weekend. It’s Confidence: How Winning Streaks and Losing Streaks Begin and End, by Rosabeth Moss Kanter. I started listening to it yesterday and will post a summary when I’m further into it.

At this point, however, I can safely say that the approach is solid. Downloading at home was a snap, although you certainly wouldn’t want to try it without broadband. Moving the files from my computer to the SD memory card in my handheld was also straightforward. More importantly, the listening application for my PocketPC is well designed. The interface is intuitive, it’s easy to hop around from one chapter to another and a cinch to insert bookmarks.

Price is also always an important factor for me. For Confidence, I could have either bought the print book at Amazon for $18.15 or downloaded the audio book for $18.17. The audio download satisfies my need for instant gratification, so the scales tipped in favor of on this one.

Take a look at their website. You too might find an audio book is a better option, at least for some of your reading.