Digital vs. Physical Recordings and the Pursuit of Royalties

Producing digital and physical copies of your music and tracking down royalties from other sources all feed the bottom line.

There was a time when the life of a musician seemed so much simpler. Those were the days before iTunes, Spotify, and peer-to-peer sharing became essential terms in the artist lexicon. But now that contemporary musicians rely on dozens of revenue streams to make ends meet, the age of simply playing shows and selling albums out of a station wagon is long gone.

Once upon a time, one of the most important words in a recording artist’s vocabulary was “royalty.” But, as we proceed further into the digital-download age, the importance of royalties has changed. Depending on your role in the music world, whether you’re a new artist or the head of an indie label, the term royalty means something different to you.

And this leads to the digital-age-old question: Is it feasible to make money selling music in the digital-only format, or should a physical release always be part of the equation? The answer you receive often depends on whom you ask.


The Many Flavors of Musical Royalties

Royalties are a tricky business mainly because there are so many kinds. According to the Future of Music Coalition, a Washington, D.C.–based nonprofit that specializes in education and advocacy for musicians, there are five different kinds of musician royalties: mechanical, public performance, Alliance of Artists and Recording Companies (AARC), neighboring rights, and digital performance. This revenue comes in addition to retail, digital, and CD sales at shows.

So what do all these royalties mean? Well, when it comes to public performance royalties, money is paid when songs are played in public spaces, such as on the radio or in restaurants. But that money, which is paid by rights organizations such as the American Society of Composers, Authors and Publishers (ASCAP) or BMI, goes only to songwriters, composers, or publishers. Then there are AARC royalties, which are paid by the eponymous organization for digital recordings of artists’ songs, foreign rentals, and foreign private copying levies.

One new kind of royalty is the digital performance royalty. The nonprofit SoundExchange pays these royalties when songs are played on media such as Internet radio (e.g., Pandora). And neighboring rights royalties are paid from foreign performances of an artist’s recordings.

Finally, there are mechanical royalties, which are calculated on the licensed reproductions of physical and digital recordings and are paid to songwriters and composers. To show the complicated nature of today’s royalty landscape, let’s look at how mechanical royalties—which have evolved considerably over the past few decades—are calculated.

The Harry Fox Agency calculates most mechanical royalties, though companies like CD Baby and record labels also pay them. Harry Fox, which bills itself as “the foremost mechanical licensing, collection, and distribution agency” in the United States, offers a statutory mechanical royalty rate for physical recordings and permanent digital downloads. For songs that are five minutes long or less, a rate of 9.1 cents is offered. However, a separate rate is offered for songs that are longer than five minutes, calculated at a rate of 1.75 cents per minute. For a song that is 10 minutes in length, for example, a mechanical royalty of 17.5 cents per download is offered.

The current rate has been in effect since January 1, 2006. Initially, 2 cents was offered per song, with no distinction for longer songs. After 1978, however, the royalty rate was increased on 15 different occasions. Prior to the last rate increase, songs of less than five minutes had a rate of 8.5 cents , while 1.65 cents per minute was the rate for songs over the five-minute mark.

So when it comes to digital downloads, how does an artist make money? In the Rolling Stone article “The New Economics of the Music Industry,” Steve Knopper explored the financial breakdown for a song by a major-label artist that sells for $1.29 on iTunes. For each song downloaded, 90 cents goes to the record label and approximately 40 cents to Apple. The label then may pay up to 20 cents to the recording artist (depending on the terms of the contract and whether the label has recouped production, promotion, and other expenses). The label also pays the statutory mechanical royalty rate of 9.1 cents to the songwriter.

For Christie Byun, a professor of economics at Wabash College who specializes in the music industry, the world of royalties has become convoluted, as artists now have to keep track of an ever-growing number of revenue streams. “It can be complicated, since the music industry is an evolving business, especially in light of the immense technological change that we have seen in terms of digital music creation and file sharing,” Byun says. “Not only that, but artists’ songs can be licensed for new uses, like ringtones and video games. All in all, the legal agreements can be pretty byzantine.”

However, despite the headache, Byun adds that artists are in a strong position with the additional legal protections available to them in the digital age that has produced these different royalty streams.

“Basically, there were rules outlined for all these new types of goods and services that specified what percentage of royalties music publishers could get. And remember that the royalty that the publisher gets is split with the artist. So it benefits artists to receive royalties on these new products for which their creative work is being used.”

The Future of Music Coalition conducted a project called Artist Revenue Streams, which looks at the financial side of the music world and where money owed to musicians comes from.

For the most part, sound recordings play a small role in the overall financial picture for musicians. After interviewing 5,371 musicians, the Coalition found that sound recordings make up only 6 percent of a musician’s aggregate revenue. In fact, 66 percent of the musicians interviewed said that they didn’t receive anything from sound recordings.

The Coalition delved even deeper into this issue, analyzing how, over the past five years, musicians’ revenue from sound recordings has changed. Out of those surveyed, 22 percent saw a decrease in revenue, compared with 18 percent who remained stagnant and 16 percent who saw an increase.

It’s safe to say that most musicians rely on many different revenue streams to make ends meet. To illustrate all the methods that musicians use these days to make money, the Coalition published a list of 42 different possible revenue streams for musicians, from label settlements to merchandise sales and, of course, mechanical royalties.


Pick Your Platform

With the advent of digital music, a new dilemma has arisen for musicians. Is it more beneficial to release music on a digital platform, or is a traditional release still preferable? Peter DiCola, an associate professor at Northwestern University School of Law and member of the board of directors for the Future of Music Coalition, says that the answer differs for each artist.

“Sometimes people try to generalize, because there’s been so much growth in digital in terms of revenue,” says DiCola. “But I don’t think this question can be answered in general, because there’s so much diversity among musicians. It will depend on several variables, including the artist’s particular genre and the different roles the artist plays in the industry.”

DiCola adds that making money through digital platforms is a lot trickier than simply reaping the benefits of having your music online. In fact, for an artist to have any type of financial gain from digital downloads, there’s a bit of work that needs to be done.”

“The choice for musicians is a little more complex than digital versus tangible. That asks only about offering downloads versus selling CDs and vinyl. But artists also have to decide whether to participate in on-demand streaming services like Spotify, Rhapsody, Mog, and Rdio, which offer a different dimension. Moreover, artists need to sign up to get their performance royalties for Internet radio by joining ASCAP, BMI, or SESAC and by joining SoundExchange.”

But ultimately, it all comes down to the bottom line, DiCola says. “Artists should be thinking about profit, not just revenue. And the profit margin on CD sales at shows can be really high, depending on the artist’s label deal. So a musician who tours a lot might do well with a physical release. Moreover, physical releases offer the opportunity for upselling—for instance, charging $20 for high-quality vinyl, which offers a good profit margin.”

From the artist’s perspective—particularly one who is just starting out on the professional level—the digital age is a blessing. For many, the profit margins are razor thin, particularly as they try to build an audience for their work. However, despite the lack of a cash windfall from digital releases, there’s still an imperative for using them.

Matt Tompkins ’09, who fronts the Boston-based band Mighty Tiny, says that artists owe a debt of gratitude to the digital platform. Though it can be difficult to generate a huge profit, the value of getting your name out is priceless.

“We as musicians have Bandcamp, Soundcloud, Spotify,, CD Baby, Myspace, and so on and so on and so on,” Tompkins says. “And, with the brilliance of folks like CD Baby, independent musicians can now easily have an online presence on sites like iTunes and Spotify, for a pretty minimal fee. Suddenly, I can have fans in Australia that I’ve never met, and who have never even seen my band live. Yes, live performance is still, in my mind, the best way to convert fans, because you’ll never be able to encapsulate that in any medium other than a venue setting—flesh and blood, in person. But this amount of widespread media saturation gets as close as it can.”

In fact, Tompkins says that when it comes to the digital versus physical argument, there’s one aspect about digital release that makes it far more preferable than its predecessor: cost. “Music in general is expensive,” Tompkins says. “And the resell value is pretty sad. Printing only 500 copies of an album can easily put your investment at over $1,200. Think about graphic design costs, packaging, registering for a UPC code, copyright costs—the list goes on. Plus, once you’re at that point, you’ve probably spent at least triple those costs on studio time.”

Nissan Wasfie, a professor at Columbia College in Chicago who specializes in the music business, echoes Tompkins sentiments on the pros of digital-only release. “The major benefit is the lower costs associated with both production and distribution,” Wasfie says.

But Wasfie adds that though digital music has emerged at the forefront for consumers, there is still a benefit when it comes to old-fashioned tangible releases. “While the costs associated with digital distribution are lower and, therefore an advantage to the new artist, there can be benefits for tangible music—for example, the vinyl ‘revival’ and its associated cache of cool.”


The Digital Makeover

There’s no question that the shift toward digital release has had a dramatic impact on the music world. But it’s not just artists and composers who are feeling the financial difference. The entire economic topography of the music industry has undergone a transformation.

According to DiCola, the shift to digital downloads has affected the economics of music in two ways. “One is unbundling: the ability to download individual songs,” he says. “That hurts profits in some ways, because consumers might just buy one song instead of a whole album. A second is the very recent emergence of on-demand streaming services, which offer a great product to consumers but very small royalty streams to artists.”

DiCola added online retailers and record labels are the biggest beneficiaries of digital downloads. He says that artists who are on major labels are actually receiving rather small shares and that those on indie labels get shafted as retailers take larger cuts. “The intermediaries usually benefit more than the creators,” DiCola says.

When it comes to life in the digital age for musicians, Byun notes that artists are now changing the way that they release their music, which ultimately affects their personal revenue streams. After all, though digital downloading makes it easier for consumers to get music whenever they want, artists now have to worry about more than someone copying their music onto cassettes.

“With file sharing, it’s virtually impossible to enforce intellectual property rights over recorded music,” Byun says. “As a consequence, the way musicians make a living has changed. Some artists even offer free copies of their albums at concerts. Radiohead made headlines when it announced it would give away the In Rainbows album on its website and invited fans to pay whatever they felt was a fair price for it—even nothing if they chose. Radiohead recognized that it was impossible to prevent music piracy, and they have switched to other means to make money from creative work. Now, the real money is made from live performances, T-shirt sales, specialty box sets, ringtones, and the use of music in video games and movies.”

Ultimately, according to Byun, though musicians and composers alike are now dealing with more nuances when it comes to generating revenue, the core of the professional music world has remained the same amid all the changes.

“The economics of the music industry have simultaneously changed and remained the same,” Byun says. “It’s the same problem artists have trying to make a living with their creative work and trying not to let the business side of things hinder their creative process. It’s the same issue for record companies and middlemen using their business skills and networks to find and promote marketable artists. The endgame is the same, but the means by which we get there is different.”