What They'll Never Tell You About the Music Business

by Peter M Thall

  One solution introduced by some is to establish a “180 deal.” What is that? Well, it’s certainly not one that covers all aspects of an artist’s career. Maybe it excludes publishing income participation; sponsorship income participation; merchandise income participation. Maybe a portion of some or all of the above. This is not a bad idea, but it requires creativity on the part of both the record labels and the artist’s representatives. During a panel discussion by the International Association of Entertainment Lawyers (IAEL) at the annual MIDEM conference a couple of years ago, when this phenomenon was just becoming part of the conscience of the entertainment bar, it was suggested that there were actually many variants of the 360 that could be explored:

  The 90 deal: Just records

  The 120 deal: Records plus limited tour and retail merchandise

  The 180 deal: Records plus full tour and retail merchandise

  The 240 deal: Records plus full tour, retail and tour merchandise, website sales

  The 360 deal: Records plus full tour, retail and tour merchandise, website sales, endorsements, acting, reality TV shows, video games, digital merchandise, cookbooks, and many others. (I had one client who was a vegetarian and Sony Music wanted to control whether he would write a cookbook, and where and how he could promote it—for example, an audio book version or promoting it live on the TODAY show would require their permission.)

  The ultimate solution is for the parties to figure out how to achieve what they need to fully function in their various capacities and to construct a relationship that accomplishes this goal in the most effective way for all parties. As always, compromise is the name of the game. But nowadays, it requires some genuine creativity in establishing realms of influence and asserting expectations from all parties. Record labels bear a certain arrogance that comes from the fact, which we cannot deny, that they are investing the largest sums of cash (if not labor) in the artist’s eventual career. If they are able to respect the investments of the other professionals, perhaps we can reach some level of parity which will eventually inure to everyone’s advantage.

  Alternative Solutions for Various Scenarios One thing that many lawyers and managers do not consider when they eventually make a 360 deal that they believe serves their immediate needs is this: What happens if there is no long-term success? How long does the record company “commission” the revenues of the very artist whose promised success does not equal the dreams of the participants? I have always been one to bet on success, but one of our principal jobs is to protect against failure. The post-term participation by the record company in merchandising, touring, etc. can paralyze an artist for years after the relationship with the label has actually come crashing down (no matter who was at fault).

  An example of the opposite situation, betting on success, would be to make sure that after the first album under the 360 structure, the artist can cancel further 360 aspects on subsequent records where the first record has been successful. Or perhaps the artist can cut it in half or establish some progressive percentages so that the “hit” isn’t as great on subsequent albums. Otherwise, the record label will be sharing substantially in the artist’s career long after the value of their contribution (tour support, for example) has been neutralized by the artist’s having caught on with the public. While this result may be controversial, the fact is that by insisting on a 360 deal—particularly after the artist has already entered into a traditional recording agreement—the label is saying, essentially, “We cannot do the basic job for which we signed the artist in the first place.” So, fine. Modify the relationship to assist the label to do its job on the first 360 album, but have the option to pull back if that modification results in a successful financial return to the label for its initial risk investment.

  Another option for artists trying to scrape together some semblance of balance between the parties is to limit the impact of the 360 deal to specific territories where the artist needs the extra support of the label: for example, the US and Canada only, or Europe only, or wherever. Where the artist’s career is well under way in one or the other territories, there is no desperation on the part of the record labels such as they are expressing in today’s economy, and there is no need to accommodate this desperation by giving away more of the store than is necessary.

  Yet another option is to give the record label shares, or stock options, in the artist’s corporate family. This idea is catching on with “music entertainment” companies, but generates additional legal fees as these deals can become very complicated and implicate tax and international tax issues, securities laws, trademark and corporate matters above the expertise of your average music attorney. A more full-service law firm can provide these services, but oh the costs! On the other hand, the artist can be given shares in the record company. After all, the record company has all of these experts at its disposal and the artist will not need to engage them. Remember, this is all about achieving some balance when both parties are seeking to share in the success and to cover their losses in the event of failure.

  The difficulty of achieving a workable 360 deal is exacerbated by the simple fact that the label is calling all of the shots because the label is spending all of the money. Therefore, in the standard 360 deal, the balance that the parties seek actually is never achieved. Nothing would resolve the eternal conflict between artist and record company more than a 50/50 relationship. No one doubts the contribution of a hit record to the enhancement of an artist’s other income. But when a record label continues to recoup solely from the artist, at the artist’s net royalty rate (see early sections of chapter 4), the recording costs, promotional costs, tour support, and video costs, when the record company calculates digital royalties as if they were actual retail sales (via a distributor or one-stop distributor),*4 demands percentages of the “show gross,” or structures payments to the artist on a royalty rather than a profit-split basis, this balance is unattainable. In conclusion, in order for a record label to earn the right to a 360 deal, as Bob Lefsetz has reported in his blog, it has to be a 360 company. Live Nation has tried to accomplish this and in the course of things has convinced some extremely important artists to establish something much closer to a partnership than has been the case in the past. Madonna, Jay Z, Shakira, U2, and Nickelback all have put many eggs into the 360 basket (and have been advanced millions to do so). Unfortunately, this kind of deal is obviously not available to 99+% of artists who have not yet established an important brand. The fact that those who have accomplished essentially what they have sought from these ties have already “made it” demonstrates the futility of comparing those deals with what the record labels are demanding today. But even with the stars’ deals, certain events can cause them to regret what they have done…long after they have paid their taxes on their enormous advances and spent the rest: for example, cross-collateralization where one record/tour cycle is successful and another one is not. If the failure comes early, and the success later, the artist will not see any additional money for years while the investor will at least be able to recoup its losses out of revenues. An ironic result was also suggested at the IAEL discussion noted earlier. The Copyright Royalty Board has established a late fee to be charged to record labels which are late in their mechanical royalty payments to music publishers. If the label and the artist rise and fall together, then if the label is late in paying mechanical royalties (which often happens because the writers are not agreed on the splits as to their respective contributions and the record label has no idea who to pay or in what percentages), the artist will be paying part of the late fee out of his or her own share.*5

  When all is said and done, the artist will have to make a fateful decision: do I accept a 360 (or variation) offer from a fully-staffed record company (whether or not a major), or do I try to do it myself (see chapter 16 and the pitfalls applicable to that option)? Rather than view the record company’s conditions as being demanding, or grasping, the artist must consider the alternatives, and try to find a way to live
with as efficient version of the 360 deal as possible—and as short a one, if possible. In the end, it’s all about negotiation with an adversary who has most, if not all, of the leverage. He has to look at the situation as an investment, but, as Bob Lefsetz wrote, Do I want to invest in GM or in Toyota? Since he wrote this, GM has had a complete turnaround, and Toyota had a tsunami to deal with. Where would you place your bet?

  THE DIGITAL EVOLUTION

  No discussion of the modern record industry (such as it is) is complete without acknowledging the earthquake that is the digital evolution. I intentionally did not use the word “revolution” which seems to be what most observers commenting on the subject think of when they explore the seismic changes in the means of both producing and delivering music which have occurred since the 1980s. Someone once said that the only real revolution that we have seen in the last hundred years was the development of rock and roll in the first place. I tend to agree. No, digitization of music is not revolutionary; it is characterized more by progress than by disruption—more by evolution than by interruption (as much as these changes have jarred an industry that was doing just fine without it). If digitization is looked upon as an advance, then, why did its introduction to the mix cause such regression in the very industry it was supposed to help grow?

  The answer lies in the inability of the “suits” who ran the industry over the past thirty-five years to understand and embrace the new technology. As I observe in chapter 5, Personal Management, skills to operate one kind of challenge rarely evolve into the kinds of skills necessary to operate another or others. Congresspeople often take the rap that they are more concerned (and better at it) about getting elected than they are at governing. The inability of executives to change with the times, to apply their management skills (such as they are) to new situations has led to the state that we are in today: failure to adopt new strategies and staffing, failure to accommodate the minimum desires and to comprehend the nature of their own consumers, and failure to respond to the passion of their former and potential to consume what they consider to be their culture, not those of the institutions. In chapter 25, Solving Piracy in the 21st Century, I point out that suing 20,000 kids, grandmothers, and parents for copyright infringement, which was the process de jour just a few years ago, was so counterproductive that what had been a very favorable, if benign, view of the music business by the public at large (as well as by Congress) turned into front-page derision. What kids said they were taking because it was free was called stealing by the industry leaders with disastrous public relations results.

  Let’s explore the ways digitalization has impacted all of us.

  The Truth as seen by a Sony Consultant:

  Sony consultant Dave Goldberg, a consultant at SurveyMonkey, wrote a memo to his client, Sony Music Entertainment, in 2014, which Wikileaks decided to disclose to shake up the music industry from its summer malaise. He indicated in his memo his view of the future of music and music commerce and made some pretty universal and revolutionary recommendations and forecasts about the recorded music industry (and in some respects the music publishing industry as well). Here are some of his conclusions:

  1. Music is becoming a purely digital product.

  2. A digital-only recorded music company will be much more profitable, delivering higher margins if lower gross revenues.

  3. Record companies should look only to subscription and advertising for their revenues.

  4. Since a record company’s existing catalogue provides 50% of its revenue and 200% of its profits from recorded music, those are the areas deserving most attention.

  5. Even streaming revenues are primarily generated by a record company’s existing catalogue.

  6. If Sony is netting $250 million in EBITDA, then the portion that is attributable to its existing catalogue is probably $500 million and, conversely, new releases, which cost 98% of its overhead, are losing $250 million.

  7. Therefore, cutting back new releases dramatically is the formula for a record company to be profitable, or at worst, to break even or to experience small losses.

  8. New releases should be in the rock or country genres; these areas are catalogue builders and are relatively less expensive to produce compared with hip-hop, etc.

  9. Act like a music publisher: invest very little money, but don’t try to hold artists for long contract periods.

  10. The new release business would be handled like an independent label: low headcount, simple deals.

  11. No new releases or signings would take place without acquiring publishing rights as well.

  12. Internationally, record companies should eliminate local repertoire—sell it off to a local company that is more invested in it.

  13. Focus on English language recordings except maybe for sales to Japan (currently the world’s second largest music market) and China (which is next?)

  14. Help digital service providers grow; Pandora should be accessed solely by subscription; Spotify should enter the radio space.

  15. Get rid of the performing rights organizations and their “tax.”

  16. Net result: record companies will realize 40% profit margins as opposed to the current ones that range from 11% to 18% in a good year.

  Impact on Commerce

  As we all know, digital downloads and digital streaming are rapidly replacing traditional physical sales. In 2014 and 2015, sales of CD units still exceeded digital download transmissions. Yet by 2016, digital downloads were dropping precipitously at a rate of more than 10% a year—to 2006–2007 levels—even as streaming (over 200 billion total on-demand streams were logged in 2015) is fast becoming the go-to means by which the public gets its music.

  One metric that provides a bit of a forecast for the future is the percentage of a country’s population that has even the means of accessing digital deliveries of any sort. In some countries, like the United States and the United Kingdom, a large percentage of their populations have access to the Internet and know how to use it; yet a low percentage of these consumers use the Internet to obtain their music needs and desires. Fewer than 60% of the citizens of the European Union have ever accessed the Internet, let alone used it to access music. This will no doubt change over the not-so-distant future—all to the benefit of the music industry—provided it can capture and monetize the activity efficiently.

  Most Favored Nations

  The European Union’s Commission on Competition has been a thorn in the side of the music industry as it tries to reconstitute itself after the precipitous fall of the last fifteen years. It has thrust itself into innumerable attempts by multinational companies who seek to combine music assets via merger or sale. And it has acted without mercy. For example, the Commission forced BMG Music Publishing to sell off Zomba Music and other publishing assets for Europe to a third party when it prohibited Universal from acquiring the world-wide rights to this illustrious catalogue. And EMI’s renowned Parlaphone label was sliced off from Universal’s purchase of the recorded assets of EMI when that company was sold.

  This Commission has now reached out to those companies in the music industry (that is, almost all of them) that utilize most favored nations (MFN) clauses in their contracts. The most favored nations concept is derived from an age-old understanding reached in innumerable international multicountry transactions among sovereign governments. It has been co-opted by commerce. In essence, most favored nations clauses (also referred to as most favored customers clauses or most favored licensee or licensor clauses) is a contract provision in which a seller (or licensor) agrees to give the buyer (or licensee) the best terms it makes available to any other buyer (or licensee). In the digital service provider world, it works the other way: the buyer (or licensee—think Spotify) agrees to give the seller (or licensor—think Sony Music) the best terms it makes available to any other seller (or licensor—think Warner Records). Even if the initial contracts between parties satisfy the MFN clause, the buyer/licensee is not permitted to modify these contracts in a way that woul
d result in the MFN clause being violated. The result is that if one party (a seller/licensor) exercises its power/size/leverage over another (a buyer/licensee) and increases the deal in its favor, even in a willing buyer, willing seller, open and free market, all of the other deals that the buyer/licensee has entered into must be automatically modified accordingly.

  Yes, all of these deals are confidential—but by audits and other means, the information gets out. Of course, one company’s deal is not always comparable to another company’s deal beyond basic provisions such as term and royalty provisions—transferring equity to the licensing party is often part of a buyer/licensee’s offer as are other “nonmaterial” provisions such as the relative amounts of advances paid or penalties for nonrecoupment at the end of a term. Creating these exceptions to the MFN is a lawyer’s dream—and a draftsman’s nightmare. Whether it negates the anticompetitive nature of MFN clauses is another question to be answered on a case by case basis. Still, rarely does a music industry contract exist without the inclusion of a most favored nations clause.

  The view of the Commission is that if one party wants to lower its price to the consumer, and it is restricted from doing so by a MFN clause, the restriction on the party becomes anticompetitive. Merely one price reduction or increase sets off across-the-board reductions, or increases, automatically. While this practice has existed from time immemorial, the Commmission’s attention has been drawn to digital music services to determine if the agreements they make with content owners are noncompetitive due to the inclusion of MFN provisions.

  Streaming