What They'll Never Tell You About the Music Business

by Peter M Thall

  Recording costs can be staggering. In 1969, the total charges applied against Simon and Garfunkel’s royalty account for recording costs for the album Bridge over Troubled Water amounted to just over $30,000. Today the recording costs for a similar album would easily exceed $350,000, and probably approach $1,000,000.

  Let’s go back and see how this factor affects what the artist will actually receive in royalties on the sales of our hypothetical $16.98 CD. Since the price received by the record company from the retailer is about $10.70, we’ll use $10.70 as 100 percent of the record company’s receipts for each CD. (All of these costs vary from record to record and from artist to artist. But the example used here is well within the norm.) Out of the $10.70, the record company must pay the costs of manufacturing physical sound carriers (about $1.00); promotional expenses incurred by the company’s own staff, as opposed to hiring an independent promoter (about $1.00); the cost of distribution (also about $1.00); union pension and welfare fees (about $0.09); and the cost of mechanical royalties to the publishers of the songs contained on the record (about $0.68). Anything left over is retained by the record company to share with the artist—but only after various charges, including recording costs, are recouped. Using our hypothetical deductions, this retained amount will be about $7. These are the record company’s gross, or retained, earnings.

  Now suppose that the recording costs listed above total $100,000. Theoretically, the record company will recoup its investment once 14,268 records have been sold ($100,000 divided by $7). However, the record company has other costs, including general overhead, tour support, independent promotion costs incurred as a result of the company’s hiring promotion companies unaffiliated with themselves, marketing, and videos. Often the total amount of these other costs can be just as much as the actual recording costs; in our example, another $100,000. Taking into account these other costs, you might think the record company would really break even after selling 28,572 units (in contract language, a unit is one copy of a record), and the royalties would start flowing to you, the artist. Think again.

  UNITED STATES CD ALBUM ROYALTY CALCULATION: RETAIL LIST PRICE VS. PPD

  RETAIL LIST PRICE ROYALTY CALCULATION

  Suggested Retail List Price $16.98

  Less

  Container Deduction (25%) ($4.25)

  Subtotal $12.73

  Standard Discounts (15%) ($1.91)

  Subtotal $10.82

  Program Discounts (5%) ($0.54)

  Royalty Base Price $10.28

  Artist Royalty Rate 15%

  Artist Royalty $1.54

  PPD ROYALTY CALCULATION

  PPD* $10.70

  Less

  Program Discounts (5%) ($0.54)

  Royalty Base Price $10.16

  Artist Royalty Rate 15.1%†

  Artist Royalty $1.53

  Source: Warner Bros. Records

  * * *

  *For an $16.98 retail price, the PPD (WEA’s base price) of $10.70 includes a 15% standard discount. (WEA, Warner/Electric/Atlantic, is the distribution arm of the Warner Music Group.)

  †Note from author: So we don’t really have an artist royalty rate of 15% but rather 15.1%? But what’s 0.1% among friends and partners? Or up the deal by 0.1% for a true equivalency. Every little bit helps. On a million records, that’s $9,000. On 10 million records—well, you get the idea.

  That isn’t the way it works. Why? Because recording costs are not recouped by the record company out of its retained earnings. Yes, the entire $7 mentioned above is retained by the record company, but on the books of the record company, only the amount that is owed to you, the artist’s royalty, is applied against the costs of the recording project. Let’s say your royalty is $0.80 per record. (Bear with me. You will soon see that a royalty of 12% on a $16.98 CD is not $2.04, as one would presume, but about $0.80.) Given that, 125,000 records need to be sold before the $100,000 recording costs are recouped. At that point, the record company will have received $875,000 (125,000 times $7).

  Unfortunately for you, your producer, who is not paid his or her share until the record company recoups all royalties owed you that are applied to recording costs, is next in line to be paid. The producer is paid on what is known as a record one basis (from the first record sold). At about $0.25 per record (that is, three-twelfths of your 12% royalty—or one-third of your 9% net royalty), the producer’s payment on the first 125,000 units amounts to $31,250, which comes out of the record company’s $875,000 gross. You have still received nothing. And, despite the fact that your royalties are calculated prospectively and not back to record one, it may be some time before you see any cash.

  To review: At first, you thought that upon the sale of 25,000 units, at $2.04 per copy, you would have been paid almost $51,000. But since you have to pay out of your own royalties the $100,000 cost of recording, the sale of 25,000 copies will actually net you zero. In fact, it will take a total of 125,000 records (that is, 100,000 additional copies) sold to bring your account out of the red. On these 125,000 records, you will receive no royalty; whereas your record company will deposit into its bank account $875,000. The producer will have received $31,250—$0.25 times 125,000 units, which will be paid by the record company out of the $875,000 it will have received from its distributors. And we have not even begun to take into account other recoupable costs that the record company can (and will) charge against your royalties.

  PAYMENT ON LESS THAN 100% OF RECORDS SOLD

  In the old days, vinyl records (in particular 78 rpm records, which were retired as the format of choice in the late 1950s) would often break, whereupon consumers would return them to dealers and the dealers would discard them. Therefore, the record companies would promise to pay artists’ royalties based on only 90% of sales on the (arbitrary) assumption that 10% of all records sold to dealers would be worthless and they would have to give dealers a credit for these shipments. This was done whether or not any of the records actually broke. Once LPs were introduced in the 1950s, there was absolutely no justification to reduce artists’ royalties by 10%. Supposedly, this practice ended in the 1960s.

  It’s back.

  Many record companies today pay royalties on less than 100% of sales. (A&M Records (now part of the Universal Music Group), the home of Carole King, Supertramp, The Police, and Peter Frampton, never paid royalties on more than 90% of records sold. The now defunct label, Jive Records (now part of Sony BMG Music), home of Britney Spears, ’NSYNC, R Kelly, Justin Timberlake, and the Backstreet Boys, also had a nostalgic tendency to play the 90% game. The record companies take what they can. Indeed, 85% is now the standard basis on which royalties are calculated. The rationale? There is none.

  “NEW” TECHNOLOGY?

  When CDs first came into the picture, many record companies wanted financial relief for what they termed the “incredible” cost of research and development. The relief they gave themselves was to pay royalties on anywhere from 85% to 90% of records sold to as few as 66.67%. Of course, most of the record companies had invested nothing in R&D, let alone incredible amounts. But, having been surprised by the advent of a new technology for which no special consideration had been made in their recording agreements, the record companies decided to include in their record agreements a catchall royalty reduction provision covering any new technology. This provision serves to reduce the royalty rate from 25% to 50% of the otherwise applicable royalty rate on formats such as digital compact cassettes or minidiscs, and now also digital phonorecord deliveries (DPDs) delivered to consumers via the Internet’s digital download capability. These technologies are already with us. How will the companies deal with as yet unknown future inventions? Already we are seeing recording contracts that provide that, when new technologies are being used, the artist’s royalty will be reduced to 50% or less of the otherwise applicable royalty rate, although 25% reductions are more common.

  When audiotape was first introduced in the 1960s—and for years thereafter—record companies regularly reduc
ed eight-track and cassette royalties by 50%. As most tapes were manufactured by licensees of the record companies, not the record companies themselves, the reduction was perhaps justified at the time, but the companies continued the practice long after they began to manufacture tapes themselves. Similarly, until CD plants became widespread, the reduction in royalties had some rational basis. But, once they did, the rationale disappeared—even as the practice continues to this day.

  A common practice among more reputable, or thoughtful, record companies when negotiating royalty rates for new technologies has been to include clauses providing that while there will be a general reduction in the royalty rate during the early years of exploiting these technologies, once the majority of similarly situated artists on a particular label revert to a more reasonable royalty rate, or once the proportion of sales of the new technologies increases to an undeniably large figure, such as 50% of the total market, the reduction will be lifted and the royalty rate will return to what most of us consider to be a “full” rate. While what used to be called the “CD concession” and now is referred to as the “new technology concession” has disappeared from some companies’ recording agreements, many companies still resist paying a full rate for the CD format, even though it has been twenty-five years since the format was first introduced and it is now the principal format for all records sold in the world. We can expect similar resistance to removing “concessions” for other technologies, including DPDs, for a long time to come.

  There are numerous implications of the total absence of a standard with respect to how and to what extent DPDs, and electronic rights, are dealt with in recording agreements in general and in clauses pertaining to royalties in particular. Several of them are dealt with later in this chapter; see “The Myth of Royalty Escalations” (this page) and “The Effects of Digital Downloading on Pricing and Royalties” (this page).

  “SPECIAL” CATEGORIES

  Singles

  Record companies traditionally pay artists a lower royalty rate on singles than on album sales even though the royalty rate, were it to remain the same, would be applied against a significantly reduced base. The retail cost of singles is, of course, considerably less than that of albums, thereby ensuring a lower royalty payment even if the rate remained the same. Yet artists’ royalty rates are reduced as well. For example, if a royalty of 9% were paid on an album with a royalty base of $11, after all the deductions, the royalty would be $0.99. If the same royalty rate were applied to a single with an effective royalty base of $3, the royalty should be $0.27. Sounds proportionate. But record companies do not pay $0.27. They reduce the royalty rate by as much as half. In our example, based on the same $3 royalty base, the actual royalty that record companies would pay on the sale of a single would be $0.135. Simple. You ask why? They answer, “Why not?” And, as if this result were not bad enough, singles royalty rates most often do not escalate based on sales achievement levels, as do album rates.

  Reduced-Price Records

  The typical reduction in the royalty rate on midprice and budget records is 50%. A successful negotiation can increase this to a two-thirds rate for budget records and a three-quarters rate for midprice records. Often, and for no apparently good reason, the royalty rate on other types of records—such as those sold through military exchange channels, soundtracks, picture discs, etc.—is also reduced. Every reduction in rate represents another few pennies lost to the artist and producer and gained by the record company. Believe me, they add up.

  Foreign Sales

  Royalty rates are also traditionally reduced for foreign sales. This is true whether or not a record company owns or controls (through subsidiaries or divisions) its own companies outside of the United States. However, in the latter case, there is room for negotiation. In such a scenario, the record companies actually do have some justification for their position. They claim that they should not be penalized for having their own divisions, since these divisions or subsidiaries have the same operating costs as those of unaffiliated companies. The United States–based companies claim that it is to the artist’s advantage to keep their recording careers “in the family”—that is, in one company whose interests in an artist’s career are global and thus broader than those of individual companies whose interests in an artist’s career are necessarily more “provincial.” They argue that the benefit that accrues to the artist more than justifies the foreign divisions being compensated in the same way a company that is a stranger to the artist’s record label would be compensated.

  Record Clubs

  Record clubs used to account for as much as 30% of a record label’s sales. Over the years, they have diminished in importance to the point that in most cases they have ceased operations. Online music services, downloads, including, of course, illegal downloads, had made a dent in this market—a dent that became a chasm. Despite this, the record-club deduction is still very much alive in recording artist contracts. Why? Let’s first see how they work.

  In order to induce consumers to join, record clubs typically gave away a specified number of records, while others were sold at full price. Thus members were, in effect, getting a discount on their selections, but the label had no royalty obligations on the free records. After the Sony BMG merger, there was only one record club left: BMG Music Service, which went out of business in 2009. In essence, through their record clubs, Sony BMG sold records, even at the traditional record club discount, at considerably higher prices than they would have had to sell to a dealer who would then mark up the record for retail sale. In order to avoid an avalanche of giveaways of an artist’s hit records, as a loss leader for the club for the purpose of selling other artists’ records, the typical deal for an artist and producer was that the company was permitted to give away royalty-free only as many of the artist’s records as they sold (that is, for every two records distributed, on only one will royalties be paid). It is frustrating to observe that foreign companies either do not comprehend the concept of paying on records given away for free, or will simply refuse to agree to a provision pursuant to which at least one of every two records distributed must bear a royalty. This is particularly galling when the foreign company (for example, Universal France) will be distributing the records in the United States via its US parent, and the US parent would inevitably have agreed to such a concept. It is also upsetting when the response from the foreign company is “Sorry, we don’t do that in [name of country].” As the saying goes, “Duh. I know that; we’re talking about applying the 1/1 concept to the United States record clubs where your affiliated company does do that!”

  For the records that they do sell, and that bear royalties, the record companies typically pay 50% of the otherwise applicable royalty rate. Wow! So if they don’t get you one way, they get you another.

  Many artists felt that they were subsidizing the company’s record club operations and would much prefer to take their chances on selling their records in traditional marketplaces at regular prices, thereby generating a full royalty for themselves. “Free” records, in reality, have been sold to induce the record club customers to buy other artists’ records! Because of this, many independent record labels had always refused to allow their records to be sold via either Columbia House or the BMG Music Service. Individual artists rarely have such leverage.

  In 2003, a class action suit (Babette Ory et al. v. Columbia House Music Club, BMGDirect) was brought against Sony BMG, charging that the record clubs’ practice of paying only three-fourths of the statutory mechanical license rate was illegal and, further, that compensation was due the music publishers for years of having been underpaid or inaccurately accounted to by the record clubs. (For an explanation of the statutory rate, see below, this page.) A tentative settlement reached in 2005 was challenged by the Harry Fox Agency, Inc., among other parties. The challengers contended that the settlement, in practice, would have made it relatively easy for Sony BMG to continue to pay less than the full rate—indeed, there was nothing in the settle
ment to prevent the service from paying less than the three-fourths rate—with the burden being on the copyright holder to object to the use. As of this writing, the court has agreed to delay implementation of the settlement so that all concerned parties will have time for additional discussion. However, the Harry Fox Agency has entered into its own agreement with the major record labels the basis of which is essentially the three-fourths rate, with an accompanying—and valuable—audit right.

  Do You Want to Be a Member of This Club?

  Over the past decade, since the decline of the CD as a medium to carry sound, many of the renowned record clubs (which became, of necessity, audio/video suppliers as well) were sold to a variety of private equity companies or private owners, most of whom ended up in bankruptcy; yet, in 2015, 110,000 members remained at Columbia House. Deals that used to offer ten CDs for the price of one, or even for $0.01, in return for a promise to purchase another ten are now merely offering one CD or DVD for one (plus shipping). Nevertheless, quite a few consumers apparently still like to receive that package in the mail containing new sounds, new dreams, and new experiences. Given other choices (downloading and streaming in particular), the current record club deals are not much of a bargain for consumers, but as I said, some people like their music delivered this way. Still, income from record clubs is hardly enough to make a dent in the income of artists, record labels, or publishing companies. Compare Amazon Prime’s $99/year paid service (with a thirty-day free trial) that gives Amazon members a smorgasbord of benefits that no other services come close to providing. To suggest that record clubs are antiques is an understatement.