Publishing as Venture Capital: A Deep-ish Dive

A well-worn adage from organizational leaders at my company is that “book publishing is the venture capital of the media world.” While cynics or the uninitiated might be prone to roll their eyes at this attempt to draw a connection between the high-flying and innovative world of venture capital investing and the seemingly staid, stagnant, and predominantly print-based publishing industry, the comparison is a lot less farfetched than you’d think.

Inspired by the October 31st Wall Street Journal article These Independent Publishers Are Challenging the Corporate Players (paywalled, sorry), and doubling as this week’s Best Thing I Read This Week, I thought I would flesh out this idea in more detail.

 

Core Idea

Before we go much further, it’s important to explain one of the key concepts that underlies book publishing: the “advance.” The book advance refers to the amount of money paid by a publisher to an author for the rights to publish the half-baked idea / proposal / partially-completed manuscript being pitched by the author. The actual amount accepted as a book advance varies widely, but in every instance is more akin to a bet than a calculation – a wager that a book will perform in line with (or even exceeding) the acquiring editor / publisher’s expectations. The estimate is normally derived from either comparable books by different authors, a previous book by the same author, or on the strength of the proposal, as well as the acquirer’s belief in the future success of the resulting finished product. Of course, competition is often involved in the advance amount, propagated by a literary agent working to sow interest across different publishing houses to create a competitive dynamic (i.e., unnecessary time pressure, preemptive / exclusive offers, etc.) and drive up the price.

The book publishing industry makes thousands of such bets on the books they publish each year (yes, thousands). And more often than not, these books fail to meet those initial expectations, and can even fail hard (<100 copies sold hard), due to any combination of poor execution by the author (i.e., a bad book) or publisher, and/or a failure to capture the interest or imagination of the bookbuying public in an environment of shrinking shelf space for physical books and an over-saturation of choices online. On the positive side, many books manage to “earn” their advance, after which the author receives a flat/scale-based percentage of the book’s cover price for every copy sold – a royalty. In even rarer cases, a book manages to exceed all expectations and “break out,” far surpassing its estimated sales due to a crucial endorsement (e.g., Oprah’s Book Club), a film or television adaptation (e.g., Crazy Rich Asians), a controversy surrounding the book (i.e., anything Trump-related), or even based on all-powerful word of mouth.

Given the difficulties and lack of formula for a break-out or bestselling success, publishers mostly pursue a ‘blockbusters’ strategy (a term and concept popularized by HBS Professor Anita Elbrse in her academic work and book Blockbusters: Hit-making, Risk-taking, and the Big Business of Entertainment). The strategy refers to placing a large number and range of bets every year, with an expectation of a high rate of failure, and the hope that a single bet yields outsized returns, compensating for all of the other bets made.

 

Publishing As Venture Capital

If you’re still with me, I doubt it’s too hard to draw parallels between the publishing industry and venture capital. As with technology investing, for every “unicorn” valuation that exceeds $1 billion (e.g., Uber, Twitter, Dropbox, etc.), there are 100 similarly placed bets by venture capitalists that don’t materialize, or fail altogether. Both industries are seen as more of an art than a science, with a high rate of failure “priced in.”

Like venture capital, within the universe of placed bets there are different types of investments, with differing relationships between the level of risk and potential reward. While “pre-seed,” or angel investing, normally takes the form of a series of smaller, diversified bets, late stage venture capital is usually focused on established successes, more complete information, and a much smaller band of expected return (or at least a higher floor.) The same dynamic exists in publishing: it’s much easier to make the case for a celebrity author with an established audience and name recognition than it is for a geeky story about being stranded on Mars by a completely unknown, part-time author.

Post-angel investing normally takes the form of alphabetically-ordered stages, or ‘seed’ rounds, whereby each successive round results in a higher valuation and more capital expended (lest a company undergo the death knell of a “down round,” whereby a company’s valuation shrinks).

Following this logic, the range of publishing bets might look something like this:

Category	Fiction	Non-Fiction
Pre-Seed / Angel Investment	Unknown/debut author	Unknown author writing about niche topic
Series A	Repeat author with history of moderate success	Unknown author writing about topic with established audience
Series B	Award-winning author with strong reputation / established audience	Renowned author with track record of commercial success
Series C	Well-known author with a longtime record of publishing success, strong legacy	Celebrity memoir, author with highly established platform
Series D and beyond	John Grisham, Nora Roberts, James Patterson	Post-Presidential memoirs, or a book by an incredibly prominent public figure

As you go down the chain of investment rounds, the expected value and “floor” of the book’s success of the book is higher, driving more certainty and a higher price. Of course, on the other hand there’s occasionally a chance that a small bet placed by on an unknown entity will have massive returns, such as Paula Hawkins’ The Girl on the Train.

Of course, in any of these cases there’s a risk of failure, so the probability of success can never be 100%. A notable recent example is the ongoing delay associated with George RR Martin’s sixth book in the Game of Thrones series – a book that has already garnered significant investment, but may never actually be completed.

 

Deal Flow

Everywhere you look, it seems like there are new venture capital firms popping up, with new theses on how to achieve “alpha” (performance in excess of market returns): crypto-dedicated funds, machine learning-informed investments, or just an excess of capital (and some hubris) on the part of the founding partners.

Venture capital firms that are unknown or have a limited track record oftentimes have difficulty sourcing opportunities, otherwise known as “deal flow,”  while well-known VC firms with decades of operation a history of successful exits, and a strong reputation in the marketplace are highly sought after, and are oftentimes offered many more deals than they can feasibly participate in.

The result is that smaller or more unknown entities seeking to establish themselves and achieve success akin to the established players resign themselves to one of the following approaches:

• Overpay: One’s willingness to dramatically overpay or overvalue relative to competing investors will yield a seat at the table that would otherwise not be offered.
• Make riskier bets: Focus one’s efforts on opportunities that are deemed to risky or unproven by the more established players.
• Make smaller bets: Deals that have smaller upside are less appealing to established venture investors, who must allocate their finite resources to meet a required return.

Similarly, in the publishing industry authors are much more likely to seek out and sign with an established publishing house, with a renowned roster of authors, a proven commercial track record, strong name recognition and reputation in the marketplace, and well-established relationships with value-added partners (e.g., bookstores, online platforms, book reviewers) to help further propel the book, and the author’s career, to success.

As a result, smaller publishers are oftentimes forced to rely on specific niches that may be seen as having a smaller potential audience (e.g., fiction in translation), and take more chances investing their efforts and capital on unknown entities such as debut authors, or books on obscure topics with limited perceived commercial appeal. As recounted in the WSJ article, this strategy has recently led to both critical and commercial success for publishers like Europa Editions (publisher of Elena Ferrante’s Nepolitanan series), Archipelago Books (Knausgård’s My Struggle series), and Graywolf Press (various recent successes, including Carmen Macado’s Her Body and Other Parties, the adaptation rights to which have been purchased by FX). All three of these publishers, as well as many of their “independent” (i.e., smaller) contemporaries, were prominently featured in the recent 2018 National Book Awards, demonstrating their outsized impact relative to their size (both in books published and invested capital).

In each case, these publishers were able to successfully publish authors that were either overlooked or deemed too obscure for mainstream presses. While these risks have paid off handsomely for their investors, there are countless examples of similiarly-placed and -believed in bets that didn’t perform nearly as well.

 

The Incumbent’s Advantage and Brain Drain

A phenomenon recently seen in the world of venture capital investing, both in the United States and China, is the seismic impact that the established and well-capitalized players in the market can have on innovative companies and their valuations. In the US, Google and Facebook have led the charge of making large investments or outright acquisitions at perceived high valuations (some of which seem shocking low in retrospect) in order to absorb talent and innovation, stymie potential competition, or de-risk their long-term future by diversifying away from their existing products. These investments come at the expense of traditional VC players, who can’t match the offers nor the promises of guaranteed resources and support of the tech elite.

To varying degrees, Facebook’s acquisition of Whatsapp and Instagram fit this category, as does their more imaginative acquisition of the virtual reality company Oculus Rift. On the Google / Alphabet front, they continue to be among the largest corporate investors across its various investment vehicles, and have made major investments into self-driving vehicle technology (covered in fascinating detail by Charles Duhigg in a recent New Yorker issue), as well as a wide variety of futuristic bets in robotics, artificial intelligence, and biotechnology. In China, the impact of the established players is even more pronounced, as a two-horse race to acquire the next great technology by Alibaba and Tencent has led to an explosion of VC investment and outsized deals.

For the entrepreneurs accepting these large investments, the rationale is clear: beyond the sticker valuation, the entrepreneurs are offered access to a near-infinite amount of resources, as well as widespread public credibility in pursuit of their mission that invites further interest, attention, and higher valuations. However, these benefits come with the attached downside of being one in a series of many investments and priorities by these highly diversified behemoths, without the attention that they would be likely to receive from a smaller investor with far fewer bets and a larger stake in the company’s success. Oftentimes, the entrepreneurs opt to take the money, and see the upside outweighing the downside.

In publishing, this is an all-too-common trend: an author is “poached” from a smaller publisher who invested in them early in their careers to take a “risk” on publishing them as an completely unknown entity. Authors oftentimes feel forced to put personal loyalties aside to accept an life changing advance amount, as well as the promise of increased exposure and association with a storied institution. The smaller publishers, who can’t reasonably expect to match the amount and associated promises made by the major players, are forced to accept their role as “incubators” of literary talent (with some limited exceptions). Suddenly, these authors go from being the prize of their smaller houses to just another author on a vast roster and crowded publishing schedule. While this “poaching” strategy is far from a guaranteed success, acquiring these authors is a relatively low-risk way for the larger publishers to acquire market share amidst a stagnant sales environment.

I’m sure there are further parallels to draw, and more concepts to be fully fleshed out, so will likely revisit this topic in the future.