Quick summary for those in a hurry: this was about the practice of auditing your publisher to ensure that the total amount of royalties paid to you as a developer is correct. Tim hails from Media Forensics Ltd, a UK-based company which performs these audits – so they were, of course, looking to sell themselves a bit, but what they said made a fair amount of sense anyway.

Royalty accounting within the games industry has become a major undertaking. On the surface, it sounds simple – pay the developer a percentage of every sale made – but in practice, it’s seriously complicated. The growth of high street retail (and other mediums, such as mobile or downloadable games) makes all the numbers that much larger. These numbers have to be put through calculations that differ every time because deals between publishers and developers are rarely the same twice (yet the formats used for these calculations are standardised to a one-size-fits-all layout that is rarely sufficient); and they have to be tracked by a tangled mess of different accounting systems that have been precariously merged as publishers have bought each other out. Jon stressed that almost all publishers try to get it right – they’re not out to screw over the developer – but they usually don’t invest enough in their accounting systems to ensure things run smoothly. Sure, there are exceptions – some publishers are worse for it than others, and some care less than others – but historically, developers get underpaid because they don’t push the publisher hard enough to get what’s rightfully theirs.

As a developer, you’re informed about the royalties you’re receiving in two ways: one, a chunk of cash rolls into your company bank account, and two, you receive a royalty report every quarter. A royalty report is a review of your title’s performance in the marketplace – a breakdown of sales and income per month. It’s quarterly, so it covers three months (and remember, ‘quarter 1’ is not necessary January, Febrary and March – it’ll usually be the three months at the start of your publisher’s tax year). There are two types of royalty report: the first is used when your contract gives you a percentage of net receipts, however that’s contractually defined – the gross income minus things like marketing, distribution, and so on. These deductions can be different for different groups of sales; for example, the deductions for distribution (getting the game to stores) are probably higher for that game store in the middle of the amazon jungle than the store a couple of blocks over from the manufacturing plant; for some games, however, they’re the same for all sales, so it comes out as a fixed amount per unit sold (downloadable games are like this). The second type of report is a distribution report, which is when your contract with the publisher specifies that you get a share of the net income/profit of the game instead of a share per unit; this type of report requires more complex analysis. Don’t forget that the cash flow effect – the way that the money must cascade from entity to entity on its way to you – means that royalties on sales made in December won’t get paid to you until mid-May.

Every publisher has a different reporting style, and more than one of the publishers out there give reports in numerous different styles. Because publishers seek to avoid having to create custom reporting styles for each project, they take the lowest-common-denominator approach: the result is you lose most of the details. Fewer details mean fewer things to ask questions about. So what you really need, first and foremost, is to include in the contract the details that you require the publisher give you (i.e. as many as possible – sales units, gross revenues, returned units, return costs, price protection, net sales units, manufacturing costs, marketing expenses, and any other deductions – by country or territory). Ideally, you should include a template for royalty reports as part of your contract, and once it’s all in place, be stubborn about it – if they’re not giving you all the details you’ve asked for, reject their report until they give you one that’s satisfactory. If you let them get away with it once, it becomes harder to reject it the second time.

Once you’ve got the information coming in, the second thing you need is somebody on your staff who can read and understand these reports, and knows how to check them for figures that don’t add up. There’s two stages to checking a royalty report. The first, Tim referred to as “Do the math:” check that their column totals add up, that the brought forward numbers match the previous report, that the percentages used are correct, that it’s not lacking sub-license or bundle activity (retail sometimes forgets to tell the publisher that they bundled your title with something – do your own scouting to see if this is happening, particularly on the web), and that things have simply been typed in correctly. Publisher staff are only human, and simple typos are perfectly plausible.

The second, Tim referred to as “Do even more math.” This is about checking your numbers to see that they are ‘normal’ for a title in your situation. Divide the gross revenues by gross units sold to get the gross revenues per unit (a newly released, full price title should be at least $30); work out your net unit sales and revenues as a percentage of the gross (for top titles this is usually at least 85%); check your manufacturing costs per unit (a PC CD should be no more than $1.50 per unit, while a console game should be no more than $9 per unit); and check the royalty amount you’re receiving per unit (is it falling as a percentage or dollar amount, and if so, why?) If you can’t do the checks, hire someone who can.

What are the most common problems MediaForensics have seen on royalty reports?

• Understated sales revenues – revenues are usually accurate for regular, high-street retail, but when it comes to non-routine things (rental, sub-license, OEM and bundling, online, mobile, etc) the figures may not have captured everything that’s been going on.
• Overstated manufacturing, distribution or marketing costs – often this happens because someone put in “conservative estimate” figures at the beginning, and forgot to replace them with the actual figures at a later point in time. You need to beware of publishers trying to include a percentage for their own staff costs – your contract probably didn’t allow them to do that. When it comes to marketing and “MDF” costs, always seek outside help in figuring out whether the figure is accurate – it’s very hard to judge how much marketing does, did, and should cost. You may have been charged for a quarter of a booth at E3, even though your game was one amongst 20 on display there; or you may have paid for a full page in a gaming mag that ended up advertising three other games alongside yours. Don’t undertake this one yourself.
• Transposition errors onto statements – aka typos. Suddenly a 13% deduction becomes a 31% deduction. You’d think this doesn’t happen, but as noted previously, a publisher’s accounting systems are often fairly disjointed and require someone to sit there and type pages and pages of figures from one system into another. Don’t forget, however, that these errors can go both ways – you may find your cut suddenly shrinking from 71% back down to the expected 17%.
• Overstated “bad debt” provisions – Most publishers state a standard 2.5% deduction for “bad debt.” This is usually far too large – most publishers have a bad debt of 1.0% to 1.5%. You can’t really find out what the true percentage should be without auditing the publisher.
• Incorrectly calculated and held retentions – this refers to provisions in your contract for returned units and price protection; such a provision is usually a “standard” percentage of net revenues. Beware of the publisher retaining units at a different rate to that specified in the contract; beware retentions not being released; and beware of retentions being carried forward incorrectly (usually typos again).
• Inappropriate low price selling activity – when the revenue per unit is lower than it should be, particularly if it’s soon after release (so prices shouldn’t have dropped yet). The publisher may be trying to get rid of some other poor-quality title by attaching it to yours with a lower price point, or the retailers may be dropping prices to try and meet their quotas. Sales made to the rental chains may show up here too.
• Weak consolidation by the HQ – it’s down to the HQ to bring all the figures from all their territories together and run them through the machine. Exchange rates are something to watch out for here (Tim mentioned one instance where a publisher had added US dollars and Euros directly, forgetting to perform the currency conversion), as are a complete failure to account for a territory (usually only the new ones). And even if they’ve got all the figures flowing in correctly, the calculations they’re performing may simply fail to reflect the terms agreed in your contract. This is usually only a problem with the smaller publishers, because they’ve got less automation in place.

Auditing the publisher can uncover mistakes like these, which may be causing you to lose a significant chunk of cash. It’s also good corporate governance, and looks good in front of your shareholders and other investors. There’s some feeling that auditing a publisher isn’t going to sit well with that publisher and may harm future relations, and while that’s true in some cases, it’s becoming increasingly the case that auditing is seen as a standard business exercise just as in the music and movie industries. EA even has a team of people dedicated to working with auditors. If you suspect that something’s not quite right, or if the publisher is being uncooperative (do they have something to hide?), then you’ll want to audit them, but even if all seems well, Tim would still like you to (pay him to) audit them. If you’re telling your publisher right back when you sign the contract, “We’re going to audit you when the project is done,” then people will be a lot less put out by it when it actually happens.

If you’re going to want to audit, you need to be prepared. Firstly, you need to make sure that your publishing contract actually allows you to audit them – some publishers are cooperative and let you do it anyway, but it’s not a good idea to rely on that, so get it into your contract. Even if it’s in your contract, the right to audit may have expired, or may only be permitted to access data from a limited period of time. There’s also likely to be restrictions on when you can perform an audit – it’s disruptive to a publisher’s accounts department to be audited, so they likely won’t want you doing it while they’re handling the Christmas sales, and so on. Secondly, before you call in the auditors, make sure you’ve got all your documentation and ‘evidence’ organised – all your contracts (the signed originals), all your royalty reports, and any amendments to anything (contractual, email, verbal – you name it, they’ll need it). Be ready to answer any questions the auditor has quickly; the longer they take, the more it all costs you, so don’t keep them waiting. Don’t call them in and then go on holiday.

So what do the results tend to be like? MediaForensics have always found inaccuracies in accounting when they’ve been called in for an audit (and granted, if there was nothing wrong then they probably wouldn’t have been called in). These inaccuracies have almost always resulted in the developer being underpaid. The publisher will usually react in one of three ways: one, “You’re absolutely right, we’ll tighten up our systems and send you a cheque immediately.” (This is not a common occurrence). Two, “Hum. Well, can we fix up a meeting in a couple of months time?” (They’re stalling for time, probably to try and push the cost they’re about to incur into the next quarter). Three, “So sue me.” While in Tim’s experience nobody’s actually had to go that far yet, you should be ready to. It’ll happen eventually.

In summary: It’s complex. There’s little standardisation, lots of opportunities for errors, and some very poor-quality systems behind the royalties mechanism. Subject your reports to careful scrutiny, and ask questions about them. Audit your publisher as a matter of routine – people are getting used to the idea, it’s not personal. And as an absolute last resort, be prepared to sue to get what you’re owed.

There were a couple of questions from the audience at the end of the session. Firstly, someone asked who gets the interest earned on the errant amount: usually, Tim said, the publishing contract will state that the developer will receive the interest, but that clause disappears during negotiations (giving up on the small amount to get the large amount). Someone else asked how long it takes: usually about a week, though once the audit is complete it can be weeks or months before your cheque arrives (the longest in Tim’s experience was six or seven months).

In closing, I found this quite an interesting session, though I’m conscious that it was in part a sales pitch. It’s good to hear that some publishers are beginning to act professionally and accept audits as a matter of course; perhaps if we all do it, they’ll stop making the mistakes in the first place.