A group of papers recently crossed my desk that reminded me of the permanent or eternal reserve that many publishers keep on individual books. I suspect that few authors are aware of this, but it’s a serious issue that affects almost every author.

The root of this problem is that many publishers keep a tiny but permanent reserve against returns. This should not be confused with illegitimate practices regarding the reserve for returns that less than reputable publishers have employed. This eternal reserve, as any of the publishers that utilize it will likely argue, is a legitimate accounting practice. And, if the permanent return is tiny and not fixed, it can be justified. If it is not, it is an egregious use of the reserve concept and a serious way of depriving authors of royalty income.

First, some background: I have been on both sides of this issue. Prior to becoming an agent I worked in the contracts and royalty areas for two of the largest publishers. In my first job I actually had access and spent some time with the large royalty books that housed the company’s royalty records. (Yes, the hand entered books that held the royalty records.) In these books you could follow the royalty records of titles that had been in print for 20 or even 30 years. I remember reviewing books that hadn’t had a return in five or even ten years. These were customarily “dead” books, long out of print. Sometimes a return came in, but rarely.

Even on these titles, a permanent reserve was usually kept. The reserve would often be 50 books, period. From the author’s point of view, you can make the case that no permanent reserve should be kept. When a book is essentially dead—let’s say three years without a recorded sale or return––even the final or permanent reserve should be liquidated. However, a publisher could legitimately argue that returns are received even ten years after a book is dead and so they shouldn’t be forced to pay royalties on books that could be returned.

From where I sit, this is a coin toss—both sides can make legitimate claims. As long as the publisher must absorb returns for credit, it wants protection from paying royalties on these unsold copies. If no returns are imminent by any common sense measure, authors should be paid royalty income that has in all likelihood been earned.

In my capacity as agent, I have several clients with long, productive careers. I have full access to their royalty records, which I periodically review. Even though there is obviously a smaller collection of authors, the patterns of sale are similar to the ones I saw as a publishing house employee. After the active life of a book, years could go by with no activity—no returns whatsoever. Sometimes a return or three would pop up. The fact is that nearly all books follow a similar pattern in their publishing lives. Ten year old books, with no new shipments, don’t suddenly return 500 or 1000 copies. In fact, I can’t remember even moderate amounts of returns for an older book (for many books this would be at least three years post first publication). If a book is very active, with new shipments, that is a different story. In that case, the book will behave essentially like a recent title and substantial bursts of returns are possible.

Despite these patterns, that anyone who tracks royalties knows, many publishers do use an eternal reserve. It is a controversial, debatable practice, but it is legitimate. But, what happens if the permanent or final reserve is abused? What if it is more than a token reserve or if it is completely disconnected from any common sense notion of how books are returned? In these instances, the publisher is simply failing or refusing to pay royalties.

One such practice that greatly concerns me is a permanent reserve that is set as a percentage of gross shipments. Even a 1% permanent reserve could deny substantial royalty income to an author. Let me give you an illustration. During the initial publication of a book 100,000 copies are shipped and the publisher establishes a standard 1% permanent reserve against this shipments, so that’s a 1000 copies. Depending on the book’s sales, the permanent reserve isn’t visible or operative, but subsumed in the traditional reserve and most likely would not have an impact on the author’s royalties. But what happens five or even ten years out? What happens when in the prior five years only ten returns were received? Why would 1,000 copies need to be held in reserve when the publisher can be confident that it will not receive even 100 returns?

Let’s continue to work with this example. What if the permanent reserve wasn’t as tiny as 1%–say 3% (3000 copies) or 5% (5000 copies). The numbers grow more and more absurd. A reserve is not supposed to function in this way. Let’s examine how the reserve is really supposed to function. In our example, we’ve shipped 100,000 copies and let’s say that 50,000 are reported sold. The publisher knows they’re sold—they’ve been paid for them, the large accounts have actually given the publisher sales figures from individual stores. Now the potential pool of returns isn’t 100,000 copies, it’s 50,000 copies. Of those 50,000 copies, let’s say 40,000 have been returned and credited. Now our 3% of shipments or 3000 copies is actually a reserve against 10,000 “unknown” copies. It’s no longer a 3% reserve for returns, it’s now a 30% reserve for returns. And, as the number of “unknown” copies decreases, this percentage steadily increases.

Obviously, a reserve set by a fixed percentage of net shipped is an unfair practice. A reserve should never be fixed; it should be based on actual experience. Publishers that employ a permanent reserve with a fixed rate based on gross shipments aren’t really using a reserve against returns at all, they are simply not paying authors royalties on every book sold, as promised in their contracts. It may be 99% or 97% or 95%, but it’s is not 100% and in some cases this can amount to a significant loss of income to the author.

The reserve for returns will continue to be an area of contention between authors and publishers. Publishers have the right to protect themselves from paying royalties on unsold copies. Authors have the right to be paid full royalty income on a timely basis and not be subjected to methods that unfairly deny them income. The clearest path to moderating this tension is for publishers to increase the flow of accurate, timely sales information to authors so the legitimacy of the reserve can be openly and objectively judged. Authors must accept that there will be instances where the publisher can legitimately delay payment of royalties until it’s clear that the books have actually been sold and will not be returned.

Last word—a reserve based on a permanent fixed percentage of books shipped is inconsistent with sound accounting practices and unfairly denies authors royalty income.

Royalties, mainly on the sale of paper based books, remain the primary source of author income. I’m going to explain the fundamental concepts you need to understand how they work and are calculated. The following is an outline, more like course notes, than a lecture. I want to keep this short and to the point, as my workshop will go into more depth about all these topics.

Let’s start with the basics. Royalties are wonderful. Royalties are the one thing that compensates you for all the difficult deals you have to accept in the course of your working lives as authors. Royalties are the safety net under the whole system.

Did you not get an advance? A $1 advance? A $4,000 advance? If the book succeeds and earns royalties, you can laugh about it. No matter how cheaply you sell a book, no matter how poor the prospects, no matter how pitiful the advance, as long as the royalty is strong, you do have a chance at realizing good income from that book. I’ll never forget the first time I held a six figure royalty check in my hand. It was the first royalty check I received for that book and it was 4 times the advance we got.

So what makes a strong royalty? Luckily, the royalty system, though under assault, is initially a good one for authors. The reason for this is that the basic royalty for commercial books is a percentage of the cover price of that book. If the cover price of a hardcover book is $20 and my royalty is 10% of the cover price, I am receiving $2 per book. That’s a full 10% of what the consumer pays.

Let me show you how good that really is. You may think the publisher is seeing 90% of that sale or $18, but that’s not so. The publisher does little direct selling, instead he must use bookstores and other distributors. To keep the numbers simple let’s assume he’s granting a 50% discount to everyone who will take the book, display it, and actually make the sale. This is not far off from the discounts many publishers do grant. So on our $20 book, he’s giving $10 to the bookstore and $2 to the author. That leaves $8, which per book isn’t bad. But then there’s the cost of being a publisher, which goes way beyond a good computer and a corner of the house. There’s rent, salaries, taxes, paper, print, binding, publicity, et cetera. Historically, publishers’ margins, the amount of money left over after expenses have been deducted, have been 10%. That’s about as small a margin as you can get in a relatively low volume business and still be in business.

So a percentage of the cover price of a book is a strong, fundamental position to be in. Authors and agents should do everything they can to perserve it. (More on that later.) Beyond showing you that the cover price royalty is so valuable, I want to contrast it with other royalty calculation systems.

There are large groups of publishers that do not pay a cover price royalty. In fact, a number of royalties in your commercial publishing contracts are not cover price based at all. They are based on the “amount received.” Structurally, this is a far less good royalty for authors.

An “amount received” royalty means that the author’s royalty is calculated on the monies that the publisher actually receives and not the cover price of the book. Academic publishers like university presses have traditionally paid on amount received. I’ve worked with a number of small and not so small publishers that only pay on the amount received.

Let’s go back to our $20 book. The publisher is once again granting a 50% discount to the bookseller. So the publisher is getting $10. Now my royalty is calculated based on the money the publisher is receiving. I’m now getting 10% of $10, not $20. So, now my royalty is $1 per book. This is half of my previous royalty. If the royalty system for commercial publishers ever shifted to this model, it would be a catastrophic disaster for authors.

I’ve used a very simple example to contrast cover price vs. amount received royalty. Of course, there are mitigating factors. The most important one is that academic presses do not grant 50% discounts, their upper limit is usually 30%. So, the amount received would be larger. There are other ways to also cope with the amount received royalty structure, which I routinely employ. I double the nominal royalty. So, if a publisher is unwilling to pay 10% of the cover price, I ask for 20% of the amount received. This isn’t a fantasy. I often get amount received royalties which are double the cover price royalty just to compensate my author for the different royalty structure.

Now that we’ve realized the value of the cover price royalty, we can better examine the full extent of royalties in a commercial publishing contract. The picture gets far more complex and troubling quickly. The cover price royalty usually only applies to sales of the book below a certain discount, in normal book channels. That means that many sales of the book are paid out under a different royalty structure, and that structure is usually on the amount received.

Let’s consider some of these.

All publishers sell their U.S. based books outside of the United States. As a general rule of thumb foreign sales–books exported to Canada and accounts all over the world that take English language books — account for 10% of sales. The average royalty here is often 5% of the amount received. That would equal a cover price royalty of 2 1/2% of cover price. That is a very small royalty.

There are other foreign or export royalties. Some publishers pay more than 5% of the amount received. Some publishers have special cover price royalties for large, overseas English speaking markets like Canada, the United Kingdom, Australia, New Zealand and South Africa. Large publishers that maintain full publishing operations in these large English speaking markets, plug their American books, which have multiple local cover prices actually printed on them, into their local distribution networks and pay cover price royalties in these markets. The local currency is converted and paid in U.S. dollars. These are attractive arrangements and attractive royalties, but only a few large publishers actually do this. So, the export royalty is a real problem. It’s true the freight costs of shipping overseas are higher. But that hardly accounts for the drastic royalty drop. Strong accounts in Canada, the Caribbean, etc., do well with English language books. I believe the export royalty is unnecessarily rich for the publishers.

Another major area of concern is discount. The cover price royalty only prevails below certain discounts granted to the bookseller or distributor. For hardcover books, it’s usually below 48%. For trade paperback books, it’s often below 55%. For mass market paperback books, it’s often below 60%. But these discounts vary widely from publisher to publisher. The royalty paid when these discounts are exceeded also varies substantially.

Let’s return to our basic example and see what happens when the “high discount” royalty clause is invoked. The publisher’s standard cover price royalty is paid below discounts of 48% percent. But for a substantial number of sales in our example, the publisher is granting a 50% discount. For each additional point of discount granted, the publisher is deducting 1 point of royalty. So at a 50% discount, 2 royalty points are deducted. We are now receiving an 8% royalty. So our original $2 per book is now $1.60 per book ($20 x .08).

It can get a lot worse than that, very quickly. Some publishers immediately go to an amount received royalty of 10% of the amount received when the discount is exceeded. I have in my files royalty statements from one particular publisher where a full 80% of all sales are made at the special discount (49% of more). As you can clearly see, there are financial incentives for the publisher to exceed their traditional discounts. They may be giving their distributors a better break, which isn’t a bad thing for customer relations, but who’s really paying for this break? If the author’s royalty is cut in half when the discount shifts one point from 48% to 49%, it certainly isn’t the publisher. Authors may not have an opinion about to whom and what kind of discounts publishers should grant to nourish their businesses, but they better take a very active interest in how discounting impacts their royalties.

Another important area to consider is the whole area of special sales and sales outside the trade. A lot of different sales are covered here, far too many for me to explore in this handout. Let me just enumerate the issues that demand your attention.

First is the concept of “outside the book trade.” The concept here is that because the publisher is selling outside of his normal channels of distribution, some special effort or some unique customer is involved and the traditional royalties don’t apply. This is a very tricky area if amount received royalties are being paid. The “normal channels of distribution” have changed and are changing rapidly. I don’t believe this is a valid concept and I think publishing contracts need to be policed so that full royalty are paid on all these sales unless they exceed the normal discounts.

Other special sales include premium sales, which are bulk sales often to a single customer, often not for re-sale. They are also often non-returnable. Again a 5% of amount received royalty is paid. This is another very profitable area for publishers. Similarly there are mail order sales and direct response sales, which again command the 5% of amount received royalties. There are also publisher owned book clubs, which similarly pay a low royalty. We can debate the economics of these sales. From where I sit, the author is making a substantial, excessive contribution to their success by taking such a small royalty.

Finally, we have the whole new world of electronic publishing. This is an area that is still taking shape and there is no industry protocol. There are competing technologies and new players of various sorts. As I write this I can identify three main new formats that need to be considered. The three formats I see are print on demand copies, electronic copies for reading in a stand-alone device and electronic copies that are intended to be read over a personal computer. Print on demand copies may pose no change to the royalty system, since they can be treated just like a printed book. Or, perhaps a new royalty is needed here. Electronic versions are far more unprecedented from a royalty point of view. Established publishers are treating them like paper bound books for royalty purposes and paying “standard” royalties. Some start up electronic publishers are paying royalties of up to 50% of the monies received for each sale. Space forbids me from fully articulating my views here. Suffice it to say that we must be vigilant in making sure the new royalty protocols for electronic books are advantageous to authors.

There are two other areas I want to mention to round out the royalty issue. When we talk about royalties, we’re talking about money and when we’re talking about money we’re talking about the most basic business concept “cash flow.” This is not a hard concept to understand. You all innately understand it. It’s having the money you need when you need it. Not 3 months from now, not 6 months from now, NOW!

Cash flow is effected by when a publisher begins to pay royalties and how quickly they are actually paid out. Some publishers won’t pay royalties until they have at least 6 months of sale on a book, some don’t require that. Some account to authors within 60 days after the close of a royalty period, some enter into the 5th month after the close of a royalty period before they pay out. All these things do affect your income.

The final area I want to mention is returns and the reserve for returns. The publishers struggle with one very basic fact of their doing business: when they ship a book to an account, it is not a sale. It is essentially on consignment. Books are fully returnable, usually indefinitely. That means that if an account returns all 20 of the copies of our $20 book to the publisher, the publisher makes no money, and, in fact, has lost money on shipping it both ways, plus the loss of income from having no sale anyway. Because books are returnable, completely at the publisher’s expense, it has been traditionally very difficult to know exactly how a book has done. You may know where 80% of the copies are, or even 90%, but you certainly don’t know where 100% of the copies are. They may be sold or they may be returned one year or more after shipping. The reserve for returns, which literally means some “sold” copies are “reserved” or held back from being paid as royalties to the author because it’s not really known whether they have sold or not.

Returns dramatically add an element of complexity, uncertainty and controversy to royalty accounting. There have been abuses. When a royalty accountant looks at some basic numbers, it’s often a matter of interpretation to determine how many books have actually been sold. Because thousands of dollars of the publisher’s money is at stake, any royalty clerk who wants to keep their job is bound to be conservative. But that can savage author incomes. If a book is selling well, continues to be reprinted and averages a total return of 10% over the first year of sale, how can an industry average of a 30% reserve be justified? It can’t. But I’ve seen it. A few years back there was a legal settlement that revealed that one publisher was essentially keeping a permanent reserve of 30% on all their books, regardless of their real sales history.

There is an antidote to the issue of excessive reserves, though it’s difficult to apply. Authors should maintain accurate records and aggressively seek sales information on their books. Royalty statements must be carefully examined to catch mistakes and to track the actual sales experience of a book. I routinely write letters of query to publishers when I find anomalies in royalty statements or when a statement does not conform to my sense of how a book did. Two years back one such letter resulted in a check for $7,000. Stay on top of your royalty income and potential.

I hope this basic background information gives you a better sense of how important royalties are and how they operate. This will continue to be a dynamic, complex, fundamentally important area of author concern. Protect your income by advocating for practices that preserve and increase author royalty income where appropriate.