How to use this Page

By Edward Zelinsky

Public pension plans should not invest in private equity deals. These deals lack both transparency and the discipline of market forces. Private equity investments allow elected officials to assume unrealistically high rates of return for public pension plans and to make correspondingly low contributions to such plans. This is a recipe for inadequately funded pensions, an outcome good for neither public employees nor taxpayers.

Ben Bernanke. Source: United States Federal Reserve.

In this low return environment, public defined benefit pension plans generally assume that they can earn annual investment returns in the vicinity of 8%. Such aggressive return assumptions allow governors and legislators to authorize smaller tax-financed contributions to such public pensions on the theory that anticipated investment gains will fund the retirement benefits promised to public employees.

A primary defense of this practice is that plans’ assumptions should reflect long-term experience. From this vantage, the current low interest rate environment is an historic anomaly. For the long run, the argument goes, public pension plans will earn higher returns.

Whatever the theoretical merits of this approach, it is troubling in practice, an invitation to push into the future the problem of inadequately funded public pension plans. That problem exists today and needs to be confronted today, as the Baby Boomer cohort retires in unprecedented numbers and places corresponding demands on public and private retirement plans.

A second defense of high assumed rates of return is that public pension plans can earn aggressive gains through so-called “alternative” investments such as private equity partnerships. Publicity about Mitt Romney’s IRA has focused attention on the often lucrative results obtained by at least some private equity investors. Many public pension plans have effectively become addicted to private equity deals and their promises of outsized investment returns.

It is, however, doubtful that these promised returns are generally obtained by the private equity industry or that such returns are obtained on the scale sought by public pension plans. Private equity is, by definition, private. Much of the good news we hear about this industry comes from the industry itself. Since there are no active markets for these investments, investors in private equity deals are ultimately dependent upon valuations by the sponsors of these deals.

In a recent paper, Professor K.J. Martijn Cremers of the Yale School of Management concluded that private equity investors have in the last 10 years done no better than investors in the stock market. Others, such as Professor Steven Kaplan of th

Yesterday I talked about how returns can be not so good for the publisher (any publisher, not just me). Today we'll talk about how returns are not always so good for the bookseller either.

Don't get me wrong. There are some serious pros from a bookseller's perspective for keeping the returns model. And since in my other line of work I am a bookseller, I can tell you what those are. (And I can even sympathize and agree with them.)

1. Reduction of Risk -- this is a biggie, and it's going to be a hard one to convince booksellers to give up. When a bookseller orders a book knowing that he/she will be able to send back unsold copies, it pretty much eliminates the risk. Yes, there are costs for the bookseller to doing returns (I'll talk about them below), but in general they vastly outweigh the risks of being left with stock you just can't get rid of (even with sales).
2. Allows Optimism -- Say you're a bookseller who has read the ARC of a book and doesn't particularly like it. You think it might do okay at your store, so you order a copy or two for the shelf. Then the publisher's sales rep comes in all bubbly about that book. You may not like it but they are expecting x number of star reviews and they're going to do y number of marketing things and be on z number of talk shows, and in the end the rep convinces you to take a 12 book dump. Because of your reduced risk above you can buy this dump even if you don't think that book will do all that great. And if your gut turns out to be right, you just return those extra 10 books back. (All right, this pretty much has never happened at our store because I work for some astute buyers. However if there is a doubt in their mind, they do err on the side of over rather than under ordering because they know they can return.)
3. Allows Events to Have Enough Books -- And this is the only part of the returns system where the bookseller and the publisher in me agree. Books ordered specifically for an event should be returnable. Period. You never, ever want an event with too few books. I've worked events like that as both a bookseller and once as a publisher, and it is just a nightmare for all involved. You end up with missed sales, unhappy customers, unhappy authors, and stressed out bookstore and publisher staff. In this case returning the books is worth any loss on both sides.
4. Take Orders without Prepayment -- Right now you can place an order at most bookstores for a book they don't have in stock without prepaying as long as the book is returnable. Why can't you do this for nonreturnable books? Because a majority of books that are special ordered for customers are never picked up or are rejected when the book arrives. Of course, I have a pretty simple solution for that dilemma, but it would probably reduce the number of people placing special orders to those who actually want the book.
   

1. Shipping costs -- most bookstores pay their own shipping to return books. (I don't know about B&N. When I worked there I was not in receiving but on the floor. I pulled returns, but didn't box them up.) Shipping books ain't cheap.
2. Labor costs -- employees have to physically get the books off the shelf to return. At B&N we were expected to spend a minimum of 25% of our week "zoning" which meant going through bookshelves with a scanner listening for the little ding that told us a book was marked for return. We were also supposed to be alphabetizing and making sure the book belonged on that shelf, but nearly all of us just ended up in a zone that glazed over and listened for the return. At the indie I'm at, we have an employee solely dedicated to returns.
3. Loss of profit -- This is the biggest drawback for a bookstore especially the independents. (Barnes & Noble buys differently.
   0 Comments on Returns from the (or my) Perspective as a Bookseller as of 1/1/1900
   Add a Comment

If I was a paranoid person, I might think Barnes & Noble had it out for me. Now in reality, the powers that be at B&N haven't the faintest idea who I am. I am just one or two pages in the NBN catalog -- pretty much indistinguishable from every other publisher in there. And from Barnes & Noble's perspective, they actually probably like me. After all, for the two books I put out in 2010 (Book of Maps & The Necropolis), they purchased nearly the entire print run of each. (In fact for Book of Maps, they originally ordered 3x the print run before I pointed out to NBN how unrealistic that was.) And in any other industry, that would be it. I'd pay my authors their royalties and take my remaining money to the bank.

But this is the book industry, and unlike literally every other industry on the planet, we allow returns.

And this is why I become paranoid about Barnes & Noble's intentions. Because although they bought nearly the whole print run of Book 3 of both The Sacred Books and the The Forgotten Worlds Series, they didn't buy any of 1 or 2. You can probably guess how many casual shoppers randomly buy the third book in a series. And since I know my sales numbers for book 2 (a reasonable forecast of sales for book 3), I can tell returns are going to be somewhere in the 85% range. If I'm lucky.

Large scale returns for me are, to put it bluntly, devastating. It would be cheaper for me to print books and toss them directly into a recycle bin or a bonfire or use them to build furniture than it is for me to sell a book and have it returned. Let's do the math:

Say I have a book that retails for $1.00.

That book sells to a bookstore at a discount that we'll say is 50%. (Discounts to people who buy from NBN vary from 47-60%, but 50 is the easiest number to use.) From there it goes to the store shelves. Yeah! On my end I've gotten $0.50. My distributor takes its cut of (this is not the actual number since I legally can't disclose that but an approximate that again is easier to do the math with) of 20% or $0.10 and my author (again this varies but we'll average for ease) gets 10% of that $0.50 or $0.05. I'm now down to $0.35 which after factoring in the cost of printing the book drops to $0.10. I then spend half of that in marketing, and finally I'm left with 5 cents.

(You may have noticed that the author and publisher make the same amount. This is intentional. Authors are considered an equal partner in each book.)

So far everything is looking good for all involved. The bookstore is getting to sell at a 100% markup, the distributor is getting its cut for its hard working sales force, and the author and I are equally sharing the profits. Great.

But then 90 days pass and the bookstore can return any unsold stock. The bookstore employee pulls the book from the shelf and returns it to NBN. Since they get a full credit, I have to give the bookstore back $0.50 for that book. But wait! I only actually got $0.35 for that book. I had to give $0.10 to my distributor and $0.05 to my author. Well, my author isn't going to get to keep that money. We're partners so if the book doesn't sell, neither of us gets anything. That royalty gets credited back to me. (However, if a royalty check has been paid, the author does not send me money back. That check just acts like another advance that has to be earned out. An author never, ever sends me money except for books that he/she buys directly from me.) However, my distributor keeps the money I paid it.

So, to make a long story short, instead of making 5 cents on that book, I have lost 10. If we were talking

So, I had planned on doing a long detailed rant on why returns were killing publishers (specifically me) that was filled with glorious numbers and might help authors and aspiring authors better understand a less well-known aspect of the book business. However, before I started, I ran across this charming post about Bookseller Math. I decided to put off the returns post until tomorrow and instead write a companion post called Publisher Math. I present it now:

Publisher Math
By Me

Like booksellers, publishers are inundated by numbers all day long -- and I'm not talking about sales or returns figures or that number on the bottom of a P&L that determines whether or not a book should be published. (And yes, all books no matter how brilliant, all come down to that single number in the end.) I mean that we also have our own mathematical way of looking at the world. If life were a university, then all the people in the publishing field would have to take a year long comprehensive course entitled Publishers' Math 101. The units would include:

• Statistics (Law of Averages) -- As you learn in statistics everything tends to trend to the middle of the pack. (Hence the infamous bell curve in grading.) You may have a few bestsellers and a few real duds, but most books fall somewhere in the middle. And for publishers this means you always have to remember the Law of Averages. What would the "average" reader like? What does the "average" kid prefer? What will the "average" sales be every month? What are the books "average" shelf life? Is it any wonder that many books in the marketplace are what we consider to be average?
• Trigonometry -- When I take my sales numbers and have Excel make fancy graphs, they always create pretty little sines and cosines. Like waves, sales have troughs and peaks. Have a particularly successful marketing push? Get a peak. However, it's always followed by a trough. Always.
  
• Negative numbers -- The amount a publisher makes after returns come back. See tomorrow.
• Fractals -- Put simply, a fractal is something that when broken into smaller pieces, those smaller pieces look remarkably like the whole. Because of this, fractals are considered "infinitely complex." Is there a better way to describe what an outsider sees when they look at the publishing industry than infinitely complex?
• Chaos Theory -- Although most evident during large trade shows like BEA or ALA, chaos can invade at any point in the publishing process. And sometimes even the smallest things (an extra dash in the ISBN of an ARC) can grind everything into a screeching halt.
• Zero-sum -- What a publisher feels like at the end of a book's life (especially with a book with high sales but high returns). You haven't really lost much but it doesn't feel like you've gained much either.

© Copyright 2006-2010 Madeline Smoot. All rights reserved. May be excerpted and duplicated for educational purposes.

Edward A. Zelinsky is the Morris and Annie Trachman Professor of Law at the Benjamin N. Cardozo School of Law of Yeshiva University. He is the author of The Origins of the Ownership Society: How The Defined Contribution Paradigm Changed America. In this article, Zelinsky discusses the failure of House Ways and Means Chairman Charles B. Rangel to report on his federal income tax return Rangel’s rental income from his condominium in the Dominican Republic. Zelinsky contrasts that failure with the ethical standards established by Rangel’s legendary predecessor as Ways and Means Chairman, Wilbur Mills. Check out Zelinsky’s previous articles here.

For most Americans, there is a run-of-the-mill quality to reports that Congressman Charles B. Rangel of New York failed to report for federal tax purposes the income from his condominium in the Dominican Republic. Congressman Rangel, as Chairman of the House Ways and Means Committee, is the nation’s chief legislative tax writer. Predictably, Republicans have decried Congressman Rangel’s failure to comply with the tax law. Democrats, with equal predictability, have treated Representative Rangel’s problem as a nonevent.

For members of the tax community, however, Congressman Rangel’s troubles evoke a more profound specter, the ghost of Wilbur Mills.

For almost two decades, Mills was the legendary Chairman of the House Way and Means Committee. Like all legends, underneath this one was a flesh-and-blood human: Mills’s career terminated abruptly as a result of his ignominious relationship with Fanne Foxe. Fanne, “the Argentine Firecracker,” was the Ashley Dupre of the mid-1970s. Moreover, in no small measure, the contemporary financial problems of the federal Social Security system are attributable to the cost-of-living formula which Mills crafted to support his quixotic run for the presidency in 1972.

However, the positive side of Mills’s ledger far outweighs these negatives. Mills was the gold standard of a legislator, and our tax system is better for it. Mills mastered the details of the Internal Revenue Code as few, if any, other legislators have done in our nation’s history. Mills had a genuine concern about the quality of tax policy.

Moreover, Mills was not just concerned with the integrity of the tax law. He was equally sensitive to his ethical position as the nation’s chief tax writer. Mills famously prepared his own tax returns and took the standard deduction. He thought it unseemly for the Chairman of the House Ways and Means Committee to take the higher, legal deductions to which he was entitled.

Congressman Rangel blames his failure to report his full income on his accountant and wife as well as the operators of the condominium who provided little data. It is inconceivable that Wilbur Mills would have mounted such a defense. Indeed, it is inconceivable that Wilbur Mills would have made such a mistake.

The principles involved are basic to our tax system: U.S. citizens must report their worldwide incomes. Rents are income.

For the integrity of the tax system, Congressman Rangel’s problems could not have come at a worse time. While we do not know the precise number of U.S. citizens failing to report their off-shore incomes, the problem is serious. In such an environment, the failure of the Ways and Means Chairman, however inadvertently, to report off-shore income is, at best, troubling.

What should Congressman Rangel do? First, he should fess up. It will not do for the nation’s chief tax writer to blame the inaccuracy of his federal tax returns on his accountant, his spouse and his business partners. He should state, simply and publicly, that he failed the Mills standard.

Going forward, Congressman Rangel should announce that he will assume personal responsibility for his tax returns and will engage whatever professional assistance he needs to help him prepare those returns accurately. Finally, Congressman Rangel should extract something positive from this episode by announcing that the federal income tax returns of all members of the Ways and Means Committee (including the Chairman) will automatically be audited annually.

Wilbur Mills would have done nothing less.

ShareThis