BMG to Roll Out Royalty Plan

Breaking ranks with industry rivals, Bertelsmann Music Group today will launch what the company calls a “fairer, more transparent” accounting system for royalty payments, a move that artist representatives say could ease the controversy over whether performers are being cheated by their labels.

BMG, home to such acts as Carlos Santana, OutKast and Britney Spears, is the first major music company to scrap contract deductions that artists say obfuscate their earnings. The action comes as lawmakers in California and New York have begun to scrutinize complaints from pop stars about questionable accounting practices in the industry.

“One reason this industry has ended up with such a bad image is because we could not look a guy in the eye and tell him, as a partner, that the contract he was about to sign was fair,” said BMG Chairman Rolf Schmidt-Holtz. “This is the first step in a larger plan by BMG to redefine our partnership with artists.”

In the years ahead, BMG plans to introduce a new contract model under which the company would control an act’s recording career for fewer years but share in a series of new revenue streams, including concert proceeds and sponsorship and film deals. BMG already is designing a new agreement that is expected to reduce the number of pages in a standard contract from 100 to 12.

Initially, BMG’s royalty revisions are not expected to result in higher royalty payments to artists. But BMG executives say the new plan will simplify royalty computations, making it easier for artists to determine what they are owed.

None of the four other music giants -- Universal Music Group, Sony Music Entertainment, Warner Music Group and EMI Group -- intends to follow suit any time soon. Still, each is reviewing new approaches to royalty accounting.

The standard industry contract is riddled with deductions devised during an era when vinyl recordings dominated the music business:

* The “packaging” deduction, which costs artists about 25% of their earnings, got its start in the early 1960s when companies began replacing the plain brown sleeves protecting 45-rpm singles with color-printed covers.

* The “new technology” deduction is a two-decade-old clause that allows labels to subtract an additional 20% from artist earnings to help companies defray the cost of their investment in CD technology.

* For more than 20 years, the “free goods” deduction has given labels the right to take an additional 20% from artist earnings to cover the cost of furnishing retailers with free CDs as an incentive to showcase the product in busy areas of stores.

“The current royalty system is incredibly opaque and difficult to unravel and audit, and I think that clearly disadvantages artists,” said BMG Chief Operating Officer Michael Smellie. “You wouldn’t accept a statement like this from your bank -- documentation that you could neither make heads or tails of. We decided it was time for us to simplify the royalty statements we send to our artists.”

Under its new accounting plan, BMG will stop computing royalties based on the suggested retail price of a CD and begin paying artists a percentage of the wholesale price received from retailers.

For instance, an artist with a 12% royalty based on the suggested retail price of $17.98 per CD typically earns about $1 -- after the company extracts a bevy of deductions. Under BMG’s plan, the same artist will receive a 9% royalty based on the wholesale price of $11.41 per CD, with no deduction, still receiving about $1.

The standard contract contains a provision permitting a music label to revise its accounting methods as long as the artist receives no less in earnings.

BMG expects some backlash from artists who may be reluctant to see their royalty percentage, on paper, reduced. Artist representatives say some acts like to brag about artificially inflated royalty rates.

That’s what happened three decades ago at Motown Records, according to attorney Donald S. Passman, author of “All You Need to Know About the Music Business.”

In the late 1960s, Motown sought to simplify its bookkeeping with a similar wholesale-based royalty system but was forced to abandon the plan after competitors used it to woo away acts, Passman said. Artists seemed to prefer signing with labels that promised higher royalties -- even though their contracts contained numerous deductions that sometimes resulted in royalty earnings less than Motown’s.

Passman applauded BMG’s new royalty effort. “Everything in this business would be so much simpler if all the companies got rid of these deductions,” he said.

Music industry accountant Phil Ames, who has performed thousands of audits for numerous recording artists, agreed. “It’s exactly what artists are crying out for,” he said. “In theory, if it became a universal practice, there would be little reason for artists to ever conduct audits.”

That’s exactly what BMG hopes to achieve. Privately, BMG executives say they plan to eventually install a secure Web site for royalty accounts so each act can monitor what it is owed.

“First we must simplify the royalty process, then the entire contract,” Schmidt-Holtz said. “This is one way we can show artists that we are serious about improving our relationships with them.”

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(BEGIN TEXT OF INFOBOX)

New formula, same results

Under its new accounting plan, BMG will simplify royalty computations on CDs and make it easier for artists to determine what they are owed.

Example of current calculation:

Royalty is based on 12% of suggested retail CD price of $17.98, but with the following deductions:

$17.98 minus $4.50 (25% packaging deduction)

$13.48 becomes price for royalties

12% (royalty rate) minus 2.4 pts. (Technology deduction) = 9.6% (effective royalty rate)

$13.48 x 9.6% = $1.29, minus $0.26 (20% free goods* deduction) = $1.03 per-unit royalty

Example of new calculation:

$11.41 (wholesale unit price) x 9% = $1.03 per-unit royalty

*Free CDs given to retailers

Source: BMG