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The Magic Bubble Bursts: Did the Record Labels make their own grave?

For almost a decade now, the major labels (at the beginning there wereRIO five of them, now only four, EMI, Sony BMG, Vivendi Universal and Warner) have declared that illegal downloading is ravaging their business by destroying the sales of physical product.  One may question this declaration, however, in few of the fact that ever since the RIAA filed its 1998 litigation again the manufacturer of the Diamond Rio MP3 player and extending to its most recent lawsuits against individuals across the country, the music industry has committed more public image faux pas than Dan Quayle and George W combined, making it one of the most hated industries among high school and college students.  It should be apparent to everyone now that it is not illegal downloads that is causing the downturn in music sales, as there are many other contributing factors, including the negative image the RIAA is generating.

This marred image is evident in the facts.  According to an article in Rolling Stone magaine entitled The Record Industry’s Decline:

About 2,700 record stores have closed across the country since 2003, according to the research group Almighty Institute of Music Retail. Last year the eighty-nine-store Tower Records chain, which represented 2.5 percent of overall retail sales, went out of business, and Musicland, which operated more than 800 stores under the Sam Goody brand, among others, filed for bankruptcy. Around sixty-five percent of all music sales now take place in big-box stores such as Wal-Mart and Best Buy, which carry fewer titles than specialty stores and put less effort behind promoting new artists.

Nonetheless, a new research study on the issue, commissioned by the Canadian government to explore issues related to copyright reform, was recently released.  The study is entitled The Impact of Music Downloads and P2P File-Sharing on the Purchase of Music: A Study for Industry Canada, and was written by Birgitte Andersen and Marion Frenz, of the Department of Management at the University of London in England.  A PDF version of the study is published here.

The results of the new study affirm many of the conclusions found in an earlier study entitled, The Effect of File Sharing on Record Sales: An Empirical Analysis. This paper was published in the February 2007 issue of The Journal of Political Studies, and was written by Koleman Strumpf, professor of business economics at the University of Kansas Business School and Felix Oberholzer of the Harvard University Business School.  Both studies directly contradict the claims of the music industry that file sharing is related to revenue losses.

In fact, the new study supports an opposite assertion, i.e., that distribution of music files on P2P networks actually promotes the sale of physical product.  Andersen and Frenz found, among people who actually participate in P2P file sharing, downloading actually increases the sale of physical product by a ration of 2 to 1, in other words, on average when a P2P file sharer downloaded the equivalent of two CDs in files, he or she would purchase of one physical CD (Note:  I have extrapolated here, as the numbers set forth in the study actually say that for every 12 P2P songs downloaded, physical purchases increased by 0.44 CDs).  It is important to note that the study concluded that, when incorporating the Canadian population as a whole (i.e., including the group who participate in P2P file sharing along with those who do not), file sharing on P2P networks has neither a positive nor a negative impact on CD sales.

One fact in the report I found very intriguing is its conclusion that the owners of MP3 players are less likely to purchase physical product.  This is interesting, in my mind, because I believe it is connected to the popularity of the iPod and iTunes.  If a person purchases the iPod and uses iTunes, there is really no need to buy physical product, whereas when a person uses a different brand of MP3 player, he or she is, in my humble opinion, more likely to go out in search of alternative means of finding music, including purchasing CD’s.  I would like to see a study which compares iPod owners with owners of third party MP3 players.  It may turn out that the biggest culprit in the demise of the record industry is Apple!

One story I found really revealing is the Rolling Stones article on The Record Industry’s Decline.  In it, the author tells the story about how the major labels were unable to come to a settlement with Napster which would have given them immediate access to Napster’s 38 million users.  I don’t know the details of that meeting, but it seems to me that when the industry burst that bubble, those 38 million users disbursed into millions of subgroups on P2P networks so varied that it become virtually impossible to get the magic back.  Hindsight is, of course, always better than foresight, but this event certainly seems to me to one of the biggest turning points in our industry’s history.

Is the music industry going to survive.  Of course!  It will certainly not be in the form many traditionalists in the industry wish it to be.  CD’s eventually be ancient relics of the past, sought after by collectors much as jazz lovers currently seek out old vinyls and record players.  The radio industry will not have control over marketing and thus the role of radio consultants on the industry will be diminished.  Marketing efforst will shift to television outlets and Internet marketing.  Search engines and online communities will continue to surface new music and expose the long tail.  Major labels will no be the sole repository of the major talent, as independents will rise to fill the void, fueled by venture capital from investors.  Whatever happens, it going to be an interesting ride!

Some further reading:

The Freakonomics of Music

File Sharing:  Zero Effect on Downloads

The Record Industry’s Decline

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Music Publishing 101, Part 4: Show me the money!

Section 106 of the Copyright Act gives the owner of a copyright a bundle of rights which includes the rights to 1) reproduce the work, 2) prepare derivative works, 3) distribute copies of the works, 4) publicly perform the work and 5) publicly display the work.  All of the music publisher’s income flows from this basic bundle of rights.  It should be noted that the right to perform the work is sometimes segmented into two descriptions, one called the grand rights, or dramatic and theatrical performances of the work, and small rights, or all public performances other than theatrical, including live performances of the work and radio broadcasts.  Here is New York attorney, Peter Shukat discussing grand rights:

To exercise control over these rights, a music publisher issues licenses to authorize various uses falling into this bundle of rights.  For example, if a company wants to reproduce and distribute a copyright in a musical composition, the publisher will issue a mechanical license to a record label, for example.  Mechanical royalties are a primary source of income for music publishers.  In the United States, the U.S. Copyright Office sets the rate for mechanical royalties, which is currently 9.1 cents for songs that are 5 minutes or less, and 1.75 cents per minute for songs exceeding 5 minutes.  The current mechanical royalty and historical rates can be found at the Harry Fox Agency’s website.  The Harry Fox Agency administers licenses for, and collects and distributes royalties to its member of the National Music Publishers Association, although a music publisher can, and often does, perform this task on its own  Since the rate is always subject to increase,  a music publisher should also request language in the license that provides that payment is made at the rate in effect at the time the product is distributed.

Another major source of income for music publishers is public performance royalties.  in the United States, these royalties are almost always collected by the three major performance rights organizations, ASCAP, BMI & SESAC.  Outside the U.S., each country has its own performances rights organizations.  See the “Resources” page on my blog for a list of and links to many of these.  As discussed in Part 2 of this series, music publishers, as well as songwriters, affiliate with (i.e., enter into an agreement with) the performance rights organization to enable them to track airplay and live performances, and collect and distribute the royalties.  Performance rights organizations issues “blanket” licenses to radio stations, television stations, large nightclubs, large restaurant chains, and retail source so that these entities can play the music of their affiliated songwriters and publishers.  In exchange, these venues pay the performance rights organizations fees based on the anticipated usage.  The societies then use varying formulas based on such factors as airplay and usage to issue payment to its affiliate songwriters and publishers.

The music publisher issues a synchronization license to the producers of  television shows, movies and commercial advertisements for reproduction and distribution of the work.  The “sync fMovie Reelee” is usually a one time payment, varying from the hundreds of dollars to hundreds of thousands, dependent upon numerous factors such as the length of the segment in which the song is used, the prominence of the song in the scene (whether it is prominently featured or in the background), and whether it is the primary focus of the scene (as, for example, BTO’s old song Takin’ Care of Business as used in the Office Depot commercials).  The publisher typically splits this type of revenue equally with the songwriter.

A less generous source of income, but still significant nonetheless, is revenue generated by printing sheet music and lyrics.  This is a type of public display, but can also fall into the category of reproduction and distribution.  Print licenses are most commonly issued to publishers of individual sheet music (sometimes called “piano copies”) and so-called “folios” (a collection of sheet music by a particular artist) and sheet music collections.  Income is also generated when lyrics to musical compositions are reprinted in a publication, such as, for example, when a book is printed in connection with a movie.  How much of this income is given to the songwriter varies widely, as it is sometimes based on percentage basis, but also can be on a flat, cent rate, e.g, 15 cents per copy.  When a percentage basis is used, it is sometime based on wholesale, sometimes retail.  The general trend among publishers in past years, however, is to split everything equally on a 50/50 basiiphones.

Of course, one rapidly growing area of revenue is in the arena of  technology, i.e., computer software, multimedia products, singing greeting cards, DVD’s and particularly ringtones.  Though these usages also involve the reproduction and distribution rights, they generally require specialized licenses and the rates a very market driven. Again, it is customary for a music publishers to split these fees equally with the songwriter.

Finally, a very significant source of income for a music publisher is foreign sub-publishing.  Outside of the U.S., music publishers solicit foreign sub-publishers on a territory by territory basis.  The arrangement is generally exclusive, meaning that the foreign publisher has the rights to exploit the music publisher’s entire catalogue of songs within that territory, including the entire bundle of rights, and issue mechanical, performance, synchronization and print licenses for the usage of the music.  Typically, the U.S. publisher will receive 75% of the income generated by the foreign sub-publisher, while the sub-publisher retains 25%.  The sub-publisher does not receive any ownership interest in the copyright and usually pays the U.S. publisher a significant advance on future royalties, dependent in large part on the amount of income the catalogue has generated in the U.S.  Foreign income is often the subject of intense negotiation in writer deals, but very often a songwriter will receive half of everything the U.S. publisher receives, or 37.5 cents of the 75 cents received by the publisher.

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Taming the “Big Bad Record Company”

What songwriters can do to improve their negotiating strength in an entertainment deal

A very common theme among my songwriter and artist clients is the subject of how they were “ripped off” by their record label and/or music publisher (for purposes of this general publication, I’ll refrain from using the actual, more vivid terms often used to describe the process!). They often feel as if they have not received the benefit of the bargain.

As an attorney who negotiates deals for these types of clients on a routine basis, however, I am frequently placed in the precarious position of walking a tightrope between trying to obtain as many concessions as possible from the opposing party while not pushing so hard as to, in my clients’ words, “blow the deal.” My clients want the best deal possible, but are very rarely willing to walk away from a deal if the terms and concessions are not good. As any good negotiator can tell you, your deal is only as good as your best alternative to the negotiated deal.

In some ways, this willingness to settle for less in order to salvage the deal feeds the very beasts songwriters and artists need to tame, i.e., the record companies and music publishers. Artist think that record companies have the ability to give them instant stardom – in fact, that is the dream of almost every struggling songwriter and entertainer. On the opposite end of the spectrum, however, record companies most certainly know that many artists are willing to “sell their soul” in order to obtain a deal.

The infamous controlled composition clause is the perfect example of how far an artist is willing to go for “the deal.” The United States government requires that a copyright owner be paid a minimum statutory rate for the mechanical reproduction of their creative work. The record label, however, turns to the artist and says, “Despite the government minimum, will you consent to accept only seventy-five percent of that to which we’re required to pay in order to get a deal?” “Furthermore,” the record label says, “we’ll only pay you seventy-five percent of statutory rate on ten compositions, no more, o.k.?” As incredulous as those questions might sound, the majority of artists throughout the history of the controlled composition clause have answered “yes” to those questions. From the record companies’ perspective, this negotiation process is just good business.

This disregard for the government’s requirements does not often occur in other industries outside of the music industry. If a company interviewing a potential employee suggested that the employee agree to an hourly rate that is less that the minimum wage, the employee would balk, and most likely the company would be reported and fined. The difference, of course, is that the employee in this scenario has a multitude of alternatives, as there are numerous companies to which he or she can apply that will pay minimum wage. That is not the case, of course, with entertainers. It has been said one’s odds of getting struck by lightning are greater than the odds of getting a record deal! Most entertainers are desperate for “the deal.”

So, the question then becomes “What is the deal worth to the songwriter or the artist?” Is it worth giving up possession of your songs without the possibility of reversion in order to receive a monthly draw in order to get that publishing deal? Is it worth giving up twenty-five cents on every mechanical dollar earned in order to receive a cash advance and the remote possibility of future royalties from a major label in order to get that record deal? If the songwriter or artist has no alternatives, then the answer to those questions may very well be yes. Or, it may be that no deal is worth giving up such concessions. The answers to these questions are as diverse and individual as the artists and their particular situations.

In order to better understand their own position, then, songwriters and artists should carefully consider their “sacred cows”– i.e., the points on which there is no negotiation – prior to entering negotiations. The difference I have witnessed between fresh young songwriters and experienced writers who have been around the Row for a while is the wisdom to know what is important to them and what is not. If a songwriter has a young child, she is likely to be more willing to walk away from a deal without a reversion clause than is a single songwriter with no family obligations. The recording artist who has a track record of selling more records the first time out than any other artist is in a better position to walk away from a deal that includes a controlled composition clause. The potential recording artist who has offers from three major labels is in a better position to obtain a higher royalty rate than the artist who has been offered a development deal.

The point is, the songwriter and the artist should think about what is important to them in terms of a deal and carefully consider their “bottom line,” the point at which they are willing to say “”no deal.” These issues should be discussed with an experienced entertainment attorney. Develop two lists with your attorney: (1) a wish list of provisions for improving the deal and (2) a “drop dead” list of items which must be included in the agreement or the deal is off, which hopefully includes a good alternative to the negotiated deal. Remember, the more alternatives a person has to the deal in hand, the better his or her negotiating strength.

This article originally appeared in the print edition of Law on the Row, Volume 2, Issue 1, on March 21, 2001.

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