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.