4.0 Issues in Book Distribution

• 4.1 Important Characteristics of Book Distribution
• 4.2 Efficiency and Technology
• 4.3 Economies of Scale
• 4.4 Inventory Management
• 4.5 The Role of a Large-Scale National Wholesaler
• 4.6 The North American Supply Chain
• 4.7 Price Deflation
• 4.8 The Publisher-Distributor Relationship

4.1       Important Characteristics of Book Distribution

The preceding chapters have mapped the trading partners and terms of trade in book distribution in Canada's English-language market. We can now summarize and extend the overview we have seen to this point through the following broad characterizations of book distribution.

Book distribution is a capacity business. Available distribution capacity--both in terms of the capacity of an individual distributor and in terms of the distribution capacity of the book system as a whole--has a direct effect on (1) the distribution options available to Canadian publishers, (2) the costs of distribution, and (3) the selection of titles that can be kept in stock and delivered quickly to Canadian accounts and consumers.

Book distribution is a scale business. The significant investment required in facilities and systems means that successful distributors and wholesalers are those that are able to spread these high fixed costs over the largest possible sales volume. This pursuit of economies of scale is a powerful force in centralizing and consolidating distribution capacity within the book supply chain.

Book distribution is a focus business. Book distributors and wholesalers have emerged as distinct specialists in the supply chain. Many of the respondents to this study noted that "focus" was a key success factor for a book distributor--highlighting the importance of an ongoing commitment to reducing errors, improving processes, investing in systems, and accumulating concentrated expertise in book logistics.

Book distribution is a cash business. Distributors are generally bound by contract to pay publisher receivables within a specified time frame. Because of this, the distributor's ability to effectively collect and manage cash, and, in particular, to manage the timing of cash receipts from accounts and disbursements to client-publishers, is critical to its survival.

Book distribution is a margin business. Like most other participants in the publishing value chain, the operating margins of book distributors are being squeezed by rising costs on the one hand, and by a limited ability to increase prices (or even price deflation) on the other. The need to maintain an adequate operating margin drives the constant search for greater operating efficiencies (and economies of scale) on the part of distributors and wholesalers. It also bears on the distributor's selection of publisher-clients, in that those publishing lines that offer higher volume and greater profitability will be more sought after than lower-volume clients that will be more expensive to serve.

In this sense, book distribution is a selection business in a couple of significant ways. First, distributors have an important role in selecting the publisher-clients they serve, and, by extension, the publishers and books that will be more prominently available within the book system. Similarly, wholesalers select the titles they will carry in stock, and so influence which books are readily available to be re-supplied to retail accounts and/or ordered by institutional buyers. 

Book distribution is a retail business, in the sense that major developments in book retail--notably the concentration of market share within large national retail chains--work their way back up the supply chain to affect the structure and operations of book distributors. For example, the declining numbers of independent bookstores has reduced the customer base for trade wholesalers across the country. Similarly, the growing market power of large bookstore chains and non-traditional retailers, such as Costco and Wal-Mart, has placed additional demands on the systems and operating standards for Canadian distributors.

And finally, book distribution is a people business. The working relationships between publishers, distributors, sales representatives, and retailers are invaluable sources of market intelligence and market access. Through the trust invested in a knowledgeable sales representative by the retail buyer, the publisher can enjoy improved access to the sales channel. Similarly, decisions made between trading partners in the supply chain--for example, the decision of a major publisher to sell directly to a national retailer--can have a significant effect on book distribution systems.

The balance of this chapter will expand on these broad observations by exploring a series of key issues in book distribution. 

4.2       Efficiency and Technology

Any serious consideration of the supply chain quickly turns to how the logistics and systems of moving books around the country can be made more efficient. Customers at every level in the chain, perhaps the end consumer most of all, expect the books they want to be quickly and readily available. This expectation is contributing to the quickening pace of trade and competition throughout the business.

At the same time, every trading partner in the supply chain has reason to shorten the distance between manufacturing and retail. Inventories are being managed more carefully at every link in the chain. Print runs are being reduced, and per-title economies of scale are under pressure as a result. Finally, virtually every publisher, distributor, and retailer in the market is on the hunt for improved sales and profitability, and this in a marketplace where overall sales are flat, prices are falling, margins are shrinking, and input costs keep creeping up.

Part of the answer to this challenge lies in more efficient management of the supply chain: in ensuring, to the greatest extent possible, that the right numbers of books are available in the right places when they are needed.

The quality of trade data and of the communications systems between trading partners are key to this improvement. Both the industry as a whole, and many individual firms within it, have invested heavily in new technologies in recent years to address (1) bibliographic data standards, (2) electronic data interchange (EDI) systems, and (3) point-of-sale data systems.

BookNet Canada, a non-profit organization funded by Canadian Heritage and focused on Canadian supply chain improvements, has introduced new innovations in all of these areas over the past five years, including Canadian Bibliographic Certification (bibliographic data standards), Pubnet (an EDI service contracted from Bowker), and BNC SalesData (a point-of-sale tracking system). These investments represent major steps toward improved gathering, management, and flow of data throughout the supply chain. 

Bibliographic data is a critical foundation technology that allows for the effective transmission of product information among trading partners. In so doing, it sets the stage for further improvements with respect to EDI and point-of-sale tracking.

Point-of-sale tracking allows retailers, distributors, and publishers to make better decisions, particularly with respect to inventory management and marketing. The traditional approach in the supply chain is to "push" product--that is, trading partners throughout the chain project demand and place product accordingly. The better sales data now available in Canada presents an opportunity to adopt more of a "pull" orientation that manages inventory according to actual demand.

Similarly, EDI has already delivered substantial efficiencies in the form of streamlined ordering, order processing and administration, and account management. Trading partners now exchange standardized transactional data regarding orders, shipments, invoices, and returns. The majority of such exchanges throughout the supply chain are now conducted via EDI, and this opens the door to greater standardization in production, packaging, and handling of book inventories down the road.

We are beginning to understand more about how these new systems and practices are affecting the book trade. While there are few publicly available measures of supply chain efficiency, Quill & Quire has conducted a semi-annual survey of order fill times over the past several years that provides some interesting indicators.

Table 4. A summary of the Quill & Quire semi-annual distribution surveys. Source: Quill & Quire.

	2002 (average delivery time, business days)	2004 (average delivery time, business days)	2006 (average delivery time, business days)
Fastest distributor	Raincoast 3.9 days	Raincoast, 3.4 days	North 49, 1.9 days
Slowest distributor	H.B. Fenn, 11.5 days	Oxford, 11.9 days	Oxford, 9.5 days
Overall average	-	7.7 days	6.3 days

In each of its surveys, Quill & Quire has drawn a slightly different regional mix of participating bookstores and this naturally introduces some variation from year to year. Even so, the survey data and accompanying anecdotal commentary from distributors and retailers paint a clear picture of improving delivery times over the four years from 2002 to 2006¹.

It appears likely that many of the factors we have explored here--competitive pressures and new technologies in particular--have played an important role in this improvement.

4.3       Economies of Scale

Along with technology improvements, the pursuit of increasing economies of scale is another tried and tested strategy for realizing greater supply chain efficiencies. This is partly because, in an environment where distributor margins are constrained by both rising costs and limited pricing flexibility, the distributor's greater prospects for sales growth and improved profitability lie in increasing overall sales volume.

At the same time, the modern supply chain generally requires significant investment in plant capacity, systems, and technology. As book industry consultant Mike Shatzkin has noted, the largest distributors and retailers invest millions in building this capacity.

"Scale is an advantage for virtually all aspects of distribution. If you've got a warehouse, you want to fill it, because you pay the same for empty space as you do for utilized space. More volume gives you more leverage to collect money and makes it easier to support a sales force. And we live in times where systems costs keep rising: several of the largest [firms] have spent double-, or even triple-digit millions in the past few years putting in new 'enterprise' systems to manage their business. That's one of the factors driving the growth in distribution activity now. It is helpful to amortize those costs over more books.²"

A firm achieves increasing economies of scale when it uses its available distribution capacity effectively, thereby spreading the organization's fixed costs over the largest possible sales volume and reducing unit costs in the process.

The concentration of book sales among a relatively small number of large retail accounts, the investment in inventory and systems required to serve those accounts, the need to stock a critical mass of salable titles that can be shipped quickly, and the level of investment required generally to build a distribution system of any scale all play an important role as well. These self-reinforcing factors contribute to a natural bias in the marketplace toward the concentration of distribution activity among a number of large distributors and publisher-distributors.

The pursuit of economies of scale is therefore a powerful, centralizing and market-shaping influence in the book supply chain. It accounts in part for the existence of a single national distribution centre for Canada's national bookstore chain (an attempt to exploit economies of scale), and the absence of a large-scale national trade wholesaler in the Canadian market (reflecting insufficient economies of scale to support this type of business). Similarly, it accounts for the high level of investment in technology and other system improvements within the supply chain.

4.4       Inventory Management

As noted earlier, inventories are being managed more carefully at every stage in the supply chain. Stores are reluctant to hold more inventory than needed, and just-in-time inventory arrangements have become the norm. In practice, this means smaller orders and more frequent re-orders as the store tries to balance its current inventory holding with the need to maintain a reasonable breadth and depth of selection and to ensure that books are in stock when needed.

Similarly, distributors are no longer prepared to carry excess inventory for publishers. But they too have to balance inventory levels with the need to ensure stock availability in order to supply customer accounts as quickly as possible.

These pressures work their way back up the supply chain and collide on the publisher's desk. From the publisher's point of view, setting the print run, particularly for new titles, is an exercise in finding the right balance between the need to maximize the economies of scale of the largest-sustainable print run with the need to avoid printing too many books that will tie up funds in inventory, incur additional carrying costs down the road, and/or eventually have to be written off or remaindered.

If too many copies are printed, the publisher is exposed to all of these problems, and in the case of remaindered stock, the supply of low-cost book product competing with other new-book inventories expands accordingly. If too few copies are printed, the publisher has to accept decreasing economies of scale on the print run, and may lose the sales for orders that cannot be filled for lack of stock.

The further practical constraint here is that the manufacturing link of the supply chain can only be shortened so far. Even with good printer capacity and a fast turnaround on reprinting, the need to go back to press for a reprint can create weeks of delay while the book is on press and then as distributors and customer accounts are re-supplied. During that time, a critical sales window can close and sales could be lost.

The following figure sums up the current imperatives and trends facing retailers, distributors, and publishers with respect to inventory management.

Figure 5. The current context for inventory management in the supply chain. 

In some respects, inventory management throughout the supply chain is the point at which the earlier issues we have explored in this chapter--efficiency and economies of scale--come into conflict. Efficiency demands that books be available when and where they are needed. If this means that retailers order more conservatively and distributors won't carry excess inventory, then it also means that publishers will find it more challenging to achieve economies of scale in their print runs and that unsold inventory will be remaindered or written off at a loss more quickly.

Similarly, the need for distributors and wholesalers to achieve the best possible economies of scale generally means that book inventory is not always readily available when needed. BookNet Canada reports that of the 689,020 unique ISBNs tracked in its system in 2006, 373,402 titles sold one or more copies during the year. For the sake of quick response within the supply chain, we could say that an ideal state would be to have a series of warehouses across the country, each of which would have these 400,000 titles available for immediate re-supply to customer accounts as needed. However, the size of the Canadian market will not support the investment required to create a re-supply network on this scale.

4.4.1    The Importance of Stock Turns

The idea of a more nimble supply chain--one that can respond quickly to market demand by reloading store shelves as needed--connects to another important concept in inventory management: stock turns.

The terms "stock turns" or "inventory turns" refer to salability of stock and are used to measure the relationship between inventory holdings and sales. In practical terms, stock that sells more quickly, meaning that the retailer "turns" its inventory more during a given period, is an important measure of operational efficiency.

As one of our study respondents put it, "With increased pressure to control inventory, there is an increased argument to use wholesalers to quickly replenish and help improve stock turns."

A 2004 brief from The Retail Management Advisors explains the concept more fully:

"The inventory of the typical store represents the largest single element of its total assets. The sale of goods from this inventory is the merchant's chief source of operating profit. Thus, the way in which this merchandise investment is put to work is of utmost importance in achieving a profitable operation...All other things being equal, a higher stock turn rate tends to lead to higher sales and a higher profit...Another advantage is that a fast Stock Turn Rate will actually increase sales due to the increased flow of fresh new merchandise into the store to create excitement for the sales staff and a reason for the customers to come back frequently.³"

The broad supply chain systems introduced by BookNet Canada in recent years, as well as the proprietary enterprise systems installed by publishers, distributors, and retailers alike, have set the stage for more active analysis and management of inventory at all levels in the Canadian supply chain⁴. However, the industry is still searching for the distribution economies of scale, through a large wholesaler or otherwise, that would help shorten the supply chain further.

4.5       The Role of a Large-Scale National Wholesaler

Some observers, including the Canadian Booksellers Association, have argued that the Canadian supply chain would be greatly improved by a larger trade wholesaler that operates at a scale comparable to leading wholesalers in the US. As the example of the American market illustrates, a large efficient operator such as Ingram can play a much greater role in a publisher's national distribution strategy, the efficient movement of inventory throughout the supply chain, and increased stock turns for retailers.

4.5.1    The Story of Pegasus

The recent history of Canada's book trade provides a singular, if highly controversial, example of an attempt to establish a major national wholesaler. In May 1999, Chapters (then the country's leading national chain) announced that it was converting its 306,000-square-foot Brampton, Ontario, warehouse into a subsidiary company, Pegasus Wholesale, in which it would retain a 75% stake. Pegasus would establish itself as a national wholesaler, operating at arms length from Chapters and with an inventory of 400,000 titles in stock.

The reaction from the book trade was immediate. Independent booksellers were opposed to ordering from Pegasus as they felt that in doing so they would be contributing to the profitability of their largest competitor. Publishers were opposed as they saw the creation of Pegasus as a move by Chapters to recover a deeper wholesale discount on all shipments from its vendors--standard wholesale discounts at the time would have been 5 to 8% higher than Chapters' typical retail discounts from publishers and distributors.

This broad-based resistance to Pegasus might have been enough to ensure its failure, despite pressure from Chapters to have all of its vendors trading through Pegasus. As it happened, the wholesaler never did establish effective operations. Rather than serving as an effective new logistics platform within the book trade, Pegasus became a notorious bottleneck that added extensive delays to publisher shipments and returned books to vendors in great numbers.

These operational problems reached their peak in September 2000 when Chapters asked three of its largest vendors--HarperCollins, Random House, and H.B. Fenn--to stop shipping to Pegasus and to ship directly to Chapters stores instead. Later that fall, Pegasus was put up for sale.

By January 2001, with no other buyers available, Chapters had bought back the outstanding shares in Pegasus, effectively concluding the attempt to create a national wholesaler and re-establishing the Brampton warehouse as an internal distribution centre for Chapters stores, which it remains to this day.

4.5.2    Still Waiting for a National Wholesaler?

In spite of Pegasus's failure to establish itself in the market, the prospect of a large aggregated inventory that can quickly re-supply retailers throughout the country continues to inform the call for a large national trade wholesaler in Canada. In the wake of the Pegasus closure in 2001, a guest column in Quill & Quire argued for the creation of a new national player in the wholesale channel.

"The Canadian book distribution sector has been consolidating recently, into fewer, larger players...The problem is that even the largest of the current Canadian book distributors can't match the scale (and cost efficiencies) of a true national wholesaler⁵."

The same article goes on to say:

"There are several logical ways to create this national wholesaler:

1. From existing Canadian wholesalers (if they're willing and able to make the heavy investments and change of focus required to expand);
2. Indigo, with a reborn Pegasus-style spin-off of their internal distribution system (if you assume that Indigo will be looking to dramatically reinvent its business to stem what is likely to be a long-term decline);
3. One of the major U.S. wholesalers, via a Canadian subsidiary or direct shipments from the U.S.;
4. An existing Canadian wholesaler in another industry looking to expand and spread its own costs out further."

Proponents of a national wholesaler point out that the leading wholesalers in the US have contributed some of these efficiencies to the market there. Ingram, with its focus on trade accounts, and Baker & Taylor in the library market, have each become a major factor in the US supply chain.

As an illustration of this, an increasing number of large publishers in the US now ship directly to their largest retail accounts, relying on Ingram to re-supply both new and previously published titles to trade accounts and to fill orders to regional and smaller accounts. This reflects the imperative of large suppliers to sell directly to their largest accounts, as we have explored earlier. But it also illustrates the confidence of publishers that a major wholesaler, such as Ingram, can efficiently serve many other channels outside of the large national chains.

In contrast, the Canadian book market is unable to re-supply itself as efficiently, and so the broader goals of more aggressive inventory management are only partly realized. Retailers and distributors are able to manage their inventory investment downward, but publishers are not always able to quickly move books to where and when they need to be in order to maximize sales.

4.6      The North American Supply Chain

For an increasing number of Canadian publishers and retailers, the search for distribution economies extends beyond the Canadian border. Sourcing book from outside of Canada is hardly a new idea, but within the last five years some of the largest publishers operating in Canada have begun shipping Canadian orders from US-based warehouses, and the leading US trade wholesaler, Ingram, has continued to expand its share of the Canadian book trade.

As Figure 6 illustrates, the Canadian supply chain is in some respects being reshaped into a more integrated North American supply chain.

Figure 6. The expanding geography of Canada's book supply chain. 

In the following pages, we will explore the regulatory environment in which this cross-border trade occurs, as well as the main supply routes for US-sourced orders shipping to Canada.

4.6.1    The Regulatory Environment

The regulatory environment for the cross-border supply chain is largely guided by two federal acts: The Copyright Act and The Investment Canada Act, and related regulations and policies.

The Copyright Act and Parallel Importation

The Book Importation Regulations of the Copyright Act offer protection to firms that have purchased the territorial rights to distribute a given title in Canada. However, the Regulations require that the Canadian list price for a title imported from the US not exceed the Canadian-dollar equivalent of the US currency list price by more than 10%⁶. If the Canadian price exceeds this point, Canadian retailers are permitted to source the book from outside of Canada regardless of territorial rights.

Recently, the Canadian dollar appreciated greatly against the US dollar, reaching parity with the US currency in the fall of 2007. As publishers typically set list prices several months in advance of publication, this currency movement effectively resulted in Canadian list overpricing for imported titles relative to US list prices. More to the point, this currency-price relationship created a situation where Canadian retailers could source some books outside of Canada at lower cost.

This currency movement appears to have contributed to an increase in parallel importation within the Canadian book trade. Parallel importation occurs when one party imports goods into the domestic market outside of the authority of the firm that owns the Canadian territorial distribution rights. This practice is colloquially known as "buying around."

The practice of buying around is controversial within the Canadian book trade, and is generally understood to weaken the competitive position of Canadian distributors and publishers as well as the integrity of the Canadian territorial rights for foreign titles secured by Canadian firms. However, as we describe below, there are also some perfectly sound reasons for Canadian retailers to order from US sources. Further, so long as the Canadian list price exceeds 10% of the US list price for any such orders, a Canadian bookseller can order from a US supplier without breaching the provisions of theBook Importation Regulations⁷.

The Investment Canada Act and Foreign Ownership Restrictions

The Investment Canada Act provides a basis for government review of prospective foreign investment transactions and aims to ensure that any such investments are of net benefit to Canada. Net benefit includes, among a number of factors, the compatibility of a prospective investment with national cultural policies, and in the particular case of investments in the book industry, with the government's policy objective of ensuring that Canadians have access to Canadian-authored titles.

Foreign investments in the book industry are also subject to the Revised Foreign Investment Policy in Book Publishing and Distribution, which constrains foreign ownership of businesses in the publishing, distribution and retail sectors. As our focus here is on book distribution, we note that the current policy includes the following:

• Foreign investment in new book distribution businesses is restricted to Canadian-controlled joint ventures.
• The foreign acquisition of a Canadian-owned distributor is prohibited, except in cases where (a) the business in question is in clear financial distress, and (b) Canadian interests have had a full and fair opportunity to purchase it⁸.

Although the current foreign investment policy effectively means that foreign-owned book distribution firms are prevented from entering the Canadian market, foreign-owned firms nonetheless have a dominant presence in the Canadian book industry. Most of the key multinational players in the book business were active in Canada at the time the Investment Canada Act came into law and were permitted to remain subsequent to its passing.

Market Effects of Current Policy

In practical terms, the Revised Foreign Investment Policy in Book Publishing and Distribution provides a measure of protection for Canadian book businesses by discouraging, through both its provisions as well as the uncertainty associated with the review process, new foreign investment in the sector. Nevertheless, within the current regulatory framework in Canada, foreign firms can and do play a significant role in the distribution of books in the domestic market, making for an increasingly integrated North American book supply chain.

• It is possible for a foreign-owned firm that operates in the Canadian market but that conducts the majority of its business, including distribution, in the US to operate its Canadian distribution system largely from the US, and to fill Canadian retail orders from its US warehouse(s).
• A US supplier, such as Ingram, is permitted to supply Canadian retail accounts regardless of territorial rights under certain conditions (such as when the Canadian list price of a title exceeds the 10 % guideline established by the Book Importation Regulations). However, foreign investment policy prevents such a firm from establishing a Canadian-based extension of its US operations.

In the following sections, we explore some current examples and trends in cross-border book supply that are emerging in this environment.

4.6.2    The US-Canada Supply Chain

Use of US Warehouses

Two of Canada's largest publishers and distributors now rely heavily on the warehouses of their international parent companies for Canadian fulfillment.

Random House Canada ships stock directly to Canadian accounts from Random's US distribution centre in Westminster, Maryland. Random House Canada also moved its customer service desk to the Maryland centre in 2003, but continues to operate a warehouse in Mississauga to re-supply key titles and process Canadian returns.

Similarly, Simon & Schuster Canada closed its Canadian warehouse operations in 2004, moving to a system of consolidated shipments from S&S's distribution centres in Pennsylvania and New Jersey. These shipments are freight forwarded⁹ via Georgetown Terminal Warehouse for onward shipment to Canadian customers.

For major international subsidiaries like S&S and Random House, this type of fulfillment strategy offers the following benefits:

1. It avoids duplication in systems costs between the Canadian subsidiary and the international parent.
2. It allows the Canadian subsidiary to take advantage of the considerable economies of scale realized through these large distribution centres in the US. Random House alone boasts nearly 2 million square feet of storage capacity in its two facilities in Maryland and Indiana. Together, these distribution centres ship 1 million units a day to more than 15,000 locations per week.
3. It provides access to a much larger selection of in-stock titles. Most distributors will establish minimum sales levels to justify keeping a title in the warehouse for immediate shipment. In the smaller Canadian market, this necessarily means a more limited title selection. In a large US distribution centre, Canadian orders can draw from this larger stock selection and can also re-supply Canadian inventories of imported titles more efficiently.
4. It respects copyright provisions both for titles originated by the Canadian subsidiary and for its distributed lines as well (as the importer of the books in such cases is the company that holds the Canadian rights).

These integrated supply chains find their primary rationale in the greater economies of scale afforded by consolidated supply operations in the US. At the same time, they are greatly enabled by supply chain technologies such as EDI that streamline ordering, order processing, tracking, and all other transactional processes for the distributor and retailer alike.

US Wholesale

Ingram is the leading trade wholesaler in the US and is widely regarded as one of the best distribution specialists in the book trade. Founded in 1964, Ingram currently operates four distribution centres in the US--in Oregon, Pennsylvania, Tennessee, and Indiana. It holds roughly 1.4 million titles in inventory and ships to more than 30,000 customer accounts in America and abroad.

The company has grown its sales in a number of ways in recent years. Along with its shipments to retail accounts in the US, Ingram's direct-to-consumer shipments (in fulfillment of both online and offline consumer orders passed from Ingram's retail partners, notably Amazon), and international shipments (to Canada, Australia, and Europe) have expanded significantly¹⁰.

As noted earlier, Ingram figures prominently in Quill & Quire's semi-annual distributor rankings, and generally ranks ahead of most Canadian distributors for average shipping speed. This finding alone illustrates the willingness of Canadian accounts to order from the US wholesaler, and also Ingram's effectiveness in shipping to the Canadian market.

As one of America's largest privately held companies, Ingram does not report its sales publicly. However, anecdotal reports clearly indicate that the company's Canadian sales have grown significantly in recent years, and over the last two years in particular. As one of our distributor respondents put it, "We're seeing erosion [of sales] to American competition that scale-wise no one can touch."

There are two main factors that encourage Canadian accounts to order from Ingram:

1. Ingram is an extremely efficient distributor. Through its national network of warehouses in the US, it is able to make north-south shipments much more quickly than most domestic distributors can ship along Canada's east-west supply routes. This is a compelling factor given both the consumer and retailer demand for prompt delivery.
2. As noted earlier, recent appreciation of the Canadian dollar created a significant, and highly visible, gap between Canadian and US list prices on imported titles. Aided by electronic ordering and inventory tools (that allow buyers to quickly check price and availability between different suppliers), Canadian retailers can now easily source these books outside of Canada at a lower cost than they can buy them from Canadian rights-holders.

Whatever the reason, the structural effects of increased US sourcing are significant. First and obviously, increased foreign buying undermines the territorial rights of Canadian rights holders (by placing lower-priced US editions in the market at the same time as a Canadian publisher or distributor is trying sell a Canadian edition with a Canadian list price). This issue is relevant to Canadian subsidiaries of multinational publishing firms, Canadian distributors, and Canadian publishing houses that also act as distributors for foreign publishers (and so rely on distribution revenues to varying degrees to support domestic publishing programs). More broadly, increased parallel importation could also contribute to relatively lower-priced imported books (relative to Canadian titles, that is) claiming a larger overall share of the Canadian market.

4.7       Price Deflation

As an integral link in the supply chain, the book distributor is affected by changes in terms and practices throughout the book trade. For example, much has been made of the effects on publishers of increasing discounts to retail accounts. What is less widely observed is that since distributors' fees are based on the value of shipped sales this also reduced distribution revenues--at least until most distributors adjusted their fees to correct for this.

A similar phenomenon is now likely to play out around the current challenges in Canadian-US list pricing. As we explored earlier, the Canadian dollar's rapid appreciation in value has resulted in effective Canadian list overpricing on many books, and on imported books in particular. However, due to the large volume of imported titles in the Canadian marketplace, list prices on domestic titles are also heavily informed by the prices of imported books.

The result is that there is considerable downward price pressure on Canadian list prices for both domestic and foreign titles. Publishers have exhibited a wide range of approaches to the price adjustments that have followed these developments. As a result, it is hard to be precise about the overall level of price reductions in the market. In some cases, however, these appear to be as much as 12% as of spring 2008, relative to the 2006 prices of comparable titles.

This level of price reduction is deep enough to reduce publisher and retailer revenues but likely not enough to encourage a dramatic change in the volume of unit sales. The table below illustrates the effect on distributor revenues of a broad 12% price reduction, presuming the following scenario.

• Unit sales = 100,000
• Average 2006 price (net) = $20.00
• Average 2008 price (net) = $17.60
• Returns = 25%
• Distribution fee = 15% of shipped sales
• Returns processing = 3%

Table 5. An illustration of the effect of list price deflation on distribution revenues.

	2006 Values	2008 Values
Units shipped:	100,000	100,000
Value of shipped sales:	$2,000,000	$1,760,000
Distribution fees;	$300,000	$264,000
Returns:	$500,000	$440,000
Returns fees:	$15,000	$13,200
Total fees:	$315,000	$277,200

With all other variables remaining the same, this pricing change flows directly through the top-line values in the table, resulting in a 12% reduction in distribution revenues. The other significant value here, however, is unit volume. The distributor is shipping the same volume--and incurring the same system and operating costs--but recovering less revenue. All things being equal, the effect is to reduce the margin and squeeze the cash flow of the distributor.

This has implications not only for the distributor but for its client-publishers as well. If price deflation persists and/or becomes more widespread, distributors will have to raise fees to compensate (effectively passing higher costs to the publishers who are also dealing with top-line revenue reductions from the lower list prices). The alternative for the distributor is to try to operate on narrower margins. However, as we will see in the following section, this presents another type of risk for the publisher. 

4.8      The Publisher-Distributor Relationship

As the previous discussion of price deflation effects suggests, the distributor-publisher relationship is an intimate one, in which each party shares a measure of business risk with the other. In particular, publishers have a vested interest in the financial health and stability of their distributors. For publishers who make any meaningful percentage of sales through a distributor, the solvency of the distributor, the sustainability of its operations, and its ability to effectively collect receivables are all issues of mutual concern.

This is because the publisher's inventory and receivables--which account for the bulk of the assets for most publishers--are under the direct control of the distributor. Equally important, the publisher relies on timely payments from the distributor for some or all of its cash flow. Any major disruption in the distributor's business is therefore likely to be visited on the publisher in one way or another.

In the modern history of Canadian publishing, there is no better illustration of this shared risk than the collapse of General Distribution Services (GDS).

For many years, General Distribution was one of Canada's largest book distributors and the distribution arm of General Publishing¹¹. GDS operated a 300,000-square-foot warehouse in Toronto and a second smaller warehouse in Vancouver. It counted nearly 200 publishers among its clients. The GDS client base featured a large number of Canadian firms, including many of Canada's English-language literary presses.

By 2001, however, GDS was clearly in trouble. Returns, which normally ranged from 15 to 25% of sales, had ballooned in March 2000 and again in January 2001 with massive stock shipments coming back from Chapters, the company's largest retail client and the nation's largest book retailer. Sworn affidavits from GDS ownership indicate that returns rose as high as 40-60% during the years 2000 to 2002.

The same affidavits indicate that Chapters delayed payments to GDS by as much as 250 days, even as General was contractually obligated to pay its client-publishers within 90 days. Between the delayed payments and extraordinary returns levels, GDS quickly found itself running out of cash.

The problem was exacerbated by the low distribution fees that General charged its client-publishers. While smaller publishers especially appreciated the lower rates at GDS, the distributor's slimmer margins made it even more difficult for it to cope with the cash crunch.

The Department of Canadian Heritage guaranteed a $5 million loan to the company in October of 2001 to deal with immediate financing concerns. But a negative cash flow spiral had begun, and the company could not stop the slide. The bank began to pull back on its credit line, and by March 2002 major client-publishers, notably Douglas & McIntyre and Key Porter, had filed termination notices and begun to move their business to other distributors.

GDS filed for bankruptcy protection in April 2002, and by the end of the year the company had dissolved. At the time of bankruptcy filing, client publishers were owed $13.3 million. As part of the bankruptcy proceedings, receivables due to publishers, as well as publishers' inventory in the GDS warehouse, were frozen.

In October 2002, Canadian Heritage announced a $2.5 million assistance fund for affected publishers. Nonetheless, most publishers lost inventory, receivables, and sales in the process of recovering from the GDS meltdown and establishing new sales and distribution systems. While none of the firms went out of business, some still bear the scars of the General collapse on their balance sheets these several years later.

GDS was a brutal lesson in distribution economics for the Canadian book trade--one that highlighted the interconnected fortunes of trading partners in the supply chain and the dangers of unsustainable distribution terms.

Reflecting on lessons learned afterward, Jack David, the publisher of ECW Press and a former GDS client, has said, "[W]e'd learned two important truths. One, that by making good choices we could survive a distributor bankruptcy. Two, that we needed to choose a distributor wisely, so we'd never have to test truth number one.¹²"

Notes

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