From veteran publishing consultant Mike Shatzkin:
When publishers decide whether or not to buy a book, or look back at a book to evaluate its performance, the analysis is done in a way that could be, and often is, misleading. This is almost universal practice, has been for at least a century, and may never change. But it is worth a few minutes for anybody interested in understanding the profitability of a publishing house to contemplate what seems to me to be rampant misunderstanding.
The problem is the practice of constructing P&Ls on a book-by-book basis. The concept itself is a logical fallacy. The idea of an individual book making a profit or loss only makes sense if there is no publishing house. That is, if you decide this afternoon to take time off from your career as a truck driver or a banker and invest a little cash in publishing a book, your exercise could at some point be measured and a profit or loss could be calculated.
Doing that would be very straightforward if you were doing it on a cash basis. You’d add up all the revenue you got from publishing the book and all the expenses you incurred in publishing it and pursuing that revenue, mash them together, and have your calculated profit or loss. You would have to account for unsold inventory if you didn’t use a print-on-demand strategy. You might have net positive cash (profit) or net negative cash (loss) and some unsold inventory (potential additional profit) that you might have to pay storage fees on (potential additional loss).
Standard accrual accounting methods would call that unsold inventory an “asset”, essentially adding to your “profit”, but that would only be true if you could actually sell it.
. . . .
But if you decided to grow your little operation and do ten books, even on a cash basis the accounting for each book now wouldn’t be quite as simple. Your production or marketing or sales team works on your whole list and how much of their time should be “allocated” to each book might be hard or even impossible to calculate. If you were being precise about it, you’d have to account for the reality that the books are not all the same. They take different amounts of effort to develop editorially and do not place consistent demands on your production and distribution overhead costs. You couldn’t actually just “add up” all the expenses for each book to subtract from the revenues to produce a profit calculation.
And imagine how much harder it would be to be precise about assigning those costs if you were dealing with hundreds of books in an organization each year. Or thousands.
Because many publishing decisions are made one book at a time and because accounting is done to the government to pay taxes and (sometimes) to shareholders as well, it is common to do the accounting on a “per title basis” and ultimately on a “per unit” basis (where we aren’t just trying to understand the profit — or loss — by title, but literally score things down to the individual unit transacted). Title P&Ls and unit cost accounting are part of the operating fabric of every large publishing house.
I’d argue publishing would work better if they weren’t.
. . . .
Here’s how book publishing economics actually works. A publishing house has overheads which are reasonably fixed: primarily rent and salaries but also including travel and entertainment, insurances, legal and accounting, and the costs all businesses have to keep operating and keep their doors open. Unless there is some conscious expansion or contraction of the publishing program, those expenses do not fluctuate appreciably based on the number of titles a house publishes or the revenues it generates from selling books and rights.
Then each book has two kinds of costs: the investments required to publish it at all (author’s advance and what used to be called design and typesetting but which would now be better described as “creating a print-ready file”) and unit production costs, the “paper, presswork, and binding” of the actual printed units. There is no unit production cost for ebooks.
When books or rights sell, the publisher banks a “margin”. For rights, that is all the revenue not paid through to the author. For book sales, it is “contribution margin”, the difference between the revenue the publisher receives from accounts and the actual direct costs required to complete the sale, which for most books requires subtracting the unit printing cost and any incremental sales commission and royalty due to the author (if the advance has earned out). The margin earned on each book has to “pay back” the book’s direct investments first but then gets applied to address overhead.
When the net positive margin generated by all the books, frontlist and backlist, in a fiscal year have covered the house’s overhead, the additional margin constitutes the house’s profit. One might say the book’s “profit” is the margin it generates, but no publishing house I know looks at it that way.
Instead, the standard practice is to assign each book its “share” of the house’s overhead. (Sometimes this is made even more complicated by assigning different overheads to books from different reporting units — imprints — within the house.) How the number to apply is calculated in each house is not transparent, and almost certainly varies, but the simplest form would be for the house to calculate what the fixed overheads were last year in relation to total sales and “allocate” each book that percentage of overheads. (The overhead number often ends up being 35 to 45 percent.) That overhead allocation pushes many, if not most, books from being scored as”profitable” to being calculated to be “unprofitable”.
. . . .
Before the rise of indie publishing enabled by Amazon, it was much easier for the big houses with their big sales and distribution capabilities, to be sure they’d get thousands of copies out on just about every book they did. Now it happens — and it really didn’t back then — that even a big house can have frequent abject failures: books that don’t even recover their direct costs (even without a massive advance against royalties). That was a much rarer event in bygone decades.
Link to the rest at Mike Shatzkin and thanks to Jan for the tip.
I actually went to his site and read the whole thing. If you dig through it, his point is that books that earn more than their direct costs but less than that plus their share of overhead, are helping because they do pay some of the overhead. I can’t argue with that, except the whole thing seems based on the notion that publisher overhead is utterly fixed, like some absolute mandate. Is there anybody–anybody?–who doesn’t think publishers could take a chainsaw to their overhead without impacting the business at all?
Maybe he does.
Or maybe he is trying to slowly softening them up for that message.
I give Shatzkin some credit. I think he is telling the publishers that they have to look at their overhead more analytically and with a sharper trimming knife. They are now competing with independent authors who are completely aware and have precise control of their overhead. Some traditional publishers realize this. I know of a technical publisher that recently moved from a Manhattan address to cubicles in a warehouse on the Jersey side of the river. Watch. I bet it happens more.
This isn’t new stuff. It’s been around forever.
I would love to have the general consulting firm’s version of the call after it was over. Mike’s ‘screw the overhead, add more titles to be profitable’ approach shows obliviousness to the biggest problem in the business model – the fixed costs are too high, possibly too high for continued existence as the environment continues to evolve. The ‘run as many units through as possible to contribute margin to our excessive fixed costs’ model is the model that sent GM and Chrysler to Chapter 11.
Publishers fixed expenses are not immutable: they can move out of NYC radically decreasing rent (and likely personnel expense), executives’ compensation is probably too high given performance, expenses for social signaling (e.g. $60M advance for the Obamas’ books) can be cut, T&E are probably out of whack though there is not enough transparency to know, etc. If the Big 5 doesn’t start learning how to run a modern business, they may get permanent vacations.
The ‘run as many units through as possible to contribute margin to our excessive fixed costs’ model is the model that sent GM and Chrysler to Chapter 11.
If the fixed costs really are fixed, that system works well.
It fails if the fixed costs aren’t fixed, or if the number of units needed to cover the fixed costs can’t be produced or marketed.
GM and Chrysler could produce the required number and more but selling them was a pipe dream. And it was no shock that they couldn’t. Chrysler in particular was totally delusional. If Daimler hadn’t gutted their FWD and small engine capacity tbey might’ve had a chance but peddling RWD tanks build off trailing edge Mercedes tech?
A total waste of Iacocca’s legacy.
I’ve read this three times, and I’m not sure I fully understand it. But here’s what I think it boils down to:
1. When it comes to selling products, you have two kinds of cost — direct costs and indirect costs.
2. In publishing, direct costs are a) the advance you pay the author, b) any royalties due the author, c) any costs associated with the actual physical production and distribution of the product, and d) any costs that go into advertising the product itself [aka the book].
3. In publishing, indirect costs include all the overhead — things like lease payments, utilities, software/hardware, accounting/IT/HR staffing, etc. — as well as the staff time (editorial, sales, marketing) required to launch the product.
4. In publishing, managers evaluate the success of a product line (a book, a book series) and thus a supplier of product (an author) by taking the overall sales of the book and subtracting the direct costs as well as a percentage of overhead. And that percentage of overhead is (often) the same for every single product [book/title].
5. That means that decisions on how much to invest in a supplier (author) presumes that every supplier needs to be able to contribute the same percentage to overhead. This would be like if auto manufacturers expected to get the exact same profit margin on luxury sedans, SUVs, sports cars and small sedans.
A few things, assuming I understand this all correctly.
A. that may be a great way to use Hollywood accounting to make sure a book never earns out (just like they make sure a film never gets to where it pays out on points).
B. Is 35-45% overhead standard in other industries? Because that seems like a high percentage to me, especially since you have all the direct costs on top of that. Plus there’s all the aggressive discounting that often happens on the sales end that changes your overall per unit sale revenue. I guess if the bulk of that is editorial, sales and advertising staff time then that high of a percentage makes more sense (although that also presumes that that staff time ).
C. No wonder advances are often so small and royalty percentages low. Squeezing the supplier is a good way to keep direct costs down. Unless, of course, it results in losing suppliers. Or you cut suppliers loose who turn out in the long run to supply more attractive product to the marketplace (or niches within it) or more reliable in producing product than your new suppliers.
D. How does backlist figure into all that? If you’re paying all that money for overhead, wouldn’t it make sense to invest some of that overhead (staff time) in selling product you’ve already paid out most of your direct costs for it (esp. if for print you move to POD)?
E. If overhead is included in calculating success of the product line, how do you know if the problem is the product or the overhead? I mean, yeah, books are widgets. But for the most part, it really helps to have a diversified portfolio of widgets to sell. And it really helps to know how much of your overhead is going into each product line.
F. While I agree that it can be difficult and cumbersome to track staff time in relation to an individual title (or even list), wouldn’t that be worth exploring so you have a better sense of your direct costs? I mean, ad agencies, law firms, design firms, etc. all track staff time. Yes, it’s so they can bill hours, but they also use that so they can know how profitable their various accounts are. And they take on some accounts to bring in a ton of revenue, but also may take on other accounts to win further business, garner awards, gain knowledge/credibility in a specific industry sector, provide more interesting projects to their staff, etc. Couldn’t you charge billable hours against a title? Maybe some publishers already do that, but from the post it sounds like they don’t.
On F:
In the corporate world plenty of companies use internal charge numbers to track usage of overhead services on a per-product basis. It is not brain surgery.
During the 90’s corporate reengineering wave/fad, overhead cost allocation was job one. Typically charge numbers were used to create internal “market economies” to rightsize specific depts and make sure products that consumed specific services paid in proportion to their usage.
Heck, even some universities use charge backs for some units (creative services, accounting, etc.).
Most of the overhead that is not directly accounted for already is likely employee time. Even unsophisticated two and three person firms have had implementable solutions for tracking time since the 1980s (e.g. Timekeeper). It is not rocket science. If your accounting system can’t handle this as a major company, you should no longer be in business.
Some big companies have in-house photo labs, print shops, studios, libraries, legal, R&D, PR, and of course, IT
Genuinely necessary but without fiscal controls they tend to become runaway empires and sandboxes that can’t even identify who cpnsumes how much of their services.
The bigger the company, the harder it gets until overhead swamps line of business.
Yep.
A. They don’t call it whale math (TM) for nothing!
B. New York offices don’t come cheap.
C. Yeah, and they wonder why there are so many indie writers out there eating trad-pub’s lunch (and breakfast and dinner!)
D. Careful, you’re attempting to use logic, and that’s against their (and Mike’s) religion. I liked him thinking not having to pay any royalties was a ‘good’ thing.
E. I like that Mike didn’t include ‘advertising’ in his list, at least even he admits they don’t bother with it for most of their books.
F. your answer was back in ‘A’, whale math helps hide all the little things their writers should be getting. Breaking it down properly would get most of the upper offices fired or jailed, much better to have a black book where you can’t tell why or how much money flows in and out which holes.
RE: A
“Earns out” is a very specific term. In a standard contract it does not include overhead or marketing costs. The shenanigans to screw the author come into play elsewhere, such as deep discounting, etc.
The reason Mike is saying this accounting is bad for authors is that it will (erroneously) cause the Publisher to not buy an authors next book.
I imagine most people on this site would find that to be a net positive, not a negative, for the author.
Right. I shouldn’t have linked those specifically. But if the P&L doesn’t look great because the overhead is in there, wouldn’t that be incentive to do the deep discounting shenanigans or upping the reserve against returns so that royalties don’t come into play?
I don’t really know what the timing on all those decisions are so maybe it’s not a factor, and it’s simply just about sales velocity and overall revenue in relation to the advance (which I do realize is what technically earns out).
A simpler way to say it:
If a book covers its direct costs, and makes a contribution to overhead costs, it is a success.
Like Felix said, just like widgets. Books aren’t special.
not all those “indirect” costs are really indirect.
Editing a book should be accounted as a direct cost of the book.
Now, not all of the editor’s salary can be accounted this way, but a large chunk of it can.
other businesses do internal charge backs to different projects as a routine thing, publishers should be doing the same thing.
“A publishing house has overheads which are reasonably fixed: primarily rent and salaries but also including travel and entertainment, insurances, legal and accounting, and the costs all businesses have to keep operating and keep their doors open.”
Most of these things are not actually fixed and all are subject to cost cutting and efficiency improvements. Many have pointed out that publishing companies could probably operate just as well without continuing to pay the extremely high Manhattan rates for office space.
Fixed in this context doesn’t mean it can’t be gotten cheaper, it means the cost stays relatively the same from month to month, and is therefore, completely predictable.
Month to month, decade to decade, century to century.
If it was good’nough for granpappy…
That one made me LOL, Felix…
“Now it happens — and it really didn’t back then — that even a big house can have frequent abject failures: books that don’t even recover their direct costs (even without a massive advance against royalties).”
‘Massive’ advance against royalties? Not everyone is Obama and if they can’t handle more than one book per writer per year then 3-5K is no where near ‘massive’.
Just another ‘too bad we (trad-pub) can’t control/milk those indie/self-pub books — we’re not getting our cut of the money they’re making (and the dang fickle puplic won’t but our gate-kept culture over their free-range junk! Those dang indies even took away our adult coloring books!)
Thanks for the translation.
At least he’s moving away from the special snowflake meme. Slightly. Belatedly.
Thanks for the TL;DR. I fell asleep somewhere in the first sentence. I did need a nap, though, so all is not lost.
Long winded way of say: pbooks are widgets and publishing is subject to the same economics as any other manufacturing business. Like, duh.
Yeah, really. You can tell he never ran an ordinary business in real life.
It ain’t rocket science.
As a CFO and COO in a prior life, I claim all accounting should be thought of as supporting actionable decisions. No point allocating overhead per book, because it’s not actionable.
There are costs per-book, costs directly for books but not breakdownable on a per-book basis, and costs for running a business. You need to know all three, and you need to take very different business decisions based on improving all three.