How Traditional Print Publishing Works

In light of the DOJ’s lawsuit against Apple and several publishers for collusion in the setting of retail prices for ebooks (Dear Author has a great post on the latest revelations from the case), I thought it might be worth talking a little bit about why the major New York publishers were so worried about the rise of digital books that they embarked on this scheme in the first place. So, get in your “way back” machine and let the mists of time fade away before the world of Amazon and Kindles and wi-fi/3G. Back to the days when books were…well, BOOKS.

DISCLAIMER: I’m not an expert in this field. My observations are based on a combination of what I’ve gleaned from my own experience in print publishing and a rudimentary grasp of accounting. I am pretty sure that everything I’m saying is reasonably accurate, but I could be off on some details. If so, mea culpa!

The business model for a print publisher looks something like this:

The publisher acquires the book’s content from a writer, usually by paying that writer an “advance” on anticipated royalties. This advance is a guaranteed minimum amount that the author will earn from sale of the book. Depending on the format of the book (hardcover, trade paperback, or mass-market paperback), the author’s “cut” of the cover price of each book sold ranges from a high of around 15% (some hardcover deals MIGHT go as high as 20%) to a low of about 4% on certain mass-market paperbacks. Whether or not the royalties due the author from sales of the book ultimately equal or exceed the original advance (“earning out”), the author is never required to pay back any portion of that advance, although an author who persistently fails to earn out her advances is an author in danger of not getting a new contract.

The publisher further invests additional upfront monies in production of the print book—editing, cover art, typesetting, printing, marketing (directly primarily at booksellers, not reader, by the way), etc. The publisher then sells the books at wholesale to retailers, who in turn sell the books to consumers at either the cover price or at a discount price wholly at the retailer’s discretion. Because the publisher isn’t waiting for actual readers to buy the books, but rather registering the sale of the book to retailers, the publisher recognizes an immediate boost to its balance sheet when the books are printed. (This also, incidentally, explains why publishers don’t tend to think of readers as their customers, but booksellers, and why a huge proportion of their marketing budgets are spent on convincing retailers to order their books.) How big a boost the publisher gets from any individual book is tied directly to the format of the book (hardcover has a higher profit margin than trade paper and trade paper a higher margin than mass-market paperback) and the size of the initial print run (the more books are printed, the lower the unit cost for each book and the greater the profit).

This, by the way, is how all other manufacturers of products recognize sales, at least as far as I know. Apple doesn’t wait for you to go to Target and buy an iPod to recognize the sale of that iPod. Apple’s customer in that transaction is Target, not you, and Apple doesn’t really care whether Target makes or loses money on selling the iPod to you or even whether Target actually sells any individual iPod. As long as Target pays Apple the wholesale price for the iPods it intends to sell, Apple is happy. (As an aside, Apple is an interesting example here simply because, unlike the majority of manufacturers, they do place some price controls on their products that prevent retailers from discounting beyond a certain point and thereby using Apple products as “loss leaders”.)

In any event, however, this model that recognizes the income from the sale of a book to the retailer rather than the consumer is the reason traditional publishers are so keen to “protect” their print books from the encroachment of ebooks. Although the profit from the sale of an ebook may actually be greater than the profit from the sale of the same book in print format (the exception to this is hardcover—the profit margin from hardcover is much, much higher than for the corresponding digital edition of the same book), that profit can’t be recognized until an actual consumer purchases the book from a retailer. The publisher can’t “guess” at how many copies of any given ebook Amazon will sell and book the profit for those sales when the book is released. This means that the publisher now effectively sells one copy of the digital file to retailers and then has to wait (possibly for several months between reporting cycles) before it can book the profit of the individual sales of copies of that file to consumers.

Now, you may be thinking that this should make that much of a difference to publishers. After all, if the profit margin for a digital book is as high or higher than for a print book and there are no printing or distribution costs and copies never run out, in theory, everything should come out in the wash. In the long haul, the publisher might actually make more money from digital sales than print. And, of course, that’s true—as long as we eliminate the hardcover format from our discussions. But hardcover is where print publishers make the bulk of their profits, and when you combine the loss of hardcover sales due to digital adoption and the much longer window between the release of a title and recognizing its sales, and you can see that publishers could have a real liquidity problem.

Moreover, without order numbers from retailers, sales numbers become virtually impossible to predict. At least when booksellers ordered X copies of a book, the publisher could expect some percentage of X to sell. When they just ship off one digital file to a retailer, there’s really NO way to guess how many copies the retailer actually thinks can sell. Orders were a tangible measurement of salability. And that’s important for publishers to know, because it’s how they gauge the salability of the books they’re acquiring now. If they don’t know have firm numbers to tell them how well their soon-to-be-released titles are faring in the marketplace, they’re operating in a vacuum, mostly guessing how well the current books are going to do and hoping they’re making the right choices for future releases.

At this point, I’m sure you’ve got another objection. “But, wait, Jackie! What about returns? Don’t those screw things up just as much as digital books?”

I’m sure most of you know that books are one of the few items retailers can return to the manufacturer for credit. This system was born of the Great Depression, when booksellers feared they wouldn’t be able to sell the books they ordered, and publishers offered them the option to return unsold books for credit. This setup probably saved the book industry in the 1930s, but its legacy is a huge burden to publishers today.

Or is it?

Okay, I don’t know much about retail accounting, but I do know quite a bit about financial industry accounting. And one of the things I know is that accountants always make allowances for losses. Sometimes they allow too much and sometimes they allow too little (hello, 2008 financial market collapse), but by and large, the “loss” associated with returns on books is probably already built into the publishers’ profit and loss statements. They assume a certain percentage of books they print will be returned for credit and account for that accordingly, so that “loss” is already recognized, for the most part, when they record the sale of a new title to retailers. (By the way, that percentage is also accounted for in the author’s royalty statements for years, unless a book happens to sell through its entire print run.)

So, all of this is my way of saying that, while what the Big 6 and Apple did when they colluded to raise the price of digital books in the hopes of stemming the ebook adoption tide appears to be 100% illegal, they didn’t do it just because they wanted to shaft ebook readers or even because they were afraid of Amazon gaining too much market power. The shift to digital represents a real challenge to the model of traditional publishing, which is really a manufacturing model. Publishers made content into books. Retailers bought the books and sold them to consumers. It was no different than selling iPods.

Digital books came along and threw a huge monkey wrench into the gears, and the major publishing houses still haven’t figure out how to handle it. That doesn’t make their actions any less illegal or objectionable, but ebooks and print books really aren’t interchangeable products from the standpoint of the manufacturer, and that’s why publishers were so desperate to protect print.