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Better Metrics for Crucial Decisions

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Too many publishers use metrics that lead to bad business decisions. Consider the three big decisions that you often sharpen your pencil to make:

1. whether to commit to publishing a book in the first place

2. where to set the retail price

3. how many copies to print

To maximize profits and, particularly, to make the best possible use of available cash, this is how I suggest approaching these decisions and others that you face as a publishing executive.

  • Recognize that publishers’ accounting systems are constructed primarily to enable bookkeeping that conforms to government regulations and to enable paying taxes. As a result, it is not at all odd that each copy manufactured carries a “unit cost” on the books, because, when it is sold, a charge for the cost of goods must be recorded. But costs are not actually incurred for each unit as it is sold; most of the costs are incurred when it is printed.
  • Also recognize that overhead is, mostly, fixed. The practice of assigning the same overhead cost figure to each sale may be convenient for accounting, but in reality most overhead costs are entirely independent of what books are published, manufactured, or sold. You don’t pay more rent because you signed up one more title, and you usually can’t reduce your warehouse space just because you printed fewer books than you thought you would.
  • Consider advance and prepress investments in each book sunk costs. It is meaningless to characterize them as unit costs because you have no clue (until it is all over) how many copies will ultimately share those costs.
  • Don’t be fooled by the fact that it’s possible to present PP&B–paper, presswork, and binding–as unit costs. The cost of an entire printing is a sunk cost once the printing takes place, and whether the number of books manufactured is close to the number sold is almost certainly more critical to a title’s economic success than the unit cost of manufacturing it.

Calculate the Contribution

Scorecards that influence executive conduct should reflect the way the business actually works. In fact, each copy sold makes a contribution to earnings, which is the revenue the publisher receives from the sale of the books minus direct costs, including such things as sales commission and actual shipping expenses. (Contribution comes from the publisher’s share of rights sales too, of course, but I’m ignoring it here for the sake of simplicity, and I’ve omitted royalty payments from the equation since they won’t kick in to reduce contribution until an advance on a book has earned out.)

Whenever the contribution exceeds the advance, prepress, and sunk printing costs, then it addresses overhead costs. When enough books have made enough contributions to cover all overhead costs, all additional contributions are profit.

I believe that this view of publishing economics reflects reality much better than the metrics almost every publisher uses, and it highlights two important facts that, in practice, are not generally accepted:

1. In terms of the value of any title to the house, overhead and profit are exactly the same thing. Each dollar of contribution in any month or year goes to cover overhead until that is covered, and then each dollar of contribution is profit. It is meaningless, and can be deceptive, to separate overhead and profit or to define them as different when you’re evaluating a title. The position of the line between them is a function of the house’s overall economics and can’t be meaningfully calculated for any one book.

2. All books that have recovered their direct costs contribute to the profit if there is any profit. Even if the house calculates overall overhead–perhaps quite accurately–as 43.6 percent of sales this year, books that brought in 5 percent, 10 percent, or 32 percent put dollars in the kitty that covered overhead and moved the house toward profit. If all those books, which are often seen as unprofitable, had not been published, some or all of the profits the house earned would have disappeared; profits would not have gone up.

If your current scorecard says a title is unprofitable, then your profits should go up if you eliminate it. If eliminating it makes overall profit go down, then it’s fair to question your current scorecard.

As I see it, titles either contribute to overhead and profit or they don’t. They can’t make “profits” or “losses” because those exist within a context larger than figures for any individual title. Accordingly, the words “title P&L” are meaningless. Using that concept, you might find that all your books are “profitable” even though you’re losing money or that they’re all “unprofitable” even though you’re making money.

To Buy or Not to Buy

Obviously, the hardest decision for any house is the acquisition decision. It is usually made without a finished manuscript in hand, so the number of variables is enormous. Will the manuscript be delivered on time, or a year late? Will it end up being the 288-page book you’re expecting, or half as long or twice as long? Will the editor have to spend 30 hours working with the writer, or 100? Will the market for the book look the same as it does now a year or two or three from now when you’re ready to publish?

What you should try to calculate is how likely the book is to make a contribution to overhead and profit. The simple rule would be: If it is questionable whether a book will recover its direct costs, then publishing it probably poses an unacceptable risk.

How do you calculate a book’s probable contribution?

First you total the estimated costs you must sink–advance and plant and PP&B for the first printing–which are usually pretty predictable, although if the total word count has a big question mark, you might have to do more than one calculation.

If you predict that you will spend $20,000 on advance, plant, and PP&B to print the 5,000 books you figure you’ll need to cover an advance of $3,500 and give you enough backup, then you’re going to divide that $20,000 by the margin per copy (as above, total revenue minus sales commission and direct fulfillment costs). A publisher that pays 25 percent of net to a distributor and sells at 50 percent off keeps 37.5 percent of retail on each copy sold, or $7.50 on a $20 book. So unless royalties kicked in soon to reduce margin, that publisher would have to sell 20,000 divided by $7.50–2,667 copies–to break even.

If you had $7,000 in rights sales, then you would have to get only $13,000 back to reach break-even, which would require selling 1,734 copies. But if you had to account for an additional $3,000 marketing campaign, on the other hand, you would raise the sunk cost figure to $23,000 and move break-even up to 3,067 copies.

The main point, though, is that the entire approach becomes much more reality-based when the question becomes, What are the odds that this book will return a contribution?–rather than, How much profit will it make?

How Much?

The way many houses calculate the retail price for a book is counterproductive. Obviously, any retail price you set must cover the direct costs of manufacturing, selling, and shipping the book in question. If you’re paying $3 for PP&B, you can’t set a retail price of $2.50 and do anything but lose on every copy. There must be a positive contribution from each copy of each book sold.

But figuring out how much of the book’s sunk cost and how much of the house’s overhead each copy sold must recover is a much harder call. In fact, it is a nearly impossible call, because it requires predicting the total sale on a book in advance, which nobody can do with any great reliability.

A publisher who tries to put those elements into the price calculation starts off on the wrong foot. Investments in author advances and overheads are invisible to the consumer. What the consumer actually sees is the PP&B. Although all books vary by content, author, presentation, and so on, most consumers will see two books with the same trim size, page count, and color density as products that should be comparably priced.

Therefore, the right way to determine retail price is by value as the consumer will see it, not by cost (even though you have to be sure your price covers your costs).

Most houses have a rule something like this: The desirable retail price is five times the unit cost, including royalty and plant, of the first printing. If you have a rule of thumb like that, replace it.

It is a virtual certainty that every major trade publisher could increase its profits if the people setting the price and print order had no idea how much the house paid for the book or what the total sunk costs are. The calculations made in connection with acquisition have been retired now, and what somebody thought–rightly or wrongly–back then is moot and potentially misleading.

Of course, it is valid to know things about market expectations–how big is the market right now, how much promotion are we doing, and what are the sales and prices of recent comparable books?

What you are trying to find is the price that will maximize total dollars in margin; that is, the price where the contribution per copy times the number of copies sold yields the greatest total dollars for overhead and profit. Ideally, this would entail accurately forecasting sales at different price points or, alternatively, predicting the percentage by which a rise in price would cut sales or a cut in price would boost sales. In the real world, forecasts are educated guesses at best, but data on prices of comparable books are easily accessible, which means you can make sure your pricing is not a deterrent. The more the book’s audience must have it–usually a condition that applies to professional books, not consumer books–the more room you have to increase price (relative to other books of the same size and heft) and perhaps boost total margin.

How Many?

The most sophisticated approach to setting a quantity for a printing involves an EOQ–economic order quantity–calculation. An EOQ balances the savings from larger printings against the costs of tying up money longer. But EOQ is only useful for titles whose sales over time are pretty dependable. Since most first-printing decisions don’t have that platform of stability, I have a simpler rule: Print what you know you will need until you know more and can print again. Books that you print, but don’t sell, to make the unit price of a printing “work” will usually cost you money; they won’t save you money. So every printing decision should start with a sales forecast. If you don’t have a sales forecast, you can’t make a sensible printing decision.

First-printing numbers don’t have to be as mysterious as they often seem. If you organize your sales efforts so that the biggest buyers of a title’s advance have their orders in before you print, then you know what you need to cover those orders. Of course, you need to print enough additional copies so that you can watch sell-through before you print again, and that component of the decision is a guess. But the sum of those two numbers is all you need in the first printing. Anything over that constitutes a risk with consequences that can be seen live and in color on every remainder table.

After the first printing, publishers today have advantages that never existed before in the data feeds they can get from the supply chain inside the book trade and from some accounts outside of it. Databasing that information so that every reprint decision is made with knowledge of what’s in the pipeline and how fast it is moving should become a standard practice. You still have to know the minimum number that makes a printing viable, but it is need, much more than price, that should determine the quantity.

It is an old axiom of publishing that the profit on a book can be lost on the last, unneeded printing. The current availability of supply-chain inventory data can help publishers stop losing those profits.

Summing Up

You can’t calculate the cost of what you sell by calculating the cost of what you print.

You can’t calculate the true financial impact of a publishing decision on your business if you include charges against that decision that have nothing to do with that decision.

And you can’t forecast sales with any accuracy by working backward from what you paid to what you need to make what you paid look smart.

Changing internal scorecards so that they reflect the true economics of book publishing is the simplest first step toward improving the financial performance of any publishing house.

Copyright © 2005 The Idea Logical Company, Inc.

Mike Shatzkin, founder and CEO of The Idea Logical Company, Inc., has been a consultant in the book-publishing industry for three decades. An observer and forecaster of digital change, he is the author of five published books; his professional activities have included agenting, editorial direction, all aspects of sales and marketing and production, and strategic planning.

This article is adapted from a speech he delivered at the New Face of Publishing conference at Humber College, Toronto, on April 15, 2005. To learn more, visit www.idealog.com or email mike@idealog.com.

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