This is a geeky post about publishing economics. Some people like that. If you don’t, you were warned before you invested any time.
Two otherwise unrelated projects last week — a book I’m working on with a veteran fellow consultant named Robert Riger and a quick consulting call with a team from a major generalist consulting shop looking at shifting publishing economics — reminded me again of the disparity between what the commercial realities of publishing really are and how they’re accounted for and thought about at operating levels. 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.
If you had to hire a designer for your book, or a production manager to help you get it printed, those costs would have been included in what you deducted. If you paid a sales force commissions, or hired a marketer to help you, those costs also would be transparent and in the calculations.
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. To the extent they are needed to pay taxes or report financials, of course they should be calculated and used. But they are very bad guides for making operating decisions. Last week’s work with Robert on our book and followed immediately by the session with the consultants led me to think that all through once again.
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”.
But what would be a more precise statement of the reality of this math is that a few books deliver margins that exceed the house’s overall overhead percentage and that many, if not most, do not.
Here’s why this matters. It makes a house see specific titles as “unprofitable” even though the financial results of publishing them are actually indispensible to the profits of the house. Let’s unpack that a bit.
My father, Leonard Shatzkin, who is the person who long ago laid out this framework for publishing economics, suggested that every house that believes that assigning a percentage for “overhead” to the calculation of title profitability do the following exercise. Recalculate last year’s business but throw out — pretend you didn’t publish — all the books this overhead-inclusive analysis would call “unprofitable”. You lose all the direct revenues and you lose all the direct costs. And then you recalculate your overall performance.
What would have happened? You would have lost your shirt! Why? Because all the books which earned 3% or 8% or 20%, but not the stipulated percentage, actually contributed dollars of margin that paid your rent and other fixed costs. You take those out and you’re running your company with not enough volume or margin.
There is more than one logical fallacy at work here but here’s the big one: it is a mistake to require the minimum overhead contribution to equal the house’s average overhead contribution in order to deem a particular book “profitable”. In fact, if you think about that for even a couple of minutes, it seems nuts.
My father’s insight did stick with and inspire one very successful CEO, Tom McCormack. McCormack was an editor at Doubleday when my father was there in the 1950s inventing Dolphin Books, one of the first trade paperback imprints in a major hardcover house. McCormack landed the CEOship of St. Martin’s in 1969. Over the next three decades, McCormack built a publishing powerhouse which is now the backbone of Macmillan.
McCormack is quite certain that the practice of measuring a book’s potential “contribution”, rather than creating an artificial P&L that incorporated an overhead percentage, was a primary driver of St. Martin’s title growth. And the title growth was the primary driver of the company’s growth, which was continuous, substantial, and has resulted in Macmillan being one of the Big Five publishers today.
The brand-name consultants with whom I spoke last week were similarly being confused by trying to separate “profitable” titles from “unprofitable” ones. One aspect of this surfaced when they asked whether “backlist is more profitable than frontlist”. In an odd way, it often most directly is not, since the publisher is more often keeping the author share on frontlist titles (which would not yet have “earned out” their advance against royalties), which means that, for a while, they keep a bigger share of the revenue.
Visualize it this way. You have a choice of selling two $20 paperback books at a moment when you really need cash. You’ll get ten bucks for each one. But one is backlist and has “earned out”, so you’ll also owe the author a royalty of $1.50-$2. The other one is brand new, or maybe an old failure, but, in any case, the author advance will cover this sale. You keep the $1.50-$2. So, which is more “profitable”?
But the question actually suggests another flaw in using “title profitability” as a meaningful measure. It is one you would pose when contemplating an acquisition. If Company A is acquiring Company B, the overhead calculations for Company B (which would have been what was applied to a title P&L) would be meaningless, because the books would soon be operating with Company A’s cost structure. So the illogic of applying a percentage for overhead would be compounded by applying the wrong percentage! What Company A wants to know is how much margin they’d get on Company B titles to apply to their own overhead structure.
Of course, things have changed a lot since Len Shatzkin formulated these ideas and even since Tom McCormack executed them. 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.
But that’s a separate problem. No major house takes on a project thinking they’ll only get a few hundred copies out. That book would fail anybody’s profitability test. But the question houses should be asking is whether the way they model titles in advance might actually be stopping them from publishing books that would have improved their profitability, even with the sales estimates they’re working with.
If you are one of the rare people who love to think about this stuff, you’d find my Dad’s books, which are definitely period pieces, enlightening. If you’re a small publisher or indie bookseller, they might deliver some really useful insight. The tome about publishing is called In Cold Type. The monograph that is precisely what it says on the tin is The Mathematics of Bookselling. Any bookstore can get you either, and of course they’re available online.