An Artist’s Guide to Royalties, Recoupment & Cross-Collateralization

If you’ve ever wondered how an artist can be in debt while the record company is still making money, the answer lies in recoupment and cross-collateralization.
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This is a guest editorial by Mark Tavern, an artist manager, consultant, educator, administrator, and arts advocate with more than 20 years of music business experience.

Rapper Kreayshawn tweeted last Tuesday (July 21) that fans should not buy or stream her 2011 single “Gucci Gucci” as she doesn’t make any money from it and is still “in debt to Sony for $800k.” She also linked to an interview with Masked Gorilla Podcast, in which she talked further about the million-dollar deal she signed with Sony’s label Columbia Records.

If you’ve ever wondered how an artist can be in debt while the record company is still making money, the answer lies in recoupment and cross-collateralization, the two methods a record company uses to recover its costs. Both are long-standing music industry practices, though they shouldn’t be taken as a sign that a particular record contract is “bad.” Like any business, record companies want to make money, and the high-risk nature of the industry has led to a variety of ways that its participants manage risk. Most industry models make use of them, so a misunderstanding can make even an artist-friendly deal look shady.

To understand these terms, let’s first talk about how royalties work. A royalty is a share of the proceeds from the sale of a product. The royalty a recording artist receives is defined in their contract as a percentage of a product’s price, known as the “royalty base price” (in this case, the products are albums and singles). That percentage, or the “royalty rate,” is determined by negotiation between the artist and the record company. (To keep things simple, I’m going to ignore streaming in these examples, as the math is much more complex and variable.)

A typical album royalty rate ranges from 12% to 20%. The rate is negotiated, partly based on earning potential and partly based on leverage, with developing artists receiving a number on the lower end, and superstars receiving one on the higher end. Beyond this “basic rate,” artists might also negotiate for higher rates on future records, or to kick in when they meet certain sales thresholds. These increases, known as “escalations” or “bumps,” are rewards for success. At the same time, the record company might negotiate for the rate to be decreased in connection with albums or singles sold in foreign territories, or at less than full price. These decreases are meant to ensure that the company can maintain a decent margin in situations where they are not making as much money.

The royalty base price is set by the record company and is the amount they receive in connection with a sale. Remember, however, that record companies are not selling directly to consumers, so the royalty base price is commonly a wholesale price (sometimes known as “PPD,” or “published price to dealers.”) The royalty base price for a physical album is currently set at about $10.00, though digital sales are handled slightly differently as there is no wholesaler. In those cases, the royalty base price is deemed to be a percentage of the retail price (commonly 70%), so an album retailing for $9.99 has a royalty base price of $6.99.

I should point out that these are current practices. Before the mid to late-2000s, record companies used a much less transparent calculation involving a higher royalty base price—Standard Retail List Price, or SRLP—and a variety of bogus royalty deductions to lower the artist royalty artificially (e.g., a 20% - 25% “packaging” deduction for CDs and a 10% “breakage” deduction for vinyl). Despite this, the trick of using “free goods”—records given away to retailers but that can still be sold—as a way to drive sales and lower the effective royalty rate still happens, so watch out for it.

To calculate what the artist receives, the record company multiples the royalty rate by the royalty base price, but only for “royalty-bearing” records. (Promotional records that are given away for free don’t earn royalties as they were never allowed to be sold.) As an example, if an artist were to receive a 15% royalty on albums, and the royalty base price was $10.00, then the per-unit royalty would equal $1.50, meaning the artist would receive $1.50 in royalties in connection with every physical album sale and $1.05 in connection with every digital album sale.

Now let’s look at advances. An advance is a “pre-payment of royalties.” Though it’s correct to think of the check (or “in-pocket” money) an artist receives when they sign a record contract as the advance, the term means much more. It’s shorthand for “advance against royalties,” meaning that the payment represents a portion of the artist’s future earnings. (Consider that when the artist receives that check, nothing has been sold yet.)

In a record deal, advances are “non-returnable”; the artist will never have to pay back the label. In fact, the record company defines almost every cost paid in connection with an artist as an advance, whether paid directly to that artist, or a third party on their behalf. Despite never being asked to pay anything back from their pocket, artists, like Kreayshawn, often talk about owing the record company money. That is a product of recoupment and cross-collateralization.

The traditional record business model assumes the record company and artist sign a contract in which the company will take ownership of the artist’s copyrights in return for paying the artist a royalty in connection with their exploitation. In this model, the artist provides the creativity, and the label provides the money. But consumers are fickle, and marketing is expensive, so record companies operate with the understanding that not every artist will become a superstar. They know they are likely to spend lots of money marketing an entire roster, hoping that one artist might achieve the success necessary to finance all the rest.

If this sounds like a risky business model, it is. The record company makes a bet that it can break an artist. If it wins—by committing its financial resources and marketing power—it turns a profit, sharing some with the artist, but if it loses, the company must eat its costs. The label owns the financial risk, and even if costs are high, the artist will still owe nothing (at least out of their pocket).

If an advance is a pre-payment of royalties, and a royalty is a share of the proceeds from sales, then an advance is money paid to the artist before anything has been earned. If that sounds like a loan, it should, but it’s not quite the same as what a bank offers (partly because the record company agrees to eat their costs and doesn’t require the artist to provide collateral.)

This is where recoupment comes in. Recoupment is the process by which the record company collects on that “loan.” Instead of asking the artist to write a check to pay them back, the record company agrees to recover its costs by keeping some of the artist’s future earnings. All of this is tracked in the artist’s royalty account, and when the earnings received equal the costs paid out, the artist is “recouped.” With their “loan” now repaid, the record company will send future royalties directly to the artist.

To visualize this scenario, imagine the artist’s account as a bucket. The bucket’s size is proportional to the amount of recoupable costs that have been incurred (i.e., the more money the company spends, the bigger the bucket gets). Now, imagine a faucet placed over the bucket through which per-unit royalties can flow. During the recording process, the bucket continues to grow as money is spent but remains empty because there are no royalties from sales flowing into it. Once a record is released, the company collects the revenue, keeps its share, and sends the amount due to the artist through the faucet, filling the bucket with the per-unit royalty for every sale.

This bucket represents the amount of money the record company spent that it can attempt to recoup; the royalties that flow into the bucket represent what the artist must pay back. Should the bucket not fill up, the artist will not receive anything. But should there be enough sales that the bucket overflows, the artist is said to be “payable,” and receives the overflow in a royalty check.

Unlike a bank loan, with its fixed amount or principal, record business accounting is a dynamic process. The record company may choose to continue to spend on a project (and therefore incur costs that increase the bucket’s size). At the same time, consumers may continue to purchase records (and thus generate sales that cause artist royalties to flow into the bucket). This structure remains in flux but for twice a year, when record companies take a snapshot of the artist’s account as of that moment and cut a royalty check (or not) depending on the position of the artist’s account.

In this example, the bucket only stands for one record, when, in reality, there is a bucket for every record. However, if the costs and royalties for each record are separate from one another, it would be possible for a record company to recoup the costs of a hit at the same time it’s stuck with the costs of a flop. This creates a different risk that record companies must mitigate.

Cross-collateralization solves this problem. Record contracts contain language that allows the company to use any royalty to recoup any cost. By doing so, they can ensure the money from even just one hit erases all the outstanding costs that may have been incurred in connection with that artist.

This tactic can be visualized by using a pipe to connect the buckets in my previous example. Just as water naturally finds its own level, the royalties flowing into a string of differently sized, yet connected buckets do the same. In doing so, the record company prevents a situation where one record is recouped and another not. Instead, all of an artist’s royalties—regardless of the source—can be used to pay back any recoupable cost, thereby allowing the record company to use the royalties from hit records to pay off the costs of the duds.

Back to Kreayshawn. The reason the California native isn’t making any money from Sony Music Entertainment is simple: the label is still recouping the costs of making and marketing her 2012 debut album, Somethin’ ‘Bout Kreay. If we do the math using my above example and based on what we know—that is, if in fact, costs totaled $1M—and we assume an album royalty rate of 15%, then it’ll take more than $660k in album sales to recoup that amount.

According to Nielsen data as of July 25, only 17k physical and digital albums have been sold to date (as pure sales), accounting for only about $26k in artist royalties. Factoring in an additional 595k copies of the single “Gucci Gucci” together with 150k in other single sales adds another $77k in royalties to her account. These numbers may only reflect pure album and single sales—and an estimate of the royalty rate and royalty base price—but even in 2011, they were still the focus of major labels, as Spotify would not launch in the US until a couple of months after “Gucci Gucci” was released.

If Kreayshawn remains unrecouped by $800k, that means the album would have to sell more than 500k additional physical copies to recoup. Ironically, her situation would benefit from cross-collateralization. Still, because she only released one album with Columbia, a sub-label under SME, there are no other revenue streams from other records available to reduce her unrecouped balance, and therefore no way for recoupment to be sped up.

Kreayshawn’s original tweet was meant to promote her newest projects, all released independently, but directing fans only to what’s new as a way to help her DIY sales (and at the same time hurt Sony’s) is not a sound strategy. Savvy marketers know to both remind long-time fans to rediscover an artist’s catalog and introduce new fans to the same material. These are benefits of streaming music: it never goes out of print and is always discoverable and monetizable. Kreayshawn admits that “Gucci Gucci” still goes viral from time to time, so while she may not be happy with waiting for recoupment, maybe “Bumpin Bumpin” the track was her way of speeding things up.

Mark Tavern is an artist manager, consultant, educator, administrator, and arts advocate with more than twenty years of music business experience. In addition to running his own management company, he currently teaches music business at LaGuardia Community College and before that at the Institute of Audio Research. Prior to 2012, Tavern worked at major record companies including Universal Music Group, SONY Music Entertainment, and BMG Entertainment. As an A&R Administrator with such labels as Island, Def Jam, RCA, and RCA Victor, he took part in more than 200 recordings, a dozen Broadway cast albums, and numerous reissue projects, including the GRAMMY®-winning 24-CD box set The Duke Ellington Centennial Edition. Visit his website for insider tips about the music business, and subscribe to his newsletter to get a free ebook: Listen Up! A Simple Guide To Getting Heard On Spotify.

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