In the frenzy to identify exactly how the Internet will improve the music business, some Web executives and tech savants have claimed that digital distribution will lead to fairer and more generous contracts for artists. These claims are based on the oft-repeated assumption that major-label recording contracts are unfair to artists, allowing the labels to grab a disproportionate share of profits. Cathartic as it is to vent at record companies and carry the banner for artist empowerment, it seems to me that many of the attacks on the inequitable sharing of the pie have been overstated. The problems most artists have with record companies (and there are many legitimate problems, don't get me wrong) have nothing to do with how the money is divided up, so long as we are talking about acts that actually sell enough records.

It goes without saying that the blockbuster artists who sell millions of albums make lots of money. Not only do such sales levels generate millions of dollars in royalties (and goose important income streams such as publishing and performance fees), but they also provide these artists enormous leverage to renegotiate. Why, you ask, would a record company owed several albums by an artist improve her deal? Because record company executives are judged on their annual, sometimes even quarterly, performances.
When I was at Mercury Records, we agreed to give Shania Twain an increase in her royalty rate in the range of 40 percent if she would deliver Come On Over in time for a fourth-quarter release in 1997. Shania had a weak deal despite having sold 10 million copies of her previous album, The Woman in Me. The boost in royalty rate was conditional upon Shania finishing her work quickly; she did, and the Q4 (ed note: fourth quarter) release of Come On Over significantly propped up the PolyGram numbers for 1997. And in the process, the renegotiated rate has earned Twain at least an extra $10 million. Every artist coming off a multimillion seller has similar leverage with the bosses of the big companies.

Conversely, artists who have a relatively small audience, say under 50,000 albums, clearly make no money for themselves or their record companies in the major-label game, so it really doesn't matter how their royalties are calculated or what their rate is.

But let's look at mid-level artists, many of whom: Aimee Mann, Chuck D and Michelle Shocked, to name a few have been outspoken critics of the major-label system. These are the artists who are most often plagued by the legitimate problems I alluded to above: insensitive executives who pressure them to copy current hit sounds; rapidly changing corporate cultures in which an artist can be romanced into signing in one season and virtually ignored by the time he delivers his album (often for reasons having nothing to do with the quality or even the commercial viability of the record), and the increasing demand on the soon-to-be-four remaining major record groups to act as efficiently managed profit centers for their multinational parent companies. This type of pressurized quarter-to-quarter accountability strikes many as antithetical to the spirit of the days when many labels stood loyally by their artists for year after year, building careers lovingly and patiently until sometimes, the big payoff arrived, or if not, so what? Why can't all labels, goes the daydream, be like Warners in the 1970s?

That this image of art making nice with commerce is as much nostalgia-tinged fantasy as reality does little to diminish the hold it has on the collective unconscious, especially that of singer-songwriters. It should be noted, though, that this golden era of artist development was facilitated by a one-time-only, post war, baby boom that dramatically spiked the number of album-friendly record buyers. And any artist around then will tell you that the royalty rates back then were anything but golden. The profits generated by these factors provided the labels the ability to stick with artists for longer periods of time, also known as “artist development." The collapse of artist-development budgets was forestalled in the '80s when $9.98 cassettes were replaced by $16.98 CDs, a “conversion" which permitted continued double-digit annual growth despite the smaller Gen X pool of buyers. When sales of catalog CDs reached a saturation point in the early '90s and companies were still required to show the same growth, cutbacks in staff and a reduced commitment to artist development began in earnest.

Up until the 1970s, record companies unquestionably hoarded a disproportionate share of the profits, and many artists, especially black artists, didn't get paid at all. Over the last several decades, however, as the business grew, a class of lawyers emerged to take advantage of the record companies' needs for marketable product, and the deals themselves have vastly improved for the artists.

Some of the criticisms leveled at the labels hark back to earlier eras. For example, some PR-hungry artists and managers have claimed that there are still “breakage" clauses in contracts, remnants from the days of vinyl. In reality most companies, including the one I ran, have long since eliminated them.

There are, however, still boilerplate formulas called “packaging deductions" (a 25 percent reduction from the CD list price) and “free goods" (15 percent). Putting aside the murky origins of such clauses, the practical effect is straightforward: they reduce the value of a point on a $16.98 CD to between 10 and 11 cents (a point is shorthand for a royalty percentage). For the purposes of this article, I am assuming a point equals 10 cents, and that the royalty rate for our hypothetical mid-sized artist is l4 points, or $1.40 per album.

So let's take our mid-level artist, and say that she managed to sell 200,000 copies of her latest CD. How does the artist make out? Based on a royalty rate of $1.40 per album, 200,000 CDs sold results in earned income of $280,000. However, before the artist buys her mom a car (or pays off her college loans), she first needs to deal with the dreaded recoupment. If our artist received a $25,000 advance and spent another $115,000 making the record, this $140,000 is deemed recoupable, which means that the label can collect that amount against royalties.

Also, let's assume the artist received $70,000 in tour support (recoupable) and another $70,000 in recoupable video and promotional support (this is usually split between the label and artist). That adds up to $280,000 in recoupable advances, thereby canceling out the $280,000 earned by the artist on points from her CD sales. Royalty-wise, it's a wash. (There's a holdback for returns of 15-20 percent, but royalties for these “reserves" are usually paid out in 18 months minus any actual returns.)

Album royalties, luckily, are not the only stream of income for an artist. Artists who write their own material enjoy a tremendous economic advantage over those who do not. If an artist writes her own songs, she earns additional monies known as mechanical royalties. Assuming a mediocre .75 percent mechanical rate per song times 11 (a roundabout number of songs on an album), the hypothetical writer-artist would earn around 60 cents an album, or $120,000 on sales of 200,000 units. (Artists with a strong contract can get up to 85 cents in mechanicals per album-and these payments are all “from record one,'' and not subject to any kind of recoupment.) Solo artists like Mann or Shocked also don't have to divide royalties with other musicians, although they will have to pay managers, lawyers, and accountants (standard is approximately 25 percent of net income). They also can make extra money -facilitated, in our hypothetical, by the sale of 200,000 albums - from concert appearances, merchandise like T-shirts, and performance royalties, from radio airplay for example, which are collected and distributed by ASCAP and BMI. None of this is to suggest that an artist selling 200,000 albums is living large; she is, however, considerably ahead of 90 percent of Americans.

What would the label make on the sale of these 200,000 albums? Are labels making their parent companies' shareholders rich at the expense of these middle-class artists? Retailers pay around $10 an album, which amounts to a gross revenue for the label on those 200,000 CDs of $2 million.

No one knows exactly how much distribution and manufacturing costs. The big companies all have large overheads to provide these functions, often creating separate divisions to handle them. The record company presidents run their divisions with internal charges for manufacturing and distribution that add up to around $2.65 a unit. There's obviously profit built into that but the per-unit amount varies, depending on the amount of overall record-group volume as well as unpredictable outside events such as retail bankruptcies. As a rule of thumb, I was always told to assume about $1.00 a unit profit on these combined functions. For the purpose of this exercise I'm assuming a “real" cost of $1.65 per unit for combined manufacturing and distribution.

Here are the record company's expenses:
· Recording and recoupable marketing costs: $300,000
· Mechanicals: $120,000
· Non-recoupable marketing: $600,000
· Manufacturing and Distribution: $330,000
· Total label expenses: $1,350,000

This leaves $650,000 in profit, right? Not necessarily. Out of that comes all of the salaries of the people who work at the record company. These include the people who do the color separations for CD covers, who create Web sites for artists, and who make hundreds of calls to radio stations, journalists, and retailers. Struggling divisions spend more, but a healthy U.S. record company with a decent catalog allots around 20 percent of their gross revenues to overhead, or, in this instance, $400,000.

That still leaves the label with a profit of $250,000, right? Yes, and the middle-level artist has reason to gripe, but not without coming to terms with a fundamental fact: big record companies weren't established to enable artists to sell 200,000 copies. Big record companies need big sales. Even the most astute A&R people are wrong two-thirds of the time. On average, even at a successful company the cost of promoting and marketing a label’s "misses" eats up most of the profits, from not only the mid-level successes but even the gold-plus hits. Executives at major labels, then, are usually disappointed by sales of 200,000.

A major record company's profits come from the Shania Twains of the world, the very artists who have the least to complain about. Remember the $600,000 allocated to marketing on 200,000 albums, this represents 30 percent of the total revenue. On an album that goes on to sell millions, the share of income spent on advertising and promotion drops to 10 percent, leaving an extra $2 an album profit for the label. After a certain point, albums sell themselves through word of mouth.

Based solely on these numbers, you might wonder why Seagram spent all those billions to buy PolyGram. Those sky-high valuations take into account two other crucial factors: international profits and catalog value.

Album prices are higher in Europe and Japan, and artist royalties are usually reduced to three-quarters of the U.S. rate. Hence, labels clear more profit per unit sold. And once again, with rare exception, the artists who generate strong international numbers are those with big pop hits.

Secondly there is the asset value of owning a catalog, which is why master ownership is so jealously guarded. The Beatles' albums still sell millions each year. Bob Marley's Legend anthology sold five million copies in the '90s. Catalogs of hits make very high margins and generate money for decades through re-issues, compilations, licensing for soundtracks, etc. It is widely assumed that the widespread use of MP3 music files on the Internet, like the introduction of any new format for music, will drive up the value of hit catalogs, but the key word here is "hit." No one ascribes much catalog value to an album that sold 200,000 in its first release.

Mid-level artists are, in essence, valuable to labels only in terms of their future potential, or if they garner such great press that they help a particular executive burnish his or her reputation as a sensitive soul. Such repute, alas, is far less valuable in the marketplace than an expertise in marketing megabits or implementing cost cutting.

One major label doing very well in the last year showed an aggregate profit margin (including a calculation for distribution and international) of a little over 10 percent. Nonetheless, there was increasing pressure from the parent corporation and from Wall Street to raise the margin to over 15 percent. Nine times out of 10, this is done by signing fewer new artists and by taking fewer marketing risks on the new artists under contract (staff cutbacks usually follow suit, as well).

If an album fails to create immediate excitement, word comes from on high to shift manpower and marketing dollars to a different project. This syndrome, far more than substandard royalty rates, is what devastates artists. After touring tirelessly and building a devoted fan base, after a year or two of pouring their hearts into writing and recording a record, after hearing cries of genius from friends and fans alike, artists naturally believe that with a little more advertising, one more video and a real shot at radio play, they too, could move millions. But the attention span of majors nowadays, with a few exceptions, resembles that of the 13-year-olds at the core of their audience.

Reduction of risk-taking by the major record groups means that cutting-edge musicians are driven to independent labels like mine, which have scarcer resources and lack the added profits from distribution or international sales. Indies have traditionally presented an alternative, both aesthetically and economically to the blockbuster-driven mindset of the majors. In the 1980s, several indie-rock labels such as Dischord and Touch and Go erected a payment system that gave artists 50 percent of the net profits.

This "partnership" may seem more artist-friendly but the net amount of money made by artists on those labels is not demonstrably greater than it would have been with the same level of marketing in a royalty-based system. It's just that the major labels rarely find themselves spending so little in support of one of their albums. More recently the redoubtable Ani DiFranco has chosen to control her own infrastructure and forgo bids from majors and indies alike. I'd posit that in exchange for maintaining total business control, DiFranco has probably sacrificed income. (And in return for the greater per-unit margin, she's had to pay a year-round staff and be her own bank.)

This decade's version of the indie-label-as-salvation mantra is, of course, the Internet-based music company. There has been much talk about the bloat of the majors, and of how much more efficient the Internet will be. This is true up to a point, although bear in mind that the big companies (when they make the move to digital) will benefit from the same efficiencies that Internet companies are relying on, and they'll have the added clout of their catalogs. Undoubtedly the math will change with the advent of Net distribution. But Internet startups claiming the change will be seen in the next year or two are selling snake oil. Companies that have reaped positive PR by offering "artist-friendly" contracts and "new business models" have yet to mint a single real-life success story. One hundred percent of nothing is still nothing. If these companies start adding value to an artist via marketing and promotion, those costs will add up and inevitably be passed along.

Looking beyond the royalty mcguffin, there are some legitimate changes brought about by technology that could be especially advantageous to our mid-level artist. These include:
-Lowered recording costs. Remember the $115,000 recording budget? Home-studio systems like ProTools have dramatically reduced recording costs. This means that artists under contract can keep more of the money from an advance, and that unsigned artists can make a decent album much more cheaply which increases their likelihood of getting a deal (funding and marketing) and making money sooner. If an artist makes an album for $45,000 instead of $115,000, with all other assumptions in the earlier model staying the same, they would begin earning their $1.40 per unit royalty after 150,000 albums sold instead of 200,000.

-Cutting out the middleman. The biggest piece of the $16.98 pie still goes to retailers. For many years to come, retail is going to be very important to most artists. Some cult artists may make their music available exclusively on the Internet, thus permitting a much higher margin for them and/or lower prices for the consumer.
-Retiring the CD. Manufacturing and distribution costs are obviously going to decline as more and more music is delivered through the Internet. The savings from digital delivery can be divided among the artist, the label and possibly the consumer. (Online and offline concert ticket pricing has taught us that the price for music is determined not by the physical costs of delivery but by what consumers are willing to pay). In theory, in a pure digital marketplace, if an album costs $14, with half going to the artist, a royalty flow on the more cheaply produced album described above could commence at only 10,000 units sold, depending on the artist advance.

Before we celebrate the coming renaissance, recognize that it will take years before many of these costs are reduced, and that until labels figure out replacement revenue streams, they'll be loath to adapt to the new models.

Furthermore, there is no evidence that marketing costs, a major expense for labels, will decline. In a complex Internet environment, it will still take serious dollars to expose new music to potential fans, and top marketing and promotion staffs will never come cheap. Artists should be able to make a living at a lower sales level, but the vast majority of aspiring musicians, critical favorites, and local bar bands will still have a hard time supporting themselves and their families. The biggest obstacle to commercial fulfillment for all but the few genuine stars will not be the music business, but the wants pf the people: the cruelest, most fickle and most generous boss of all.

Danny Goldberg, president of Artemis Records and Sheridan Square Entertainment, has worked hands on with more popular musical talent than literally any other recorded music executive in the 1990s. He is also one of the very few who has worked with every major genre of popular music: rap, country, folk, classical, jazz, pop, rock, R&B and jazz