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 BMR Associates, Inc.

Flashing Yellow: Midsize Publishers Face Backlist and Productivity Declines
A BMR Associates White Paper
October 2004

Participants in the attached Midsize Publishers' Survey will most likely use the results as a benchmark for their own performance. The survey has a wealth of data that can be used to compare the performance of each participating publisher against the hypothetical "average" or "typical" midsize publishing firm. We at BMR are interested in exploring not only such typical performance but also the best performances. What distinguishes the performance of the best publisher from the average publisher? What steps can publishers performing below par take to improve their bottom line? In this white paper, we present our preliminary answers to these questions.

First, in our analysis of the survey data, we established that there is a direct correlation between operating profit and return on assets (RONA), which we believe to be the best measurement of financial performance: the higher the operating profit of a publisher, in general, the higher the RONA. To simplify our presentation, we’re concentrating on establishing which factors improve operating profit, assuming that for a well managed publishing house, RONA will follow.

What drives profitability?
The Profit and Loss statement of a typical midsize publisher has four elements that affect profitability: revenues, cost of goods sold (COGS), other publishing income and operating expenses. The survey data indicates, contrary to conventional wisdom, that superior performance of most of these variables does not necessarily determine the level of profitability. Publishers with higher revenues did not necessarily have higher profit margins. Publishers with low COGS did not manage to translate this performance into higher operating profit levels. It is often said that in Trade publishing, the level of other pub income determines ultimately the profitability of the publisher. However, we did not find this correlation in the survey data.

The only 3 variables in our survey which showed a direct correlation with operating profit were:

  1. backlist performance (as a % of revenues)
  2. fixed operating expenses (as a % of revenues)
  3. revenue per staff member
Thus, (1) the higher the publisher’s backlist as a percentage of total revenues, the better the operating performance, (2) the lower the fixed operating expenses as a percentage of revenue, the bigger the bottom line and (3) the higher the revenue per staff member, the higher the publisher’s profit level (see below).

The latter two factors--fixed operating expenses and revenue per staff member--are related to each other. Increasing staff with no increase in revenue leads inevitably to lower revenue per staff member and, since staff compensation typically represents more than two-thirds of fixed expenses, higher fixed operating expenses as a percent of revenues. Thus, there are really only two independent variables, backlist performance and staffing levels, that we correlated to profitability.

Not much of a surprise
The relations discussed above should not come as much of a surprise. We’ve long known of the importance of the backlist in creating profits. In fact, since most new titles lose money during their first pub year, the ongoing profitability of the typical publishing house is mostly a function of backlist performance, and any deterioration in this performance has an immediate negative effect on the bottom line.

In addition, the name of the game in publishing--just as in every other industry-- is productivity. In publishing, one useful way of measuring productivity is by tracking title output per staff member. With all other factors remaining constant (i.e. price, variable costs and unit sales), the more titles that are produced per staff member, the higher the revenue --and subsequently--the profits.

So, to strengthen the bottom line, “Best of Class” publishers have in common a strong backlist and a staff that generates appreciably higher title output per staff member than the competition while maintaining minimum standards of revenue per title.

The Yellow Light
To see how midsize publishers are doing, we compared this year’s midsize publishers’ performance with a comparable survey we did almost 10 years ago (see exhibits 1 and 2), and uncovered the following trends:
  • Operating profit, although still at respectable levels, has taken a hit, going from an average of 15.4% to 11.0% of revenues
  • The main culprit seems to be operating expenses, increasing to 41.0% from 34.6%
  • Somewhat offsetting this deterioration is the drop in COGS and an increase in other pub income
  • Backlist sales have decreased from an average of 62% to 52% of total revenues
Operating expenses are up primarily because of the sizeable increase in average staffing levels (during this 10 year period, staffing levels increased 2.2 times faster than revenues). In addition, productivity took a hit as titles per staff member dropped from an average of 3.6 titles to 2.3 titles, although this deterioration was somewhat offset by an increase in revenue per new title (helped significantly by price increases).

While some factors contributing to the drop in COGS may be sustainable (e.g., technological innovation in the production process, and the shift of manufacturing overseas), others certainly are not (e.g., price increases substantially higher than inflation, soft conditions in the paper markets, increased retail discounting buffering consumers from rising list prices). The combination of increased operating expense levels and the drop in backlist performance is a development that needs to be addressed if present levels of operating profit are to be maintained. Given these troubling trends, we were surprised that midsize publishers are doing as well as they are.

What can be done to counter these trends?
During the past decade, midsize publishers have by and large successfully negotiated a rapidly changing market environment. Chains have been replacing small mall stores with “big boxes” carrying significantly larger inventories. This shift created gaps in shelf space that publishers rushed to fill--producing lots of new titles, raising backlist stock levels, and in the process creating a momentary mini boom. Now, however, at the store level there’s increasing pressure on inventories and a focus on front list/best sellers. On the publishing side, increased title output has weakened market segmentation, driving publishers into each other’s market niches, while requiring higher staffing levels.

To maintain or increase their bottom line in this environment, midsize publishers need to take, as a minimum, two steps:
  • Strengthen their backlist performance
  • Increase their productivity

Strengthening backlist performance
Sales of backlist titles will continue to suffer as long as chains continue to gain market share while insisting on carrying selective new list titles/ best sellers and aggressively monitoring backlist inventory turn. To counter this trend, many publishers are attempting to lessen their dependence on traditional retailers and wholesalers by exploring new distribution channels--including going directly to consumers--or diversifying their product lines. These channel programs are being pursued by both in-house initiatives as well as the purchase of new expertise though selective acquisitions.

Internet booksellers--whether Amazon, publishers’ own websites, or other outlets--have created a major opportunity to support sales of backlist titles even with minimal support from chain retailers. However, this opportunity can only be realized if consumer demand can be created and subsequently directed to the appropriate suppliers. Many smaller niche publishers have successfully capitalized on this opportunity (particularly in the reference and how-to areas) because consumers search for information on particular topics using search engines such as Google or Amazon. Moreover, for general interest publishers, replacing the opportunistic sales achieved through bookstore browsing may be accomplished in the near future via such recently introduced internet services as Google Print and Amazon’s Search Inside, both of which let shoppers sample from more than 100,000 titles as an enticement to make a purchase.

In addition, we know of a number of publishers who are attempting to strengthen their backlist by finding titles that can serve as the basis for line extensions, exploring possible author or character branding, recycling former strong but possibly dated titles, and otherwise “mining” their backlists.

Enhancing productivity
There are also steps that can be taken to enhance productivity, primarily through headcount control. As a first step, publishers need to identify where possible excessive staff build-up has occurred. Our survey results provide some clues:
  • Production as well as Art and Design during the past 10 years have seen a build-up at a rate 300% times faster than revenue.
  • Staffing levels in Sales and Marketing have increased 60% faster than revenues.
  • Administration staffing, supposedly a semi-fixed expense, has increased at a rate of 34% faster than revenues.
Some of these increases are due to the creation of entirely new jobs (e.g. webmaster, network administrator, sales manager-specialty, etc). Other new positions are the results of organizational growth and the creation of new managerial levels within publishing houses, particularly in sales and marketing as well as in administration. In some functions, there has been a substantial increase in staffing, such as in design where eight designers now do the job done by two a decade ago.

The question facing midsize publishers is whether these various staff additions are generating the incremental gross margins necessary to maintain acceptable operating profits. For example, just because desktop publishing expertise can be readily hired, does not mean large in-house staffs in this area are the optimum solution.

Possible next steps
As we indicated earlier, we believe that, in general, midsize publishers continue to generate adequate profit levels. They have the resources and structure missing in most small niche publishers, yet are mostly unencumbered with the bureaucracy of large houses.

The best strategy for midsize publishers at this point is to step back and take the time to evaluate what is working, and what needs to be revised or even eliminated. As a guide for such a review, we suggest that midsize publishers begin by asking themselves the series of questions on the next page. By methodically reviewing their present publishing programs to identify opportunities for strengthening their backlist and enhancing overall productivity, midsize publishers will be able to maintain their profitability in the coming years.

Attachment 1
Increased Profitability through Strengthening the Backlist and Enhancing Productivity
  1. Strengthening the Backlist:
    1. What has happened to our backlist performance over the past decade?
      1. If there’s been a deterioration, what steps have we taken to reverse this decline and are they still effective?
      2. What else can we do to reverse the decline:
        • More effective online marketing?
        • Character or author branding?
        • Methodical backlist “mining”?
        • Diversification of channels/ of product lines (e.g. more aggressive efforts to sell into channels that could support backlist on certain subjects)?
      3. How aggressive are we at acquiring titles that capitalize on short-term trends or fads which, by nature, have a shorter shelf life? Are there longer-term trends that we can instead pursue effectively?
      4. How can our sales force and marketing department team up with retailers to optimize backlist stock levels and sell through?
    2. Do we have the in-house expertise to launch such new programs or do we need to buy outside expertise?
  2. Increasing Productivity
    1. What has happened to our overall staffing levels, function by function, in recent years compared to overall sales growth? Are there areas that have grown substantially faster than revenues?
    2. If so, have the resultant incremental expenses been covered by increased gross margin contributions?
    3. Are there performance metrics-- other than Gross Margin-- that we are using to evaluate the effectiveness of various publishing programs? If so, do they continue to be appropriate given current strategies and market conditions?
    4. Do we need in-house staff for all our operating needs or can we cost- effectively buy outside expertise?
    5. As a result of the above analysis, what existing programs need to be strengthened, which are candidates for elimination, what are new approaches to be further examined?
    6. Who’ll be responsible for following up?

Exhibit 1

Exhibit 2

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