In a post on October 20, I described decisions made by the Southern District of New York in a lawsuit between authors and Cengage. The authors had alleged breach of contract as well as bad faith dealings by Cengage in regard to their products Cengage Unlimited and MindTap. Read about it here.

This is more of a thought piece—generated in part by an aspect of the authors’ allegations—about what would constitute good faith in a publisher’s interactions with authors. I ask this not as a legal matter, about which I am not qualified to opine, but as an ethical one.

The authors’ allegations stem from an uncontested aspect of both the MindTap and Cengage Unlimited royalty allocation models. In both products, Cengage counts a portion of each sale as non-royalty-bearing income. In the case of MindTap, that non-royalty-bearing portion is called ‘ancillary materials’ encompassing “tests, studies guides, exercises”. For Cengage Unlimited, this portion is called ‘courseware’ but apparently includes the same ancillary materials as MindTap.

There is a second element to this contemplation that stems from a September 29 interview with Cengage CEO Michael Hansen on Cheddar, the live-streaming financial news network that broadcasts from the floor of the NYSE on market days. If you would like to watch the full interview, here is a link.

In the interview, Mr. Hansen is asked whether new business models that aggregate Cengage products for low flat fees per semester would damage profits, and he answers candidly that it would…”except for if you gain volume,” thus acknowledging that Cengage’s aggregated subscription models depend on gaining market share for success. The usual way we think of market share gains is that they must come from competitors. That could be part of the strategy, but there might also be a play here to increase the market size by reclaiming the part that has been soaked up by used books, which benefit neither the publishers nor the authors. In any case, acknowledging that CU’s success will depend on gaining volume seems correct, but may be too facile. These new models change multiple variables in the profitability formula, so they are impossible to assess without access to more information. How much additional sales volume is needed to break even with this model? What happens to author royalties as Cengage sells access at a lower price, and further reduces the royalty base by excluding the non-royalty-bearing costs of their software platform and ancillary materials?

It must be noted that publishers are not duty-bound to produce equivalent royalties for authors across all different pricing models they may use to disseminate a product. Still, if you aggregate thousands of textbooks into a product with a price that is a small fraction of the sum of prices for the stand-alone titles and then reduce the revenue further by excluding certain costs from royalties…it is reasonable to wonder whether that is a good faith move with a realistic prospect of producing fair compensation for so many authors whose livelihoods may wholly or partially depend on it.

The ethical dilemma here turns on the allocation of income between the publisher and the authors, who are paid by a royalty, or a share of that income. Although there are variations, the average royalty rate for authors seems to settle around 15%, leaving the publisher with an 85% share. In the print environment, that much larger share is justified by the fact that the publisher bore nearly all the direct and indirect costs of producing the textbook, so had much greater financial risk in the venture. Authors risked their labor, and hoped to receive fair compensation for it if a book was successful; but authors do not, generally speaking, lay out their own cash to bring textbooks to market.

Note that the traditional allocation of income was largely premised on a well-understood print textbook economy. To be sure, there can be substantial costs in digital distribution such as infrastructure, software development and maintenance, preparing textbooks for the platform, the development of ancillary online learning aides, data centers, and digital support staff. Even so, the costs of digital publishing create a shift from mainly variable costs for print (i.e., there is a cost for printing and distributing each additional print book) to mainly fixed cost in a digital environment (i.e., fixed costs for infrastructure and software are distributed across all products, and there are very low or no costs for each additional distribution of a work). The significance of this shift is that it demands economies of scale and favors widespread distribution.

Back to our ethics question. The publisher still retains the 85% share of income in the new digital environment, but they are in effect recovering much of the fixed cost prior to paying out any royalty, and they are bearing much lower, if any, variable cost associated with the distribution of the digital product. That means their 85% of the royalty-bearing portion of income likely represents a higher profit margin per sale. These circumstances alter the risk allocation between the publisher and the author, placing far more risk on the shoulder of the authors. If enough market share can be gained so that total royalty-bearing income is equal to the prior status quo, it might be fair to say that the authors have not, on average, been damaged (although the allocation of royalties among authors in the new model also require scrutiny…a topic too complicated to broach here). If, however, the market share cannot be increased sufficiently to maintain equal total sales income, then the authors will lose out with every dollar short…but the publishers will not. Since will recover their cost before sharing profits, and will receive a higher profit margin per unit sold, they can achieve the same level of profit with less gain in sales volume than the authors can.

Insufficient information has been provided about the increased volume necessary for the plan to work, and the differences that will enable the publisher, versus the author, to break even. The royalty allocation methodology, and how the publisher determines the amount of income it can exclude from royalties are abstruse calculations, badly in need of transparency. It seems probable that the executives at Cengage, and other publishers developing similar models, have targets and expectations for how aggregated products can sustain the company’s profits. It would be an act of good faith for them to share their models more forthrightly with the authors whose work they depend on, and whose livelihoods depend on the financial success of the new model.