In some cases (more common outside the U.S. or with indie labels), the record company and artists split the net profits of an album 50/50 (or along some other percentage in the range of 50/50). To calculate the net profits, the label takes the gross receipts for the album and deducts all of the direct costs. The gross receipts are all of the money that the label makes from the album through wholesale sales of the CD. The direct costs include things like:
- Studio time and labor costs to record the album
- The costs of producers, technicians, etc. to produce a master
- The costs of pressing and packaging the album
- Shipping costs to get the albums to retailers
- Marketing, advertising and promotion costs
- Warehousing costs
- Legal costs
- Personnel costs
- Royalties paid to songwriters
Here, too, there is still a fair amount of wiggle room for the label. For example, the record label may be paying personnel $10 per hour but charge a retail price of $40 per hour when charging the cost of the personnel to the album as a direct cost. Part of that is justified (e.g. the label pays more for an employee than the hourly rate, including things like FICA, benefits, etc., plus there's office space, equipment, and so on). But the markup is probably 100%. So the label is making a nice profit off of these expenses, and may still be making money even when the artist is making nothing.
This quote from Courtney Love's letter to recording artists summarizes the position of most artists:
Record companies have a 5% success rate. That means that 5% of all records released by major labels go gold or platinum. How do record companies get away with a 95% failure rate that would be totally unacceptable in any other business? Record companies keep almost all the profits. Recording artists get paid a tiny fraction of the money earned by their music. That allows record executives to be incredibly sloppy in running their companies and still create enormous amounts of cash for the corporations that own them. The royalty rates granted in every recording contract are very low to start with and then companies charge back every conceivable cost to an artist's royalty account. Artists pay for recording costs, video production costs, tour support, radio promotion, sales and marketing costs, packaging costs and any other cost the record company can subtract from their royalties. Record companies also reduce royalties by "forgetting" to report sales figure, miscalculating royalties and by preventing artists from auditing record company books.
From this discussion, you can see that there is no guarantee at all that your band will make any money from a recording contract. You are gambling that your album will be able to break through into the top 5% of albums and go gold or platinum.
The bottom line is that you want to push for the highest royalty rate possible, especially if there are a lot of recoupable expenses in the contract. You also want to push for the highest advance possible, since that may be the only money the band actually receives. Keep three things in mind when you negotiate the rate:
- It is likely that the first royalty number you see is negotiable. It is common to put a low-ball figure in the contract to give the label room to negotiate.
- It can't hurt to ask for a higher rate.
- The fact that you have been offered a contract means something. The label looked at your band or your solo act and saw talent that looked profitable. If one label can see that, it is possible that other labels would have the same reaction. This gives you a bargaining position.