The royalty family

Here’s a sentence to reel you in: royalty management is all about finding lost millions for developers.

But first, we should define what royalty management is.

Royalty management is a generic description for the management of all royalty or profit share based contracts, usually between the developer and the publisher, or other related parties. This includes, but is not limited to, general advice on contract wording and observations on possible income, suggested improvements to contract clauses, possible contract omissions and checks on audit rights.

The focus of RM is on the practical application of a contract. RM partners may also offer specialist audit services including desk review (pre-audit advice), audits and reports together with regular statement maintenance to ensure your royalty stream is managed throughout the lifetime of the title. RM partners compliment your legal counsel and your agents’ activities.

IT ALL ADDS UP
That’s a grand opening statement, with a lot to take in, and I can hear you all now: “So what? What does that really mean to me as a developer?” Well, I guess the easiest way to highlight the benefits of undertaking well co-ordinated RM activity is to throw out a figure. $16m. That’s the total sum of monies that both Media Forensics and Loxley Royalty Management have jointly uncovered for developers since our inception in 2002. That figure again – $16m. That’s a lot of money.

From this you can see that a developer who adopts royalty management as a core activity within its business benefits from the knowledge that they are keeping pace with the products performance in terms of sales, returns, deductions and, ultimately, the royalty or profit share resulting from this activity. They will understand the implication of every detail in the contract, and will be in a great position when it comes to future negotiations. Further to this, if you choose the right partner, the developer/publisher relationship can be strengthened. Royalty management is – or should be – an intrinsic part of the developer business process. It isn’t there simply for when things go wrong.

So we know that you should be taking a keen business interest in RM, but what exactly is an audit? Even the word scares a lot of people – think a tax or VAT audit – but in reality it shouldn’t. A royalty audit is made up of an executive summary containing information on the errors found (if any), sales and market data, the methodology used by the audit company, detailed checks and any findings explained at length. A conclusion, useful recommendations on the next steps, and any suggested contract improvements will also be supplied so to make moving forward productive and painless.

CO-PUBLISHING VS STANDARD AGREEMENT
But let’s go back to basics for just a moment. Most developers take their product to market in one of two distinct ways – either via a standard publishing agreement, by far the most popular occurance within the industry, or via a co-publishing deal. In a standard publishing agreement, where an advance is recouped over time and a royalty paid thereafter, the contract clauses pertaining to the definition of net receipts and the audit rights become the key focus of the audit, together with checks on the advance and royalty payments to date.

In a co-publishing agreement, for example, where some kind of profit share is in place, more of the contract terms are audited due to the nature of the agreement. For instance, marketing spend may need to be checked by territory, and wholesale pricing rules may apply. With a co-publishing audit there is usually a lot more to review and validate, with a corresponding greater depth to the report.

If all this sounds as though it’s intrusive activity, to a certain extent you’d be right. A publisher’s royalty team will need to work with the developer’s auditors to provide information, but this is why they’re in place. If an audit is carried out properly there should be no negative impact on the business relationship as it stands and, in a lot of cases, should actually strengthen the relationship.

By ‘carried out properly’ I mean that the chosen auditor is knowledgeable, understands the videogames business and is fair and equitable. There is a danger that things could go wrong if a contingent auditor, working on a success fee, spends an unreasonable amount of time on an audit hoping to uncover something. Publishers royalty teams traditionally have little patience for long drawn out audits and general procrastination. But, if your royalty managers are a specialist team with a proven background working on a fixed fee, or even a lower day rate, perhaps with a bonus structure, you can expect a professional, tactical approach which will leave your relationship 100 per cent intact long after the audit has finished.

To get a publisher’s perspective on this, I spoke to Laura Cohen, royalty director at THQ. I chose THQ because the publisher offers an excellent example of how systems and processes should work in the video game business.

“The relationship between a publisher and developer should not be negatively influenced if the developer exercised their audit rights,” said Cohen. “Many times developers are just looking for a royalty statement that provides sufficient unit and net sales information to see how calculations are derived from the contract language previously agreed upon by the parties.”

She added: “This information often reduces developer concerns that sometimes lead to the exercising of audit rights. If an audit is requested by the developer, it is up to the third party auditor and the publisher to ensure the audit is conducted professionally, timely, and in a smooth and non disruptive manner. Written notice should be given to the publisher notifying them of the developer’s desire to audit. The publisher and independent third party auditor should agree to the scope of the audit and the support that will be provided prior to any fieldwork. The publisher should be allowed enough time to gather and organize the support before actual fieldwork begins. If these preparation steps are taken, the audit can be conducted in a timely manner.”

Oxford-based handheld and iPhone developer Exient, has adopted an RM model for the past five years. “We’ve employed RM specialists to provide analysis and reports on our royalty statements, and we regularly receive feedback and advice on contract points,” explains David Hawkins, managing director of the firm.
“Exient benefits from a consistently current and accurate picture of the commercial success of our titles. This, in turn, frees up my time so that I can focus on other business priorities knowing that I will be provided with the guidance and information when needed.”

DISCREPANCIES
As we can clearly see, an audit carried out in the correct way has the potential to do a lot more good than harm. In fact, there are very few reasons not to audit.

But what about when an audit shows a discrepancy? After all, my opening paragraph stated a figure of $16m so there are clearly accounting discrepancies to report. Should we assume that there has been some catastrophic failure in the system and everyone is ganging up against the developer?

No, not in the slightest. Most errors are just that – errors, mistakes. These can be made throughout the statement, for example with incomplete sales numbers, missed bundle sales, OEM and license deals omitted, incorrect royalty percentages applied, underspend on marketing, cost of goods overcharged – the list is almost endless. Errors made are rarely, in my opinion, malicious. Of course, there is also the flipside of the coin – the one where audits actually go against the developer. It rarely occurs, but I have seen corrections needed which reduce royalties payable to the developer. In my experience it tends to be a small correction and, as long as there’s no refund clause, it won’t cause the developer to lose sleep.

EXPENSES
There are obviously costs involved in auditing a royalty statement, and these costs can vary greatly depending on which route you take. A typical audit within the UK – most audit companies can also carry out work in overseas markets – can take as little as one day and as long as three weeks. If you have a very successful triple-A product released across three or four platforms on a co-publishing agreement, then you could realistically expect the audit to take between eight and ten days. The going rate for an audit company can be anywhere between £500 and £1,000 per man day. Accounting firms may choose to charge differently, depending on whether a partner or junior member of staff is working on the audit. If available cash is tight, then a good option may be to negotiate a lower day rate and higher contingency or bonus, but check your contract first as a contingent auditor is not always contractually permitted.

Auditing is sometimes seen as a bit of a black art, but it should be seen as an almost essential part of a developer’s business strategy. An audit could result in getting you nearer to ‘recoup’, and also helps to reassure the company directors and shareholders that you are managing and verifying the flow of data into your company. Additionally, the information you learn from the audit could be of real value elsewhere in the business so there are really very few circumstances where an audit is a waste of resources.

THE REST OF THE WORLD
Outside of the videogames industry is a world of licensors and licensees; those that own IP and those that effectively lease it. These various industries adopt an annual approach to auditing and treat it as part and parcel of the bigger picture. It is, in effect, the norm. With the continued maturation of the publishing and development industries isn’t it perhaps time that royalty management was seen as an entirely normal business practice within these disciplines as well?

Faye Sieracki will be speaking at ‘Best Practices in Running a Games Business’, a free event hosted by Sheridans, on the 28th January, 2010 from 5pm. Spaces are limited. To attend email: events@sheridans.co.uk