7 Profitability as a Challenge

To state that business profitability is an important issue for book distributors may seem trite or obvious. Yet, as we have seen, the profitability or even the very survival of the distribution sector in the book trade involves a balancing act requiring a sufficient critical mass to cover substantial unavoidable expenses, particularly in terms of warehousing capacities and the development and maintenance of computerized management tools. It is recognized that "Distribution and fulfillment remains a major cost component throughout the book trade."¹ These requirements explain the limited number of distributors and the high barriers to entry to the profession.

There is scant data on the financial performance of French-language book distributors. It is often believed that, considering the large financial flows that pass through the distributors, they experience gross revenue far higher than that of other book professionals. Yet, the available data shows a certain precariousness among distributors.

Marc Ménard first revealed in 2001 that distributors' performance for 1998-1999 showed a gross average profit margin of 22.5% and a net average profit margin of 2.4%, which remains low when compared with small American distributors, which recorded a gross margin profit of 33.3% and net of 3.6% for the same period.² Four years later, in 2002-2003, the gross profit margin of distributors (businesses whose main activity is the diffusion and distribution of books) increased to 24.6%, but the net profit margin fell to 1.5%.³ [translation] "At this level, it can even be described as inadequate. However, only three out of 23 businesses report a loss. Thus, distribution seems to be characterized by very narrow margins, but virtually assured profitability."⁴

A similar portrait emerged from the data published by the OCCQ for 2005-2006. It shows a relatively stable gross profit margin, 24.8%, but a continuation of the decline in net profit margin, which was then 1.4%.⁵ We also see an alarming drop in the number of businesses reporting a profit: in the group studied, 16 recorded a profit, and 8 reported a loss (compared to 3 in 2002-2003).

The most recent data available on book distributors' financial performance is for 2005-2006. It shows a strong increase in distributors' gross profit margins (increasing from 24.8% to 29.0%) as well as in their net profit margins (increasing from 1.4% to 5.7%). However, this improved performance may be only in a limited number of firms, since the number of businesses showing a loss has remained roughly the same, from eight businesses showing a deficit out of a total of 24 in 2004-2005 to seven out of 21 in 2005-2006.

Despite this somewhat sobering data, Marc Ménard noted in 2001 that distribution firms had high shareholders' equity (27.7%). The same is true for retained earnings (25.7%), which indicates good financial health. Similarly, [translation] "with debt ratios, we note few significant anomalies, with ratios showing rather low debt in both cases [Quebec and the US]."⁶ However, distributors must remain vigilant, particularly at a time when the role of each segment of the book trade is constantly at risk during a period of major technological change.

It is also essential, for any distributor that wishes to maintain its operations, to reach a critical size that allows it to cover its fixed costs and spread them over the largest possible number of titles, and possibly reduce its variable costs through increasing economies of scale, which results in decreased unit costs. The distributor must therefore be fully aware of the distribution of operating costs for each expense category.

The following two tables show the distribution of unit operating expenses for diffusers and distributors. We can obviously consider that in general these costs remain the same and are added together for diffuser/distributors. Although, in the light of the data available, as they specifically concern costs related to the management of new titles, they remain relevant in measuring the significance of each expense field.

Table 15. Diffusers' unit operating expenses, 2004-2005

	Operating Expenses by Activity	Operating Expenses by Group of Activities
Publisher relations	$0.08	$0.17
Distributor relations	$0.02
Bookseller relations	$0.07
Demand assessment	$0.03	$0.05
Supply assessment	$0.02
Soliciting orders	$0.27	$0.27
Accounting and IT	$0.04	$0.04
Promotion support	$0.70	$0.70
Returns management	$0.01	$0.05
Restocking management	$0.04
TOTAL	$1.28	$1.28

Source:   Étude sur la mise en marché des nouveautés par le système de l'office au Québec, Table de concertation interprofessionnelle du milieu du livre, 2007, p. 185.

 

Table 16. Distributors' unit operating expenses, 2004-2005

	Operating Expenses by Activity	Operating Expenses by Group of Activities
Publisher relations	$0.01	$0.08
Distributor relations	$0.02
Bookseller relations	$0.05
Soliciting orders	$0.09	$0.09
Receipt	$0.10	$1.05
Warehousing	$0.34
Deliveries preparation	$0.21
Shipping	$0.40
Accounting and IT	$0.09	$0.09
Promotion support	$0.08	$0.08
Returns management	$0.20	$0.33
Restocking management	$0.13
TOTAL	$1.72	$1.72

Source:   Étude sur la mise en marché des nouveautés par le système de l'office au Québec, Table de concertation interprofessionnelle du milieu du livre, 2007, p. 186

For diffusers (Table 15) — or for diffusion work carried out by diffuser/distributors — the main cost item is fixed costs: $0.70 per unit to support diffusion, that is, work done by representatives in retail trade networks. This expense represents a fixed cost, since each diffuser must have a team of representatives to serve retailers. Even though the size of this team normally depends on the scale of the diffuser's activities (the size of the catalogue being diffused), the fact remains that the number of titles diffused may increase without increasing promotion support costs. The diffuser must therefore attempt to reduce its costs elsewhere, either through an increase in the number of title diffused (however, certain costs will remain proportional to the number of titles), or by increasing efficiency (collecting orders, managing returns and restocking, assessing supply and demand, etc.).

From the distributors' side, the division between fixed costs and variable costs is even sharper. Warehousing alone represents 19.8% of operating expenses. It is essential for the distributor to maximize the use of its warehouses by accurately estimating the impact of excessive growth, which would increase its warehousing needs beyond its capacities. Most other expenses are related to the circulation of titles; increasing efficiency at all levels will allow the distributor to take full advantage of economies of scale. To cite only a few examples, we must consider that the unit costs of shipping packages to a retailer will be inversely proportional to the number of packages. The distributor must have a critical mass that will allow it to increase the number of packages per shipment in order to reduce unit shipping costs, ignoring the fact that increased fuel prices could have an substantial impact on shipping costs and therefore on distributors' revenue. Managing returns and restocking, which account for 19% of operating expenses, requires maximum efficiency, both in the computerized management of book movement — managing returns could be the source of many errors — and in logistics management.

While facilitating the work of diffuser/distributors, new technologies in the book trade also increase the complexity of some of their operations. As Turner-Riggs points out, "Aided by improved inventory systems, booksellers are managing inventory more carefully: placing smaller orders, re-ordering more frequently and as needed, monitoring sales performance more closely, and returning or not even carrying slow-moving stock."⁷ For the distributor, this results in an increase in the volume of books in circulation, and therefore in distribution operating costs.

The need for the distributor to improve its performance and increase its critical mass in order to take advantage of economies of scale necessarily means focussing on concentrating distribution activities into one increasingly large business. [translation] "Considering the constraints of critical size and the economies of scale inherent in this type of activity, any rationalization trend will obviously encourage business concentration."⁸

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