Tuesday, May 31, 2011

Contract Red Flag: Net Profit Royalty Clauses

Posted by Victoria Strauss for Writer Beware

In the comments thread of a previous post, a reader asked whether there is a difference between royalties paid on net income and royalties paid on net profit. There most definitely is a difference--and, depending on the circumstances, royalties paid on net profit is a major red flag.

LIST PRICE

The ideal royalty is paid on list or cover price--the actual retail price of the book. So if your list price is $20, and your royalty is 10%, you'll get $2 for every book sold. For big trade publishers, including larger independents, royalties paid on list price is standard for domestic sales.

NET INCOME

Smaller publishers, on the other hand, are more likely to pay royalties on net income or net sales proceeds--the money they actually receive for the book (list price less any discounts or commissions charged by retailers, wholesalers, and/or distributors). This means your royalties will vary, depending on where your book is sold--but they will vary in predictable ways. Again using a $20 book and a 10% royalty as an example, sales at full list price from the publisher's website would generate a royalty of $2; sales to physical retailers at a discount of 40% would generate a royalty of $1.20; and sales to wholesalers at a discount of 50% would generate a royalty of $1.

Royalties paid on net income aren't as desirable as royalties paid on list price--obviously--but they are common in the small press world, and don't necessarily ring warning bells. However, you do need to carefully parse the contract language, and understand what you're signing. For instance, here's a net income royalty clause that could look like a list price clause if you don't read carefully:
"The Publisher shall pay the Author or his duly authorized representatives...a royalty of seventeen percent (17%) of the retail price thereof on the Work, less returns, less discounts, and less distribution fees."
Always look for a precise definition of the amount of money on which the publisher will be calculating your royalties--for example:
"The Author's royalty will be 20% of the Publisher's actual cash receipts (the list price of the book less any discounts due to vendors.)"
Beware of contracts that use terms like "net income" or "publisher's proceeds" or "sales price" or "gross income" without clearly stating what they mean. Another thing to watch for: some publishers deduct not just discounts, but taxes, transaction fees, and/or shipping and handling fees--all of which further reduce the amount of money on which your royalties are calculated.

NET PROFIT

Royalties paid on net profit are an entirely different animal. In this case, the publisher pays on whatever is left after a menu of additional expenses--manufacturing, publicity, warehousing, even editing--have been subtracted. This can substantially deplete the amount on which your royalties are calculated. For instance, for that $20 book with a 10% royalty, the publisher's net income (let's say $10, based on a 50% discount) might be further reduced by deducting shipping and handling (say $2) and manufacturing costs (say $4). That would leave just $4 available for royalty calculations, for a royalty of $0.40.

Publishers that pay on net profit often pay higher royalty percentages than average, and if the percentage is large enough--50% or more--it may offset the deductions. But be sure you know exactly what those deductions are. Deductions should be precisely defined, so that the publisher can't add expenses at will (no vague "associated costs", and if "book production costs" will be deducted, do those include editing and other fixed expenses as well as printing?), and the publisher should be willing to give you at least an estimate of the actual amounts involved--average manufacturing costs, for instance.

Be aware also that publishers that pay on net profit rarely use that actual term, so you need to be on your guard for telltale language. Below are examples of net profit royalty clauses, taken from contracts in Writer Beware's files, with the relevant terminology bolded.
"For each Edition of the Work when sold at discounts of FORTY PERCENT (40%) to SIXTY PERCENT (60%) of list price, the Publisher shall credit the Author's account with a royalty equal to TWENTY-FIVE PERCENT (25%) of the amount determined by deducting all manufacturing costs of the copies so sold from the amount received by the Publisher, net of returns."
"The Publisher shall pay the Author twenty percent (20%) of the wholesale price received for every copy of the Work sold in Hardcover, Trade Paperback, or Mass Market Paperback edition, less costs of printing, returns, and other associated warehousing costs."
"Royalties...shall be calculated on the basis of monies paid to and received by Publisher, less any transaction fees (e.g. Paypal), shipping & handling fees, sales or other taxes, import or export duties, commissions or other charges payable to third parties, and less editing fees of fourteen (14%) of the Publisher's retail price of the work."
"[Publisher} will pay the author 25 percent of net revenues from the sale of The Work. Net revenue is defined as the total receipts less book production costs."
"The Publishers shall pay to the Author the following royalties...On all copies of the Work sold through bookshops...ten percent (10%) of the Publishers' Net Receipts less bookseller's discounts and manufacturing costs. On all copies sold through the Publishers' website: ten percent (10%) of the Publishers' Net Receipts less maufacturing and distribution costs." [Net Receipts has previously been defined as "all amounts received by the Publishers less production costs & digital storage with the printers."]
"Royalties are calculated as a percentage of the Net Retail Price (discount rate minus printing costs.)"
This last one is my favorite, not just for all the stuff that gets deducted, but because it's so unnecessarily complicated:
"[Publisher] shall pay Author a royalty of 25% (twenty-five percent) of Net Work Revenues on sales of the Work during the Term of this Agreement.
a) Net Work Revenues means Gross Work Revenues after the deduction of Work Expenses; Gross Work Revenues means all amounts actually received by [Publisher] for its own account from the exploitation of the Work that are identifiably attributable to the Work as a standalone work;
b) Work Expenses means all reasonable amounts actually incurred by [Publisher] in connection with the exercise of the Granted Rights that are identifiably attributable to the Work as a standalone work, to a maximum amount equal to 25% of Gross Work Revenues. By way of example only, Work Expenses include the costs of creating versions and copies of the Work (including, without limitation, manufacturing costs related to the Work and the costs of manufacturing ancillary products), shipping costs, advertising expenses related solely to the Work, and charitable contributions derived from sales of the Work, but do not include expenses related to the general overhead costs of Publisher."

16 comments:

Krista D. Ball said...

Thanks Victoria.

One of my contracts outlines exactly what "net" includes. However, I've seen contracts where "net" was undefined and was left open to cover anything...including the stamped envelop to tell you that you have no royalties this month...

fantasydreamer12 said...

Excellent! This is very helpful info. I've always wondered about how book royalties are deducted.

Rogue Mutt said...

That's why in Hollywood you always get your percentage off the gross.

Livia said...

This is scary. It's not obvious to me what the difference is between "list price of the book less any discounts due to vendors" and "(discount rate minus printing costs." What makes the second one tricky and the first one not?

Rose said...

Thanks, Victoria, much appreciated. I have a contract that says, "The above royalties shall be computed on actual net receipts." No discussion of what net receipts means. I assume that's a poor contract and something I should address in future ones?

Victoria Strauss said...

Livia, what makes it tricky is that extra stuff is being deducted from the amount on which your royalties are calculated. Paying on net profit is not standard publishing practice.

With "list price less discounts," royalties are paid based on what the publisher actually gets from vendors. For a book that retails at $20, and is bought by a vendor at a 50% discount, the publisher would receive $10. That would be the amount on which your royalty percentage was calculated. Say your royalty is 10%; you'd get $1.

With "list price less discounts less printing costs," the publisher gets that same $10 from the vendor--but then deducts from that the cost of printing the book. Let's say printing cost is $4. So the publisher would get $10, subtract $4, which leaves $6. Your royalty would be calculated on that. Assuming again that your royalty is 10%, you'd get $0.60.

40 cents doesn't seem like a big difference--and if you only sell a handful of copies, the difference probably wouldn't be a big deal. But for greater sales, it can have a significant impact. As I noted in my post, some publishers that pay net profit royalties also pay large royalty percentages, and that may even things out. But at smaller royalty percentages, paying on net profit can really reduce what a writer is paid, especially if the publisher uses vague contract language to enable it to deduct whatever it feels like.

Victoria Strauss said...

I should say that, like much nonstandard practice, paying on net profit is not terribly common, and seems mostly to be confined to the small press and micropress world. If you stick to larger, more established publishers, you're much less likely to encounter it--and if you're familiar with the terminology, you'll be much more likely to spot it where it occurs.

Victoria Strauss said...

Rose, yes, that is something to address in future contracts--you do need to know exactly what the publisher means by "actual net receipts" (or whatever terminology they use) if the meaning isn't clear from the wording of the contract itself.

Ideal would be getting the publisher to write the definition into the contract, but if it won't do that, an email exchange where it clarifies the meaning should do. That gives you a "paper trail" if there are ever any problems.

Ghost Girl (aka, Mary Ann) said...

Excellent clarification, Victoria. Thanks a bunch!

Jay said...

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A Valentine Joseph said...

Thanks a bunch for this... It is very helpful

Julian Griffith said...

Hm. Mine looks fairly reasonable by these standards: 50% of cover price on ebooks through publisher's website, 25% of cover price for print, and 40/20 for ebook/paperback for third party sites, cover price less distribution fees. And when the book's net profits have equaled the production costs, the royalty percentage increases, and they give you an itemized list of production costs at the time of release.

Small press, not perfect, but at least fairly transparent & the percentages are good?

Anonymous said...

I'm holding a contract that defines net receipts as this: "amounts actually received by the publishers from sales of the work... less allowances for returns, credits and bad debts, any and all commissions (including without limitation sales agent and distributor commissions) and any sales taxes and, in the case of third party licenses, less any administration costs, withholding or local tax required by law and any bank transfer fees as applicable."

Seems like it's describing net profits, based on your comments above, no? Does this look like a bad deal?

Victoria Strauss said...

Anonymous 10/22/13,

I'd still define that clause as "net income." The publisher is deducting taxes, returns, etc. in addition to wholesaler/retailer discounts and commissions (commissions being whatever chunk of sales is claimed by distributors like Smashwords), but the deductions are still limited to costs relating to the sale of the book to the public. "Net profit," on the other hand, deducts not just costs relating to sales, but costs relating to production and/or marketing.

Anonymous said...

Victoria, thanks for the answer. I'd like to clarify that this is a major publisher with its own sales force, not a small one selling through Smashwords. It offered me a shockingly bad contract, one that I may very well send you; you probably won't believe it either (considering who the publisher is).

Some production costs are indeed part of the contract. And the publisher was evasive, disingenuous,and deflected when questioned about it.

Victoria Strauss said...

Please do send me the contract, Anonymous. This definitely sounds like something I should know about. All information and documentation shared with Writer Beware is held in confidence. beware [at] sfwa.org. Thanks!