The Business Rusch: How Traditional Publishers Are Making Money

Kristine Kathryn Rusch

Of course, this past week has been just as busy in publishing as the last several weeks. The changes are amazing, especially considering how stable the industry used to be.

Third quarter earnings have come in, and the publicly traded publishing companies must report them. (Or, at least, their parent companies must.)

For those of you who blithely predict that traditional publishers will go away, I suggest you click on over to the links below and look, actually look, at those earning statements. For the rest of you, here are the headlines:

Pearson, which bills itself as “the world’s largest learning company,” reported increased sales (6%) and operating profit (13%) in the first 9 months of 2011. But the interesting part of its statement is about Penguin, the publishing company. Overall sales at Penguin remained flat, but… profit margins were up because of the rise in e-book sales. While paper books declined, e-book sales “more than doubled from last year.” Three months ago, Penguin reported a 128% increase in e-book sales. This little statistic will be important later in this blog post.

Harlequin’s parent company Torstar was down slightly “largely due to foreign exchange rates.” But they expect “lower book returns relative to books distributed which should contribute to improved operating results.” Again, we’ll look at that a bit below.

Simon & Schuster, which has been in the e-book market longer than any traditional publisher, reported through its parent company CBS that sales and profits were up. Once again, we see this little tidbit in the earnings report: “Strong growth in the sales of more profitable digital content was offset by lower book sales.” [emphasis mine] The increased profits, then, were “driven by lower direct operating costs, including expense decreases resulting from the significant increases in more profitable digital sales as a percentage of the total revenue.” [Again, emphasis mine]

This explains Simon & Schuster’s announcement days later that it will create a “dedicated digital sales team” that will have “responsibility for our corporate social media efforts, and continue to develop larger cross-imprint publishing and marketing opportunities.” Of course, buried in this announcement is the fact that in the reshuffling, lots of other folks will lose their jobs as their positions—from the old way of doing things—will be eliminated. S&S is going where the money is, and the money is now in digital sales.

Profits are up in almost every company required to report, except at Lagardère, which owns Hachette, which owns Grand Central and Little Brown among others.

Since Lagardère are behind everyone else getting into the new media world, their profits are down for Hachette Book Group—8% in the U.S., and 10% in the U.K. Even so, the report states this: “The e-books boom continued in the third quarter, mainly in English-speaking countries.” In the first 9 months of 2011, the e-book sales were 21% of net sales in trade publishing in the U.S., and 9% in the U.K. market.

Then the report states this: “The October launch of several e-readers in France should help the French market take off.” Like the companies above, Lagardère is banking on the e-book market as well.

Lagardère is blunter in its statement than the other companies. It states this in the Outlook section of the report: “The [Lagardère] Group is taking a cautious outlook looking forward to the end of 2011, given the highly volatile overall environment.”

In other words, Lagardère is as stunned by the rapid changes as the rest of us. The difference between Lagardère and some of the other companies on this list is that Lagardère was behind the curve—far behind—and is now struggling to catch up.

I want you to notice a few things before we go farther. I have said repeatedly that traditional publishers will not go away. Traditional publishers are part of international corporations. Torstar is based in Canada. CBS is based in the United States. Pearson is based in the U.K. And Lagardère is based in France. I cannot stress to you how large these companies are. Look at their reports, and you’ll see holdings upon holdings upon holdings. The publishing companies are a part of their business, but not all of their business by any stretch of the imagination.

So the people who continually predict that traditional publishing will disappear simply do not understand how multinational companies with holdings around the world operate. Look at the reports. You will start to get an idea.

I haven’t explored the earnings report of all of the major companies, but the ones I’m finding show some uniformity. E-book sales are up. And even in the recession, many of the publishing arms of these multinational companies are profitable.

How is that possible? After all, Borders is gone, Barnes & Noble has decreased shelf space for books significantly, and even though independent booksellers are on the rise again for the first time in ten years (yay!), in no way can they make up for the loss of retail space for paper books. Every grocery store has cut back, Wal-Mart has decreased shelf space, as has Target and many other book retailers.

Similar situations have happened around the world. Indigo in Canada cut back on shelf space, and large book companies in Europe have cut back as well.

And yet, profits are up, by both of the measures that the reports list. The first measure—sales—is up, and so is the second measure—operating profits. This means that not only are the companies selling more books (in one form or another), but they’re making more money while doing so. In the few companies where sales are not up (flatlined or lower), operating profits have still risen.

Normally, when we discuss a rise in operating profits, we mean that the cost per title is down. In the past, decreasing the cost per title happened on the backs of employees who got laid off or took serious pay cuts, or it happened because the company reduced rents on office space or renegotiated expensive printing/labor/other contracts.

This time, the decrease in the cost per title happened mostly due to one thing on the publishing side of these companies: e-books.

In fact, report after report states this, although few say it as clearly as Simon & Schuster. The continual reference to “more profitable digital sales” throughout the report is pretty damn blunt for an earnings statement. What’s missing is why digital sales in general and e-books in particular are more profitable.

So let me break that down for you.

It’s not just that e-books are less expensive to produce. They are less expensive to produce, just not as much as you might think. The massive overhead that traditional publishers have is still charged against an e-book (and if you want to get one glimpse of how massive that overhead is, take a look at this article from The New York Times a few weeks back. Time Warner used the Times article as a bargaining chip to negotiate a smaller rent deal).

The e-book still has to be designed, developed, proofed, and shipped to distributors. Although that shipping word reflects a place where the publisher saves money: no massive shipping costs on e-books—just the cost of the in-house computer and the tech person who researches the various sites and hits “send.” That’s a savings.

As is the fact that the publisher doesn’t have to produce two books to sell one, like they do with their print books. (This is a reflection of the returns system.) Torstar (Harlequin) mentions this prominently in its report with this statement, “lower book returns relative to books distributed which should contribute to improved operating results.”

In other words, Harlequin is printing fewer books and selling more e-books, so each book is making more money than it ever had before.

There are still production costs with e-books, but no paper costs; still art costs, but no cost to print something with four-color. Since e-books are cannibalizing the mass market paperback, that represents a savings as well.

(An aside: I will miss the mass market paperback. It’s my favorite paper format. But as the shelf space for the mass market paperback disappears, so are the mass markets themselves. Romance still thrives on mmps, but many other genres from mystery to science fiction to literary mostly publish in hardcover and trade these days. Very few mass markets at all. It’s getting to the point that if you want to read an inexpensive book, you’ll need an e-reader.)

But the biggest place that the publishers are saving money in the e-book side of things is author costs. Ten years ago, e-book rights got treated like any other subsidiary right. The authors got 50% of whatever the publisher got for that book.

The assumption in subsidiary rights is that the publisher would outsource them. That was especially true ten and twenty years ago, when book publishers published books only. But those of you who went to the links I posted above should have noted that the parent companies were major conglomerates with other holdings. So now, a lot of what used to be outsourced, from audio books to e-books, get produced in some other part of the parent company.

The suits at the parent company put pressure on the book publishers to change the contracts to reflect the in-house nature of the production. Contracts bought rights directly instead of splitting them, particularly in houses that also have a sister company that’s, say, an audio company.

Writers, writers organizations, and agents fought a lot of those changes, arguing that they still required the 50% of whatever the publishing house “got” for those rights. This battle got quite heated, and everyone expected give on both sides.

The battle was fought five to ten years ago (depending on the company), and back then, no one thought e-books would ever make any money.

Not ever.

So the writers, writers organizations, and agents had to cave on something to show they were “giving back” in the negotiation. They agreed to 25% of net or 15% of gross on e-books around that point, because “everyone knew” that e-books would never account for more than one-tenth of one percent of a book’s sales.

Ooops.

In current contract negotiations, e-books are no longer considered a subsidiary right. They’re a major point of sale, along with hardcover, trade, and mass market rights. Traditional book publishers have made e-books rights a deal-breaker in contract negotiation.

Either writers give the traditional publisher 15% of gross or 25% of net, or there is no contract. Some publishers are getting even stingier: 15% of net, not gross, and if you don’t like it, writer person, walk away.

So many writers don’t walk. Hell, I have several contracts with those numbers in them, and back when I signed them—ten and five years ago—I too thought e-books would remain a subsidiary right. I’ve signed contracts with worse e-deals in the past three years, but in a more calculating way, hoping the traditional publisher’s push on the books would have a positive impact on the sales of my indie-published titles.

It was a gamble, and honestly, the jury’s still out on whether that gamble’s paying off.

Anyway, back to the publishers’ profits. The publisher is now paying significantly less in royalties to the writers than the publisher ever paid in the past.

I’ve done this math before, but it’s worth doing again for those of you who fail to get it. This time, let’s just use a $6.99 price point as our example, and a 25% of net e-book royalty rate from the traditional publisher, and let’s ignore the problem of “net” entirely.

At $6.99, the writer is entitled to $1.22 of that book. Subtract the standard agent’s commission of 15% and the writer gets $1.03.

On that $6.99 sale, Amazon gets $2.09, the publisher gets $3.67, the agent gets $0.18, and the writer gets a whopping $1.03. The only person who gets paid less than the content creator here is the agent, and that’s because the agent got 15% of the writer’s take.

If the writer sells that e-book herself, she gets $4.89, without paying her agent. That’s a difference of $3.86 going to the writer.

And that’s assuming that the publisher: a) accurately reports the sales; b) defines “net” as the amount the publisher gets after Amazon (or B&N or Kobo) takes its cut; and c) does not decrease the cover price of the book.

In the past, the past the writer got 50% of cover price on e-books. So even if the publisher or Amazon sold that book at a discount, the writer still got 50% of the original cover price. Meaning that a $6.99 e-book sale gave $3.49 to the writer. No matter if the publisher only sold the book for the discounted price of $3.99.

Cover price is still the gold standard for royalty rates on print books. Only a few smaller traditional publishing companies pay writers based on net receipts, and in those contracts, “net” is clearly defined as what the publisher receives from the distributor (be that an actual distributor or a bookstore).

Most traditionally published print books pay the writer an 8-10-12% royalty rate on the cover price of a mass market paperback (which is what a $6.99 book would be), although many of these publishers have also added a “discount schedule” so that books sold well under cover (like that $3.99 above) would have a different royalty rate.

So on the paper book sold at full cover price, the writer would receive maybe O.55 cents, 0.69 cents, or 0.83 cents per copy. For those of you about to get up in arms about that, remember that the publisher has to produce two paper books to sell one, so the publisher is only getting $3.49 per copy—and must charge off all the various other expenses from that. Before the author costs get figured, a paper book publisher makes about $2.00 maximum per mass market paperback. And then forks out anywhere from 55 cents to 83 cents to the writer.

The writer, then is making anywhere from 27% to 41% of what the publisher makes. Look at it this way, if the writer got those royalty rates on her e-books—27% of net or 41% of net from her traditional publisher, she would be making $1.32 to $2.00 on the book before agency fees. After agent, it would be $1.12 to $1.70.

Those of you who really have no sense of how publishing works are probably thinking, What’s bugging this Rusch woman? She’s talking pennies here.

Pennies that you add up over thousands, tens of thousands or hundreds of thousands of copies of your book. So let’s look at that for a minute. That $1.12 per copy equals $1,120 spread out over a thousand copies sold of that book. Over ten thousand copies, that’s $11,200. Still think that’s chump change?

Now, consider this: Traditional publishers never expect to make a lot of money on one book. They expect to make a little bit of money on every book.

When you look at the number of books that Penguin publishes every year or Harlequin or Simon & Schuster, and you increase the profits made per book by two to three dollars, you’re talking millions, tens of millions, maybe hundreds of millions in increased profitability—by moving to e-books.

You see why, with e-books at 21% of the market and growing, traditional publishing companies are making money with shelf space disappearing. These companies are making money in a recession. Imagine how much money they’ll make next year, with the introduction of all the cheap tablets, and anticipated significant rise in e-book sales.

These publishers are making money on the backs of traditionally published writers.

This change has a bigger impact on the bestsellers than it does on the midlist writer. It’s really simple. Do the math. The bestselling books will continue to sell at hundreds of thousands, if not millions of copies.

In the past, bestselling writers would make sizeable royalties on those sales. With a move to e-books, the royalties are being cut significantly.

Look at it this way, which is best-case. Instead of making $2 per book on that $6.99 ebook, the bestseller now makes $1.22 (this is before agent, remember). That’s 39% pay cut.

Or multiply that by one-million copies. The bestselling writer made $2,000,000 in the old method. Now the writer is making $1,220,000.

Okay, most of you wouldn’t complain about that. Except that the $780,000 is now going into the publisher’s pocket, not the writer’s. And let’s not even talk about the loss that the agent will suffer, making 15% of the writer.

Is it becoming clear why profits are up at the traditional publishers? The profits they’re making is coming out of the pocket of the writers.

And we haven’t even discussed the problem of “net” receipts. Some of the oldest contracts have no definition of net. Most good recent contracts do, but the old ones—negotiated by literary agents without law degrees, agents who have no idea that every word in a contract is important—usually had no definition of “net” at all.

Since this hasn’t yet been litigated in a publishing contract, to my knowledge, undefined net is whatever the publisher deems it to be. If the cases do get litigated down the road, the definition will switch to “industry standard.” But right now, no one knows what “industry standard” is.

I know you guys hate my math posts, but if I don’t do them, you can’t see what’s going on. And here the math is really clear. Simon & Schuster (through parent company CBS) says it all: the increased profits are “driven by lower direct operating costs, including expense decreases resulting from the significant increases in more profitable digital sales as a percentage of the total revenue.”

Imagine what these quarterly earnings reports will look like in 2012 after the increase in digital sales. Imagine what the earnings reports will look like when, like most are predicting, e-book sales hit 50% of the market.

Who will make money? Online bookstores, yes. But the largest chunk of the pie in those e-book figures I gave you above now goes to the traditional publishers. And if writers continue to sign away their profits just to get a book published traditionally, then that chunk of the pie will grow.

I know this made your brain hurt. Print the blog out, look at it carefully, and follow the links. Then think about this very carefully.

The industry is changing, and if a writer wants to stay in traditional publishing, she will make a lot less money that she would have made ten years ago—even with the same number of book sales.

Traditional publishing isn’t going to go away. If anything, traditional publishers will become more profitable in the years ahead.

But the traditionally published writers won’t.

Just sayin’.

I write my non-traditional little blog here once a week, taking time away from my fiction writing to do so. If you find value in this nonfiction blog, please do leave a tip or a small donation on the way out. Thanks!

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“The Business Rusch: How Traditional Publishers Are Making Money” copyright 2011 by Kristine Kathryn Rusch.

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