Fools Go Forth: Digital Distribution And Artist Compensation

It is no secret that most entertainment companies are inefficient businesses — they spend far too much and save far too little. Nothing exposes this inefficiency like digital distribution. Even better — nothing exposes the inequities in artist compensation like digital distribution.

Artist royalties are calculated based on a contractual formula. Depending on your agreement, you might get a percentage of net revenue that takes the sales price less returns, bad debt that sort of thing. Or a percentage of net revenue that factors in certain costs like product manufacturing, mastering, freight, whatnot. The deals differ across industries, but, interestingly, when you look at how book royalties, music royalties, and home entertainment, formerly video, royalties are calculated, they are remarkably similar. Motion picture participations (video royalties are a subset of this) have additional complexities that I won’t cover here.

These costs continue to be factored into royalty calculations despite the fact that there’s a vast difference in expenses related to physical product and digital product. While I haven’t been able to test it, I am quite convinced that there are some music companies who are automatically deducting a calculated amount for manufacturing and freight from every digital dollar received (this is how some accounting systems are set up, not necessarily an intentional rip-off). At the end of the day, artists receive 5%, 6%, 12%, due to historical calculations that have no bearing on today’s market, much less the market of the past ten years.

The reason artists aren’t better compensated is not this:

… The rest is handed over to the labels, which pass on some paltry sum to the artists and writers who haven’t yet learned to negotiate decent online rights to their work. The difference is pure profit. …

First, of course, is the fact that most of the agreements these industries operate under were negotiated long before digital distribution was a glimmer in an executive’s eye. There will be shifts on a go-forward basis, but these will be long, hard battles.

I vividly remember the initial push to home video in the motion picture industry and the resulting squabbles due to the fact that pre-1981 contracts simply did not contemplate this distribution stream. The studios — all of them — developed a method based on costs and revenues for the time. Unless your deal said differently (and it didn’t for about a decade to come), you got 20% of net revenue. This generally approximated the studio’s income less all costs less a distribution fee. Pretty standard and the math kind of worked. I tested it.

Second, critically, is the fact that most artists do not have a lot of negotiating power. Britney Spears might have some clout on these clauses, but the average musician or writer gets a standard deal. It’s not about learning to negotiate; it’s the fact that these clauses are non-negotiable. In the publishing industry, as least one major house is giving their writers a 6% royalty on e-books — this is the so-called “club” rate, reflective of a simpler time when the publisher received (in theory) a royalty from a sub-distributor who operated Columbia House-style. Granted, the “club” was effectively owned and operated by the publisher, but that’s another issue.

I am considering taking bets on how long it will be before this inequity resonates with artists. The studios are treating certain digital distribution streams on a royalty basis — the 20% model noted above — and other streams in a different manner. There is logic behind this, of course. How can a publisher justify a 6% royalty on a product that is bits and bytes and generally has no costs associated with it (bandwidth, production, and marketing will naturally be incurred to some degree). How can music companies offer a paltry royalty when they’re receiving such a huge piece of the pie?

For the latter two industries, artists are likely to seriously consider self-distributing or looking at alternative models, such as dedicated electronic publishers. In the motion picture industry, it’s going to be a long process, in some cases negotiated on a case-by-case basis, in others a result of lengthy guild discussions and strike threats — the participations formula is separate and distinct from the residuals formula, so there will be two levels of deal-making happening.

Artists have always had it stuck to them by the man. Historical money has sorta, kinda supported this unfair accounting practice. If you follow the music industry — or any other entertainment industry — don’t focus so much on rising downloads versus falling CD sales. Focus on bands like Clap Your Hands, Say Yeah who managed to produce and distribute a fairly decent selling hit record outside the music machine.

And don’t accuse the artists of failing to know how to cut a deal. That’s foolish.

• Downloads: Music to Labels’ Ears