The Economics of music for attorneys and others: A redux (part four)

By John F. Sase, Ph.D.

Gerard J. Senick, general editor

Julie G. Sase, copyeditor

"Aside from the creative and technical aspects of recording an album, there are legal and contractual issues that must be considered before even entering the studio. The artist or label paying the expenses of recording must be sure that everyone is on the same page regarding whether fees and/or royalties are to be paid and, if so, how much is to be paid to each party."

-Howard Hertz,

entertainment attorney,

Hertz Schram PC,

Bloomfield Hills, MI (www.hertzschram.com)

Depending on the individual foci of law practices, attorneys may take cases regarding intellectual property and contracts in the music industry. Often, composers and performing artists remain neophytes in matters of the economic and legal issues of their industry. This month, we continue to address the basics of economics and law that intermingle in the production, recording, manufacturing, and marketing of recorded music. For the benefit of our readers, we will minimize our economic techno-speak as we present our basic treatise on issues involving the market for music. We hope that our efforts will aid attorneys, both individually and in the education of their clients who pursue a career in the field music.

The Basic Business of Music

Legal and economic perspective complements the artistic and technical side of recording. For legal issues, our go-to entertainment attorney Howard Hertz explains that any tangible contribution to a song (the composition) or a recording (known as the master) may result in issues of copyright ownership or performance rights being held by any person who contributes to the work. In order for an artist or record label to emerge from the studio with an album that they own fully and may distribute for sale to the public, agreements must contain proper "work-for-hire" language. In essence, work-for-hire implies that such contributors relinquish ownership claims on the composition or master by stating that all of the work was performed for equitable compensation received.

Hertz further emphasizes that all producers, engineers, and side-person musicians who have worked on the project must sign these agreements. Typically, the artist or label should own the copyright to the master recordings, contractually. Alternately, the copyright ownership in the underlying composition may be owned by multiple writers and other contributors to that piece of music. However, all of the parties involved may agree in writing that the artist or label may "buy out" these rights. Due to the potential complexity of such agreements, contributors often fill out a "split sheet" for each work following the recording of the compositions. This sheet lists the determined percentages of the song or instrumental that each contributing party provided along with the percentage of rights owned by the publisher for each party involved. Then, all of the contributing parties sign the split sheet, thus making the determined split a legally binding agreement.

A Band as a General Partnership

Many musical groups that lack the understanding of business law overlook the fact that the law will treat them as a general partnership rather than as a limited liability company (LLC) or as a subchapter-S corporation (which differs from a subchapter-C entity in our U.S. Corporation Laws). Operating as a general partnership implies that the law considers that all partners hold equal-ownership shares if no written agreement exists. In respect to the business of music, Hertz says that, according to the court, each writer who has contributed words or music to a composition owns an equal share in it. It is important to note that this decision holds true when no written and signed agreement exists to the contrary, despite the percentage of the writer's contribution. Hertz provides this illustration: "[I]f three writers contribute to a work and have no signing to the contrary, they each own one-third of the copyright, even if one of the writers only contributed one line of lyrics and might have likely agreed to a five or ten percent share of the song if it was put in a split sheet." A word of wisdom to all musicians, audio producers, and engineers: have a qualified entertainment attorney on your side to guide you through these choppy waters.

Replicating and Marketing the Final Product

The 500 hours of time, energy, and artistic angst invested in the production of an album buries itself as a sunk-cost. We define sunk-cost as the non-retrievable fixed cost associated with the production of recorded music for sale. In the act of producing recorded music, time constitutes the major portion of the upfront, fixed, sunk-costs. These costs cover all of the work and expenses incurred up to the point at which the glass, metal, or ceramic master and the cover and disc artwork used in the replication of commercially manufactured CD and vinyl products are made. In respect to these costs, we note that a downloadable MP3 and similar formats may not require this final step.

The amount of funds that an artist needs to invest in order to reach this point depends upon the location (New York, Los Angeles, and Nashville versus everywhere else in the country), the amenities, and the reputation of the studio employed. Reportedly, the current high-end studio cost exceeds $3,000 per hour. Ignoring incidentals and not including upfront fees to contracted producers, engineers, and side-person vocalists and instrumentalists, studio costs may necessitate a project budget in excess of $1.5 million (500 hours x $3,000 per hour). Based on the sales needed to recover these costs, not many artists go "gaga" (or should we say "Gaga") over this price tag. As noted previously in this series, the average studio cost per hour in urban areas outside of major markets appears to fall in the range of $75 to $200.00 per hour. This recording route reduces the average studio cost to $168,750 ($75 times 500 plus $200 times 500, with the total being divided by two) per album project, assuming that the artist(s) does double duty as producer/engineer.

If an artist acts as a producer/engineer, s/he may be able to release the music to the public for $20,000 to $37,500. One can achieve this goal either by using a budget-conscious studio priced at $75 per hour or by investing $20,000 or more in his/her own digital-audio workstation such as Pro-Tools HD (www.avid.com/pro-tools) and a small assortment of high-quality microphones, pre-amps, and acoustic sound-control material. For many musicians who want to record their music, the latter serves as a viable option. Given the relative complexity of the compositions and the musical arrangements used for their recordings, some artists manage to get their albums out the door for about $10,000. For the sake of comparative discussion, let us work with these last three figures and assume that the artist becomes an entrepreneur and manages the entire release.

CD replication has become highly competitive. The price per lot of 1,000 copies has decreased to about $1,000, depending on the type of artwork and packaging. This results in a unit-fabrication cost (the making the physical CD) of $1 per CD. However, one needs to add the promotional costs involved in a release. One major and effective cost of this type requires the strategic gifting of copies to radio stations, clubs, and individuals in order to prime the proverbial pump. Also, using social media such as Facebook and YouTube can provide "free" advertisement. For the sake of simplicity, let us assume that the promotional cost for a CD that contains ten songs averages $1 per CD. The more CDs that are manufactured, promoted, and sold, the more money that an artist needs to invest in the project. In short, manufacturing and promotion costs vary with quantity. Therefore, we refer to these costs as variable costs that total $1.50 per CD, on average.

Let us say that the artist averages direct net-revenue of $10 per CD. This suggests that the CD might be priced at $14 and sold at live performances, distributed as digital downloads, and made available at online and brick-and-mortar stores. We can phrase our economic question as a break-even analysis (see Economics for Attorneys 1, https:// youtu.be/VgpU8Rm11dA). In the world of business, an entrepreneur considers a break-even point of three to five years as reasonable.

Considering an artist as a start-up business, let us anticipate a break-even point at five years - sixty months starting with composition, arrangement, and production in the first year. At this juncture, we have two questions to consider: If the album is released at the end of the first year, how many copies will this artist need to sell over the following forty-eight months in order to break even? How many copies will s/he need to sell per month in order to achieve this goal?

Using $1.50 as the variable cost per copy, the upfront sunk-cost of producing the master recording constitutes the key determinant in our calculation. If we divide this fixed amount by the difference between the net price at which the album is sold and the combined cost of manufacturing and promoting each copy, we arrive at the break-even quantity that must be sold. The Break-Even Quantity equals Fixed Costs divided by the difference between the Average Revenue and the Average Variable Cost, and then rounding up to the whole unit. If the total production and mastering costs amount to $38,000, then an artist needs to sell 4,471 CDs at a rate of 94 discs per month for four years. If the artist economizes or sets up his/her own project studio for an investment of $20,000, then s/he needs to sell only 2,353 CDs at a rate of 50 discs per month (about two per day). An artist who possesses sufficient musical talent, recording skills, and market savvy may achieve this goal at a barebones studio that charges $25.00 per hour may be able to break even by selling 1,471 CDs at a rate of 31 discs per month (one-per day).

The Great Beyond

As Hertz stated in our opening quote, "The artist or label paying the expenses of recording must be sure that everyone is on the same page regarding whether fees and/or royalties are to be paid and, if so, how much is to be paid to each party."

We have focused on what may be called an Entrepreneurial Indie Label, one in which an artist or group does everything from production to direct sales (e.g. merchandise tables at gigs) except for two chores. Fabricating the CDs or vinyl may be done through companies such as Discmakers (www.disc makers.com). Hopefully, the artist can sell copies with the help of a music-marketing service such as CDBaby (www. cdbaby.com) or promoted through a music-streaming service such as Spotify (www.spotify.com). Then, these recordings can be sold online, as digital downloads, and at brick-and-mortar stores as hard copies. The next rung up the ladder requires that the small, entrepreneurial music company signs with a major or minor label. At this point, a good entertainment attorney to represent the artist(s) becomes even more indispensable.

The Digital Age

The record industry continues to reinvent itself in the Digital Age. This age has brought affordable means to artists in order to accomplish what only multi-million-dollar recording studios could do previously. Online distribution has become feasible and preferable to many artists through CDBaby, iTunes, Amazon, and similar sites. What these turns of events leave to labels as their major responsibility is to do what they continue to do best-finance, promote, and distribute product to large markets. In Love's Manifesto, a blog by recording artist Courtney Love, she states, "If a record company has a reason to exist, it has to bring an artist's music to more fans and it has to deliver more and better music to the audience. Previously undiscovered artists benefit from the huge promotional break that only a major label can offer. It takes a ton of funds to break a new artist - funds that most artists do not have on their own" (12 July 2001, http://www.indie-music.com/modules.php?name=News&file=article&sid=820).

Rerecording/mastering, fabrication, distribution, tour support, and other promotional investments all require capitalization. In determining which artists to sign, labels consider his/her sales potential. The label bases its decision on what the artist has accomplished beforehand. A rough rule of thumb remains that major labels sign artists who have made verifiable sales of at least ten thousand albums on their own. The artist assumes the risk and costs of test-marketing their music. In addition, labels consider plans for touring in order to support direct product-marketing to a wider audience. In addition, labels assess the feedback received on the music through social media and use this information in their marketing and distribution efforts.

(pic Roulette)

We may compare the business of music to the spin of a roulette wheel. A wheel has thirty-six black-and-white numbers plus a green "0" and a "00." The gambling house wins on these last two numbers. Their odds of winning are 5.26 percent - the two green numbers divided by the total of thirty-eight numbers on the wheel. Generally, the record industry hits the break-even point on 10 percent of their releases. However, only 5 percent of releases turn a profit. These releases subsidize the 90 percent that lose money.

Therefore, cash advances bestowed upon artists are determined by their ability (both musical talent and the potential to sell albums), the costs that may be recoverable from an artist, and the probability of success in a marketplace that ultimately relies on the 5 percent of releases that eventually become profitable. An advance is an ADVANCE. Essentially, it is a loan that is repaid through royalties (percentage of the sales) that hopefully are earned on future record sales. Under its contract with an artist, the record label is going to want to be paid back - and to be paid back first.

The label withholds all artist earnings from sales until it recoups production, marketing, and distribution costs. Furthermore, sequential or multi-album contracts allow for the repayment of advances for one album from the income earned on multiple albums. This method of securitizing the investment made in an artist by the record company is known as Cross-Collateralization. Apart from a few exceptions, a label can recoup every cent invested in an album from artist-royalty points. As a result, most artists receive $0.00 from their royalty points until recoupment by the label is complete.

So, how do artists go about making money from their recordings? Very simply, they can achieve their goal by remembering that they are involved in a business as well as an art. Furthermore, this business takes place in what economists refer to as a perfectly competitive market-the market interaction between buyers and sellers sets the price for similarly situated products. This price remains relatively constant at any point in time. Due to this market quality, revenue increases at a constant rate as greater quantities of a recording are sold. As a result, there are only two ways to increase profits: one is to sell greater quantities of the product and the other is to decrease the costs of production, manufacturing, promotion, and distribution.

Takeaway

Though the music business has evolved dramatically and is in the process of evolving even further, it remains possible to release music and to earn a profit if knowledge of the business is acquired and applied. We hope that we have edified our readers about the physical, economic, and legal aspects of the recorded-music industry over the past four months during a season in which many of us have diverted our professional time to ensure a fair midterm election. Furthermore, we again thank our guest Howard Hertz for his enlightening contributions to this column. We wish our audience a wonderful Thanksgiving and a stress-minimized beginning of the Holiday Season.

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Dr. John F. Sase has taught Economics for four decades and has practiced Forensic and Investigative Economics since the early 1990s. He earned an M.A. in Economics and an MBA at the University of Detroit and a Ph.D. in Economics at Wayne State University. He is a graduate of the University of Detroit Jesuit High School. Sase can be reached at 248.569.5228 and by e-mail at drjohn@saseassociates.com. You can find his Economics videos of interest to attorneys at www.youtube.com/saseassociates.

Howard Hertz has represented numerous artists and entities in the entertainment field for more than three decades. In 1979, he established the law firm of Hertz Schram with Bradley Schram. Hertz specializes in entertainment law and is the lead attorney of Hertz Schram's Entertainment Practice Group. He earned his B.A. and J.D. at Wayne State University. Hertz can be reached at Hertz Schram PC, 248.335.5000 and by e-mail at hhertz@hertzschram.com.

Gerard J. Senick is a freelance writer, editor, and musician. He earned his degree in English at the University of Detroit and was a supervisory editor at Gale Research Company (now Cengage) for more than 20 years. Currently, he edits books for publication and gives seminars on writing and music. Senick can be reached at 313.342.4048 and at www.senick-editing.com. You can find some of his writing tips at www.YouTube.com/SenickEditing.

Published: Wed, Nov 21, 2018

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