What Every Record Label Should Know about Digital Distribution
by Michael Ashburne, Esq. © 2009 All Rights Reserved
It doesn’t take peering into a crystal ball to see the future of the music distribution industry: It’s going digital. It is only a matter of when, not if, the preferred method of purchasing music by the American consumer will be the internet download. A case in point: on April 3, 2008, I-Tunes announced that it had become the number one retailer in the
Notwithstanding the rapid rise of digital sales of music, the lion’s share of the money earned from music purchases is still earned from the sale of CD’s. In 2007, it is reported that in terms of dollar volume, CD’s accounted for between 85 and 90% of all recorded music sales dollars. Although wholesale prices of CDs has dropped from the $8.50 range down to the $7.00 range, even relatively modest sales achievements of 15,000 units can yield substantial revenues for independent labels – far, far above the expected sales income likely be earned from digital distribution of the same album. But digital sales are growing by 50% a year and CD sales are dropping by 20% a year.
As a result of these changes in the buying habits of the music consumer, independent labels in today’s market are caught between two worlds and music distribution is in a period of transition. A label needs to have one foot in the digital world and one in the physical world to fully exploit the potential of their catalogues.
Physical distribution arrangements for independent labels are well established. Some of the better known national independent distributors are RED,
In the digital distribution world, the pathway to the consumer has had more twists and turns than a John Grisham novel. It started when the major labels were caught sleeping by Napster on the potential of the internet to distribute music. Before the majors finally won their lawsuit for copyright infringement against Napster, millions of young record consumers had grown up on free music downloads using peer to peer file sharing services.
It has taken the spectacular explosion of the i-Pod, the enormous catalogue of iTunes , and steady pressure on illegal downloaders from the Recording Industry Association of America to slowly but steadily improve the sales of digital music over the internet. At the present time, the ratio of illegal downloads to legal sales is approximately 20 to 1, but digital sales of music in the US in 2007 still amounted to $2.1 Billion.
Online Music Sales
With the increase in legitimate digital sales has come a dramatic jump in the number of on-line music retailers (i.e. companies offering music downloads to consumers over the internet through their websites) not only in this country, but abroad as well. In addition to iTunes, consumers can purchase digital music through Amazon.com, Emusic, Napster, Real Networks Rhapsody, Liquid Audio, Microsoft Zune, On Demand Distribution’s network of stores, and other niche online retailers like Beatports who service the DJ market. For the independent label, it is crucial to insure that its catalogue is available through these myriad of internet locations. Here are some of the things independent labels need to be aware of to successfully take advantage of the opportunity.
First, labels should make sure that they have complete authority to distribute any masters that they control digitally. It is quite common for physical distributors to attempt to secure digital distribution rights as a condition of distributing the label’s product in physical form. This should be resisted. In most cases, the physical distributor that secures such rights will simply turn around and assign them to a digital distributor, taking a percentage in the process. There is no advantage to the independent distributor in this arrangement when they can enter into digital distribution deals directly. But there are disadvantages. If an advance is received from the physical distributor, no revenue will be paid through until that advance is recouped. If digital distribution is retained by the label, sales will be paid through monthly possibly providing a valuable income stream while the physical distribution agreement is unrecouped.
Secondly, labels should understand in the online retail distribution world, exclusivity is not commonly expected by a digital retail service that offers downloads directly to consumers. That is the reason why it is so common to find the same songs offered for sale on many retail digital music websites, just as you would expect to see in the physical retail world. The website that does the best job of attracting the buyer and offering the best price will get the sale. For the label it would be highly limiting if their catalogue was restricted to only one commercial website such as, say Zune.
Sales of Digital Music on the Web
Here is a list of the top 5 retail music websites active in the
Apple iTunes: 67%
eMusic: 11%
Real Rhapsody: 4%
Napster: 4%
Zune (Microsoft) Music: 3%
There are hundreds more online retailers around the globe. Each country has online music retailers that are popular in that region.
I. Digital Aggregators:
The sheer number of commercial websites offering music downloads around the world makes it a task for the typically under-staffed label to contact, negotiate, format masters with appropriate protocols, contract, supply, service, collect, and monitor each separate website provider account. Fortunately, a small but growing number of companies have focused on acting as a digital distributor for independent labels interested in positioning their product on all reputable commercial music websites. Popularly known as “aggregators” these companies have concentrated on securing favorable licensing terms with most of the known internet music providers on the one hand, while soliciting the catalogues of large numbers of small independent labels on the other. The result is that collectively, an aggregator can offer to its distribution partners on the internet a catalogue of songs that begins to approach that of some of the major labels.
Some of the larger aggregator companies that are active in the United States are IODA (Independent Online Distribution Alliance), The Orchard(who merged with Digital Musicworks International, but since has collapsed both brands under The Orchard banner), INGrooves, IRIS Distribution, and Tunecore. In addition, CD Baby has a digital distribution arrangement for its customers,
Typically an aggregator will expect an exclusive agreement with an independent label for a period of 1-5 years for a percentage of the income collected that ranges from 10% to 30%. It will take the label’s CD’s and Videos, format them as needed for its digital outlets, and will insure that all of the label’s catalogue will be made available to all of the commercial websites with which it has agreements. There may be fees for processing content provided by the Label. As is the case with a physical distributor, the label is still expected to promote, publicize and create the demand for their recordings. However, some aggregators will provide assistance with digital promotion opportunities.
The aggregator will provide monthly statements to the label showing the source of digital sales, a detailed list of songs downloaded, and other income generated by the songs in the catalogue. Usually the money is wired into the account of the label and the statements are available on line. There is no need for reserves or manufacturing charges which makes the accounting much more simplified.
With the exception perhaps of sales through Emusic which traditionally pays publishing separately, practically all the other commercial websites pay the label one sum to the label which is expected to pay publishing, artist, and producer royalties to the royalty participants.
The typical payment arrangement for a downloaded track sold for 99 cents nets the label in the area of 62 to 67 cents. If an aggregator is representing the label, this will be reduced by the amount of their commission. Publishing mechanicals (currently 9.1 cents per download unless a reduced rate has been agreed upon) have to be paid from this figure, leaving the balance to be shared between the artist, producer, and label according to their contracts. INgrooves takes their percentage after deducting the mechanical fee for the download, making it a better deal for their clients. I believe all others effectively take the entire fee received for the download sale, including the publishing, in their split.
Some internet services offer subscription services that allow the customer to stream an unlimited number of songs during the subscription period or have ‘tethered’ downloads which expire when the customer ceases to subscribe. Although the unrestricted download price is not used in such circumstances, the service will still pay a fee to the label based on the number of times that their songs are streamed which will in turn be passed on to the label by the aggregator minus their commission. The current rate is approximately .01 Cents per stream. Whether publishing mechanicals are
due on such proceeds can be a close question. Since the label is responsible for such payments, it should have a defensible policy in place.
In addition to the fee-sharing model, there is an emerging new economic model for compensation of aggregators. Tunecore.com uses such a model. Instead of retaining a share of the income from digital sales to the independent label, it remits 100% of the digital sales income and charges $19.95 a year per CD to the label – regardless of sales activity. Whether you sell a million downloads or ten, the fee is the same. While exclusive during the term, the label can decline to renew at anytime. Tunecore contracts are on their website. They are the click-through variety and appear to be non-negotiable.
II. Considerations When Dealing with Digital Aggregators
A. Due Diligence Prior to Contracting
Aggregators usually require an exclusive commitment. Therefore, it is important to evaluate the reputation and characteristics of the company. Some factors to consider:
1. Phone accessibility of key staff
2. Market Share
3. Experience, in general and in the genre of music
4. Marketing possibilities
5. Technology platform used and whether proprietary
6. Mobile phone expertise
7. International coverage
8. Payment reputation and accounting frequency
B. Contract Issues in Digital Distribution Agreements
The following areas are contract areas which may be negotiable in a negotiation between a digital aggregator and an independent label.
1. Term of Exclusive Agreement
From the label perspective, shorter is best. Since the digital world changes so fast, who you want to be in business with today may be quite different in two years. Try to limit the term to no more than 2 years. One if you can get it.
2. Content to Be Delivered
A label may desire to entrust its entire existing catalogue to the distributor or only certain titles. New titles may be automatically included or excluded unless specifically added by the label. The label should carefully evaluate the pros and cons of each approach where available. In addition, labels should exclude from the aggregator exclusivity and commission any digital content sold by their own websites.
3. Charges for Encoding
It is not uncommon for some aggregators to charge for encoding CD’s and Videos into the necessary technical format for worldwide digital delivery over the net. Some aggregators may waive or reduce those costs if the label has leverage. Be aware of the nature of the charges and attempt to reduce them.
4. Fee Charged
The 10-30% fee charged by most aggregators (except Tunecore) can be negotiated – particularly if the label has some leverage. Some aggregators will want higher percentage fees if they perform more services.
5. Payment Thresholds
Some services impose minimum payment thresholds as high as $200 per month. This should be resisted. With electronic accounting systems, there is little justification for this.
6. Mechanical payments to Publishers
The payment of publishing mechanicals on downloads sold will usually, but not always, be the responsibility of the label from its share of the monies remitted by the aggregator. Foreign web sales may require separate payment of mechanical by the on-line retailer in the country of the sale. In negotiating the digital distribution agreement, make sure that it is clear who is paying the mechanical and under what circumstances. Some aggregators do not charge their commission against the mechanical portion of the download fee. It may be necessary to secure sub-publisher relationships in foreign territories where mechanicals are being earned in order to collect them. Also, the label should insure that it has mechanical licenses for digital downloads (DPM or Digital Permanent Download) in place with publishers for compositions in its catalogue where it does not control the publishing rights to those compositions.
7. Control of Catalogue Placements on the Web
It is becoming increasingly popular for aggregators to give labels the control over what websites their music appears. This should be explored during negotiations. Labels may want to decline to permit their music to appear on a particular website for a variety of reasons. Promotional and giveaway programs should be subject to label’s approval or at the least, the right to “opt out” after notice.
8. Approval of name, image, biographical information, album cover art
More and more visual content is being displayed by online music retail websites than ever before. While it is helpful to marketing efforts, the label should retain traditional contract control over the information displayed.
9. Audit rights
Make sure that they are included and are available for a minimum of two years after the rendering of the statement, regardless whether the agreement is still in effect.
10. Customer Sales information
Explore the nature of the sales data that may be captured by the distributor and passed on to the label. Any specific geographical or customer information may be very useful to the label in its future marketing efforts. Ask if weekly sales data can be provided
11. Master Performance Royalty Collection
Determine whether it is in the label’s economic interest for the aggregator to collect and remit master performance royalties from around the world from royalty collection societies as part of their collection responsibilities.
11. Marketing Efforts
Most aggregators will not commit to specific marketing efforts since they do not ordinarily control the display of content on the on-line retailers. However, internet marketing is changing daily and the topic should be raised to see if there are any commitments that the distributor can agree to in this area. Some labels are experimenting with digital-only releases. The motivation varies. At times the purpose is to give certain websites an exclusive on a particular track which in turn is specially promoted on their website. The aggregator may request additional tracks for this specific purpose.
12. Synchronization Placements
Many aggregators seek to participate in any placements they secure for the Masters provide to them by the label. This activity benefits the label and should be encouraged as long as: (a) it is non-exclusive (2) does not conflict with any other placement agreement already executed by the label with another placement entity (3) is subject in each instance to the label’s prior approval (4) the fee split is reasonable and pre-agreed.
13. Ring Tones and Ring Backs
This is a potentially lucrative area. Typically aggregators will want the right to supply these digital products to the phone companies and their partners who supply the ring tones. If this activity is desired to be excluded from the agreement, it should be addressed during negotiations because the normal language in an aggregator’s agreement would give them exclusive rights to distribute these products.
III. Direct Digital Distribution by Label-Owned Websites
While most purchases of digital downloads occur at the websites of the major online retailers, future trends suggest that labels will find ways to direct their hard core fans and customers directly to their websites to make purchases of digital music. Tracks which are not available elsewhere may be featured, along with special promotions and fan-based subscription services. Direct digital sales from the label’s website are more profitable without the aggregator fee and the label has the opportunity to capture all of the customer’s data for marketing purposes. To prepare for this activity, the label needs to have its Masters in the correct encoded digital form and access to the software platform that will provide the appropriate customer user interface. Hiring a consultant to manage this activity would be highly advisable.
IV. Digital Music Distribution through MySpace
Often small Artist-owned labels utilize MySpace to house their music and artist promotional activity. MySpace will be shortly be launching MySpace Music which will enable the artists who have music on their websites to sell it digitally direct from their webpage. As of this writing, pricing and other details are still unavailable. However it is clear that for the artist without the means to construct and manage their own independent website, MySpace Music offers an economical and effective way for Artists to market themselves and sell downloads of their music directly to customers without resort to a third parties or complicated contract negotiations.
Conclusion:
While CD’s remain an important source of income to independent labels, the future is clearly digital. Mining these digital distribution opportunities is key to future financial viability as CD sales continue to decline. It is my hope that this article has provided some illumination of the practical and legal aspects of this new digital music frontier as it continues to unfold.
