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.