Tuesday, January 06, 2009

Artists Beware of New iTunes Variable Pricing

Several sources are reporting that Apple will soon allow variable pricing through its iTunes store for music distributed by three of the four major labels. In exchange, Apple will be able to sell more music DRM-free.

DRM-free is a long-overdue concept, and variable pricing is not inherently a bad idea; quite the contrary. Variable pricing simply acknowledges that not all songs are created equal. Crappy songs should not cost the same as good songs. Mercedes and Honda aren't required to sell their cars at the same price; even Doritos and Publix corn chips are priced differently. Music should be no different. However, there is a downside, one that artists must be keenly aware of in their recording contracts.

Most artists are paid a royalty based on suggested retail list price (SRLP). So-called "retail" royalty rates are almost universally subject to reductions based on the selling price. Let's say your royalty is 14%. However, that's 14% of SRLP for "top line" records - records selling in the label's highest price category.

That royalty could go down by 10-25% for so-called "mid-line" records, and could be cut in half for "budget records." Therefore, if a top-line record is one selling at $18, and a budget record is one selling for $9, the artist could end up only getting a 7% royalty (50% of 14%) on a $9 record (50% of top-line price). They get double-screwed.

The percentages vary - how much the royalty is reduced or even what percentage of the top-line price constitutes a budget- or mid-line record depends on the label, the success of the artist, and the skills of the negotiator.

The justification for these reductions has been that labels spend a lot to get the record out, and if it sells at a lower price then the label needs a larger cut in order to make ends meet. The question with digital, however, is whether this logic should still control (presuming it was ever based in reality to begin with).

Artists already in deals should review their agreements to see if they provided any exceptions for digital from the regular royalty rate calculations. It could be that digital singles are paid at the regular album rate (rather than the reduced singles rate for physical albums); better still, it would go a step further and say that digital sales will always be at the top-line rate, regardless of selling price.

Even if labels were justified in reducing the royalty payable on budget- and mid-line records, the digital arena is still too malleable to fix rules on royalty rates based on a traditional physical model. Presuming they were justified in reducing an artist's royalty by 15% on a mid-line physical record, does that number still make sense in digital? Or what if a mid-line record is defined as 80% of the top-line price; do we even know what a true top-line price is at this point? And prices for digital can vary far more significantly, where a top-line track might sell for $1.50 but a budget track will sell for $0.25, with the majority falling in at $0.80 - $1.10.

Of course, the big issue with digital sales is the lack of physical product, meaning no manufacturing costs, no inventory costs, minimal distribution costs, etc. Basically very little fixed costs directly attributable to digital sales. Therefore, the label doesn't have this financial brick wall that it must contend with - if it has $3.50 invested in a CD and is selling it for $5.00, it's worried about selling all the copies pressed and not loosing money. If it's selling a download for $0.50, pretty much the whole shebang is nothing but gravy (recording costs, tour support, and other general artist expenses notwithstanding).

At the end of the day, variable pricing is a smart thing and is good for all parties involved. Artificial price controls really do not benefit anyone and the market should determine the price of music. However, artists need to be keenly aware that variable pricing could result in a substantial reduction in royalties payable to them. Any artists negotiating new deals or re-upping their current ones should definitely take this into account; those already tied to deals need to maybe sweet-talk their labels into revisiting this point due to potential changed situations. It'll be a hell of a lot easier to fix this problem now than it will be 4-5 years ago, after the labels get used to the new status quo.