3.0 Terms of Trade

The following chapter provides an overview of how—and how much—distributors, wholesalers, and sales agencies charge for their services. We also explore some of the major determinants of distribution cost from the publisher's point of view, including the effect of returns and the relationship between sales volume and cost of distribution.

3.1        A Brief Introduction to the Canadian Book Trade

To recap, the major participants in book distribution in Canada's English-language market are as follows.

Distributors provide fulfillment and warehousing services to the publisher for a fee, have exclusive territorial rights to the publishing lines that they represent, and sell to all types of customers, including wholesale accounts.

Wholesalers buy selected titles from many publishers and distributors on a non-exclusive basis and then re-sell to retail and institutional accounts.

Sales agencies are national teams of sales representatives, who may be formally or informally associated with one or more distributors. These teams provide sales representation for a range of publisher-clients and are paid on a commission basis.

The Book Retail Sector in Canada provides the following observations with respect to terms of trade in the supply chain.

  1. Unlike in other retail sectors, in the book trade, the manufacturer (the publisher) establishes the list price1 for each book.
  2. Books are sold to wholesalers and retailers at a “trade discount” from the list price, which effectively represents the margin for a wholesale or retail account on each copy sold. For example, if a publisher sells a book with a list price of $20 at a 50% discount, the publisher will receive $10 for the book and the retailer will realize a $10 margin, presuming the book is sold for the full list price 2.
  3. Contrary again to the trading practice in many retail sectors, all books sold through traditional bookstores are sold fully returnable; booksellers can return books to distributors or publishers if they find they are unable to sell them.
  4. Partly because of established returns practice, most publishers accept a payable period of 90–120 days on bookstore receivables. This is a lengthy period compared to many industries, and one during which the publisher bears responsibility for underwriting all cash requirements of editorial, design, production, and marketing. If a retail account is itself pressed financially, this payable period can stretch beyond the 120-day mark and/or the publisher may receive a shipment of returns, as opposed to an invoice payment, to draw down accounts payable for the current period.

With this as a backdrop, this chapter will explore common terms of trade for book distribution. The discussion here will be necessarily general for the following reasons:

  • These costs may be structured in various ways through the negotiations between any two trading partners (and the trading terms that these reflect).
  • Out of respect for the confidential discussions carried out during this study we cannot disclose the terms of individual distributors or other firms.

3.2       Sales and Distribution Costs

For purposes of illustration, let's assume for the moment the following scenario:

  • A publisher with annual shipped (or gross) sales of $500,000
  • Returns are 25% of shipped sales
  • Sales are made principally through traditional book retail channels
  • The publishing house relies on a commissioned sales team for its sales representation

At current market rates, this publisher's distribution costs will break down as follows:

  • Basic fulfillment: 15% of shipped sales
  • Returns process: 3% of returns
  • Sales commission: 10% of net sales

These rates lead in turn to the following calculation of sales and distribution commissions:

List 1. Calculating sales and distribution commissions in relation to net sales.

  • Shipped sales: $500,000
  • Returns at 25%: $125,000
  • Net sales: $375,000

Sales and Distribution Costs

  • Basic fulfillment at 15% of shipped sales: $75,000
  • Returns processing at 3% of returns: $3,750
  • Sales commissions at 10% of net: $37,500

Total Commissions and Fees: $116,250

  • Distribution costs as a percentage of net: 21%
  • Sales and distribution as a percentage of net: 31%

In practice, the distributor may charge a combined rate for basic fulfillment that factors in an estimate for returns handling, or they may bill returns as a separate item (as in our example above) that reflects actual returns rates.

The difference in accounting for this cost may simply be a matter of approach for a given distributor, or it may reflect the negotiated terms (and the accommodation re: returns risk in particular) between a given publisher and its distributor. Either way, it has become more common in recent years for book distributors to incorporate a charge for returns handling.

There have been other notable changes in distribution terms in recent years as well, particularly in the following areas:

  1. Rising freight charges. Historically, book retailers have been responsible for shipping costs from the distributor. In recent years, however, it has become increasingly common for distributors to pay some or all of the freight costs of shipping orders to retail accounts, and to high-volume accounts in particular. These costs are now commonly passed on to the distributed publisher as an additional charge. These costs are hard to measure with certainty, but the examples we reviewed during the study suggest that they range from 2 to 6% of net sales, depending on the publisher's sales volume.

  2. The introduction of excess inventory charges.In previous years, distributors would normally warehouse virtually all of a publisher's inventory. Today, it is more common for a distributor to limit the volume of inventory that can be warehoused under a basic distribution agreement. Typically, this stock limit is equivalent to 6–12 months of sales, either by publisher or by title, and the publisher is charged a carrying fee on any inventory above this limit. These costs are again difficult to estimate as a percentage of sales as they may be charged by the distributor on a pallet, carton, or unit basis—with costs of $.01–$.03 per unit not uncommon.

    This type of charge is a perfectly rational step for any distributor given the focus throughout the supply chain on reducing unnecessary cost and inefficiency at every turn. However, overstock charges also have a number of significant implications for publishers. First, they represent a new, additional cost passed to publishers. Second, they compel publishers to manage warehouse inventories much more actively, meaning that:

    1. this becomes an additional demand on management time within the publishing house;

    2. the publisher may have to accept lower print runs (and so diminishing economies of scale) on new titles and reprints; and

    3. the publisher may have to incur additional costs for separate warehouse space and/or more frequent re-supply shipments to the distributor.

With both these additional costs and the earlier estimates in mind, we can imagine that a comprehensive calculation of sales and distribution costs for a typical publisher can easily approach 30–35% of net annual sales.

3.2.1    The Effect of Returns on Distribution Cost

The practice of selling to retail accounts on a returnable basis persists in the book trade under the following rationale: each book is, at least to some extent, a unique product; even a small general bookstore will carry roughly 20,000 titles (a daunting buying and inventory management proposition for any retailer), and given the oversupply of books there is considerable pressure on retailers to buy aggressively. Seen in this light, returns practices in the traditional book retail channel can be understood as an accommodation between publishers and booksellers, and as an attempt to establish an equitable distribution of inventory risk, particularly with respect to new titles, across the supply chain.

There are different ideas about what constitutes an ideal rate of returns in the Canadian book trade. However, many publishers believe a certain level of returns is a necessary cost of doing business, and that otherwise it would be impossible to get retailers to take the same degree of risk in stocking new titles.

That said, the problems of rising returns levels are well documented. When returns get too high, publishers wind up with falling receivables, burgeoning inventories, and a cash flow crunch. Using the example we explored above, the following table illustrates another effect of rising returns: an increase in distribution costs.

As the table indicates, distribution costs in this example rise between 3 to 4% of net sales for every 10% increase in returns levels.

Table 2. The effect of rising returns on distribution costs.

 

Distributor Rates

20% Returns

Fees

30% Returns

Fees

40% Returns

Fees

Shipped

15.0%

$500,000

$75,000

$500,000

$75,000

$500,000

$75,000

Returns

3.0%

$100,000

$3,000

$150,000

$4,500

$200,000

$6,000

Net

 

$400,000

$78,000

$350,000

$79,500

$300,000

$81,000

Effective distribution cost as a
percentage of net sales:

19.5%

 

22.7%

 

27.0%

3.2.2    The Effect of Sales Volume on Distribution Cost

As noted earlier, there is an inverse relationship between distribution cost and a publisher's sales volume. Distribution is more expensive, as a percentage of sales, for smaller firms and less so for larger firms. This is because the costs of serving a lower-volume client are spread over a smaller number of orders and units shipped whereas the larger volumes and order sizes of larger clients can be processed and shipped more efficiently.

Table 3 illustrates this phenomenon using the actual sales and distribution costs for a sample of English-language literary presses and a standard 30% returns level throughout.

Table 3. The effect of sales volumes on distribution costs.

Annual Shipped Sales

Effective distribution cost (percentage of gross, no returns)

Effective distribution cost (percentage of gross, 30% returns)

$90,000

18.4%

19.4%

$60,000

18.9%

19.9%

$30,000

22%

23%

$10,000

27.8%

28.8%

The significance of this cost-volume relationship is two-fold:

  1. It means that the distribution marketplace rewards size. Larger players accumulate efficiencies that strengthen their competitive position. Smaller firms face additional margin pressure arising from relatively higher distribution costs.
  2. It also means that it can be challenging for smaller firms to secure effective sales and distribution arrangements. These publishers will be more expensive to serve, and so less profitable, than will higher-volume clients. Even if, as is generally the case, the distributor passes these higher costs to client-publisher in the form of higher distribution fees, the overall profit contribution of the publisher's account is still limited due to its small sales volume. As a result, smaller firms are less attractive to many distributors and have fewer viable distribution choices within the supply chain.

This reflects as well the significance of distribution collectives, such as LitDistCo, for small publishers in Canada's English-language market, and illustrates that, absent such a mechanism, there would be few sustainable distribution options for such firms. In aggregating their individual sales through a distribution collective, a group of small publishing firms can effectively operate at a more cost-effective sales volume.

3.2.3    The Distributor's Contribution to Publisher Cash Flow

The distributor's payment schedule is an additional formative aspect of trading practice, and often one of the great advantages of contracting for distribution services. Distribution contracts specify a payable period—typically between 90 and 120 days—in which the distributor will transfer payment for the publisher's current sales.

This usually includes a holdback to reflect a forecasted amount of returns. Even so, the distributor's schedule of payments represents a relatively predictable and stable revenue stream for the publisher—relative, that is, to the speed with which a publisher, especially a smaller firm, could expect to collect receivables directly from its retail accounts.

3.3       Wholesale Terms

In comparison to typical fee structures for sales and distribution commissions, wholesale terms are relatively straightforward. Generally speaking, wholesalers buy from publishers or distributors at a 50% discount from the list price and then sell on to their customer accounts at a 40% discount. In other words, the wholesaler's operations and profitability have to be supported by the 10% margin between the wholesale and retail prices.

While the terms in the wholesale channel are straightforward, the competitive environment for wholesalers is less so. In the intensely competitive book marketplace, retail accounts are compelled to buy at the best price in order to boost their own margins, and this creates additional pressure for them to cut out the middleman—the wholesaler—and buy directly from the publisher or distributor. As noted earlier, publishers' discounts to high-volume retail have crept up above 45% in recent years. Therefore, an increasing number of traditional and non-traditional retail accounts can recover several additional margin points by buying directly from the publisher. This pattern can push a wholesaler out of an account, and at the least, creates what one of our respondents described as “a constant grind on price”—a steady pressure for wholesalers to move to higher discounts.

At the same time, costs are rising for wholesalers, and for that matter, for all other members of the supply chain. Freight costs go up each year (a pattern that could be accelerated by the recent dramatic increases in oil prices), and labour markets are tight in many parts of the country.

Most wholesalers respond to these pressures by offering a range of specialized, value-added services targeted to the requirements of their key sales channels. The challenge is to deliver services that offer real value to the customer account, with effective market access/inventory management for the benefit of the publisher-vendor account, and all at a sustainable cost and as efficiently as possible. 

Notes


1 The list price (the established retail price of the book) is determined by the publisher and printed on the cover of the book. The list price provides a fixed reference point for the calculation of trade discounts extended by publishers to booksellers, price discounts extended by booksellers to consumers, and also author royalties. Prices may be listed in various currencies for imported titles or for Canadian books sold outside the country, in which case the currency of the nation where the book was originally published often provides the basis for a foreign-currency equivalent price. Publishers generally establish foreign currency prices (or Canadian dollar prices for imported titles) up to a year in advance based on anticipated exchange rates. For books sold both in Canada and the US, both the Canadian and American list prices are typically printed on the cover.

2 Historically, these discounts have been in the range of 50% for wholesalers and 40–44% for retail. Over the past ten years, however, retail discounts have crept upward (particularly for high-volume accounts) and are now more commonly in the 44–48% range.

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