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    3.0 Royalties

    3.1 Retail or Dealer Price?

    Some few years ago most UK record deals provided for the calculation of record royalties on the retail price of records sold. For some while most deals have provided for record royalties to be calculated on the dealer price. In the distant past record royalties were calculated on the wholesale or dealer price but, as some record companies also owned record shops, there was a feeling that the price might be manipulated. The artist’s best protection was to have his record royalty calculated on the price at which the record was actually sold to the ultimate customer. With the abolition of retail price maintenance (many years ago) and, more recently, the increasing competitiveness of the retail sector, confusion has developed over the prices at which records are in fact sold by retailers. Even though a company may suggest a retail price there tends to be fierce discounting. Accordingly, there has been uncertainty over the accuracy of the retail prices used for royalty calculations.

    Before the current mechanical royalty rate of 8.5% of dealer price was established by the Copyright Tribunal, the mechanical royalty rate was 6.25% of the retail price. In those days, in order to resolve the uncertainty over retail prices, MCPS and BPI agreed a formula to establish a notional retail price by multiplying the dealer price by a fixed percentage. This procedure is no longer necessary in the case of mechanical royalties which are now calculated on the dealer price (see chapter IV Part II paragraph 1.2 for an explanation of mechanical royalties). Many contracts are still in operation under which record royalties (as opposed to mechanical royalties) are calculated on the retail price. This is now calculated on an “uplifted” dealer price in a manner similar to that previously adopted by MCPS and BPI in relation to the calculation of mechanical royalties. The notional retail price is calculated by multiplying the dealer price by something between (usually) 125% and 132%. In some agreements, the same result is achieved by calculating royalties on dealer price but uplifting the royalty rate by a similar margin.

    3.2 Packaging Deductions

    Until recently, all majors insisted on perpetuating the ludicrous system under which royalties are reduced by the application of packaging deductions or allowances. Though described as packaging allowances they bear no relation to actual packaging costs. Many years ago, when packaging allowances were first introduced (at more modest rates), the companies tried to justify them by arguing that the royalty should attach to the music or the record but not its package. Few companies attempt to justify packaging allowances any more and most will candidly admit that the allowances are merely artificial reductions. For many years arguments over packaging allowances often generated illwill between the parties. Since the companies have given up attempting to justify the allowances, artists and their advisers have been more ready to accept them. The general approach now is to accept packaging allowances with a metaphorical shrug of the shoulder and to concentrate on securing an appropriate rate of royalty, having allowed for the fact that the royalty rate will be reduced by the packaging allowances.

    For example, an artist may be entitled to a royalty of say 18% of the dealer price. The record company will insist upon a packaging allowance of usually 25% for CDs and sometimes 30% for DVDs. Accordingly, in the case of a CD the 18% royalty is not 18% at all; it is 18% of 75% (i.e. the dealer price less the 25% packaging allowance). In other words, the royalty rate being offered is 13.5%. The company will not offer 13.5%. Instead the company will insist upon offering 18% of 75%. Very few people are fooled by this.

    The first major to simplify its royalty calculation provisions by, in particular, abolishing packaging deductions was BMG Records (in 2002). It offered reduced rates of royalty but was able to demonstrate that its offers were at least as favourable as the offers it previously made at the higher rates under its old royalty system. Gradually, the other majors are following suit and simplifying their royalty calculation provisions. This process has been given a boost by the fact that downloads are now so widespread and there is a particular absurdity in applying a packaging deduction to a download (although there have been attempts to deal with this simply by changing the terminology and referring instead to “technical” deductions).

    3.3 Returns and Net Sales

    Royalties are not calculated on the number of records manufactured, although mechanical royalties usually are. They are payable on “net sales”, i.e. records sold (rather than given away) and not returned. In some territories (notably North America), records are sold on a sale or return basis which means that the dealer can send all or any of them back to the distributor if he is unable to sell them. In the UK, records are sometimes sold on a sale or return basis but only in exceptional circumstances (e.g. where there is an expensive TV advertising campaign and the only way the distributor can persuade dealers to buy enough stocks to meet expected demand is to reassure them that they can return unsold records). However, in the UK there is what is known as a “returns privilege” under which dealers may return up to 5% of records distributed to them. A dealer might take five records each from twenty artists on the same label, totalling 100 records. Under the returns privilege he may send back a total of five records. If he chooses to return five records by one artist that artist suffers 100% returns. The dealer may in any event return faulty records.

    Until recently, many companies accounted to the artist only upon 90% of net sales. Using the example of the 18% royalty the effective rate for a CD is in fact 18% x 75% (to allow for the 25% packaging allowance) x 90%, i.e. 12.15%. This practice is said to date back to the days of the old 78rpm shellac records. In those days royalties were calculated on 90% of records manufactured, on the rough and ready assumption that 10% broke. This has no relevance today. “Net sales” will in any event be defined in order to exclude faulty products or returns.

    3.4 Royalty Base Price

    In order to calculate what an 18% royalty of dealer price is worth we need to establish what is usually referred to as the royalty base price. Although we talk of “18% of dealer”, in fact, the royalty is not necessarily calculated on the actual dealer price, but on an artificial price, which is arrived at by deducting the packaging allowance (if one applies) from the dealer price. In addition, the artist should be aware of the possible impact on the royalty base price of discounts. Ideally, the artist’s royalty should be calculated by reference to the PPD (published price to dealers) less any packaging allowance. In some cases however, the royalty is calculated not on the PPD but upon the actual dealer price after discounts. All distributors have what they refer to as “file discounts”, i.e. different discounts depending upon the category of dealer involved. HMV will command bigger discounts than the independent corner record shop. However, these discounts usually do not affect the royalty base price.

    3.5 Free Goods

    A further complication arises by virtue of what is known as the “free goods” policy. There is confusion over what is meant by “free goods”. Sometimes this means records given away free for genuine promotional purposes to DJs, reviewers and the like. The artist is not paid a royalty on records given away for these promotional purposes, i.e. upon what might be called “actual” free goods.

    In North America, records are distributed on the basis that for, say, every ten albums distributed nine are deemed to be sold and one given away for “promotional purposes”. Sometimes two albums in ten are given away. In the case of singles, usually at least three singles in ten are given away. These “freebies” are known not as “actual” free goods but as “automatic” free goods. Automatic free goods of course are merely a disguised discount. It would be just the same if all ten records were sold rather than nine but at a 10% discount. However, in the case of records given away free the artist receives no royalty. This is separate from the issue of the percentage of net sales which attracts a royalty. If a US company pays a 16% royalty on 90% of net sales but gives away an average of 20% of its records as free goods and applies a 25% packaging allowance then the real rate of royalty is 16% x 90% x 80% x 75%, i.e. 8.64%. [ ]

    3.6 What Rates?

    3.6.1 UK Rates

    A new artist signing to a UK major would expect to receive between 15% and 20% of PPD (published price to dealers). However, there would usually be a number of embellishments to this. Again, let us assume a rate of 18%. This rate would apply for UK sales and is sometimes called the “headline” rate.

    3.6.2 Overseas Rates

    The artist should try to secure the same rate of royalty for the major overseas territories but the 18% might reduce to say 16% for sales in major overseas markets, perhaps Germany, France, USA and Canada, Australia and Japan. Elsewhere, in the lesser markets, the rate might reduce to say 14%. The royalty would usually be inclusive of any royalty payable to a third party producer. We deal with producers more comprehensively in Chapter III but if we assume that the producer is paid 3% of dealer price, this would give a net rate for UK sales of 18% less 3%, making 15%. If the artist suffers territorial reductions then he should try to ensure that the producer accepts similar (pro rata) territorial reductions (so that if in the major overseas territories the artist receives a 16% rate rather than 18% then the producer should only receive 16/18ths of his UK rate for those territories).

    Territorial reductions tend to be more dramatic under US contracts. If the “headline” rate for US sales under a recording contract with a US major were 16% (and US recording contracts tend to provide for marginally lower rates than would usually apply under UK recording contracts) then, very often, the rate in the major overseas territories (including the UK) might be 2/3rds of the US rate (i.e. 10.66%) and in the remaining countries of the world might be 50% of the US rate, (i.e. 8%).

    3.6.3 Escalations

    The rates will often escalate automatically for later recordings. If the rate is 18% for the first album under a five album deal, then perhaps this will also apply for the second album but rise to 19% for the third and fourth albums and perhaps 20% for the fifth (with similar increases in relation to the overseas rates). Very often, (perhaps in addition to the automatic escalations) there may be sales-based escalations. For example, the 18% rate in the UK might increase to 19% on sales in excess of 200,000 copies and perhaps to 20% after 400,000 copies. Any escalation of this kind would normally apply only to the excess sales of that album and would not be retrospective. In some cases the higher rate might automatically apply for all sales of the next and later albums. Escalations based on sales would normally work territory by territory with different sales targets in each case.

    3.6.4 Format Reductions

    There are also likely to be format reductions. Singles might be at a reduced fixed rate of perhaps 12% or 13%. Alternatively, the rate for singles might be three percentage points less than the “headline” rate. When compact discs were first introduced most record companies refused to issue records in this format unless the artist agreed to a reduced rate of royalty (usually 75% of the otherwise applicable rate). The (rather flimsy) justification given for this was that as a new format unit costs of production were high. Some companies even tried to plead a need for a “break” in view of the research and development costs but, of course, none of the record companies had to bear any of these costs (they were incurred by the hardware manufacturers). The reduced rate for CDs disappeared from most contracts some years ago although the reduced rate continues indefinitely in relation to some back catalogue items. The CD “rip off” involved a “double whammy” in that not only was the royalty rate reduced but also the packaging allowance was increased, generally to 25%. Most artists and their advisers were so relieved no longer to have to suffer a reduced rate that they accepted the 25% packaging allowance without complaint (even though compact disc duplicating costs are now minimal).

    3.7 Real Royalty Rate

    The onset of digital delivery and the loosening of the major’s stranglehold over the industry have hastened the demise of the misleading system by which record companies sought to confuse the royalty issue. It has become common practice for artists and their advisors in discussions with record companies to talk in terms of the “real royalty rate” which helps make the charade more transparent. Contrary to popular belief, lawyers have no wish to perpetuate the old system. They would prefer to concentrate on the real issues. Moreover, more and more record company executives have expressed dismay over the old system and the trend at present is certainly for more simplicity in relation to royalty calculation provisions.

    3.8 Further Reductions

    Despite the progress which is being made in simplifying matters some royalty reductions are still common.

    3.8.1 Budget Sales

    The company will generally offer half rate royalties on records sold at less than full price. Most labels have a published full price category (which might have a published price to dealers in the case of a CD of £8.45) a separate midprice category (which might have a published price to dealers in the case of CDs of £5.95) and a lowprice or budget category (with a published price to dealers of perhaps £4.95 or less). The costs of manufacturing and distributing lowprice records are the same as for the full price records, except that there may be a small saving on packaging costs . The company’s margin will be considerably reduced. The company will argue that the artist’s royalty should reduce in line with the reduction in the company’s profit and that this is not achieved simply by calculating the royalty on a lower sale price. The artist should investigate the company’s pricing policies and ensure that the definitions of full price, mid price and budget price are sensible and do not allow room for abuse. The company will usually wish to pay half rate royalties on anything less than full price. One compromise is to accept 3/4 rate royalties on mid price sales and half rate only on genuine low price sales.

    3.8.2 Record Clubs

    A significant number, perhaps in the region of 15% to 30%, of total album sales by established artists are made through record clubs. Record club sales attract half rate royalties. Most contracts provide that, for example, no royalties are payable on records given away by the club to attract new members. However, record companies rarely conduct their own record club operations. They merely grant manufacturing licences, or sell finished records, to the record clubs and allow them to get on with it. The company will not know whether the club has given away the records or sold them. The company will generally be paid for all records supplied to the club but, owing to the volumes involved, the clubs will receive substantial discounts. The company may only have to deliver large quantities of records to the club’s fulfilment centre, and will not have to worry about distributing those records to the shops. The clubs can drive a hard bargain on discounts so a reduced royalty rate may be justifiable. However, a 50% reduction almost certainly is not justifiable. Nevertheless a half rate royalty on record club sales remains fairly standard.

    3.8.3 Compilations

    The compilation album market has grown steadily over the years. Most record companies now derive a substantial part of their income from compilation sales. At one time artists and their advisers were sceptical about the benefits of compilation licensing. The concern is that if a successful track is widely available on multiartist compilations, the public may prefer to buy a compilation featuring the recording rather than the artist’s own album. The contrary view is that exposure of an artist on compilations creates a greater awareness of that artist, and stimulates sales of the artist’s own recordings. At one time, there was a general feeling that the widespread availability of an artist on compilations rather “cheapened” the artist. Some still subscribe to this view.

    The artist’s record company may put together its own multiartist compilation album, either entirely of its own artists or, more likely, a combination of its own artists together with repertoire licensed in from other record companies. In such cases, there is no convincing reason why the artist should not receive the full “headline” rate of royalty. This will be pro-rated between the number of tracks on the album. If the headline rate of royalty is 18% and the artist has only one of 20 tracks on the album, he or she might expect to receive one twentieth of the normal rate, i.e. 0.9%, for the album. Nevertheless, the companies’ standard position is to offer only a 50% rate in relation to compilation use. Again, assuming a headline rate of 18%, compilation use would therefore attract a pro-rata share of 9%, i.e. 0.45% on a 20 track album. The artist should resist any reduction in the headline rate for compilation use on the company’s own releases.
    The situation is different in the case of third party compilations, which account for most compilation activity. In these cases, the company grants a licence to a compilations specialist in return for a royalty. If the royalty received by the company equates to the headline rate which it pays to its artist, the company will be left with nothing. The companies’ standard position is therefore to offer the artist 50% of the headline rate. This is not necessarily fair to the artist. As we have seen, this may reduce the artist’s rate to, say, 9%. At least in the case of first rate current repertoire licensed for inclusion on something like the “Now” series, the company is likely to receive, say 20% or perhaps even 25%. If the company receives 25% out of which it pays the artist 9% (which will only be paid if the artist has recouped), the company is earning nearly twice as much as the artist. The company will consider this to be entirely reasonable. After all, this means a ratio of nearly 2:1. The record company will claim that in order to support its substantial overhead costs and the various A&R costs which have to be written off in respect of unsuccessful artists it needs a ratio more in the region of 3:1 (see paragraph 1.6)

    The artist may reluctantly accept the 2:1 or 3:1 ratio on full price sales (he or she has little choice), where the record company has a significant role to play, and carries significant overhead costs in order to do its job. However, different considerations should perhaps apply where the company merely licenses its rights in relation to what is often referred to as “secondary marketing” activities.

    An artist will sometimes succeed in securing 50% (or more) of the company’s receipts. The contract might provide that the artist receives half rate royalties or, if greater, one half of the company’s receipts. Alternatively, (although this amounts to the same thing), the artist may receive the full rate of royalty or, if less, one half of the company’s receipts. In extreme cases, the artist may receive a share of any advances received by the record company from the licensee.

    3.8.4 TV Advertising

    Many years ago record companies introduced half rate royalties if the company paid for a television advertising campaign. They thought it unfair that the artist should benefit from the company effectively “buying” extra sales. As time went by, artists’ advisers found more sophisticated ways of limiting the impact of this. The reduction should only apply at all if the television advertising campaign is substantial. This has led to complex definitions of what is meant by “substantial”. The reduction should only apply for a limited time, usually from the start of the campaign until the end of the next accounting period following the end of the campaign, or perhaps the accounting period after that. Sometimes, the company imposes a reduced royalty on all sales during the accounting period in which the campaign starts, even if that happens several months into the accounting period. None of this solves the problem that the total reduction in royalty might work out at more than the cost of the campaign. The artist may end up paying (by way of a reduction in royalty) more than the entire cost of the campaign, with the company profiting from all the extra sales achieved. For a while, the companies argued that this was fair because television advertising campaigns are expensive and involve considerable risk. However, market research is now so sophisticated that any risks have largely been removed. The record company will usually only spend on TV advertising if it is confident that additional sales will justify the cost. The trend is now for full royalties to be payable but for all or part of the costs of the campaign to be recoupable.

    3.9 Performance Income

    Every time a record is broadcast or played in public, the broadcaster or venue owner exercises rights controlled by two distinct music licensing companies. PRS For Music (“PRS”) grants licences on behalf of writers and publishers for use of copyright in the words and music. PPL grants licences on behalf of record companies for use of copyright in the sound recording. In addition, PPL collects income for performers on sound recordings in respect of the broadcast or public performance use of their performances as included in those sound recordings. PPL represents its record company and performer members in the UK and also other territories through its bilateral agreements with overseas music licensing companies.

    More about PPL

    3.9.1 PPL’s Areas Of Licensing

    The two main types of licences issued by PPL are Broadcast Licences and Public Performance Licences. Examples of sound recording use that would be permitted under a Broadcast Licence are radio airplay, and the incidental use of sound recordings on television. PPL also licenses certain new media uses of sound recordings, such as internet radio or the on-demand streaming of television programmes. Public Performance Licences cover the playing of sound recordings in, for example, shops, clubs and bars, factories and offices and many other UK businesses. In some cases, this also covers playing sound recordings at those premises via TV/radio (which is legally distinct from the Broadcast Licence needed to broadcast those TV/radio services in the first place).

    In addition to these two main types of licensing, income is also collected by PPL for certain types of copying of PPL’s sound recordings, such as that undertaken by tailor made music service providers. An up to date list of these service providers as licensed by PPL is provided on the PPL website and includes providers of exercise compilations, background music compilations and in-store radio. Certain other types of dubbing are dealt with by the rights holder directly and not through PPL.

    PPL does not license library music or synchronised music for theatrical feature films or advertisements. PPL’s sister company VPL licenses the public performance, broadcast and copying of music videos. Its PPL Video Store service supplies copies of music videos.

    An increasingly significant PPL revenue stream is the income collected from overseas music licensing companies, with whom PPL has over 40 bilateral agreements. Through these agreements, PPL can collect overseas income on behalf of record companies and performers alike, relating to the use of their sound recordings and performances locally in overseas territories.

    PPL makes its main distribution of licensing income to its record company and performer members each summer. In addition to this, where payment adjustments are necessary, for example to reflect changes to repertoire ownership/performer line-up information, these are dealt with quarterly. International income is often distributed on a monthly basis, and always within 90 days of receipt by PPL.

    3.9.2 Split Between Performers and Rights Holders

    PPL distributes income to both the rights holder and the performers on a sound recording. The rights holder is essentially whoever owns the rights in the sound recording and is usually a record label separate from the performers. However, exceptions exist and where a performer makes their own recording, through their own label or otherwise, and owns or exclusively controls the copyright in it then they will also be the rights holder from the PPL perspective. They would be entitled to payment from PPL as both rights holder and performer of any licensing income collected in respect of that recording.

    All income collected by PPL, apart from the income for music videos and dubbing (where legally performers’ rights are treated differently), is split with a 50% allocation to the rights holder and a 50% allocation to the performers on the track. The 1992 EC Commission Directive on Rental and Lending Rights and Piracy (92/100/EEC) formalised the legal right of performers to income from public performance and broadcast of sound recordings. Performers cannot assign their rights to this performance income, whether to a label or any other third party.

    100% of the income for music videos collected by PPL is sent to the rights holder of the music video. 100% of the income for dubbing collected by PPL is sent to the rights holder of the sound recording.

    In all cases, income is distributed by PPL less its actual running costs. There is no fee to join PPL either as a record company or performer member.

    3.9.3 Allocations for Unregistered Performers

    PPL usually ascertain which performers performed on a sound recording (and whether their performances are legally qualifying, based on the territory in which the performance was given, or the territory in which the performer is a citizen/resident) through the information received from the rights holder and also through their own research.

    PPL will allocate a percentage of the performer income to all featured and non-featured performers of which they are aware, even if those performers have not registered as members of PPL. Then, once a previously unregistered performer has registered with PPL, they will be paid the sums allocated to them, currently backdated to December 1996.

    At times a featured or non-featured performer who has been accidentally omitted from PPL’s records will raise a claim. If a performer has been missed out and no allocation has been made for them, they can register their claim with PPL who will investigate and allocate retrospectively what they should have received. PPL will provide a lump sum payment and distribute to them in the usual way in the future.

    3.9.4 Income Split Between Performers

    The performers’ 50% performance income share is split between the featured performers on the track, for example the named band members, and the non-featured performers on the track, for example the session musicians. The standard initial split gives featured performers 65% and non-featured performers 35%. However, an individual non-featured performer cannot receive more than 9% and so, where there is only one featured performer and one non-featured performer, there would be a 91% – 9% split of the 50% performance income share.

    While a performer may not assign their performance income, featured artists may agree between themselves to change how the featured performer share is split between them. Non-featured performers may not agree between themselves to change how their share is split. Generally, on tracks with less than 5 non-featured performers, which are deemed to be ‘Line Up Complete’, the overall featured share will exceed 65%.

    On rare occasions, featured and non-featured performers will (independently of PPL) unanimously agree to change the 65 % – 35 % split. In order to formalise such arrangements a Performance Share Agreement can be signed by the relevant performers and registered with PPL. This is not a common occurrence as PPL has to be satisfied that such agreements are not harmful to performers with less bargaining power. By way of example, some featured performers may only wish to employ non-featured performers who will agree to a vastly reduced share and, potentially, such arrangements could change the split to 99% – 1% of the performance income share, which is a split that PPL would be unlikely to approve.

    3.10 Other Uses

    Record contracts usually contain provisions dealing with the artist’s income from any use of the recordings beyond the manufacture and sale of records. Many agreements give the artist 50% of the company’s net receipts from such uses. Those receipts are sometimes referred to as “flat fee receipts”.

    This might extend to any “premium” use, i.e. the exploitation of the recordings in connection with another commercial product or service. For example the record company may supply records to Kellogg’s to give away free to anybody sending in a set number of tokens from Corn Flakes packets. Kellogg’s pay for the records even though they are then given away free. The artist should not accept that no royalties are paid on premium sales. Sometimes the company offers half rate royalties on premium sales which might mean that an artist on a headline rate of 16% would receive 8% of whatever Kellogg’s pays for the records. There seems to be little justification for this. A fairer system would be for the artist to receive a percentage (say 50%) of the company’s receipts. As a precaution, the artist should always insist on a right of approval over premium use. This allows the artist to insist on full disclosure of the financial arrangements so that if necessary the royalty provisions may be varied before approval is granted.

    The most typical example of flat fee receipts is the income generated by the grant of synchronisation licences, i.e. the use of a recording in the soundtrack of a film or in an advertisement of some kind. Again, typically, the artist would expect to receive (or at least be credited with) 50% of the fee.

    3.11 New Formats

    It is now many years since the CD format was introduced but an explanation of what happened at the time provides a useful cautionary tale. The record companies looked for ways of reducing their artist royalty liabilities (see paragraph 3.6.4 above). They argued that compact discs were more expensive to manufacture than vinyl or cassette (which was probably true for a very short time when compact discs were first introduced and when they were manufactured and sold in relatively small numbers). The most common approach was to offer a royalty on compact discs equivalent in terms of “pennies per unit” to the royalty on the sale of the equivalent vinyl disc version of the same record. In the event, the public wholeheartedly accepted the compact disc format and was persuaded to pay substantially more per unit than the vinyl or cassette equivalent. Nevertheless, for several years, all new contracts included provisions for reduced rate royalties in the case of compact discs. Sometimes the rate itself was lower (perhaps three quarters of the otherwise applicable rate); sometimes the royalty was calculated on the vinyl or cassette price rather than the compact disc price; sometimes there was a higher packaging allowance. In the case of existing repertoire (which the record companies had acquired under the terms of contracts entered into before compact discs were contemplated) the record companies would usually refuse to release that repertoire in compact disc format unless and until the artist granted a royalty “break” of some kind. As a legacy of all of this, whilst full rate royalties are now paid for compact disc sales, nevertheless a 25% packaging allowance still applies. There is a trend for packaging allowances no longer to apply but when this is the case there is a compensatory reduction in royalty rate. There is a widespread feeling amongst older managers and artists that they were out manoeuvred by the record companies in relation to compact discs. For this reason, it is unlikely that the record companies will be given so easy a ride in relation to any new formats introduced in the future. Many new recording agreements still contain a definition of “new technology” and provide for reduced rate royalties. Perhaps in the hope of pulling off a similar stunt, some contracts state that if at any time records are sold in an as yet uninvented format, a reduced rate will apply. If pressed, most companies will accept that this provision should either be deleted altogether or that the reduced rate should only apply for a very limited period. This is sometimes linked to the point at which the format is no longer “new”. This might be defined as the end of the accounting period during which sales in the new format first exceed a given percentage of total sales.

    3.12 The Digital Revolution

    All those provisions in relation to the calculation of royalties in relation to physical formats which over the years have caused so much debate are fast becoming of little more than historic interest as the digital revolution takes hold. However, for the moment, there is still much unfairness. Some historic recording contracts are worded so that any income from exploitation by means of digital transfer will fall to be dealt with under the secondary exploitation provisions so that, often, the record company will be obliged to pay one half of its receipts to the artist. The artist may argue that this is appropriate (perhaps even generous to the record company) because although traditionally the record companies have had to organise and pay for complex manufacturing and distribution arrangements no such complexities (and no such expense) arises in the case of the arrangements necessary for a download service. On the surface, this of course is true. However, the problem for the record companies is that if they are to continue in much the same guise as before, with substantial staff levels and so that they continue to invest in new talent and if they are to market their artists effectively then, the record companies argue, they need to maintain much the same ratio of profits between the record company and the artist as before which is to say something like 3:1. Without a profit ratio of this kind there is the fear that the record companies will be unable to sustain their current overhead costs and the same level of investment in new talent. On the other hand, artists are generally unimpressed by the suggestion that most record companies increasingly have little or nothing to do in terms of the physical manufacture and distribution of records but that nevertheless only, say, 25% of any income should be paid to the artist. For the moment the majors generally offer a royalty on downloads at the headline rate (perhaps 18%) calculated upon what the company receives.

    3.13 Download Royalties

    After a frenetic period of panic and experimentation most labels (and in particular the majors) now account to their artists for downloads on a basis similar to that which applies for physical records. In other words, whatever royalty the artist receives on a physical record will be applied to the digital record. However, labels have managed to preserve the concept of dealer price even in the digital world in that most of the majors insist that the digital retailer must account to the label on a minimum per unit price for each download. However, in the recording agreement “dealer price” will generally be defined for digital sales as the lower of any designated or “published” dealer price and the label’s actual receipts from the sale in question. The label will usually insist that there will be excluded (for the purposes of calculating the artist royalty) credit card agency fees. The labels have slowly loosened their grip on the traditional deductions that have applied to record sales and it is generally now possible for the artist to negotiate that for the purposes of calculating the artist’s royalty the dealer price (however that may be defined) will not be subject to packaging allowances or new format deductions or a mid price deduction (by reason of the “normal” digital rate comparing unfavourably to the physical format rate).

    3.14 Streaming

    Streaming is where the recording may be played (these days on request) but is never owned by the user in the same way as a download. Streaming models tend to be free to the user and so rely on the (generally small) amounts of advertising revenue to provide a basis of payment. In the United Kingdom the PRS has set a minimum streaming rate of 0.22p per stream for the use of the underlying composition.

    3.15 Subscription Models

    Typically this will be any model where the recordings may be accessed (as a stream or even a download) during the subscription period only. With downloads, they either cease to function after the subscription period or, in some cases, the user can keep them if they were downloaded during the subscription period. Some scrutiny is required to ensure that the artist receives proper accountings. Generally this requires the label to insist that the digital retailer provides a full breakdown of the usage and to pay a pro-rata share of the subscription fees accordingly. More controversially, some labels have taken an equity stake in the start up subscription services as part of the consideration for the grant of the licences. However, predictably, no part of the “equity” stake acquired by the label is shared in any way with the label’s artists.

    3.16 Breakdown of a Digital Download Sale

    At the time of writing a typical fee for a download is 79p which includes about 14p VAT and 2p credit card charges so that the “retail” price for royalty calculation purposes would be set at, say, 63p. The retailer’s gross margin (from which bandwidth and other technology costs must be paid) will be around 9p so that the “dealer” price is thus around 54p. The label must pay the mechanical royalty which will be around 5p thus leaving around 49p. The gross artist royalty (to include any producer royalty) will of course depend upon the rate of royalty which has been negotiated on behalf of the artist but this may be, say, around 10p which of course leaves a “profit” for the label of around 39p (and thus, on this example, around 4 x the entitlement of the artist/producer).

    3.17 Concerns Over Digital Sales

    In addition to the well publicised cases of piracy, there are other concerns about digital sales reducing the value of music. Broadly these concerns may be summarised as follows:

    the user is losing interest in owning product and could be quite content with accessing content for free through one of the ad supported streaming services; revenue for ad supported services is practically non-existent (at the time of writing this is less than 1% of total sales for music, by most estimates) and the more those services are used the more download sales are reduced; download sales do not replace, in money terms, the value of the physical record sales they replace, so whilst physical record sales are in decline, the growth of digital record sales has failed to replace the revenue. Currently digital record sales are around 20% of total sales (higher in certain genres); the digital retailers, now able to offer music compatible on any player given that DRM has been removed, are competing for market share by driving the price of downloads even lower.
    3.18 DRM (“Digital Rights Management”)

    DRM was a controversial matter concerning the use of digital downloads. DRM could control any number of aspects of the use of those downloads, from the number of plays to the number of burns to the device on which they would operate. It was the latter aspect of DRM that proved controversial, more or less guaranteeing the iTunes stores’ monopoly on selling to iPod users (since the major record labels would not sell DRM-free tracks). There has been a reverse on this during 2008/9 and now most tracks are available in MP3 format, which is DRM free.

    However, the issue of DRM is likely to resurface in the context of subscription services where tracks are due to expire after a certain period of time.

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