By David Lowery

(Part 4 of a 5 part series)

What follows is based on my notes and slides from my talk at SF Music Tech Summit. I realize that I’m about to alienate some of my friends that work on the tech side of the music business. These are good well intentioned people who genuinely want to help musicians succeed in the new digital paradigm. But if we are gonna come up with a system to compensate artists fairly in the new digital age we need an honest discussion of what is going on. The tech side of the music business really needs to look at how their actions and policies negatively impact artists, just as they have pointed out the negative effect record company actions have had on artists.

Too often the debate is about pirates vs the RIAA. This is ridiculous because the artists, the 99 percent of the music business are left out of the debate. I’m not advocating going back to the old record label model, to an industry dominated by the big 3 multi-national labels. This is a bit of hyperbole intended to make us all think about this question: Is the new digital distribution paradigm really better for the artist?

Meet The New Boss, Worse Than The Old Boss? Part 4

Finally what about the ‘white hats in the digital music ecosystem? By this I mean the legitimate digital music stores like iTunes, Amazon’s MP3 store, Rhapsody, eMusic and Google’s Play. I call them white hats because this seems to be the only part of the digital music ecosystem which has consistently paid artists. Still if you dig into how the money gets split you start to encounter problems when you compare it to the old record label system.

All the big stores take about 30% of gross on a 99 cent song. But here is the catch. If you are an independent artist you have to go through an “aggregator” to get your songs into iTunes/Amazon. This will cost you a minimum of 9%. Except Google. Google should be commended for not requiring the aggregator for their store. However iTunes represents about 70% of the digital music market. Amazon is a distant second (13%?) . I could find no data on Google’s store now called Play. So for now lets just focus on iTunes.

The genius of Steve Jobs was that he was not afraid to be greedy. Like most Apple products, Steve Jobs built the thing he wanted and picked the price and margin he wanted. This is commendable in a CEO. That’s why I own Apple stock. I doubt there were any consumer studies. He didn’t really negotiate with the suppliers and consumers on price. A kind of take it or leave it proposition. Fortunately it paid off for Apple.

Now when you are building a brand new digital music store, a concept no one else has ever really done on a large scale there is considerable risk. So in 2003 (when iTunes store launched) a 30% margin is totally justified. Nearly a decade later after the concept is proven, after the store has brought millions of new consumers into the apple ecosystem and after billions of dollars of hardware have been sold is 30% a reasonable margin? It’s no longer a risky proposition. I say no.

My techie friends immediately point out that all those servers, all those engineers and all that software is really really expensive. Ok… then this is another example of the failure of theory of Disruptive Innovation? So John Dvorak is right when he calls Disruptive Innovation the biggest crock of the millenium? Disruptive innovations are supposed to be much much cheaper than what they “disrupted”. So if the mom and pop record stores could sell physical product profitably on a 40% margin with all that shipping, returns, breakage shrinkage, real estate and stoned employees AND big chains like best buy and walmart with their deep discounts could sell music on a 20% margin, then the only conclusion is that the iTunes store is incredibly wasteful and inefficient way to do business.

I don’t think that is the case. I think that selling music as mp3 downloads from Apple/Amazon servers has to be more efficient than shipping thousands of breakable CDs all over the world. So I think what has happened is that over the years that 30% margin has become parasitic. Parasitic in an economic sense meaning it’s not really justified by the value it’s adding. The 30% is simply the result of iTunes/Amazon being more of a bottleneck or gatekeeper. The fact that sites like http://www.bandcamp.com and http://www.cdbaby.com can do the same job on a lower margin suggests that the 30% is artificially high.

I know the Apple-can-do-no-wrong crowd is sharping their knives right now. But hear me out. If the market lets Apple take 30% they should take 30%. The part of me that is an Apple shareholder applauds this action. And Apple should continue to charge this margin until it is forced to lower it by it’s suppliers or competitors.

Until apple really has some reasonable competition, until the music conglomerates figure out it’s in their interest to license new online stores, create other competitors cheaply and efficiently, iTunes is not gonna have any competition. And as iTunes sales grow and physical sales shrink , Apple’s market share is only gonna get bigger. Apple will become more powerful and behave more like a monopoly. If iTunes recorded music store were it’s own separate company it’s gross revenues would represent over 30% of the market. It would be the biggest recorded music company by revenue except UMG. Apple is the most valuable company in the world. In a way you can argue that Apple IS The Man 2.0.

But unlike UMG , WMG or Sony, Apple (or any of the digital music stores) does not recycle any of their revenues back into the creation and development of artists and songs. And this is part of the problem.

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What percentage of revenue from digital sales goes to an artist on a record label?

This is a long and fairly complicated calculation and I’ll save the details for my book . But the percentage of revenue that goes to artists on a label is about the same as under the old record label model. It may be slightly better because there have been some improvements from the artists perspective. For instance the old record company scam known as “free goods” is impossible to justify with digital downloads.

Under the new digital model I calculate that most label artists get between 15%- 35% of wholesale. For example the most recent of my recording contracts says I should get a total of 20.5 cents on a 99 cent song (including mechanical royalties). This works out to 29.7% of wholesale. So this part of the new digital paradigm is about the same as the old record label system.

So when you compare share of revenue for artists on record labels under the new digital system to the old system it looks pretty good. At least until you consider the fact that the price of music has dropped. For instance, an artists royalty on an album is now calculated at 6.90 not at a $10.00 wholesale price as it was in the 1980s. . This drop in the price of music was inevitable. But the record label’s expenses fell considerably in the switch from physical to digital products whereas the artist’s expenses (the recording budgets) did not. So this had the effect of reducing artists net revenues and shifting revenue towards the record labels. For the new digital distribution model to be as “fair” to the artist, the artist share of download revenue should have increased. It stayed the same or increased only marginally.

But let’s look at this in real dollars. Let’s take my artist royalty rate of 16% and compare who gets what under the old pre digital system and the new system. (don’t forget i’m also including the mechanical royalty).

Looked at this way I think you can see the problem. Artists revenue falls but the artist still needs to pay for recording. Record label revenue falls but the new digital distribution system provides them enormous savings. They have eliminated manufacturing warehousing and shipping costs.

And then there is that iTunes store 30%. Seems kind of high to me. What is their risk? Today in 2012? Do they really deserve more per album than the artist? At least the record labels put up capital to record albums. At least the record labels provide the artist with valuable promotion and publicity. Historically in the music business when someone was taking more than 20% of gross revenues that had some “skin in the game”. They risked losing a lot of money.

Between the record labels and the digital retailers like iTunes, once again the artist gets squeezed. If you add to this the cannibalization of sales from streaming sources that pay too little and illegal file-sharing that pays nothing at all you can see why the artists have much less money now. This also helps explain why artists are spending dramatically less time and money recording.

The New Boss, in this case Apple, takes 30 percent, takes no risk and provides the artist with almost nothing in return.

Always look for that Union Label.

In the late 80’s through the late 90’s the Music Business experienced a boom. Not as big as some have reported. When adjusted for inflation and population only 13% higher than the previous peak in the 1970s. Nevertheless it was a boom. It’s instructive to look at what the record labels did with their profits when it was flush with cash. They created what I like to call “The Grunge Bubble”. Record labels bid up the advances for new artists to unheard of levels. Unknown rock bands were getting signing bonuses of $750,000 dollars!

The record labels flush with cash not only dumped a lot of money into signing artists directly, they also gave money to other people, veteran artists for instance, myself included, to start our own sub-labels. Then the sub labels went out and gave that money to other artists as well. This was a really good time to be an artist.

But here is the important point. Record labels value content and content creators. Sure they kept a lot of money for their executives (although even mid 90’s music executive pay is dwarfed by tech executive pay.) But record labels unlike tech companies, know they built their businesses on those who create content. Therefore when they were flush with cash they set out to buy the services of as many artists as they could. This had the effect of sharing the wealth with musicians. It may have been uneven it may have been wasteful, it may have not touched every artists and the labels may have pocketed most of the revenue but at least they felt they needed to give something back to the content creators. They knew artists created something of value.

For a very long period of time record labels provided a decent living to thousands of lucky artists. They may not have guaranteed an artist riches but It was like having one of those good union manufacturing jobs. In fact you could have your royalties paid to you in such a way that you qualified as an AFTRA/SAG member and then you had union health Insurance and a Pension! Unlike the tech industry the music conglomerates are PRO UNION.

Now look at the “Innovation industry”. They do not value content. In fact they argue they are doing the content creators a huge favor by “distributing” content. (the distribution myth is a canard that needs it’s own post, Chris?). They think their services and networks are the only thing of value in the digital ecosystem. This is like the owner of Shoreline Amphitheater thinking people are paying for the privilege of sitting on the chairs. Further they seem collectively obsessed with their own self proclaimed genius. And we lowly content creators are some sort of ungrateful wretches. Just look at how their blogosphere surrogates talk about musicians. If Wall Street titans hadn’t claimed the mantle “Masters of the Universe” in the 1980’s the zeppelinesque egos of the tech industry would claim it.

A friend of mine who works in Silicon Valley likes to point out that Silicon Valley IS the new Wall Street. It attracts the same “I wanna get rich at whatever cost” sleazebags that used to go to Wall Street and bilk old ladies out of their pensions.

And just like the Wall Street the tech industry has funded an army of professional Washington lobbyists to weaken, undo and even eliminate laws it finds inconvenient. In this case copyright protection for artists on the internet. The desired result is that internet/tech companies will never have to pay for using artists songs, movies, books and photos.

The New Boss doesn’t value what you create. And the New Boss would like to change the laws so that your songs are no longer yours.

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Tomorrow in Part 5 we will look at the one class of artist that should in theory benefit the most from the new digital distribution paradigm. The completely independent musician. We’ll compare that to the old system. Finally i’d like to briefly discuss some solutions.