The Shatzkin Files


Planning the next publishing model: a new take on “no returns”


Although there are some very good minds working on the next publishing model — Jane Friedman with Open Road and Richard Nash with Cursor being the first two that leap to mind — I have developed a couple of thoughts that might be helpful to them or to others planning to avail themselves of the new opportunities which are bound to be arising.

What I think both Jane and Richard have spotted is that “scale” is diminishing in its ability to provide a publisher with competitive advantage. Certainly, it is still true that the surest-fire big successes still require substantial advances to authors and aggressive laydowns of inventory that do require scale. If you want to publish Patterson or Evanovich or any author with a proven track record of bestsellers, guaranteed to move hundreds of thousands of copies, you have to take a cash risk for advance and inventory commensurate with their guaranteed minimum sales level and you have to go after the entire market, which takes money and organization, to recoup that investment.

But that covers no more than one percent of, let’s say, 100,000 titles a year published by established publishers and an even tinier percentage of the total number of new books if one includes those issued through self-publishing operations. (I am staying away from real numbers here because I haven’t done the analysis needed to discern them. The million-plus number of new ISBNs reported by Bowker contains hundreds of thousands of titles that are neither new nor self-published, but which are reissues of out-of-copyright books set up by companies that use technology to process the files into a print-ready state.)

Nash is explicitly expecting the collapse of the overall trade publishing model. Friedman has never expressed that expectation, but she’s exploiting the combination of old contracts that are ambiguous about ebook rights and the big trade houses’ reluctance to go beyond a 25% of net receipts royalty on ebook sales to make high-profile ebook captures. Her company professes to be “marketing-focused” and she has hired two of trade publishing’s most expert digital marketers, Rachel Chou from HarperCollins and Pablo Defendini from Tor. She has a partner, Jeffrey Sharp, with a filmmaking background. So there appears to be a clear emphasis on ebooks, new publishing forms, and digital marketing, not on “scale.”

A month ago I wrote that I expected 50% of the market for narrative books (words, not pictures; simple design, nothing complex like a cookbook) to be delivered through online purchases by the end of 2012. That was based on an expectation that 25% of the sales of those books would be ebooks.

Since then, I’ve decided that prediction is too conservative. Now I think narrative books might pass that benchmark six months or a year sooner than that. Hachette’s most recent financial results attributed 8% of US book revenue to electronic in the first quarter of this year. In a speech delivered last week in Australia, Carolyn Reidy of Simon & Schuster gave the same number — eight percent — as her company’s current share of revenue attributable to digital. Eight percent of revenue is something more than 8% of units (because ebooks are cheaper), and the number would be higher on their narrative books (because the 8% is across a list that includes a lot of books not available as ebooks.) If they were at 12% of units on narrative books in the first quarter of this year, they could be at 25% of units on narrative books by the first quarter of next year, which would be about two years ahead of what I was expecting just a month ago.

And what is true of both Hachette and Simon & Schuster must be a pretty reasonable approximation of what we’d see at any of the other Big Six companies.

The portion of the market that buys online doesn’t require pre-printed inventory. Setting up with Lightning and Amazon and perhaps Baker & Taylor would enable all online purchasers to get their print copies on demand. Today I am offering what I think is the solution for distributing  inventory more broadly into brick-and-mortar stores without a publisher risk. If Nash or Friedman have thought of this already, they haven’t announced it.

The brick-and-mortar world has three main components: chains, mass merchants, and independents. Here’s a deal structure that I think can be appealing to the big customers and, which, with a bit of tweaking,  can work to the benefit of the smaller ones as well.

When publishers sell to the trade channel, they collect approximately half of the retail price of the book for each one sold. They bill their channel partner that full amount when the books are shipped to the store, and credit their channel partner that full amount (with some relatively minor exceptions) when returns come back. Of that half they collect from the channel, about 20% (10% of retail) is the publisher’s cost of printing the book, 20-30% (10-15% of retail on hardcovers; actually less on paperbacks) is the author’s royalty, and the balance (about 50-60% of the money received) covers the publisher’s cost of doing business, including paying for books printed and not sold, and profit.

In a print-on-demand scenario, the manufacturing cost doubles (or more), so 20 or 30 points of the 50 or 60 remaining to the publisher are chewed up. Some contracts allow the publisher to get back some of the author royalty in that scenario, but absent that the publisher’s margin is definitely reduced so that they only “clear” 20 to 30 percent of the cash received. On the other hand, they shed the costs of unsold inventory (which can be substantial), they lose the requirement to capitalize inventory, and they can diminish or eliminate all sorts of operational costs for warehousing and inventory management. Sellers of print-on-demand services, including Lightning, have been laying out this reality to publishers for years.

In the present scenario, the channel partners — retailers or wholesalers —  are at cash risk for the return freight (and sometimes the inbound freight). And they have the full cost of the book tied up until they sell it or return it.

Here’s the new solution for a no-returns, no-inventory-risk-for-publishers world.

Publishers say: we are doing an initial press run which you can be part of. There will be no inventory maintained at the publisher. If the channel demands a subsequent run and will support it, we’ll do it. But otherwise, everything beyond the press run is available only from the wholesalers providing POD services.

The press run offer to channel partners works like this: you pay the cost of printing and delivering the book. And that payment is firm. You buy that inventory at its cost and you own it; no returns. That’s going to be about 10% of the established retail price.

But the payment above that, the rest of the purchase price by the channel, is paid on sale (or, to use the term of art, “pay on scan.”) To provide some incentive for the retailer to support a book with inventory and push up that first (and often only) press run, and then later to give them the margin for markdowns, I’d suggest that the second payment diminishes over time. The total “cost” to the retailer should be 55% of the retail price for the first 60 days after inventory is delivered, dropping to 50% for the next 60 days, and 40% thereafter. That would leave the publisher 30% of the retail price in margin on the slowest-selling books, of which the author, under the best contracts that exist today, would get half. The publisher would get half, but would have no inventory cost (that was paid up front) and no returns processing.

This formula should work fine for Barnes & Noble, Borders, Books-a-Million, and the mass merchants, who can buy 1000 or 2000 copies of a book they want to carry and get that press run price. Serving the independents is more difficult.

We stipulated at the top that all books are set up for print-on-demand at Amazon and Ingram; perhaps at Baker & Taylor too. If those books are ultimately sold to the wholesaler on normal discounts (about 50%), the relatively higher POD cost would chew up most of the publishers’ margin. We’re positing that POD could be 25% of retail (rather than about 10% for press run), which would leave only 25% for royalty and publisher’s margin. By today’s standard contracts, that might only leave 10% for publisher’s margin. There are two possible ways to claw back margin and both of them could work.

One is to negotiate lower author royalties for sales made through print-on-demand. Let’s remember I’m formulating how a new publisher ought to operate; they don’t have any legacy contracts yet. And, I might add, both Open Road and Cursor have aspects of their model that are more advantageous to authors than today’s standard. That’s how Open Road is getting those ebooks, paying 50% instead of 25%. And Cursor offers a short-term deal that nobody else does. So, on balance, the author might see herself as better off even though the royalty on some trade sales would be reduced.

Another possibility is that Ingram or Baker & Taylor (and you only need one to say yes to more or less oblige the other) can be persuaded to accept a lower discount on these POD books. For one thing, they make a bit of margin on the POD. For another, these books will not be available at all direct from the publisher (which has moved to a no-inventory model), so the wholesaler can offer a lower discount to their customers as well and still be “competitive.” And the wholesaler has no inventory risk or carrying cost either and no cost of sending returns back to the publisher. A slightly reduced margin structure still ought to work out profitably for them.

Of course, many devils are in the details. Publishers would need retailers working this way to report sales to the publisher on a daily basis and pay promptly, perhaps weekly (after all, the retailer is only paying after they’ve collected the customer’s money.) There is “shrink”, books stolen or which otherwise disappear without going through the cash register. That cost is entirely borne by the retailer today and the publisher will need some check and balance to assure that it doesn’t become a payment dodge under this arrangement.

But as the publishers move to a world where inventory risk can be substantially reduced, it just makes good sense to look for a way for the brick-and-mortar sales channel to gain some benefit from that idea as well. Working this way can enable a 21st century publisher to cut operations costs dramatically and even, perhaps, improve their cash flow.

When I first recognized that we’re in sight of the day when half the sales can be achieved without inventory, it looked like an obvious game-changer for publishing. Now I’m seeing the way to change the other half of the game as well.

And having walked through this door of perception, I close with a message for all the no-returns advocates out there among publishers. You want to eliminate returns to reduce your risk. That’s reasonable. But your risk is really the cost of printing the books; it wouldn’t be royalty on books not sold and it shouldn’t be profit on books not sold. So shouldn’t any no-returns policy also relieve the store of those elements of the risk as well?

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  • chris

    I think I may be lost here, Mike. Feel free to enlighten me where ever I am wrong.

    “Publishers would need retailers working this way to report sales to the publisher on a daily basis and pay promptly, perhaps weekly…”

    I think there's a fatal flaw in that sales and distribution model right there. You remove the 'sale or return' model, then you want to increase the retailer's instore workload … and make them pay promptly? Good luck with that!! :)

    Also:

    “The press run offer to channel partners works like this: you pay the cost of printing and delivering the book. And that payment is firm. You buy that inventory at its cost and you own it; no returns. That’s going to be about 10% of the established retail price.”

    I'm probably confused here. So does this mean no returns credit on these titles and the retailer buys the initial run on a title for the cost of production? If so, would B&N seriously buy 2000 units outright? And if they did, aren't they simply going to discount the shit out of it anyway to compete with every other retailer? Kinda leaves a zero-sum gain.

    For starters, they'd even have to compete with Walmart, Kmart etc. Who will inevitably welcome any new trade terms that allow them to sell a new title for 10% of jacketed retail price… or less as a loss leader.

    As much as the return model is flawed, my understanding is that it provides a safety net for bookstores. Sure it can be manipulated by retailers and it sure as hell isn't efficient for publishers, but taking it away will probably just hasten each business' demise.

    And lastly, you're talking about a model that will survive by lowering author royalties. I'm pretty sure the new business model of publishing and distribution will be an era of author as publisher or author signing with community marketers like Cursor. I would envision these guys utilising POD and digital distribution but not at the expense of lower author royalty.

    Outside of the bestsellers, I think the bricks and mortar space will look very frightening for publishers in the not-to-distant future.

    • /blog Mike Shatzkin

      Well, we agree completely on that last sentence!

      There would be no additional burden to the big retailers which I suggest
      work this way. (The smaller retailers would have to buy from wholesalers,
      which leads to the POD pricing, which leads to the other things that concern
      you.) Those big retailers capture all their sales at the register and,
      frankly, report daily sales *now* internally and, in some cases, to their
      suppliers. There would be no additional administrative burden here to speak
      of.

      Ultimately, the retailer is not at risk for anything but the 10% of retail
      if the book doesn't sell and they wouldn't have to send it back. I guess
      what you point out is that The Plan needs one further modification; if the
      book doesn't sell in a year, the publisher should allow the retailer to sell
      it at any price and split the revenue with the publisher 50-50 (after
      deducting the amount already paid for the manufacturing cost.) So discount
      moves to “shared markdown” after that period of time.

      You are postulating that publishers will “use POD” and not lower author
      royalties. I'll be interested to see if somebody tries that; unless POD
      prices come down dramatically, I don't think it is possible. I don't see
      enough room in trade book pricing to allow a full author royalty, POD print
      prices, and coverage of a publisher's operating expense, but perhaps a very
      efficient operator will prove me wrong.

      Mike

      • http://www.graybookspublishers.com Ed Gray

        You're right, Mike, that POD pricing and current standard author royalties don't work. Don't you suspect (or maybe you know) that it is precisely that sort of arithmetic that led HarperStudio and others to adopt the profit-sharing model with authors? Because once that author/publisher arrangement is in place, pricing and distribution flexibility of the sort you propose here is not just possible, but encouraged.

      • /blog Mike Shatzkin

        Ed, I really have no idea what was behind the thinking of Harper Studio. But
        I actually doubt this was a big part of it. Fact is, the focus of general
        trade publishers (and Harper Studio, for all its innovative thinking, was
        that) is on big books, not on picking up the relative pennies leaking from
        sales that could be cured by POD. But you're right that a profit-sharing
        model would make it simple to implement something like this.

        Mike

      • http://SecretSpeakers.com Karey

        Aside from questions and concerns about pricing and returns raised in the comments, I'd like to reply to your comment that, “The smaller retailers would have to buy from wholesalers, which leads to the POD pricing.” I predict that the POD pricing model will effectively push writers to write works with lower page counts so they don't price themselves out of POD printing costs.

      • http://www.agiopublishing.com Bruce Batchelor

        Yes, Karey, that's likely to be a trend, catering to the twitter-length attention span of some of the audience. :-)

        Also I think there is room for the POD printers (LSI and others) to lower their pricing, especially on longer books.

      • http://SecretSpeakers.com Karey

        I agree that LSI and others have room to lower pricing for longer books. I had to find another solution other than LSI because of that limiting factor. POD printing would have cost more than the book itself for the consumer.

      • /blog Mike Shatzkin

        I am sure that LSI pricing is one part cost-driven and one part
        margin-driven. They don't need to price every possible POD combination at
        rock bottom, or even competitively, in order to be the supplier of choice
        for many because of their enormous aggregation and market presence.

        That said, it would be nice for you to tell us where you found that cheaper
        pricing for longer books, unless you're protecting a trade secret.

        Mike

      • /blog Mike Shatzkin

        But, Bruce, if the potential for price-cutting in POD is for *longer* books
        (and I'll take your word on that; you are much more steeped in that
        technology than I am), wouldn't that mitigate *against* the idea that
        writers would aim for *shorter* books?

        It does make sense that we see more shorter stuff, both because e-delivery
        makes it work economically and because of the Twitter-texting cultural
        effect you mention. But I don't think POD pricing or printed book pricing
        will drive it.

        Mike

      • /blog Mike Shatzkin

        It's an interesting thought, and as I think it through, you may be right but
        I would think for a different reason. The key is the difference in pricing
        by *method*, whether by big-press offset production line or one-off digital
        print. A shorter book costs less to print by both methods and a longer book
        costs more. The consumer expects skinnier books to be cheaper and fatter
        books to be more expensive. So it really doesn't change things for print.

        But it *does* change things for digital! So far, the consumer really has no
        way to gauge the length of an ebook (there are file sizes, but these are not
        considered important metadata and they're subject to all sorts of potential
        misinterpretation because the file might not be all text.) Maybe in the
        future the ebook publisher-retailer will tell you that you're getting 50,000
        words or 250,000 words for your $12.99 (or $3.99) but nobody's trying to
        tell you that now. In effect, the writer in print was getting extra
        compensation for a longer book, since the price was based on length and the
        royalty was based on price.

        So it could be that any writer who calculates the optimum number of words
        for commercial gain may do that calculation differently. On the other hand,
        because ebooks allow extra words for no extra cost, things that editors
        might previously have cut out (to keep the length and, therefore the retail
        price, lower) might be allowed to stay in.

        We already know that “short fiction” is often sold as ebooks. Kindle broke
        short story anthologies out in to separate titles to sell from the
        beginning. There have been short stories being sold in the romance genre for
        years by the establishment (Harlequin) and the upstarts (Ellora's Cave),
        which was enabled by ebooks (short and cheap doesn't work in the
        brick-and-mortar world.)

        There are a lot of forces pushing in different directions.

        Mike

  • Phil Spinelli

    While it is interesting to dream about possible ways to re-engineer the entire publishing industry (and I encourage it), we have to be realistic and accept the fact that economic, competitive, and consumer forces in the end will do the shaping. The best a publisher can do is tell everyone to buckle up, rightsize the overhead, think creatively, and keep their eyes peeled for opportunities that make good business sense.

    • /blog Mike Shatzkin

      Hard to disagree with any of that!

      What I'm trying to do is to anticipate changes to enable people to plan for
      them. But you're surely right that the ability of any one player to shape
      the course of things is extremely limited.

      Mike

  • http://www.bookindustrybailout.ca Bruce Batchelor

    Thanks, Mike, for floating some trial balloons.
    I suggest a far simpler plan. Yes, end returns entirely – that's sooo obvious to everyone outside the book publishing industry. That will stop bookstores over-ordering – they will be on the same grounds as all other retailers (grocers can't return bananas that don't sell, for example). Then raise the margin for bookstores, from 40% to 50%. The bookstores simply sell inventory in place at whatever price suits them — just like the grocer or hardware merchant does.
    Because there is no return shipping (which the bookstore pays under the current model), the bookstore is having an extra cost-saving. Because the distributor isn't doing nearly as much (books only go one direction; no return and credits to process; fewer books in warehouses), the distributor's margin can be cut in half – saving the publisher about 7 or 8% which almost covers the increased margin to the bookstore. [I doubt Ingram and B&T will be happy with this suggestion, but they can make it up, as you've noted, in profits on their POD printing operations which will surely grow.] By having no over-ordering and returns, the publishers will be saving the cost of over-printing — which is enormous (over one billion books every year are wasted!).
    For publishers, they can still gamble on an initial low-cost-per-unit offset print run (later supply could be POD, of course), and could perhaps take on the Dutch model of offering a slightly bigger discount on the initial purchase — to give an incentive and pass on the risk (and some of the advantage) to bookstores.
    All the above can be done without changing the authors' royalties at all. And it doesn't require payment on scan. If a few of the larger publishing houses started doing this, everyone else would quickly follow.
    One significant advantage is that the bricks-and-mortar stores' profits will increase! They've cut out the cost of return shipping and are getting 50% discount instead of 40%. They sell slow titles “in situ” at a mark-down price which still gives them some profit and draws in bargain-happy customers.
    Good for the environment, publishers, booksellers, customers, authors. Not so happy are the distributors, printers, shippers and paper-makers. But they've had their day.
    Simple, eh? Spread the word.

    • /blog Mike Shatzkin

      In my opinion, it won't work, Bruce. And any big publisher that tries it
      will quickly retreat.

      Bob Miller made the point when he spoke in Canada that the “no returns”
      option caused problems for Harper Studio with the stores that signed up for
      it. They got very cautions about what they stocked, to the point that the
      publisher wanted to restore returns to entice them to take more inventory
      which the *publisher* thought wasn't particularly risky but which the stores
      did when faced with the inability to return. And the publisher felt that
      lower orders were hurting sales so it was very painful for them.

      And you say the “distributors margin can be cut in half” and then cite the
      wholesalers, who aren't exactly the same as “distributors” (although Ingram
      has operations that do both of those two operations.) The actual
      distributors (Ingram Publisher Services, NBN, Perseus, etc.) usually charge
      for processing returns so their basic cost structure would be unchanged. The
      wholesalers don't handle much in the way of returns; many (probably most)
      books bought from them that end up being overstock are actually returned to
      the publisher. (This is painful for the publisher. They sold the $30 book to
      the wholesaler for $15 and then might credit the store back as much as $18
      – sometimes — because stores buy on lower discounts. Many publishers dodge
      this by crediting returns at 50% regardless of the purchase price, but that,
      of course, means that direct sales to stores aren't actually “fully
      protected” (to use a very old-fashioned term for returns.)

      Simply declaring “no returns” guarantees only one thing: lower sales. As
      shelf space in stores is shrinking, it is likely to be an easy way for
      stores to decide which books not to order in a time when they're going to be
      ordering fewer.

      Mike

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