• Return on equity is the ratio of net income (after payment of preferred dividends) to the net worth or common equity in the enterprise. Return on equity measures income generated for each dollar of capital invested by the ordinary owners who have no special first claim on profits in the form of preferred dividends.

As measured by net profit margin, Plenum Publishing was more profitable in 1997 than 491 companies in the S&P 500, according to Business Week. Reed Elsevier's net margin was higher than 473 of the companies in the S&P 500 for 1997. Both Plenum and Reed Elsevier had extraordinary net profit margins compared to the periodical publishing industry as a whole, and Wolters Kluwer was near the upper quartile. However, as noted, high margins on sales may be necessary to earn a sufficient return on the equity that must be attracted. Wolters Kluwer provided a higher return on equity in 1997 than 482 of the S&P 500 companies, Reed Elsevier higher than 448, Plenum higher than 361, and Wiley higher than 302. Even though Wiley's net margin was relatively modest (4.7%), it excelled in providing a strong return on equity (17.2%). This ability to turn a net margin into a high return on equity is characteristic of the publishing industry in which either a small amount of equity can be put to work to generate considerable sales or the industry leverages equity by borrowing to produce high returns on small equity stakes. In simple terms, this means that publishers either do not need to raise a large amount of capital to produce publications or that publishers borrow what money they need rather than selling equity stakes. A detailed analysis of the origins of these returns on equity is beyond the scope of this article, but a high return on equity is at least a potential indicator that equity holders are benefiting from investing in activities not subject to competitive forces. In combination with other evidence, the return on equity figures help bear out this assessment.

The periodical publishing industry as a whole, at the lower quartile, median, and upper quartile levels, converts margins into return on equity at multiples of three or four times. Wolters Kluwer and Wiley attained these industry levels of performance as measured by return on equity as multiples of their margins. However, because Wiley started from a lower margin, only Wolters Kluwer approached the extremely high return on equity of the upper quartile of the industry. Compared to most other industries, Reed Elsevier fairly efficiently used capital to earn a high return on equity from a very high margin, but it was not nearly as effective with its margin as other top-performing publishers. Plenum did a poor job of converting a very high margin into return on equity; this gives some indication of likely inefficiencies on the part of Plenum relative to the other two companies and relative to periodical publishing in general. However, we cannot definitively state the origins of these return on equity figures without a very detailed analysis of the debt and equity structures of these companies.

If the net margins of Wolters Kluwer, Reed Elsevier, Wiley, and Plenum had been 5.0% (the median in the overall periodical publishing industry as measured by Dun & Bradstreet's Industry Norms & Key Business Ratios 1997-98) the customers of the three companies would have saved approximately $884,653,000 in 1997. Alternatively, if the three companies had earned a return on equity of 18.8%, the customers would have saved approximately $490,145,000. Of course, those customers were not all purchasing only scholarly publications from these companies. That raises the issues of how much revenue these companies derive from scholarly publishing (as opposed to their other product lines) and how these companies regard their own scholarly publishing segments.

Company Views on the Scholarly Publishing Market

The annual reports contain some information about the companies' views of the scholarly publishing market and their intentions to focus on this profitable business.

Wiley reports that 47% of revenue for 1997 was derived from science, technology, and medical publishing, consisting of journals, encyclopedias, newsletters, and books: "A fundamental strategy is to develop journals, newsletters, subscription books, multivolume reference works, and other continuity products. Such products serve customers well by keeping them up to date in fast-moving fields of science and technology, and they benefit Wiley by generating predictable income and substantial cash flow." Educational publishing, mainly of undergraduate texts, accounted for 25% of 1997 revenue for Wiley, and professional publications mainly focused on business professionals generated 28% of revenue in 1997.

Plenum reported that in 1997 subscription journals accounted for 63% of sales, books for 26%, and database products for 9%. No particular emphasis is reported on growing one segment relative to another.

It is noteworthy that Wiley's profits in scholarly publishing are essentially similar to the periodical publishing industry overall. Reed Elsevier in particular is probably profiting from the structural differences between the market for scholarly publishing versus the market for periodical publications more generally. Plenum's relatively inefficient use of capital is illustrated again here by the dramatic contrast between the savings as calculated on industry-standard net margin versus industry-standard return on equity. Wolters Kluwer is considerably more profitable in its scholarly publishing businesses than the periodical publishing industry median ratios. However, Plenum's high margins and inefficient use of high margins and Reed Elsevier's high margins and high return on equity stand out as worthy of our attention as customers.

Discussion

The financial performance of vendors is of interest to (potential) customers for several reasons. On the positive side, a financially sound company can be more safely relied upon if the intention is to build a long-term relationship. The profitability of a vendor may also indicate the superiority of its products and services or a better understanding of the market served. If a competitive market is operating, the very definition of a free market means that successful companies succeed for these reasons. Therefore, the financial performance of a vendor can help to guide purchasing decisions by providing information about the collective judgments of the marketplace of customers.

The costs of acquiring scholarly information are relatively substantial in research libraries, and even in terms of entire universities' budgets. If we find ourselves being customers in a non-competitive scholarly communication market that is too expensive for our participation in the breadth and depth needed for a healthy scholarly system, what is to be done? When regulation is as unlikely as it is in today's current political environment, and when the product or service is as vital as scholarly information is to research communities, then the customers can only pursue innovations that will end the reliance on buying in a non-competitive market.

In the short term, this financial information might be useful in negotiations or debates with commercial publishers. However, the fundamental problem of a lack of competition cannot be addressed through negotiations. Ultimately, research institutions must help to create a system of scholarly communication that is either strongly competitive and commercially based or a system that is not predicated upon the generation of profits from the communication process itself. This summary of publisher finances illustrates in an inexact way the premium paid for relying on the current inherently non-competitive economic model of commercial scholarly publishing. The lack of competition is fairly obvious in the finances of the companies, but the lack of competition can be confirmed by an analysis of how all the participantsÑauthors, readers, and publishersÑoperate within the commercial scholarly publishing process.

Free markets encourage innovation in the deployment of resources precisely by tolerating extraordinary profits for new enterprises when risks are high and before a competitive market is established. Thus, companies regularly make claims to investors about playing in markets where competition is sparse or non-existent for the moment due to the innovations of the company. However, sustained non-competitive markets in a mature industry are generally an indication of a structural problem in the market that prevents the entry of competitors over time.

In the case of scholarly publishing, the major impediment to competition is that all of the direct incentives for authors lead them to publish in well known channels to reach the largest number of readers without regard to the cost of those channels to the readers. However, the reader is not free to choose new channels because those channels are typically not filled with the same content early in the development of a publication. This system of incentives makes it very difficult to develop competitive communications channels. The customer, i.e., the reader in this economic model, is disempowered within the system because the product is "must-have" and "single source."

Reed Elsevier comes close to stating this in Elsevier's 1997 filing with the U.S. Securities and Exchange Commission (20-F), when it notes for investors that the company is increasingly "concentrating on high value-added areas of 'must-have' information and significantly reducing its exposure to the consumer markets." In the consumer publishing market, the publisher produces the content and other publishers can compete by producing similar content themselves. In the scholarly market, the content is produced by authors external to the publisher, and authors are reluctant to move to another publishing channel for any reason other than broader awareness or prestige, which are inherently difficult to produce early in the development of a channel. This is a very positive market situation for a publisher because it avoids competition so long as the economic model is not disrupted by innovation. New publishing channels that include technological or structurally innovative features, reach broad audiences, and offer prestige early in the life-cycle might lure authors away from established channels. But perhaps even more importantly, we must keep in mind that the innovation must ultimately disrupt the non-competitive economic model at work in commercial publishing. Improving scholarly publishing functionality with technological innovation will not in and of itself introduce competition. The innovation to change the economic model must focus on developing a structure to align authors' and readers' shared interest in broad dissemination. This is precisely the challenge to the customer community for scholarly communication. We must innovate to produce competitive communication systems over time or continue suffering under a system of shrinking access due to the lack of competition in the present system.

Universities have excellent reasons for pursuing such innovations. The most important reason is not that the current system is too expensive and cannot handle a steadily increasing volume of scholarly communication. Both of these are serious problems, and even minimizing all non-beneficial " publishing for tenure" is only a short-term mitigating approach in the face of increasing collective knowledge. However, overcoming these problems of cost and volume has a much more important benefit for universities than any potential direct cost savings on library acquisitions. The most important benefit of a changed economic model for scholarly communication falls to universities as producers rather than as consumers: scholarly publishing makes publicly known the value of research of all kinds. Only by making that research known can it be valued and financially supported by the various supporters of scholarly enterprise, ranging from corporations to foundations to legislators to other scholars. The worst disservice to the research community by the current system of commercial scholarly publishing is that it dooms scholarly research to reach a shrinking audience as commercial publishers profit from the artificial scarcity enforced by high prices. The greatest rewards for universities in creating a new system of scholarly communication are in the potential for increased support based on increased awareness of the intellectual products of the universities. If any point bears special emphasis in our thinking about the value of innovations in electronic scholarly communication, the value of increasing readership should.

Ease of access to quality information is the fundamental goal of both authors and readers -- "producers and consumers," to put it simplistically. When a researcher takes on the maze of literature databases, the frustration of shrinking local library collections, the long-delayed document delivery services, and the shocking copyright fees, it rapidly becomes clear that there has to be a better way, given that the author and the reader share the desire to communicate. Readers and authors are already finding ways around the frustration imposed by the current scholarly publishing system. SPARC and other initiatives give us the opportunity to facilitate and institutionalize that process.

Finally, it should be noted that this article is not intended as an indictment of any particular commercial publisher or all commercial publishers as a group. Indeed, we are finding many for-profit publishers are adopting business philosophies and practices that may ultimately contribute to a more competitive and viable marketplace for scholarly communication.

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