When a Guarantee Is Not a Guarantee
August 18, 2020 | By Michael Clarke
Guaranteed revenues provide the cornerstone for many publishing services agreements (PSAs), the contracts that professional societies enter into with large publishers related to journal publishing. Guaranteed revenues typically fall into three categories:
- A signing bonus usually paid upon execution of the agreement or its renewal
- Editorial support payments including honoraria for editors, support for editorial board meetings and editorial strategy meetings, and other editor support
- A guaranteed minimum royalty payment usually paid in advance at the start of each contract year
It is the third category — guaranteed minimum royalty (GMR) payments — that is the topic of this post.
Note that guaranteed revenues are only one component of the financial terms of most PSAs. Contingent revenues, chargebacks, and in-kind support are additional components frequently included in these agreements. For more on the structure of financial terms in PSAs, please see: The Journal Publishing Services Agreement: A Guide for Societies.
The Importance of Guarantees
Guaranteed revenues are not a part of every PSA (that is, you are not guaranteed to be offered them!). But for societies fortunate enough to own journals of sufficient stature to command them, they become an essential focus of the PSA. Receiving guaranteed revenues may well be the primary reason a society enters into a PSA in the first place. The society may seek to reduce its business risk and stabilize its revenues — a PSA with revenue guarantees provides exactly that.
A second, and increasingly important, reason that societies look for revenue guarantees — and in particular GMR — is that an increasing proportion of journal revenue is derived from sales of publisher packages. How the society’s royalty is calculated from these revenues is effectively a black box from the perspective of the society. Absent a forensic accounting team, attempting to predict, decipher, or audit royalty payments from some publisher packages is just no longer possible. This is because the deal structures of institutional and consortia packages have become increasingly complex and the variables used to calculate the share to each journal too numerous. GMR provides societies with a predictable revenue steam that does not require attempting to unpack the contents of the black box.
Finally, societies seek guarantees because they provide a level of accountability. Publishers base their guarantees on detailed financial estimates. Those financial estimates are in part dependent on overall market conditions, but they are also dependent on the publisher’s performance in sales and marketing. A GMR provides greater incentive to the publisher to meet or exceed revenue estimates.
Guaranteed minimum royalty payments, along with other guaranteed revenues, therefore provide both predictability and risk mitigation, which are especially important for societies during periods of market volatility or disruption. The bargain between society and publisher is that the publisher assumes the business risk in exchange for the society giving up some revenue upside, as it is now sharing revenues with the publisher. In volatile market periods, the publisher will make more money in some years and less in others and will smooth the revenue flows for the society in exchange for a percentage of the journal revenues.
When a Guarantee Is Not a Guarantee
Societies looking to mitigate their risk and receive predicable revenues must be cognizant of guarantees that do not, in reality, do either of these things (or that do them poorly). Many boilerplate publishing services contracts do not provide truly guaranteed revenues, even if those revenues are positioned as “guaranteed” in the publisher’s proposal (or even in the contract itself). Instead, we frequently see these contracts put conditions on guarantees, such as clauses for annually adjusted guarantees or guarantees limited by a “material adverse change” to the business.
Annually adjusted guarantees. We often review PSAs where the GMR is based not on a specific annual monetary value agreed to at the start of the contract term, but rather on an annual forecast by the publisher or on a percentage of the previous year’s royalty (or another similar formula). In other words, the society will know what it will receive for a royalty payment at the beginning of a given year, but not what it will receive the next year or 5 years in the future. While this structure provides revenue predictability for a given year, it provides no predictability or protection from market downturns over the contract term.
Conditional guarantees. Material adverse change (MAC) clauses (sometimes called “material adverse effect” clauses) are widely used to limit GMR. MAC clauses are found in the boilerplate contract language of most publishers. These clauses exempt the publisher from paying the society GMR in the event of a material change to the business — in a negative direction — resulting from market conditions. What constitutes a “change” and whether it is in fact “material” might be specifically defined or left vague. In some cases, the clause can be invoked at the discretion of the publisher; in other cases it can be invoked only under certain specified conditions (for example, a revenue drop of a certain amount in any year of the contract).
MAC clauses typically stipulate that the terms of the PSA will be renegotiated if the clause is triggered — therefore revoking the “guarantee.” Future GMR payments will be based on the outcome of the renegotiated agreement — not the original terms of the PSA. (We have never seen a MAC clause used by a publisher to renegotiate a larger GMR!).
The big problem with MAC clauses, from the perspective of a society entering into a PSA, is that they effectively turn GMR into a guarantee for when times are good. PSAs are thought of by many societies as a kind of insurance policy for journal publishing. If a primary consideration in entering into a PSA is risk mitigation — protecting the society when times are bad — societies must tread very carefully where MAC clauses are concerned.
While MAC clauses are typically not invoked by publishers except in rare circumstances where there is a fundamental and lasting change to the business, such rare circumstances do occur from time to time (if they did not, there would be no need for MAC clauses). The COVID-19 pandemic may ultimately result in just such a circumstance — university and hospital budgets are facing unprecedented cuts, and reprints and other commercial revenues are in the midst of a contraction.
Societies with active PSAs that include the provision of guaranteed minimum royalties may wish to review their contract for MAC clauses or other language that may impact GMR. For societies that will be renewing their agreements or entering into a PSA for the first time, we caution you to fully understand the extent to which GMR might be subject to annual adjustments or MAC clauses before accepting a publisher’s offer and entering contract negotiations. Careful and iterative bidding and negotiating during the RFP process can result in limitation or even removal of conditions that render a guarantee not a guarantee.
Societies are at disadvantage in negotiating PSAs as they negotiate them infrequently, whereas publishers negotiate them routinely. We advise clients to seek out and retain business advisors and legal counsel familiar with PSAs and MAC clauses to advise in negotiations.
Note: Nothing in this article is meant to constitute legal advice. Societies entering into publishing services agreements should always retain guidance from legal counsel.