Wednesday, September 26, 2012

Your Slice of the Pie Part 1 (Gross and Net Profit Concepts in Creator Owned Deals)

A couple of weeks ago I introduced the different types of rights you could license as a creator and the different types of revenue you can get from a licensed work. In that post I hinted that there were specific concepts that impact how much you’re paid on any given deal. This post (and probably the next few posts) will go into more details about the economics of creator owned deals.
Types of Revenue
As a refresher from the earlier post, I need to point out that the various ways that creators are paid in creator owned deals. The three major ones are:
  • A royalty is a percentage that the artist earns for every finished unit that is sold. For example, an artist might receive 30% of every one of their comics that is sold to the public.
  • An advance is money that is paid before the work is finished. For example, a writer of a novel might receive money up for her novel based on the proposal not the finished product.
  • A minimum guarantee (MG) is money paid up before the work is finished, based on anticipated sales. For example, if a toy company plans to sell a new licensed toy for $10 and the creator gets 10% of that sale, then the creator gets $1 per unit sold. If the company expects to sell 100,000 units, then the MG that the artist gets for this deal is $100,000.
Definitions of Revenue
In general there are two ways that revenue is calculated for your royalty or minimum guarantee. There are gross profit and net profit.
  • Gross revenue or gross profits is the pure income that a product or service generates.
  • Net revenue or net profits is the income that a product or service minus certain expenses.
In the vast majority of cases, publishing deals are calculated by net revenue. The key for a creator is to know what is being included in the definition of net revenue and avoid situations where the expenses are always greater than the revenue generated.
Question: Let’s say you produced a comic called the Greatest Comic Ever (GCE for short). A publisher says they are willing to make a deal with you to publish GCE. They offer you 50% the wholesale profits as part of the deal. The comic sells for $2 wholesale. Is this a good deal?
Answer: That depends. The truth is there is no way for you to know if this is a good deal or not until you understand how the contract defines profit.
  • If the contract says you get 50% of the gross profits then you get $1 per book sold.
  • If the contract says you get 50% of the net profits then you have find out what is deducted from the gross to calculate the net.
The Net Revenue Trap
It is a fairly common business practice to deduct the cost of goods sold from the gross to determine the net. Cost of goods sold means whatever the publisher has to pay to produce and distribute your book. Those costs can include editing, printing, shipping, advertising, returns and a few other items. Most publishers track their costs in a document called a profit and loss sheet, so they know what percentage of every book goes into the cost of goods sold. Many publishers will list exactly what goes into the net calculations. This is helpful for figuring out where the money is going.
The problems occur when the creator has no idea what goes into the net calculations or the definition of net is so broad that it wipes out any potential profit for the creator. In the most unscrupulous contracts, the publisher will creatively expand the definition of net revenues to the point that the creator never gets any profit for his work even if it sells millions of copies. For example, if the wholesale price of GCE is $2 but the net deductions are $3 per book then the net profit is -$1 per book. That means you get $0 no matter how many copies the book.
Playing Your Position
It is unrealistic for an artist or creator to understand the nuances of licensing revenue, especially when they first enter the market. You need to focus on your craft and create the best property you can. You also need to have access to financial and legal professionals who can explain potential deals to you and allow you to make informed choices. That is why it pays to break down each contract and understand its implications before you move forward.
Next week, I’ll try to explain the concepts of recoupment and payment cycles to give you a better idea of when you can expect to get money from a deal.
Gamal Hennessy

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