ROYALTY CALCULATIONS IN BOOK CONTRACTS 


IVAN HOFFMAN, B.A., J.D.


We often hear about book royalties in a fashion that is illusory. To discuss a royalty rate without at the same time discussing the basis for the rate's calculation is like comparing apples to oranges. To banter about numbers like 8%, 9%, 17% or such is only one part of a significantly more complex issue. In theory, a publisher can pay a writer a royalty rate of say… 96%! and the publisher can still make tons of money and the writer nearly none at all.

Please keep in mind that I write not as an advocate for either publisher or author but merely to explain. As any good attorney, what I believe depends upon what may best serve my client's position. [grin]

Moreover, all royalty recipients face the same issues. It is not merely the writer that must pay attention but the publisher as well for there may be occasions when the publisher is on the receiving end of a royalty arrangement, such as in a licensing deal, a foreign sub-publishing deal or the like. But for the sake of simplicity in this article, let me focus on the royalty provisions between a writer and publisher in a traditional book publishing agreement.

The significant question to ask is: "Upon what figure is the percentage royalty rate to be calculated?" In other words, by what number do we multiply the royalty rate? Examples range from "net monies received by Publisher," "gross cash receipts," "the suggested retail list price," "wholesale price," and perhaps other variations on that theme.

In other words, we must initially distinguish the term "royalty rate" from the term "royalty." The first refers to a percentage figure that is multiplied by some other figure; the second refers to the actual dollar and cent amount for each version of the book that sells and is not returned. The first sounds nice but it is the second you take to the bank. Or not.

GROSS VS. NET

In some instances, the author may be paid a percentage royalty rate based upon some calculation of income received by the publisher. This figure may be a gross or a net income amount but merely reciting either gross or net in the agreement does not provide enough information. The devil, as they say, is in the details.

Both the author and publisher must take some care to define how the base figures are calculated. What deductions, if any, are allowed before the rate percentage is applied? If the percentage rate is paid upon "net," a specified list of deductions from "gross" should be spelled out in the agreement. What items may the publisher deduct before multiplying the author's rate against that amount? Are advances received by the publisher included? If so, what if the publisher makes a deal for several books and receives a non-allocated advance on all those books? Does the author share in that? Or is the author's share based only on income received from "sales" as opposed to "all income" received by the publisher? Are sums received by the publisher to reimburse it for fees incurred in the transaction deductible before the author's rate is calculated? These fees may include licensing fees or fees paid to agents in other countries or even in the United States for special markets. And what if the licensing is done through a company "owned and controlled" by the publisher-in other words a separate division of the publisher? Are those fees deductible?

RETAIL VS. WHOLESALE

Another form of calculation is when the royalty rate is multiplied by either the "suggested retail list price," the "wholesale price," or something else related to either. A royalty rate that is based upon the suggested retail list price will often be significantly lower than one based upon a wholesale calculation. Which formulation is used depends upon the publisher's accounting practices. For example, a contract from a publisher that bases its calculations on the suggested retail list price for a book that has a suggested retail list price of $9.95 (eg. $10.00) may provide a royalty rate of maybe 8-10% to the author. The author then ends up with somewhere between 80 cents and a dollar a book. However, the author may end up with the same dollar and cent royalty if another publisher were to account to the author on the basis of a wholesale price if the author's royalty rate was between 13 to 16%, assuming that the wholesale price is 60% of the suggested retail list price.

A calculation that is based upon the wholesale price is very similar to the formula in which the royalty rate is based upon the income received by the publisher. Both are based upon actual receipts, if in a loose way.

This previous discussion has been about calculating royalty rates and royalties for the normal "trade book" edition. However, there are often more significant royalty calculation provisions that may substantially change the actual dollar value of the royalties paid by the publisher and received by the author. The stated gross royalty rate is often in reality considerably less depending upon the actual type of sale the book creates.

ESCALATING OR DECLINING ROYALTY RATES

Often publishing deals offer the author an increasing rate based upon increasing sales, the theory being that as a publisher prints more books its production costs are reduced and the author earns the right to a higher base rate. These increases can kick in at 5,000 unit increments or some other figure upon which the parties may agree.

Additionally, the royalty rate may vary depending upon whether the edition is a hard cover or soft cover one and the rate may change upon certain break points within each of those categories. In other words, the author may receive a certain royalty on a hard cover book up to say 15,000 units and then a higher one on sales thereafter. The same with soft cover, although the unit measurement may change because costs and thus profits change with different editions.

However, if there is this escalation provision in the agreement, exactly which units are counted toward the fulfillment of each threshold is important. Often excluded are sales through other than "normal trade channels," such as book clubs, special marketing plans and mail order sales.

Publishers would argue that these latter sorts of sales should be excluded not only from the escalation provisions but should also be the subject of a reduced royalty rate because their costs vary in those categories and because they are themselves merely getting a royalty from the licensee and not selling at full wholesale price.

On the other hand, the author could argue that sales through book clubs are essentially cost-free for the publisher since the club does the production and so absorbs the cost. Thus, although the publisher may receive less per book, the publisher has no attendant expenses, thereby justifying not only a full rate but inclusion in the escalation formula as well.

The same may be said, the author may argue as well, of special marketing plans, such as premiums to a particular buyer. While it is true that the publisher may receive less per book since these deals are usually made at a discount in excess of the normal wholesale discount, the production costs are factored in and may often be charged back to the customer if they involve special imprints etc. Additionally, these books are almost always sold on a "non-return" basis, thereby making whatever sales are made "final," thus reducing the publisher's costs as well since they do not have to worry about handling returns. This category of "special marketing plans" may also include sales where the discount to the buyer is larger than the "normal" trade discount.

Finally, a sale made through mail order is essential a full-priced retail sale and since it always includes a surcharge to the customer for "shipping and handling," mail order sales are most likely a higher profit margin sale than those through normal trade channels.

In response, a publisher may claim that these may involve licensing these special markets to others and thus the profit margin to the publisher is still less than normal trade sales and so justifying both a reduced royalty to the author and exclusion from the escalation provisions.

Sometimes excluded as well are sales of "revised editions" of the book. This situation may arise when a book is selling well and the publisher asks the author to do some revisions, either to make it timely or otherwise. If the revised edition is not counted toward the threshold sales but is instead placed in a separate category, the author may be losing out on the higher royalty rate applicable to sales had the revised edition been considered as part of the original edition for this purpose.

OTHER DISCOUNTS FROM THE GROSS ROYALTY RATE

Since "sales" in a book arrangement vary by market, as above and in other categories, the rates paid to the author vary considerably depending upon the market. For example, in many of the categories above, the rate paid to the author is often one-half (1/2) of the rate paid on sales through "normal trade channels." The publisher would argue that the publisher is receiving less than it would in the "normal trade channel" type of sale, even though the profits may, as I have indicated, be actually higher. The author might counter by saying that even if the publisher is receiving less, its royalties may not actually be one-half of what they otherwise receive and so the author should be entitled to a pro-rata royalty in the same ratio as the normal wholesale price bears to the licensed royalty rate.

For sales through other marketing plans, plans that include radio and television advertising ("infomercials" for example), coupon advertising, through on-line services on the Internet and other such markets, the royalty rate is often one-half of the normal rate. It is worth both parties attention to these markets since they are often "emerging" ones and as they mature and costs and rates stabilize it may pay for each side to revisit the royalty structure.

Foreign sales by the publisher itself usually bring a one-half rate as well, again under the theory that the publisher is only receiving a royalty. However, if the publisher licenses the rights to a third party, this should be covered by the licensing provisions in the agreement discussed in the next paragraph. (see "Foreign Publishing Deals")

Additionally, there is the whole market called "subsidiary rights," including the use of the book as the basis for other media such as television, motion pictures, CD-ROMs, merchandising, audio books and commercials, translation and reprint rights, among others areas. Often the income from these licenses is split equally between author and publisher (although other percentages can be negotiated) but each must be careful to define how the "splittable" income is defined. If "net" income is the basis, the difference between "gross" and how the "net" is calculated should be carefully considered.

In all of these areas, the author may ask for a percentage not only of the royalties so received by the publisher but of any advance so received as well. It is not always self-evident that such is the case. It depends upon the language of the agreement.

There may be many other categories of reduced royalty rate sales. There may be export sales, sales during a period when less than x units are sold and other such sales that are outside of the "normal trade channels."

RESERVES AGAINST RETURNS

For perhaps historical reasons, the publishing industry (and other entertainment industries as well such as the record industry and the CD-ROM business), retailers are allowed to return unsold merchandise, usually for some extended period of time. As a result, a "sale" is not a "sale" until, well until it is a "sale." Publishers, accordingly, have included a provision entitling them to maintain a reserve against future returns, which returns may not take place until several accounting periods after the initial "sale" is made.

Given this industry return practice, such a reserve seems appropriate. However, the author may ask for some stated and written policy limiting such reserves to a percentage of the amount sold during the period and a time frame after which the reserve will be liquidated. What this means is explained in this example: Publisher sells $1,000.00 worth of books in period 1. It's historical record with the industry for this type of book tells the publisher it may expect a return factor of say 20%. So in its accounting to the author for that period it shows sales of $1,000.00 but a reserve of $200.00. If the agreement between the author and publisher provides for liquidation of that reserve within let's say 2 accounting periods after it was established, then within a year, assuming semi-annual accountings, the $200.00 is paid out to the author less the amount of actual returns received.

Publishers may not wish to be tied down to a given formula, especially for new authors or books that are perhaps less "mainstream" than other books. They may ask to be allowed to hold back "reasonable" returns, a phrase that creates much openness in the agreement.

CONCLUSION

In sum, both the author and the publisher should be aware of the subtleties involved in negotiating the royalty clauses in publishing agreements. The ultimate resolution of these issues will depend, like so much else, on the relative bargaining positions of the parties. For the author in demand, the results may be one thing. For the first time author, another thing entirely.

And in any conversation between authors regarding their deals, merely announcing their royalty rate is not likely to determine who will pick up dinner. The royalty rate received by the author in a book contract is often quite different than the royalties he or she takes to the bank.

These issues are often the most contentious in the negotiation. However contentious, each party should be at least understanding of the other's position, not only because it may lesson the adversarial nature of the deal-making process but also because knowing a bit of the other's business issues makes compromise often easier.

Deal making should be profitable for both sides. If it isn't for one, it most assuredly won't be for the other, immediate and short term appearances to the contrary notwithstanding.

© 1996 Ivan Hoffman

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This article is not intended as a substitute for legal advice. The specific facts that apply to your matter may make the outcome different than would be anticipated by you. You should consult with an attorney familiar with the issues and the laws.

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No portion of this article may be copied, retransmitted, reposted, duplicated or otherwise used without the express written approval of the author.

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