Analog contracts in a digital world

Shaking hands over a signed contractCollege level textbooks and their publishers have been in the news a lot lately, with all of the major higher education publishers emphasizing a shift to a digital first market strategy. The vast majority of publishing agreements for established textbooks were written in a world where print books were the dominating market offering. As the world shifts, there are certain contractual provisions to be mindful of when evaluating one’s royalty statements and in negotiations over amendments.

In reality, print sales still dominate, but publishers are trying to move away from the model, and the future of higher education materials is uncertain.

Royalty rates in higher education can range from a low of 8% for an ELT book to a high of 20% for a successful book in the advanced mathematics. It’s safe to say that the average royalty rate for college level textbooks is around 15%.  This rate is typically applied to net sales of the work, that is the money a publisher receives from sales less returns. This is in contrast to the trade publishing world where royalties are based on the list or cover price of a book, regardless of the actual price for which the publisher sells the book.

No hard and fast rules or formulas exist as how industry standards were set in the textbook world, but royalty rates were meant to reflect a fair distribution of gross profits between publisher and author. In the trade world, this split of profits works out to be fifty – fifty. In higher education, the split appears to be a bit more in the publishers’ favor.

Gross profit is simply sales less the cost of goods sold. Higher education publishers consider royalties, printing, paper and binding as well as some allocation of prepublication costs in calculating gross profit.

The trade publishing industry dealt with the question of eBook royalties in the early 2000’s finally settling to a royalty rate of approximately 25% of net receipts to the author. Authors have argued that this amount should be as high as 50% to more closely mirror the effective gross profit split discussed above, but because of most favored nation clauses in many agreements, the industry has largely settled on this rate. The higher education publishing industry has not dealt with electronic royalty rates as uniformly and is left trying to answer questions such as “What is a unit?” and “What is the work?” Some of these questions are addressed in new contracts but many are left trying to apply the terms of a royalty agreement for print books to electronic versions of textbooks and other materials.

One can point to a number of reasons as to how we got to this point and arguments can be made as to why the standard rates should or should not apply to electronic materials.

Higher education publishing differs significantly in that authors typically do not have agents, so negotiations are largely individual, there is not one agent pushing for better terms across a wide author constituency. Textbooks in eBook form came onto the market more slowly than trade books.  Reproducing a photo rich textbook into electronic format is more complicated than a text only novel (not to mention all of the current adaptive learning components that are part of many textbook offerings). Further, the market was slower to accept electronic versions of textbooks, even today, studies suggest many students prefer print over electronic formats. Finally, many publishing agreements were finalized before electronic versions were even contemplated. Higher education textbooks go through many revision cycles, but the original publishing arrangement still governs.

Given the lack of information regarding the cost of electronic textbooks and related materials and the variation in offerings amongst publishers, it is difficult to advocate for a standardized electronic royalty structure similar to the trade industry.

Let’s touch on some of the ways royalties may be impacted by older contracts that don’t address electronic rights. A hypothetical contract has a tiering clause when a certain number of unit sales are achieved. The publisher’s royalty system may be set up to capture the cumulative sales of print units in order to trigger the higher royalty rate but may not include the sales of eBooks. Authors should read their contracts to determine what types of sales should count toward each tier and review royalty statements carefully to ensure that correct royalties are being paid.

Foreign sales typically have a lower royalty rate because of higher shipping costs and greater price sensitivity in overseas markets. Understanding the basis for lower foreign royalty rates, one should consider these royalty rates in connection with eBooks and electronic materials. Many older contracts simply do not distinguish between print and electronic sales, and thereby apply the stated royalty rate for all sales of the work in a given market (i.e. domestic, foreign or high discount). Thus, the foreign sales of an eBook could pay half the domestic rate. Authors should consider that once the eBook has been developed and produced, there is little to no incremental cost associated with the sale of that eBook. The publisher is in effect sending a master file of electronic content to the distributor or directly to the student/customer. This begs the question, should the foreign sale of an eBook pay a lower royalty than a domestic sale?

The elephant in room is the question about what constitutes a textbook and how should authors and publishers share in the revenues and costs of new electronic versions. Electronic versions of textbooks come in many forms depending on the publisher and may be packaged with a print book or only sold as an electronic offering. Publisher pricing strategies now charge less for electronic offerings than print, making the purchase of a new print textbook less attractive to customers. Some print packages contain electronic access to materials that may never be used by students. It is unclear how royalties are being calculated on the thousands of combinations of packages available to students including digital offerings. Royalty statements do not provide enough information to determine the value ascribed to an author’s work in a package versus other elements. Some publishers deduct a portion of the revenue base to cover the costs of developing new platforms.

There is no denying the shift in the higher education textbook publishing market has created ambiguity in existing publishing agreements with respect as to how authored materials can be distributed and how royalties should be paid. Authors are always wise to check their contracts, review their royalty statements and ask publishers how their contracts are viewed in light of the ever-changing electronic landscape. It may be prudent to amend contracts to clarify the understanding between author and publisher, or existing contracts may contain more favorable terms than what publishers are currently willing to offer.

Juli Saitz

Juli Saitz, CPA, is a Senior Managing Director at Ankura, leading the contract and royalty compliance practice. She has extensive experience serving clients including textbook authors as well as multi-national corporation licensors. Juli has helped authors and corporate clients recover millions of dollars in asserting their audit rights related to licensed copyrights, trademarks and patents. She is focused on the shift in the publishing industry to electronic content delivery methods and adaptive learning platforms and the resulting effect on author royalties.