What They'll Never Tell You About the Music Business

by Peter M Thall

  4. However, never underestimate the imaginative workings of the record company’s mind. There is yet a fourth formula for calculating DPD percent (to 18%), and it is applied to the record company’s receipts ($0.659) from DPD sales through digital music services such as iTunes rather than to the online company’s gross receipts ($0.99).

  So which result do you think is fair?

  15% of $0.99 with standard deductions or 15% of $0.5569: $0.08 [as if a sale]

  15% of the record label’s net receipts ($0.659) after publisher and union: $0.10 [as if a sale]

  15% of the sale price ($0.99) without deductions: $0.15 [as if a sale]

  18% of the record label’s net receipts ($0.659) [recent settlements]: $0.12 [as if a sale]

  50% of the record label’s net receipts ($0.659) [standard licensing split]: $0.33 [as if a license]

  The claims and the settlements affect only existing contracts that were entered into prior to the digital age, which both the labels and the artists fought to interpret their way. New contracts, of course, are drafted to protect the record companies from similar claims. Why did the artists involved settle for so little? My read is that their lawyers were in so deep in litigation costs, and since the artists were so poorly funded, the plaintiffs tended to grasp at almost any offer rather than continue a full-fledged war against the majors. Since Sony, Warner, and Capitol (now part of Universal) have settled, it is likely that the above solution (number 4) or something close to it will prevail. Next: the independents.

  Hardly a victory for the aging, and financially challenged, artists on what will surely become the bulk of their aggregate “record” sales over time.

  DPDs and Music Publishing—Implications for Mechanical and Performance Rights

  Digital phonorecord deliveries also involve music publishing issues. For example, does the controlled composition rate apply to them? No, it doesn’t. In 1995, the federal government passed the Digital Performance Right in Sound Recordings, a law protecting digital, but not analog (terrestrial radio, for example) performance rights. The law also permitted record companies to pass on to the online download service company (for example, iTunes) the same license, so that the third party did not have to acquire its own license. While the rate is statutory, the collector of these mechanicals is the record company, not the Harry Fox Agency or the independent music publisher. Once the record company has collected these monies, it keeps them until it must account to the publisher for ordinary brick-and-mortar sales. In the meantime, record companies are considering all sorts of ways to increase their slice of the pie. For example, can they apply the controlled-composition cap on singles? Can they recoup other costs against mechanical royalties due the artist-writer or the artist-writer’s publishing company? The latest language du jour is that the record company will pay the “lowest applicable rate established by the applicable US or Canadian law.” Put the fox (the carnivore, not Harry Fox) in charge of the henhouse and anomalies are sure to follow. Finally, who is keeping track of the accuracy of DPD-originated royalty accounting? The music publisher? The writer’s accountant? The artist’s account? Are they comparing notes? The natural differential in accounting periods and at least a six-month lag in reporting sound recording earnings as opposed to music publishing earnings ensures that there is no simple way to match DPD sales with mechanical royalties earned from them.

  Royalty Payments Versus Licensing Fees

  The question here is, Is a digital download a sale at all? The mere concept of royalty—and many of the now-antediluvian deductions on which royalty bases are formed—may be unworkable in the context of electronic rights. What is a digital download, if not a license? In licensing situations, the traditional record contract already recognizes that receipts derived from licenses should be shared. The split is usually 50/50.

  How can record companies reconcile the nature of a digital delivery of any kind with the application of a royalty rate based on the retail or wholesale price of hard goods—sound carriers—such as CDs? Whether a download, webcast, podcast, or stream, there is very little direct cost in getting the music into consumers’ hands (or at least into their computers and MP3 players—and soon into their televisions—whether or not on a permanent basis). Most intellectual property experts feel that, at most, consumers are obtaining a license when it comes to DPD deliveries. If a 50/50 license revenue share can be rationalized in some areas, why not all? But try to convince record companies of this. As far as they are concerned, they have sold a record and this sale is no different from the sale of a CD at a record store. Both go through third parties before reaching the consumer. And they will remind us that their costs of making any artist successful remain constant. They claim, then, that they cannot afford to share income from DPDs equally with artists when that source of money may soon approach that from customary channels. Even as consumers are thinking more in terms of “renting” music rather than building a record collection, record companies are imposing, via artists’ contracts, the opposite view. And there is nothing you can do about it unless you have leverage. Once you do have the leverage, you may be able to renegotiate the provision affecting downloads prospectively but rarely, if ever, will you be able to fix the past. Record companies know this and always end up on the side they want to.

  Electronic Rights and “the Catalogue”

  Another consequence of the digitizing of music is that the recorded performance will always be available. It will never be deleted from the catalogue. Anyone who wants a copy of a particular piece of music can access it via the Internet and download it. This fact will wreak havoc with those artist agreements that provide for reversion of rights in the event that record companies fail to keep the artist’s records in inventory or in release in whatever format is provided for. Of course the record companies, even today, repackage records from other eras into midprice and then budget formats—ever aware of the fact that somehow, somewhere, there is someone who might want to buy the record. But this possibility of permanent availability might generate whole new versions of downward pricing (and downward royalties). New York’s former attorney general, Eliot Spitzer, and other attorney generals, are investigating whether the standard $0.99 DPD price is the result of an industry’s fixing prices—probably legally. It is only a matter of time before we see considerable upward and downward variations in these prices. Indeed, in 2006 Beyoncé’s “Check on It” was offered for download by different cell phone providers for $0.99, $1.99, and $2.99. Walmart offered it for $0.88, and Rhapsody offered it to subscribers for $0.79. And don’t forget the Russian menace www.​Allofmp3.​com, which offered it for $0.10! No wonder that the UK phonograph industry has targeted this rogue player for destruction. In recent years, the industry seems to have settled on a $1.29 price for new and current hits.

  The Bottom Line on Pricing

  Ordinarily, when negotiators either compromise on a point or decide it is not worth arguing, they understand the implications of what they are doing. In the case of negotiating the impact of DPDs, however, no one can even imagine the consequences of failing to get it right, and no one even knows what getting it right means.

  In the end, artists will probably pay the price for the current lack of precision in artist–record company negotiations and for the lack of clarity in achieving an understanding as to where a digital download occurs, what release commitments mean in the digital age, what royalty rate should be applied, whether a DPD is a sale or a license and how this choice impacts royalty rates and release commitments, and whether a record that is available via the Internet can ever go “out of print.” And if the artists do not pay, the consumers most definitely will.

  Record companies have two rationales for keeping their royalty calculations complicated: the first, which you may not hear directly (but I have), is to confound the artist and the artist’s representatives; the second is that the worldwide computer systems of the companies are set up in such a way that these systems recognize only the established (wha
t we might refer to as the “bizarre”) interrelations among the various deductions. Anything simple would be a foreign language to them.

  Clearly, it is very important that all accounting provisions be carefully and thoroughly considered. Their language will determine whether the artist ever receives even what the royalty provision, on its face, appears to say should be due. Attorneys and managers negotiating these agreements can fight only so hard to stop the avalanche of record companies’ initiatives to cut artists’ royalties down to where they want them. There is going to be a point when the party without the leverage is going to have to simply give up the fight.

  —

  In 2003, BMG gave a nod to transparency, simplicity, and fairness in recording agreement structure and language. Unfortunately, they immediately took it back. Truth be told, even the so-called transparency that they claimed to have achieved was obtained at the cost of honesty. The bottom line amount of royalties payable to artists and producers had not varied in the slightest. Anatole France said if 50 million people believe a foolish thing, it’s still a foolish thing. Of course, the Sony BMG merger ended that experiment! The convoluted methodology of calculating royalty payments that shocked us for decades is still being used—and its use is even more widespread than it was in the past. They are still “foolish things.”

  I had thought that transparency was the wave of the future, but no, it was not to be. As the recording industry shrinks, the companies’ search for the ever-imaginative edge over the artist continues apace. Universal Music Publishing was one of the first to claim transparency. As with Kobalt, you can now observe your royalty earnings online as they are recorded. But all this does is provide an early view of what you will be receiving at regular intervals of six months in the ordinary course of issuing accountings. It does not provide any in-depth breakdown of how these royalties have been calculated.

  Other provisions that have found their way into recording agreements have actually evidenced a certain contempt at any attempt at transparency. Billboard magazine has cited several dozen examples including (a) undertakings that permit a label to use a duet’s performance in video games without compensation; (b) careless use of the word “licensees” that would allow not only authorized licensees to utilize master recordings, but anyone, even a commercial product company; (c) permitting advertising on video clips on Vevo, Yahoo, YouTube, or on the artist’s website without compensation; (d) the wholesale use of links on an artist’s website to sites that the artist might find objectionable or in whose revenues the artist will not share; (e) charging “service fees” to music services such as iTunes for providing delivery of data to these services; (f) placing software on CDs that monetize the CDs for the label, but not for the artist; (g) haphazard use of outtakes, including those that are not actually finished recordings; (h) using artist’s likeness in virtual characterizations on video games; (i) carelessly marshalling data that invades the artist’s privacy after the term of the contract has ended; (j) passing along to soundtrack companies controlled compositions rates that were never intended to be applied to any records except the artist’s own; and many more examples.

  In general, exploitation of sound, songs, tablature, and lyrics has become so inventive these days that it is incumbent on the artist and his representatives to be extra careful to limit the right of record labels to utilize music as a means to an end that is something other than what is agreeable to the artist or that is not financially meaningful to the artist.

  Consider also the impact of the 360 deal (see this page) on all of these points—restrictions secured by the artist on the record deal portion may not apply to the publishing or touring portion unless specifically dealt with in the various interlocking agreements.

  Like Hertz or Avis Rent-a-Car, surprise: the record companies are actually not in the business whose product is included in their names (for example, “car” or “record”); they are in the financial business—their concern, for their shareholders, and for their own pocketbooks is the spread between the cost of money and what they receive via rentals or sales. As record companies become more and more “media companies” or “entertainment companies” or “we don’t know what we are companies,” what is a truth in other businesses will more and more apply to them. No wonder that we are seeing more and more financial institutions and financiers entering the music business. Following are some examples of how 360 deals changed the face of contractual relationships between record labels and artists. The examples are gleaned from both domestic and international Sony, Universal, and Warner Music Group contracts, the three remaining majors.

  • There are often virtual container charges on DPDs.

  • Video costs over $125,000/$150,000 are now 100% recoupable.

  • “Personal enhancement” costs (trainer/clothers/appearance) are now part of the record deal and they are, of course, recoupable.

  • Websites are owned and maintained by the record company, but the artist has to pay the maintenance costs.

  • The trend is to take streams of money and to apply a factor that takes into account virtual charges—for example, free goods (when there are none). Somehow or another, the “penny rate” always ends up the same.

  • The maximum term can be as much as sixty-three months for a two-album deal (with an add-on of eighteen months after the end of the term just for the heck of it).

  • Excuses by the multinationals regarding these excesses are actually quite amusing. For example, “Sorry, this is an international guideline.” “We cannot keep advertising off of your website because it would be too difficult to handle.” “You cannot, of course, share in the income.” “Sorry, we do not understand forward recoupment.” And the omnipresent, “This is not how we do it in this country.” “Tax credits? I do not understand your request.”

  • Rerecording restrictions are extending to seven and even ten years versus the traditional five years after recording or two years after the end of the term, whichever is later.

  • Often record companies take the royalty rate (let’s say 15% of the PPD—essentially wholesale) and apply that number to all sorts of income that the record companies used to split 50/50 with the artist (for example, synchronization fees). They similarly apply the 15% to ringtone receipts from third parties, something that is inconsistent with the manner in which record companies used to divide third party licensed income. The 15% number has a certain cachet for them. They hope it has the same for you.

  • The scope of record contracts now includes voice greetings that do not even utilize music. Sales via USNRC (United States Normal Retail Channels sales) which, if they reach a certain level, kick off royalty increases or improved advances or other terms, do not include DPDs, or if they do, they only include digital albums with no credit for singles. Ordinarily, the sale of ten to twelve singles would constitute an album for this purpose, but this variation would have to be separately negotiated.

  It is satisfying to report, however, that Warner Bros. Records (and its affiliated label, Atlantic Recording Corporation) have made valiant efforts to simplify their contract drafts, even if the terms remain fairly much the same. The table on this page shows a quantitative comparison of the old versus the new method of royalty calculations. The means are different, but the ends are almost identical. On the plus side, at least the time it takes to negotiate contracts, and the attendant legal costs and management time, are considerably reduced. Unfortunately, the 360 deal is a catastrophe for those who desire fairness and transparency in artist/record company relationships.

  360 “DEALS”

  Round and Round it Goes

  Where it Stops Nobody Knows

  —FROM THE ORIGINAL AMATEUR HOUR ON RADIO 1948–70

  Rationale

  Why the quotation marks in the title of this chapter? Because the word deals suggests a meeting of the minds; 360 deals are just another phrase for the impenetrable fortress that the record labels have created to protect their total hold over “their” artists
. Briefly, as many of you know, 360 deals represent the effort of record labels to protect their hegemony over artists in the current era when “records” as such represent a smaller portion of the entertainment dollar than ever before. Record labels have recast themselves as “music entertainment companies.” They’re not entirely wrong to do so. From time immemorial, their investments in record production, marketing, promotion, sales, and general exploitation of this gold mine of an invention have generated so much money for them that they have ignored the ancillary income generated by their own investment and hard work on the record side of the artist’s career: touring, merchandise sales, publishing income, tour and nontour sponsorships and endorsements, secondary ticketing (a new profitable source of income), tour VIP/travel packages, fan clubs, and the like. Once peer-to-peer sharing (stealing of music) had reached critical mass, they necessarily had to look outside of their own special milieu for other sources of income to justify the massive expenditures that they incurred each time they gambled on the possibilities of a musician/singer (who burnished their assets by calling them recordings artists) making it big. They claimed, and still claim, that this new economic model would actually build a better relationship with their artist—they even refer to that new structure as a partnership.*2