What Every Label Should Know about Digital Distribution
by Michael Ashburne, Esq. © 2011 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 time when the preferred method of accessing music by the American consumer will be over the internet – whether streamed or downloaded. A case in point: on February 24, 2010, Steve Jobs’ birthday, I-Tunes announced that it had sold 10 billion songs. The old fashioned experience of digging through the bins will remain, but only for an increasingly small minority of die-hard CD and Vinyl collectors.
Notwithstanding the rapid rise of digital sales of music, the lion’s share of the revenue earned from music purchases is still earned from the sale of CD’s. In 2009, it was reported that in terms of US dollar volume, CD’s accounted for approximately 65% of all recorded music sales dollars compared to 35% for digital music sales. Although wholesale prices of CDs payable to independent labels has dropped into the $6.00 to $7.00 range, even relatively modest sales achievements of 15,000 units can yield substantial revenues for independent labels – far above the expected sales income likely to be earned from digital distribution of the same album. Digital download sales are still growing slightly but at a slower rate than a year ago, and CD sales are still 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 physical world and one in the digital 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, ADA, Caroline, Koch-Navarre, and relative newcomer Fontana owned by Universal. Assuming that a distributor is willing to take on the label’s product, a distributor will solicit orders from retail chains, stores, and one-stops. Historically, distributors manufacture the product and advance the costs of manufacturing against the anticipated sales revenue. However, with slower CD sales, they are more cautious about offering to advance manufacturing costs for fear of getting stuck with unsold inventory. Even some established labels are being notified that they must cover the cost of manufacturing up front. In addition, the label is expected to pay for all promotion, publishing and artist royalty payments. A percentage of sales income will be held (i.e. reserves) for a period of time to cover anticipated returns of albums from retail accounts.
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 lawsuits for copyright infringement against Napster and its successors - Grokster, Kazaa and other file sharing internet services - millions of young record consumers had grown up on free music downloads using these peer-to-peer file sharing services.
It has taken the spectacular explosion of the i-Pod and i-Phone, the enormous catalogue of iTunes, and publicity generated by successful lawsuits against illegal downloaders from the Recording Industry Association of America to slowly but steadily improve the paid-for sales of digital music over the internet. Still, at the present time, the ratio of illegal downloads to paid sales is approximately 20 to 1, so for every one billion in legal sales units, 20 billion files are traded without direct compensation.
Accessing Online Music Sales
With the increase in legitimate digital sales has come a dramatic jump in the number of online music retailers (i.e. companies offering music downloads and on-demand or non-interactive streaming to consumers over the internet) not only in this country, but abroad as well. In addition to iTunes, which garners 70% of the digital marketplace, consumers can purchase digital music through Amazon.com (8% of the market in 2009)), Emusic, Napster, Rhapsody, Microsoft Zune, On Demand Distribution’s network of stores, and a host of other niche online retailers like Beatport and Juno who service the DJ market. For the independent label, it is crucial to insure that its catalogue is available through this myriad of digital music outlets. Here are some 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. Labels must either own the copyright of their masters, or have an exclusive license from the copyright owner to distribute them over the internet. The same is true for the underlying musical compositions. Labels need ‘digital mechanical rights’ for all songs in their catalogue. For songs in which you do not either own the copyright to the composition, or do not have the required digital mechanical license, third party services such as Limelight from Rights Flow can help secure a license.
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 label 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 possibly remains unrecouped.
Secondly, labels should understand that there are various approaches to making their catalogue available to potential customers online, ranging from the label or artist’s own website to the ‘iTunes’ of the world. It is important to understand when exclusivity is expected and when it is not. For digital distribution agreements with independent labels, the norm in this day and age is exclusivity for the term of the agreement. If two different digital distributors are representing the same title and it is placed with a digital retailer, the sales for that title will be diluted between the two distributors. It makes little sense for the label, distributor, or artist and there is the potential for customer confusion. However, the label is not typically precluded from offering digital sales of their own catalogue on the label’s website. CD Baby, which caters more to independent artists than labels, requires exclusivity for its digital sales service, but the artist can terminate at any time.
Label Catalogue Placement with Retail Online Websites Via Distributors or “Aggregators”
The vast majority of digital music sales occur at online music stores. As mentioned above, the iTunes Music Store (iTMS) represents approximately 70% of the industry’s digital music revenue, so it is essential for a label’s catalogue to be available there. In addition, there are hundreds of other online retailers around the globe. Each country has online music retailers that are popular in that region. As you might imagine, these online retailers typically do not like to deal directly with multitudes of artists and independent labels. Even if they were open to doing so, it would be challenging for a label to deal directly with numerous web retailers. To negotiate contracts, appropriately encode for unique digital specifications, deliver, request changes, collect revenue, and monitor each separate online retailer would be a huge obstacle for the typically under-staffed label .
Fortunately, a small number of established companies have focused on acting as a digital distributor for independent labels interested in positioning their product at all reputable commercial music websites. Popularly known as “aggregators” these digital distribution companies have secured favorable licensing terms with most of the key 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 or distributor can offer to its online retail partners a catalogue of songs that begins to approach that of some of the major labels and obtain better financial terms as a result.
Some of the larger digital distribution companies that are active in the United States are IODA (Independent Online Distribution Alliance), The Orchard, INgrooves, IRIS Distribution, and Tunecore. In addition, CD Baby has a digital distribution arrangement in place for its customers with a modest 9% distribution fee. Once a digital distributor is representing the label’s catalogue, the digital distributor places their member- labels’ catalogues with many reputable online websites to have the broadest possible chance to service an interested buyer. This is why it is 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 and the distributor it would be highly limiting if their catalogue was restricted to only one commercial online retailer. However, with the label’s consent and cooperation, digital distributors often do provide exclusivity to certain songs to an important online retail website in exchange for promotional benefits.
Another important function of the digital distributor is to sort through the hundreds of new retailers emerging each year, research, isolate, and service those that offer a valuable product at a fair rate. Many copycat online retailers offer the same titles at a discounted rate and this only serves to devalue the client’s product. In this manner, the digital distributor operates somewhat as a venture capitalist might, looking at new web retailers for elements of success and value before engaging in the operational costs and time required of a new agreement.
Typically a distributor 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%. If the label has a highly valuable catalogue, an advance may be negotiated. The distributor will take the label’s CD’s and videos, format them as needed for its online retail partner outlets, and will ensure that all of the label’s catalogue is 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 well as credit card transaction fees, bandwidth storage and other items. 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 distributors provide marketing support to secure features and exclusives at retail, much the same as you would see from major label content. They may offer advice in terms of album and track pricing , promo tracks, catalog merchandising, and even optimal release dates for new content.
The distributor will provide monthly statements to the label showing the source of digital sales, a detailed list of songs and albums sold, and other income generated by the label’s catalogue (i.e video sales, ringtones, etc). Usually, the money can be wired directly into the label’s bank account and the statements are available online. There is no need for reserves or manufacturing charges which simplifies the accounting.
With the exception perhaps of download sales through Emusic which has traditionally paid publishing mechanicals separately, practically all the other commercial websites pay 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 a distributor 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 by the label 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. Other distributors take a percentage of the entire fee received for the download sale, including the publishing.
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’s digital distributor based on either the number of times that their songs are streamed or a pro-rata share of a fee based on the income of the service. This fee will in turn be passed on to the label by the distributor minus their commission. Whether publishing mechanicals are due on such proceeds can be a close legal question, but most labels take the position that only performance royalties are due to publishers on streamed content which are collected by ASCAP, BMI, and SESAC . Since the label is responsible for making such payments, it should have a defensible policy in place.
In addition to the fee-sharing model, another popular model for compensation of distributors is used by Tunecore.com. Instead of retaining a share of the income from digital sales to the independent label, Tunecore remits 100% of the digital sales income and charges $19.95 a year per CD to the artist or label – regardless of sales activity. Whether you sell a million downloads or ten, the fee is the same. While the Tunecore agreement is exclusive during the term, the label can decline to renew it at anytime. Tunecore contracts are on their website. They are the click-through variety and appear to be non-negotiable.
Considerations When Engaging Digital Distributors
Due Diligence Prior to Contracting
Distributors usually require an exclusive commitment. Therefore, it is important to evaluate the reputation and characteristics of the company. Some factors to consider:
Phone accessibility of key staff
Client size (are you a big fish in a small pond?)
Length of time in business
Experience, in general and in your genre of music
Retail marketing proficiency
Technology platforms available (reporting and/or new content submissions)
Mobile expertise
International coverage
Payment reputation and accounting frequency
Contract Issues in Digital Distribution Agreements
The following are contract areas which can be negotiable in a negotiation between a digital distributor 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 two years, one if you can get it. At the end of the term, the agreement will continue until terminated by notice from the Label or Distributor.
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 distributor exclusivity and commissions on any digital content sold by their own websites.
3. Miscellaneous Charges
Encoding: It is not uncommon for some distributors to charge for encoding CD’s and Videos into the necessary technical format for worldwide digital delivery over the net. Some distributors may waive or reduce those costs if the label has leverage. Be aware of the nature of the charges and attempt to reduce them.
Credit card processing fees, content storage and bandwidth, bad debts, performance royalties, fees paid to agents: Some distribution companies will seek to deduct fees of the above nature but this should be resisted. If allowed, the label should insist that all such costs be prorated in proportion to the amount of content subject to the license, divided by the total amount of content on the service.
4. Distribution Fee Charged
The 10-30% fees (except Tunecore, which as noted above, has a per album fee) can at times be negotiated – particularly if the label has leverage in the form of popular or extremely rare content. Some distributors will request higher percentage fees if they perform more services.
5. Payment Thresholds
Some services impose minimum dollar thresholds for issuing payments which can be 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 distributor. Foreign web sales usually require separate payment of mechanical by the online retailer in the country of the sale to the local mechanical rights society. In negotiating the digital distribution agreement, make sure that it is clear who is paying the mechanical and under what circumstances. Some distributors 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 ensure 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 distributors to permit labels to control where 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 of 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 sales data is available online at the distributor’s website.
11. Master Performance Royalty Collection
Determine whether it is in the label’s economic interest for the distributor to collect and remit master performance royalties from around the world from royalty collection societies as part of their collection responsibilities.
12. Marketing Efforts and Promotional Tracks
Most distributors will not commit to specific marketing efforts since they do not ordinarily control the display of content on the online retailers. The size of their catalogue makes it unrealistic to expect much in the way of marketing except possibly for new releases. 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 promotional digital-only releases. The motivation varies. At times the purpose is to give key retail websites an exclusive on a particular track which in turn is specially promoted on their website. The distributor may request additional tracks to be used for promotional purposes.
13. Synchronization Placements
Many distributors seek to participate in any placements they secure for the Masters provided 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.
14. Ring Tones and Ring Backs
This is a potentially lucrative area. Typically distributors 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 distributor’s agreement would give them exclusive rights to distribute these products.
15. Videos
Many digital distributors will also distribute music videos which can either be done on a for-sale or promotional basis. If the label controls a number of videos, they should discuss the inclusion and uploading of those videos to the distributor’s service so that they can be offered to their distribution partners.
Direct Digital Distribution by Label-Owned Websites
While most purchases of digital downloads occur at the websites of the major online retailers, trends suggest that labels will find ways to attract 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. Products offered by Topspin, Nimbit, Bandcamp and others can help organize the label’s direct-to-consumer web sales. Direct sales from the label’s website are more profitable without the distribution 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 platform that will provide the appropriate customer user interface. Hiring a consultant or marketing firm to manage this activity is highly advisable.
Conclusion:
While CD’s remain the dominant source of income to independent labels, the future is clearly digital. Recent studies suggest that streaming has been gaining more popularity than downloads, but both are important revenue sources. Mining these digital distribution opportunities is a key component to future financial viability for labels 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 frontier as it continues to unfold.
Michael Ashburne
Law Offices of Michael Ashburne
539 Summit Drive
Pinole, CA 94564
Ph: 510-715-5000
Email: mrashburne@aol.com