The brutal truth about earning out

From Blake Atwood:

What does earning out mean?

When an author signs a book deal with a publisher, the publisher pays the author in the form of an advance on future sales, aka an advance against royalties, aka an advance.

Let’s be optimistic and say that your literary agent sold your book to a publisher for $100,000. That means that prior to your book having gone on sale, you will have made $85,000.

Don’t forget: your lit agent gets 15 percent of what you earn. That number isn’t always the same for every agent, but 15 percent is typical.

That advance money may be paid in a lump sum, but it may also be doled out to you at specific publishing milestones, e.g., when you sign the contract, when you submit your manuscript to the publisher, and when the book is published.

Let’s assume that it takes approximately two years for those three events to happen. At that rate, you’re paid $28,333 three times over two years. Can you already see how even a sizable advance may not mean an author can quit their day job? We haven’t even accounted for taxes yet!

To “earn out” means that a publisher sells enough of that author’s book so that the publisher recoups their investment in the author.

In other words, the publisher needs to earn $100,000 before the author will ever see more money as a result of sales of their book.

Considering that an author stands to earn maybe $2.50 per hardcover book and less for other editions, at best, the publisher will have to sell 40,000 books for the author to earn out their $100,000 advance.

. . . .

According to Jane Friedman, 70 percent of authors don’t earn out their advance.

In other words, a majority of authors are paid anywhere between $5,000 and $1,000,000 in an advance and their book sales never match how many the publisher thought they could sell.

Fortunately for these authors, they don’t have to pay the advance back to the publisher. The advance is a calculated financial risk that publishers take on their authors.

. . . .

Literary agent Jeff Kleinman shared an apt visual for advances and royalties: Imagine a jar filled with 100,000 marbles. When you sign a book deal, you and your agent are given those 100,000 marbles. The publisher takes the jar back. Once they fill it back up with 100,000 marbles made through book sales, then the jar overflows and the author (and agent) “earn out” and begin to see royalty checks on top of what they’ve already been paid through the advance.

But that only happens 30 percent of the time.

Link to the rest at Blake Atwood

Here’s a link to Blake Atwood’s Author Page on Amazon. If you appreciate Blake’s insights, you might want to check out his books.

PG notes that it’s not unusual for a wide variety of little nibbles that some publishers and agents sometimes take from the author’s royalties. Some publishers and some agents add little fees for this and that, which can add up. Fedex fees charged by the agent to send you your royalty statements and royalty checks are one small example.

PG regards items such as these as part of the cost of doing business as a literary agent and, as such, the costs should be borne by the agency.

(Note: For simplicity’s sake, the following hypothetical does not include book wholesalers that all large and many small publishers use to warehouse and ship orders to individual bookstores and book chains and whoever else wants to purchase them.)

And don’t forget the notorious reserve against returns. For those who are unfamiliar with this process and how it is sometimes manipulated, PG will provide a quick overview.

  1. Publishers are happy to ship bookstores as many printed copies as the store is willing to accept. How can you expect the bookstore to make towering stacks of a book unless they have lots and lots of copies?
  2. All big bookstores and most small bookstores have the right to return any unsold hardcopies of a book the publisher has shipped to them and receive for full credit of the wholesale price the publisher charged them for the books in the first place.
  3. As an example, Bob’s Big Books orders 200,000 printed copies of Lucky Anna’s first book at the wholesale price of of $10 per book. To spare you any arithmetic, this means that Bob is receiving books with a retail price of Two Million Dollars. If Bob sells all 200,000 copies of the books at the suggested retail price, Bob will be depositing Two Million Dollars into his bank account. Of course, out of the two million, he’ll be paying rent, salaries, taxes, etc., but if Bob is a good manager, he’ll make a bunch of money after paying the related expenses involved with selling 200,000 copies of the book.
  4. However, although Bob has plenty of Lucky Anna’s books to stack up in his bookstore, he sells only 25,000 copies of the book.
  5. What is Bob going to do with 175,000 unsold copies?
  6. Under a long-standing system used by traditional publishing in the US, Bob can send his unsold 175,000 copies of Lucky Anna’s book back to the publisher for full credit.
  7. Bob only has to pay for the 25,000 books he sells for a total of $250,000
  8. The publisher then has 175,000 more hardcopy books sitting copies sitting in a warehouse somewhere.

What’s a Publisher to Do?

1. In a reasonable-sounding accounting manner, the Publisher holds a financial reserve against book returns. Lucky Anna is only paid a royalty for amounts the publisher has actually received, less a reserve for returns.

2. Let’s assume hypothetically that a salesperson for a traditional publisher makes a two million dollar sale of a single title written by Lucky Anna to Bob’s Bookstore. The Publisher determined that setting a return against reserves of $1,900,000 would be prudent.

3. Conveniently, even though the Publisher shipped Two Million Dollars worth of one of Lucky Anna’s books to Bob’s Bookstore, after subtracting the $1,900,000, the reserve amount the Publisher set, The Publisher is required to pay Lucky Anna royalties only on the $100,000 remaining after subtracting the $1,900,000, the amount the publisher has set as a reserve against returns.

4. Multiply the calculations for Bob’s Books by 1,000 other bookstores, and you can see the calculations getting very sticky.

5. When Bob’s Bookstore returns $1,750,000 worth of Lucky Anna’s books to the Publisher, theoretically, the Publisher should pay Lucky Anna royalties on the $150,000 Bob sold beyond the amount the Publisher estimated that Bob would return for credit.

6. “However,” the Publisher thinks, “not every bookstore is like Bob’s. Some of the other bookstores will certainly return a higher percentage of books they didn’t sell than Bob did.”

7. Traditional publishing contracts allow the Publisher to withhold “a reasonable reserve for returns.”

8. “Reasonable” is, of course, in the mind of the Publisher.

9. Back to our hypothetical, the Publisher has sold books to a zillion other bookstores. The Publisher reasonably decides that not every bookstore is exactly like Bob’s. Some will sell a higher percentage of the books shipped to them than Bob did and others will sell a much smaller portion of the books shipped to them than Bob did.

10. Theoretically, a smart and highly computerized publisher would have track records on what the rate of returns each bookstore demonstrated for at least a few hundred of the titles the Publisher had released. But that would require the Publisher to spend a lot of money on analysts and statisticians to examine the data and calculate probable return rates for fiction, non-fiction, various genres, etc. And what English major wants to walk into that bramblebush?

11. PG’s understanding is that, to the extent traditional publishers think about the number or percentage of books that will be returned for credit, they either use intuition and listen to the music of the publishing spheres or they just lump almost all books into a big bucket. Rules of thumb prevail to the extent anyone thinks about accurate forecasting.

12. Given this fundamental truth, PG understands that most traditional publishers hold a higher amount of reserves against returns than they expect they will ever need.

13. Whether anyone does an accurate job of recalculating Lucky Anna’s past royalties should reserves for returns be much higher than the number of actual returns would justify, PG doesn’t know. He has his suspicions, however.

14. However, PG is certain that mistakes will be made by the Publisher and its underlings. He suspects that, on occasion, a mistake will be identified and remedied. On other occasions, a mistake will go unidentified or be ignored on the theory that the Lucky Anna will never ask about it.

15. Theoretically, Lucky Anna’s literary agent is double-checking the publisher’s reports for errors and jumping on the publisher when she locates one. Or, more often than not, the agent is out pushing for new business and delegates the arithmetic to the agent’s underpaid staff. This brings in more English majors earning low salaries into the mix.

16. More than a few agents have lots of turnover of back-office staff and not a lot of time to train newbies thoroughly. Or they have close to no back-office staff.

17. In the United States, there is no official set of requirements that must be met before an individual hangs out a shingle saying they’re a literary agent and are accepting new submissions.

18. Someone can get out of prison after serving a ten-year sentence for accounting fraud on one day and open up shop as a literary agent the next day.

19. What could go wrong?

20. PG acknowledges that there are some very hard-working and dedicated employees in at least some publishers and at least some literary agencies. He has no intention of slandering such individuals. However, he will say that for most authors, accurately assessing who will do a good job on their books and who will not is effectively impossible.

5 thoughts on “The brutal truth about earning out”

  1. I’m unhappy with the OP and its reliance on commercial-publisher-established mythology. The most obvious one:

    To “earn out” means that a publisher sells enough of that author’s book so that the publisher recoups their investment in the author.

    Just… no. “Earn out” means that a publisher has recouped enough of the advance that any further moneys due to be shared with the author — whether from royalties or rights fees — result in a check (or electronic payment) and not a bookkeeping credit on the author’s royalty account. It need not have a damned thing to do with when a publisher “has recoup[ed] their investment in the author,” that is is showing a profit on that book — and usually doesn’t. The actual profitability for a book that requires neither permission fees nor in-house generation of illustrations is ordinarily — in medium-and-larger-publisher trade publishing — 75-80% of the full face value of the advance. In different segments it’s different percentages less than 100%.

    The publisher is almost always “line-item profitable” at a substantially lower gross sales number than mythology says. This is due in part to the way that advances are set, based upon cost-sales (also, inaccurately, called profit-and-loss) spreadsheets. This is about both bad math and bad data. For example, the c-s almost always selects printing-and-binding costs at or above the 80th percentile of comparable bids; care to guess how much a large publisher’s non-editorial-department management expects to actually spend? It’s similar for many, many other costs, especially those that (the presumably non-accounting-sophisticated) members of the editorial department take on faith. Then, too, the publisher typically holds back a substantial portion of the advance, earning investment returns on “committed” funds for from 6 to 24 months, and sometimes longer (the portion of the advance George R.R. Martin will receive on delivery of the next Game of Thrones has been earning interest for, umm, a while now).

    And it gets worse when one applies, like, actual accounting standards when the publisher must follow them. Basically, that would mean a publisher that must itself issue SEC-compliant financial statements, instead of being hidden inside a conglomerate’s consolidated statements which at present means… let’s see… exactly none of the dozen largest US publishers. I’m sure an actual accountant could rattle off a lot more examples.

    The OP bought into the mythology. I’d say “drank the Kool-Aid®” but that would imply that this is cult-like behavior… wait a minute…

  2. I don’t think the accounting works here. The publisher can earn $100,000 long before the author earns out. Publisher’s profits are not limited by the author’s royalty per book.

  3. I appreciate that others made the point I was going to make, that a book can be profitable to the publisher even if the advance isn’t “earned out.” Another point: A lot depends on the percentage of royalties. An author might be paid 10 percent of cover price, or 5 percent, or something else, whatever the contract says. Clearly the publisher makes more money if the author only gets 5 percent, and it takes twice as many sales for the advance to earn out.

    Another point about returnability is that bookstores often expect self-published books to be fully returnable/refundable. This means an individual author might have to pay the full printing cost of dozens or hundreds of books, possibly when they’re returned far into the future (and without warning). Few authors can afford to do this. And whereas a major publisher can control the print run, an author using print-on-demand generally can’t. I would never make my books refundable. I’d rather lose sales than my entire bank account.

    • Book returns are a dated, launch window-obssesed legacy practice that makes no sense in an age of POD and UPS delivery.

      A bookseller can order a handful of each title and keep reordering as needed (like most smart retailers do) but many bookstores over-order just to use the excess as promotional decor.

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