Friday, June 6, 2014

Why Are Publishers Telling Us E-Books Are So Profitable? Another Book-Business Fallacy

Coverage of the Hachette-vs-Amazon dispute has recycled various misconceptions about what’s happening, as Michael Cader noted Wednesday in Publishers Lunch. But one of the most widespread fallacies you may hear, and not just relating to Hachette/Amazon, is that “e-books have been more profitable for publishers than print books,” as Evan Hughes put it in Slate. The chunky margins generated by e-books, the thinking goes, are what the publisher and the 600-pound gorilla of bookselling are tussling for.

Even before this dispute, some industry voices, led by Mike Shatzkin (echoed by Hughes in the piece just cited, and of course the agent community), have argued that in a sense publishers have been asking for trouble by maintaining such high margins on e-books—like kids walking back from the candy store, their pockets bulging, past the local bully. Shatzkin proposed that publishers raise their royalty rates on e-books so that they could gain some advantage by sharing the “extra” profits with authors before the retailers could zero in on them.

Mike’s suggestion was prescient, and there are other good arguments for passing along more e-book revenue to authors (starting with, "they could use the money"). Nonetheless I believe publishers would have been better served by pointing out, long ago, that the notion of e-books as a magical cash cow is wildly misleading. Because the supposedly greater profits from e-books—when published alongside traditional print editions—are an artifact of accounting. The margins that both Amazon and Hachette find in e-books are only as high as they are because of all the resources Hachette devotes to hardcovers and paperbacks.

Today in mainstream publishing, e-books are almost invariably published alongside a hardcover or paperback edition. This means the e-book edition floats on top of a huge investment in whatever that title is, which in most houses is not charged against the e-book edition.

Consider the following costs incurred in publishing a new title:

The advance—frequently the largest single line item in the investment in a given book, and in many houses charged entirely to the first print edition. Even when it’s allocated otherwise, there are many other costs that are charged the print book, such as:

“Plant” costs—such as copyediting and proofreading, typesetting, design, illustrations, legal vetting, maps. These are typically charged to the hardcover edition, even though the paperback or e-book editions benefit equally from them. (Side note: for the same reason, even in pre-e-days, paperbacks were often seen as more profitable than they "deserved" to be.)

Furthermore, marketing costs are also charged to the hardcover even when the e-book is published simultaneously. These include promotion (catalogues, advance reading copies, BookExpo displays, etc); advertising; and publicity (review copies and ARCs, author tours). Obviously all these efforts are working to sell the e-book just as much as the print edition.

And alongside those expenses are the heinous, eye-watering costs of producing and distributing physical books:  Printing, sales commissions, warehousing, shipping, and all the hideous inefficiencies of taking returns.

Wait a minute, you’re saying, now you’re going too far. Why should the new, innocent e-book be charged for costs of the bad old dead-tree "legacy" (shudder) business?
Because the existence of printed books, the trafficking and display of them, is still a critical marketing tool for e-books!

What is the currency of advertising? Impressions. Every physical book you see as you go through your day is an impression, just a like a Coke ad on a bus shelter or a Coach logo on a handbag--each of those glimpses is a little hit of marketing. Think about the millions of printed books out in the world--displayed in store windows, piled on tables, racked at the checkout in supermarkets and drugstores. Or seen in the hands of people on airplanes and buses; given as given as Christmas or Mother's Day presents to people you know. 

We know that one of the reasons people buy books is that they see other people enjoying them (hence the enduring popularity of bestsellers, even in a long-tail marketplace). There is no question that many of the titles on the e-book bestseller list are boosted by the visible popularity of hardcovers and paperbacks. The thankfully still-robust presence of printed books contributes significantly, I would argue, to the “mindshare” enjoyed by any e-book--not to mention the overall "mindshare" of "book" as a category of entertainment.  

There are, to be sure, e-only bestsellers—works that achieve significant sales without riding the coattails of a print edition. I would guess, though, that very few titles which have achieved true blockbuster e-book sales—tens or hundreds of thousands of copies—have done so without a blockbuster print edition helping to spread the word. (Fifty Shades of Gray, a bestseller as an e-book, became a megahit when Random House published a print edition.)

Perhaps I’m pressing a point if I go from there to arguing that the cost of trucking a new title to a Barnes & Noble distribution center ought to be spread across its e-book edition. But the larger point is that it’s arbitrary at best, and again, misleading, to think we can neatly separate print from e-book costs, when publishing any title is a multi-platform campaign. And it leads to fuzzy thinking about the business if we look at the P&L spreadsheet for a given book and say “wow, the e-book is really profitable” when the poor hardcover is carrying 80 or 90 percent of the investment load. What’s really happening, if you look at this another way, is that the print edition is subsidizing the e-book!

My point here is not to bash the e-book business. It is true that e-books have an enormous economic advantage over print when it comes to manufacturing and distribution, because the incremental unit cost of creating & delivering an e-book is virtually nil. (Even better, no warehousing and no returns.)  You need no publishing expertise to see this, and it’s one reason why it seems intuitive to say e-books are more profitable.  

Some publishers, I’m afraid, have encouraged this misapprehension. Corporate houses in particular like to trumpet the profitability of their digital businesses because it makes them look “innovative” and tech-savvy and gives Wall Street an easily-grasped, upbeat story of a growth driver in the industry. Trade publishing companies have historically thrown off quite modest, not to say anemic, profits and have for decades been caricatured as quaint, retrograde, etc. so maybe we can’t blame them for bragging about better margins that seem to come from new technology.

But for all the reasons above, it's wrong to consider the profitability of an e-book edition separately from an accompanying print title. And it makes no sense for publishers to boast of wonderful margins on e-books, unless they are also going to apologize for the lousy margins they get on print titles.

Publishers are straining mightily to maintain a healthy publishing ecosystem that includes print and e-books, online selling and brick-and-mortar bookstores. This is not out of nostalgia or an inability to grasp the digital future, but because they understand, as explained above, that print and e-book sales boost each other.  And if they give away too much of their revenue from e-books, whether to retailers or to authors, they risk making that multi-format marketplace unsustainable.


Julia Johnston said...

Fascinating stuff, Peter, thank you. Well... very interesting anyway!

Ned Stuckey-French said...

Thank you for this. Such a clear, powerful well written analysis.

Peter Ginna said...

Thanks for the kind comments!

Unknown said...

Nice pitch to even out the accounting, but even if E-books picked up their full freight, the "disruption" is still overwhelming the book publishing industry. I haven't been able to adjust to e-books other than the convenience of poolside and travel reading. The population is not going to switch to E-books quickly but the change is inexorable. The publishing industry is not in its death throes, but radical restructuring has to occur and more realistic accounting is the first step toward an effective survival strategy. Thank you for pointing out the need for realism in coping with this major restructuring(if from this side) or,imposition(if from without).

G. Genova said...

There are hidden costs in maintaining e-anything for sale and delivering it upon receipt of payment received online. E storage, e backup, e searchable database, e IT and web developers, and such. I've been trying to create and e publisher for sheet music and it could potentially be a lot cheaper than printing and shipping, but so far the technical costs involved and the continual upgrading of such e services have me wondering.

Peter Ginna said...

@Ken, thanks--I don't disagree that we are going to see plenty more disruption.

@G. Genova, you raise a good point that I didn't even get into. There's a very substantial amount of overhead that goes into creating e-books--even if the cost of any additional copy is very low, all the expenses you mention, and more, must be absorbed by publishers. Some of it can be outsourced, but it still has to be paid for somehow.

brucejquiller said...

Excellent points, this piece offers a much-needed corrective to the simple-minded blather about e-books so often cluttering the airwaves and newspapers. People who have been talking about the inevitability of print books disappearing in favor of digital texts must be shocked at the way the growth of e-books have suddenly slowed down. No one knows what the future holds. There may even come a time when people aren't smacking into each other in public places as they stare at their phones. There are powerful economic interests pushing us towards ever increasing amounts if screen time.

brucejquiller said...

I meant the way the growth of e-books has slowed not
"have"....and of screen time,
not "if."

Anonymous said...

You say, "And it leads to fuzzy thinking about the business if we look at the P&L spreadsheet for a given book and say “wow, the e-book is really profitable” when the poor hardcover is carrying 80 or 90 percent of the investment load." I'm not sure I understand this. You cite that the hardcover could be subsidizing the e-book but in many cases, the hardcover is not carrying that 80-90% of the load. Many authors will tell you that their e-sales vs. print on a new release are close to 50 / 50 or even higher for e in some cases, yet they're not making the same royalty on e as on a print copy. Hence, it takes longer to earn out the advance and in some instances, the e-version can cannibalize print sales because it's priced less and for many readers, is more accessible.

I'm traditionally published and always want to give publishers the benefit of the doubt; I also firmly support the printed book. I don't even read e myself. But it seems to me, 25% royalty of net on e is rather low, compared to what the house earns. Authors are struggling and advances are lowering every year; yet publishers post record profits in their quarterly statement. I'm confused about the logic here. Before e, publishers made do with a hardcover followed by trade, or trade alone in non-hc deals. E sales are a boon, as we lose bookstores and display space, but are not authors the last beneficiaries of the profit at the end of the day in this model?

Anonymous said...

This is all irrelevant anyway - the point Shatzkin et all are making is publishers have been reporting record profits because they keep such a high % of every ebook they sell. An author can never earn out while his publisher makes a very serious profit on that authors books. If an author gets a 100K advance and sells 20K hardcovers and 20K ebooks he will not earn out but the publisher will take in over 400K. That's fair?

Peter Ginna said...

Anonymous #1, you’re misunderstanding the numbers (which, I grant you, can be less than intuitive to follow). The hardcover’s share of the investment load does not depend on what percentage of sales are hardcovers. It depends on how the house allocates the lump-sum costs I mentioned, such as copyediting, jacket design, typesetting, marketing, and so on—and also any unearned advance. I’m sure how those allocations are done may vary from house to house, but at some houses I know most of those costs are assigned to the print edition. So even if the hardcover and e-book each represent 50 percent of sales, the e-book doesn’t have to recoup as much investment to be profitable—regardless of what the royalty rates are.

As for the royalty rates, keep in mind that the print royalty is computed on the list price, not the amount received per copy as it is for e-books. And that amount is typically 50% or less of list. So when the hardcover royalty is 15 percent, as it usually is after 5000 copies, the author is getting 30 percent or more of what the publisher collects--*better* than the e-book—while the publisher is applying all those costs against it. Again, one way of looking at this is that the p-book is subsidizing the e-book. Especially if, as I argue above, that a vibrant print book marketplace is part of what helps sell e-books.

There is a perfectly valid argument, based on unit costs alone, that authors should receive higher royalties on e-books. But by the same logic, publishers could argue they should receive significantly *lower* royalties on print. No publisher has wanted to go there, understandably; they have been happy that the overall profits from the print/e-book combination has sustained their business model.

Anonymous #2, I don’t know why you would conclude that “an author can never earn out while his publisher makes a very serious profit.” In most trade publishing arrangements, unearned advances are the biggest drag on profitability, so the publisher can’t make really big profits *unless* the author earns out his advance. In your example, by my reckoning the author would earn out his advance on a typical royalty schedule and a typical hardcover price of $25.

To both Anonymouses (Anonymice?), I would say that “record profits” for publishing houses involve clearing a pretty low bar. Ten percent is considered a good profit margin in trade publishing, so we’re not talking about Google or Apple-type margins here, but of eking out a few more percentage points. And in the last few years those profits have been whittled from overall sales numbers that have been declining. When I got into the business a joke I often heard was, “How do you make a small fortune in book publishing? Start with a large one.” It’s still true, I’m afraid.

C.W. Gortner said...

Thanks for your reply. It clarifies some questions for me. I'll readily admit that I'm more than a bit confused at how these numbers shake out in the long term - and I'm an author who earns out his advances every time. And I was just thinking, is it a sign of the times that I've been wary of posting under my name for fear of being tagged as an agitator, thereby pissing me off my respective Big 5 publishers? (Three to date). Guess I'll take the chance now.

Part of the confusion for authors like me is that we really do not have a complete understanding of these "allocated costs" and most of us - barring the rare 1% of uber-rich authors - who earn mid-five to low-six-figure advances tend to veer to the side of "They're making a killing on e-sales and we're getting ripped off." Better transparency in this situation would really help; royalty statements can be like rubric cubes and no one in publishing likes to talk about profit or author earnings in a very coherent way. It becomes difficult to ascertain who is friend or foe: Amazon, which pays every month and supports indie platforms (I haven't used them, yet, but several of my friends are now hybrid authors, with both traditional and indie titles) or the houses we work with?

Most authors with traditional contracts who are doing well, myself included, don't want to see publishing as we now know it vanish into the Amazon vortex. I welcome the variety of options available and support authors empowering themselves, but I like my editors, too, my teams at the houses that work hard to see my books to the market; I like bookstores and want to see them thrive.

But the nagging e-book profit question does hang heavy over the author community and fosters a sense of mistrust. Rash judgments are made and publishers blamed for sticking it to us, when in fact discussions like these can indeed assist authors to better understand the mechanics around publishing and find common ground when it comes to earnings.

Sandy Thatcher said...

I've been making this argument for a long time now, most recently in personal correspondence with Evan Hughes, but it's a hard assumption to dislodge from the minds of people who haven;t actually worked at a publishing house.

RES said...

Thank you, thank you, thank you.

Peter Ginna said...

@C.W., Thanks for your further comment, and thank you for posting under your own name. Based on my own experience, I doubt any publisher is going to tag you an "agitator" for raising honest and understandable questions about your royalties. I have long said that publishers' royalty reporting is needlessly confusing for authors (and everybody). I can tell you that if you are earning out your advances you're doing better than a lot of authors.

@Sandy, thanks for the comment. I'm glad to hear the post makes sense to someone who knows the business well.

Martyn Daniels said...

the logic is right but the answer may not be so simple. We have simply poured the physical content into the digital container and presumed that is the answer and job done. This itself is a very questionable route in that it creates a direct competitive product that will imbalance the physical supply chain and economics over time whilst reducing revenues which are governed by a small group of players with different economics. The answer would be to create a related but different product which encourages reading , introduces physical content and authors, may be a subsidiary right etc IT may be about enhancing content but given the rise of the smartphone as the device solution a more radical rethink of content may work equally well.

Peter Ginna said...

@Martyn, i'm not sure I entirely follow your point about the physical supply chain, but I agree that digital technology and platforms such as smartphones might allow the creation of different products. We know there's a robust market for fiction on cellphones in Japan, for example. My focus here, though, was specifically on the putative profitability of e-books that are published alongside print counterparts.

Bob said...

Simple solution-- don't do print for all titles. When I commented on Mike Shatzkin's blog that we didn't need to sell print at Cool Gus to be in business he repeatedly told me I was wrong. That a publisher absolutely must have print to be successful. I would argue the opposite in many cases. We have POD available if someone really wants to order print, but we don't do print runs, we don't do shipping, returns, yada yada. And we do quite well.

I would submit that having offices in New York City must account for some overhead. And a business model that is decades out of date might hurt a smidge. Frankly, publishers have done quite well the last couple of years on their eBook margin. To expect it to last the next several years is counting on those multibook contracts with big name authors.

Peter Ginna said...

@Bob, I can't speak for Mike Shatzkin, but what might be viable for you is not necessarily viable for a large publisher whose authors expect to see their books in a physical form in bookstores. There's no question that there are problems with the business model of "legacy publishers" nor that many authors and small publishers can make a profit selling e-books only. My post does not say otherwise. My point is that IF you publish print, it's highly misleading to talk about "e-book margins" in isolation.

Lori L. Lake said...

I'm afraid this part of the article is simply not true: "It is true that e-books have an enormous economic advantage over print when it comes to manufacturing and distribution, because the incremental unit cost of creating & delivering an e-book is virtually nil."
Creating and delivering an e-book costs plenty. Someone still has to pay for editing, copyediting, proofing, cover creation, ISBN, formatting, meta-data entry, debugging, and all the "paperwork" online in order to get the e-book up successfully on multiple sites/platforms.

I do believe that print publishing DOES partially underwrite those costs above - but the cost to make an e-book is certainly not "nil."

Many of the big publishers are doing a horrendous job on their e-book formatting. 50% of the e-books I've bought from the Big 5, for example, are so shabbily assembled (bad paragraphing, weird characters inserted, ridiculous spacing, etc.) that perhaps they DO think the cost should be nil. Clearly, they are not devoting staff time and attention to proper creation of Mobi and ePub formats more are they debugging and making corrections.

Peter Ginna said...

@Lori, you're quite right that to publish e-books well involves costs. I have not said otherwise. They key word in what you quoted above is "INCREMENTAL." The costs of file creation (formatting, ISBN, etc.) you mention are all part of what I refer to as plant costs above--they are a lump sum regardless of how many copies you sell. Once those costs have been paid, each *additional* copy sold costs virtually zero--in contrast to print, where each copy has costs for printing, warehousing, shipping, and so on. Note that I spoke of the cost advantage *when it comes to manufacturing and distribution.*

My point in this post is that because in houses like the Big 5, a lot of the plant costs that DO go with e-books are shared with the print edition, publishers often tend to overlook them and to see e-books as more profitable than they'd be if they were creating e-originals.

Caleb Mason said...

I agree completely that all the costs of a multi-platform title should be allocated across the board. This topic reminds me of how the software publisher where I worked in the 90s would argue among business units and finance on how to allocate the considerable Web infrastructure expenses. At first the direct marketing people thought the Web fixed costs were free so their P&Ls were biased against the print catalogs that in fact drove the bulk of the business through the Web site. But the costs of running a Web site are huge and need to be fully burdened upon the people using it to make sales and receive their bonuses. Integrated marketing requires true cost allocations so everyone involved understands the real costs.