How Record Companies Make Money

How Record Companies Make Money
by Diane Rapaport

This article is written with the U.S. market in mind and using U.S. dollar figures. It can, however, be applied to any Western record company and how they work.

Record companies make money by selling recordings. It is a high-risk business. According to the Recording Industry Association of America (RIAA), approximately 90% of the records that are released by major recording labels fail to make a profit.

Independent labels have to be more careful in their choices and in their allocation of expenses because they do not have the resources to cover many failures. However, they can make and promote records for far lower costs than major labels and be profitable with far fewer sales.

The budgets for making and selling recordings are tied to what labels estimate they will sell. Knowing how many recordings might be sold makes it possible to budget recording costs. Most profitable labels have histories of selling and promoting that enable them to estimate gross income.

Recording Costs
Recording costs are borne by artists, not record companies. Record companies commonly make loans to artists (all-in advances) for these costs and recoup them from royalties.

With the exception of jazz and classical artists, new major label artists can spend between $100,000 and $500,000 to make a record, but recording budgets of one million dollars and more are not uncommon. Many independent artists will spend less than $15,000.

Manufacturing Costs
Manufacturing includes replicating recorded material and packaging. The costs depend on the number to be manufactured. Manufacturing costs are generally borne by recording labels, although labels try to deduct packaging costs from the base price on which they pay royalties.

Major labels pay approximately $.50 to $.55 per CD. Independent labels that order more than 100,000 CDs a year pay approximately $.65 per CD. Labels that buy less than 10,000 CDs a year pay approximately $1.20 per CD. These costs include the printing of 4-page package inserts and tray cards.

Royalty Costs
Record labels pay two royalties: The first is a record royalty to the performing artist(s); the second is a mechanical royalty to composers and publishers.

Some companies pay record royalties on a percentage (8% to 16%) of the suggested list retail price (SLRP) less a packaging cost, generally 15% to 25% of the SLRP. Others base royalties on the wholesale price to distributors. For a CD with an SLRP of $16.98, a common packaging deduction of 25% is $4.25 and the amount paid to the artist will be calculated as a percentage of $12.73. Thus, at a 10% royalty, artists will receive $1.27; at a 14% royalty rate, $1.78.

Record labels pay composers and publishers mechanical royalties. They try to cap mechanical royalty budgets at ten songs payable at 75% of the statutory rate ($.80 per song in 2002), which equals $.60 per song under the controlled composition clauses of recording contracts.

Promotional Costs
Major labels budget approximately 20% of annual gross income for promotion and selectively allocate the funds according to sales projections for each artist. Independent labels generally budget 10% of projected gross sales of all recordings annually and selectively allocate that budget.

Promotional costs include designing and printing promotional and packaging materials for recordings; press kits and Web sites; and advertising, radio promotion, videos, public relations and mailing costs. Some or all the costs for packaging, video production and radio promotion may be recouped from artists' royalties, depending on contractual agreements.

Distribution Costs
The record companies decide on the suggested list retail price (SLRP) of each format. The SLRP helps stores to determine the discount price they charge customers and helps performers determine the price to charge to fans at gigs and by mail order.

The price at which distributors buy from recording companies (distributor wholesale price) is also set by the record companies. This is commonly 50% to 55% off the SLRP. If the volume is high enough, the discount can go to 60%.

The price at which stores buy from record distributors (store wholesale price) is determined by the distributors. This is commonly 55% to 65% of the SLRP. Stores return unsold product at 100% of their cost.

The price at which record stores buy from record companies that own their own distribution warehouses is approximately 75% of the SLRP.

Potential Profits
How do these costs relate to a million selling album?

At common discounts, record companies receive approximately $10.00 per CD ($16.95 SLRP). Thus, projected record company gross income is ten million dollars.

Out of this the record company will spend approximately $625.000 in manufacturing costs; approximately $1,000,000 in promotion (another $1,000,000 will be charged against artist royalties); $1,780,00 in royalties to the artists (at 14% of the SLRP of $16.95, less packaging); and $600,000 in publishing royalties (at 75% of statutory). After subtracting $4,005,000 from its ten million gross income, the record company has a gross profit of $5,995,000. It will recoup its million- dollar advance to the artist and its promotional costs.

Reprinted with permission from TAXI: The Independent A&R Vehicle connecting unsigned artists, bands and songwriters with major record labels, publishers, and film & TV music supervisors.