Thursday, February 07, 2008

How Publisher's Make Money When the Advance Doesn't Earn Out

A little while ago, I mentioned in a blog that publishers can make money even when an author’s advance doesn’t earn out. I promised to explain that.

Let’s take some basic terms and apply them:

  • Standard hardcover royalties for most trade publishers (meaning non-academic, e.g., Simon & Schuster, Random House, Penguin Putnam, HBG, etc.) are 10% of the retail price on the first 5,000 copies sold; 12.5% on the next 5,000 copies sold; and 15% on all copies sold thereafter.
  • The average discount granted to booksellers is 50%.
  • Penguin Putnam, one of the largest publishers in the world, says a book sold at greater than an 85% discount has effectively been sold “at cost” and no royalties will be paid. By “cost,” I mean the cost of paper, printing, and binding. From this we can extrapolate the following: a $25 book costs $3.75 to manufacture, or 15% of $25. Now, I don’t actually agree that a hardcover book costs that much to manufacture, particularly if you are printing tens of thousands. But it’s a deal-breaker to change in the contract, so let’s assume that’s correct for now.

Thus, if the publisher sells the $25 hardcover to the bookseller at a 50% discount, it pockets $12.50. Assuming that this sale is in the first 5,000 copies, the royalty is $2.50 to the author, in the second 5,000 copies it’s $3.125, and after that it’s $3.75.
$12.50 less $2.50 is $10.00. Now, we aren’t factoring in a lot of things, like paying the editors, or the sales guys, or the copyeditors, the electric bill, etc. One rule of thumb is that 1/3 the cost of any product goes to “keeping the lights on” and paying general overhead. So let’s round up and say $4.00 of every copy sold goes to that. The net is still $6.00 in the publisher’s pocket. And, remember, it was only $2.50 in the author’s pocket. So the simple answer is that for every copy sold, the publisher makes more than twice per copy than the author, so if the advance wasn’t huge, one can intuit that a publisher could make a profit without the advance earning out.

Sure, these are all rough numbers, but they should make the point, even if looked at in more detail.

If a publisher ships 10,000 copies of a $25.00 hardcover for which it paid a $20,000 advance, the math should roughly work out as such:

  • $25.00 retail price
  • 50% discount
  • $12.50 wholesale price
  • Sell-through of 50% equals 5,000 copies sold x $12.50=$76,000.00
  • Royalty on each of those 5,000 copies is $2.50 for a total of $12,500.00 in earned royalties
    Write-off on the 5,000 copies that were returned is cost of manufacturing x 5,000=$18,750.00.
  • No royalties are paid on copies that are returned and remaindered. If returns are then remaindered for $2.00 each, publisher gets back $10,000.00 of the $18,750.00 for a net loss of $8,750.00.
  • Contribution to overhead for each copy sold is $4.00 x 5,000=$20,000.
  • Unearned advance that has to be written off is $20,000-$12,500=$7,500.

Ready?

$76,000-$12,500-$8,750-$20,000-$7,500=$27,250.00

Even if you are stickler and say that the cost of overhead for each of the unsold copies has to be factored in—another $20,000—you're still leaving $7,250.00 in the publisher's pocket.

So, even though the advance never earned out, the publisher made money selling only half of the books it manufactured and shipped.

Again, these are very rough numbers and certainly do not include every cost a publisher may incur, but I think they demonstrate sufficiently how it works.

So how do books lose money? Well, it’s pretty simple: Publishers anticipate a book will be big and pay a very large advance. They encourage booksellers to order large numbers of copies and maybe even offer incentives to get them to do it. These incentives are called “co-op,” and may include paying Barnes & Noble to feature the book on a table in the front of the store or paying Amazon.com to send out an email to every customer who ever bought one of the author’s earlier books. Factor in overprinting, overselling, and a large advance on a book that turns out to not be as big as the publisher expected and the book will lose money. Kind of like if you opened a new store, ran big ads, hired a clown, and then a blizzard hit on opening day and no one shows up.

Oops.

The thing to keep in mind, dear reader, is that 99% of books are not bought for huge advances. And according to one CFO I met with while I was chairperson of the AAR's Royalty Committee, 90% of the books his house publishes do not earn out their advances. Yet this house grows and grows. So, obviously, books can be profitable while not earning out their advances.

I know, I know. If I had led with that, I could have saved both of us a lot of math. Deal with it.

Z

1 comment:

Chiron O'Keefe said...

Thanks for the break-down on royalties and advances. Truly makes the head spin, doesn't it?

It's good to know that books can be profitable even without earning out their advances.

--Chiron O'Keefe
Ashland, OR

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