Basic Royalty Calculations
Mark Cuban’s The Sport of Business

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.

Comments

Helmus

Would like to see comments from authors and other interested parties re: non-returnability...Would this stop overpublishing?

Music CDs are returnable to Sony...iTunes downloads are not...perhaps if we drive the cost out of the business some, we can get consumers interested at a lower price point...

Michael Miller

The problem with nonreturnability, in general, is that the retailers won't go for it. If all books were sold nonreturnable, then they'd order a whole lot less. Of course, there are the occasional promotional deals that are sold nonreturnable, but these are typically at extremely high discount -- enough to kick in the "half royalty rate" clause, which no author likes. The returns situation is just one more part of the book selling business that we all have to live with.

Which always prompts the question, if book retailers buy most books at 45% or so off list and can return anything that doesn't sell, how come they make such slim profits? No offense to John Helmus or his former employers, but just how bad a businessperson do you have to be to screw up this good a deal?

Helmus

Real estate costs...inventory carrying costs (less than 2 turns back in the 80's and 90's) and probably barely 3 turns now.

Frontlist is a loss leader...you barely made money on it...still an issue...Harry Potter will sell hundreds of thousands of copies but at 40% off plus cost of real estate, and employees, freight, etc.

Backlist is the moneymaker...

Realize that 10 years ago the mall stores were big, but they charged an arm and a leg for rent...its ok in the shoe biz i suppose, but for books it was different.

Think about the average bestselling computer book on bookscan sells about 500-600 per week. thats less than one copy sold per store in just the 650 B&N superstores. so if each of those stores carries 2 copies of a bestseller (as does walden, borders, dalton, booksamillion), then think of all the non-performing inventory that week. its rough for a sku intensive category like computer books...

basically lots of wallpaper kills profitability in book business...sku reduction helps and transitioning the slower sellers from bricks and mortar to online will only help their profits...

fyi, at the time that b&n went public in the 90's, their competition was borders...it was all about title count. who had more. the wall street analysts sent staffers in there to count titles so that one could have bragging rights and hopefully help stock in mktplace.

definitely changing now...

retailers will do nonreturnable, but the publishers are too scared to go that way...they want to load stores up...harcourt tried to go nonreturnable many years ago and no other publisher would follow so despite what might be good business sense, harcourt had to move back to returnable. buying nonreturnable means buying carefully based on rate of sale rather than speculating...publishers didnt want the low up front buys that would result from nonreturnable because it would lessen the chance of earning out on advances to authors. or at least so they thought.

Joe Wikert

Yes, I could see where switching to a non-returnable model would be both exciting and frightening. It would be great to know that none of those copies that just left the warehouse are ever coming back. It seems the publisher would be conceding two critical items on this though: deeper discounts and reduced placement. Accounts would obviously ask publishers for a deeper discount. If it were a straight-up swap, deeper discount for non-returnability, maybe publishers would jump on it. But as you just mentioned John, this also undoubtedly would mean lower buys from the accounts as they try to limit their exposure on non-returnable products. I guess you’d need to crunch some numbers on this, but it’s hard to get excited about a model with both deeper discounts and lower buys.

Michael Miller

If selling nonreturnable means lower buys (i.e., less stocking), then it's not a good deal. We all know from experience that more copies on the shelves equals higher sell-through. That's why publishers like to load up the retailers.

BTW, what's everyone think about the significantly lower sell-in these days vs. several years ago. I'm seeing extremely low advance sales on some books -- somewhere south of one copy per store at B&N. How can a book sell if there's less than one copy in a store (i.e. -- some stores with no stock at all)? Customers can't buy something that isn't there...

Yvonne DiVita

Oh puh-lease! The solution to returns is called Print on Demand. And, there are professional companies that produce professional, quality books via Print on Demand...I'll put any one of my books up next to one of yours, and not only do they LOOK just as good - they read just as good. And, yes, the author PAID me to produce them...but, after that, the 30% royalty they get puts more $$ in their pocket than they'll get from a traditional publisher. Without ever having to worry about returns.

Joe Wikert

Hi Yvonne. You're right about the benefits of print on demand (POD) but Mike is also correct about the benefits of deep stocking and promotions. In other words, POD does indeed prevent the dreaded "we're out of stock, we'll order it for you, come back in 2 weeks" scenario, but it's no replacement for the shelf presence of a deeply stocked title, one on endcap or featured in some other type of promotion.

I spent a bit of time today poking around on your company's website (www.wmebooks.com). I would encourage any author who is researching a POD or self-publishing alternative to visit your site as well.

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