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Follow the Money: Who's Really Making the Dough?

November 1, 2001
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Money gets a bad rap. You've heard the clichés: money is the root of all evil, money can't buy happiness, and so on. Money itself can't be bad — it's just a thing, like a rock, a chair, or a blender. It's the pursuit of money that gets people into trouble. People who enjoy making money are often labeled as superficial, shallow, and greedy. That's why you never see “money” on the Playmate of the Month's list of favorite things. That's why professional athletes embroiled in contract disputes always claim, “It's not about the money.”

Record companies are often characterized as the ultimate embodiment of money-grubbing evil. Unfortunately for them, the Napster unpleasantness has merely exacerbated that characterization. In fact, many people think record companies are just plain bad. Why is that? Certainly, record companies exist to make a profit, but so do most companies. Perhaps it's because of the way record companies make their money: they make it from our heroes, the musical artists.

All notions of musical parasitism aside, record companies perform the critical functions that allow artists to reach the masses. That's fine, you say. The problem with the record companies is that they're too greedy. You see them selling millions of albums at $15 to $18 a pop. Where do the truckloads of cash go if not into some big-shot executive's pocket? What about artist advances and money for marketing and promotional budgets? Where does all that money come from? Who gets what along the way? In this column, we will look at how record companies work and how the money finds its way from the consumers to the artists and everyone else who works to get the music to the public.

LABELS 101

In their most basic form, record companies are like music venture capitalists with production, marketing, and distribution arms. They locate, finance, and develop new talent; oversee music production; market the music through promotion and advertising and by securing airplay; and distribute the finished product through retail outlets and online services. That is expensive stuff, and risky too: only about 5 percent of new artists even sell enough records for the record company to BREAK even, and as few as 5 to 10 percent of a label's artists pay for all of the music released by the company.

Before looking at the math behind record deals, a brief disclaimer is in order: the following numbers are generalizations based on a mainstream artist at a major record label. Every negotiated record deal contains different terms and conditions of payment.

IT TAKES MONEY …

When a label signs an artist, the record company advances the recording budget to the artist at no risk. If the album fails to sell, the artist is not personally responsible for paying the money back. The record company recoups its investment in the album only if the public buys it. However, the artist does not see any money from the album sales until the label makes back its investment.

A typical recording budget for an artist's first album is between $250,000 and $1 million. The record company will also spend approximately $250,000 to $500,000 to market a new artist to the public. Pressing the album and shipping it to retail outlets costs from $1 to $2.25 per unit, depending on the size of the pressing (more units cost less per unit). A new artist typically receives between 12 and 16 percent of the album's suggested retail price as a royalty. In addition to those costs, the record company must pay royalties (called mechanical royalties) to the music-publishing company for every unit sold. The record company usually caps its mechanical royalty costs at $0.755 per album (10 songs at $0.0755 per song). To recoup those expenses, the record company receives a wholesale price for each unit sold by the distributor from $7.50 to $11.50 per album, depending on the genre and artist. (For a look at where the money from a single CD sale goes, see Fig. 1).

With those numbers in mind, we can make some assumptions and show why every record an artist releases is a risky investment for the record company. If the artist receives a $250,000 advance and the record company spends $250,000 on marketing, the record company has spent $500,000 dollars before one album has been sold. If the record company receives $10 per unit from the distributor and has to pay $1.25 for pressing and shipping and $0.75 for mechanical royalties, the record company ends up with $8 per album ($10 income minus $2 pressing, distribution, and mechanical royalties) before deducting the artist's royalties. Assuming a suggested retail price of $14.99 and an artist royalty rate of 15 percent, the record company owes the artist approximately $2.25 per unit sold. After deducting the artist's royalty, the record company's net income from the sale of the record is approximately $5.75 per unit sold. The record company must then pay for its overhead and all of the albums that don't sell well enough to pay for themselves, $5.75 at a time. For that hypothetical album, the record company must sell 86,957 units to cover its out-of-pocket costs, which do not include the everyday costs of running an international business. Although 86,957 units may not sound like many units to sell, only about 16 percent of all record releases reach that sales figure.

TO MAKE MONEY

So what about the artists? They're really raking it in, aren't they? Well, yes and no. Huge stars make lots of money, but most artists, even if moderately successful, generally struggle to make a buck. First of all, the artist won't see any royalty money until the record company recoups its advance production budget. To further complicate the math, the artist usually must pay 3 percent of the royalty to the record producer. Deduct the 3 percent from the royalty rate, and the record company recoups its $500,000 advance at $1.80 per unit sold. Therefore, the artist won't begin seeing money from sales until 277,778 units are sold, and only about 3 percent of records ever reach that sales figure.

At least he or she will have fun with the advance money, right? You've heard about the parties artists throw when their big advances come in. Actually, that $250,000 represents a relatively small cost-of-living budget, even if the album sells relatively well. Assuming that no management, attorney, or other professional fees were paid from the recording budget, which would never happen, the artist will probably spend $200,000 of the $250,000 advance on actual recording costs. That leaves $50,000 to split among the band members. If the band has five members, each member receives $10,000 to live on until the album recoups its budget, as calculated above. That time period is generally about a year to 18 months if the album sells well.

Furthermore, those calculations don't include the money that the band must pay to its legal team or management for the deal. Lawyers typically charge an hourly rate (from $175 to $350) or a percentage of the artist's total gross income (between 3 and 10 percent). Managers typically charge between 15 and 25 percent of their client's gross income. Accordingly, the manager and the lawyer could easily end up with $75,000 of the $250,000.

OTHER MEANS

Before you run out to loan Metallica some money, keep in mind that other streams of income are available for reasonably successful artists. For example, artists can earn money from touring, though most bands tour primarily to support album sales and airplay. Also, some artists can make money through endorsements and other marketing strategies. However, the best opportunity for artists to make serious money is to write their own songs. I'll never forget seeing the lead singer of a moderately successful band flying first class while the rest of the band was condemned to coach. You can guess why: he was the songwriter.

The primary source of income for artists who write their own songs is mechanical royalties. Typically, a performing songwriter owns his or her own publishing company. That company enters into a copublishing agreement with a larger publishing company whereby the two companies co-own the copyrights to the songs. Of the mechanical royalty income, the songwriter receives 50 percent, the songwriter's publishing company receives 25 percent, and the larger publishing company receives 25 percent.

Assume that all of the songs on the hypothetical album are administered by a single publishing company (in a copublishing deal with the songwriter's publishing company), and that, according to the mechanical royalty projections laid out previously, $0.755 total mechanical royalty income is generated per album sold. Of that amount, the songwriter is paid 50 percent($0.3775). Of the remaining publisher's share, the songwriter's publishing company and the larger publishing company each receive $0.18875 per album sold. In the end, the songwriter receives a total of $0.56625 per album sold ($0.3775 plus $0.18875), and the publishing company receives $0.18875 per album sold.

Furthermore, the publishing company and the songwriter make money from any public performances (for example, airplay and live cover performances) of the album's songs. Although public-performance income is difficult to hypothetically quantify, approximately $0.013 to $0.014 is generated per public performance. That money is divided among the publishing companies and the songwriters. Public performance income is generally not as significant as mechanical royalty income, but think about how many times you hear a popular song on a single radio station in a single day and multiply that by the number of similar format stations around the world.

Songwriting money can add up fast. For the songwriter, an album that sells a million copies generates $566,250 in mechanical royalties alone and added income from airplay, which is above and beyond what the band members in coach are making.

That's where the money goes. Hopefully, those figures will help you realistically assess your risks as an artist or songwriter and maybe go a little easier on the record companies. For better or worse, selling music is and always will be a business. Caveat emptor!


Eric Leach is an intellectual property and business law attorney at the firm of Goodman and Leach. He can be contacted at eleach@goodmanleach.com.

Bill Henslee is a professor at Pepperdine University School of Law, where he teaches copyright and entertainment law. Contact him at william.henslee@pepperdine.edu.

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