Is it Apple’s fault for launching iTunes and forever severing songs from albums? Is it the record executives’ fault who, facing this shift from $17 albums to $0.99 singles, continued to rely on old, byzantine licensing and sales models, even as their industry hemorrhaged money before their eyes? Is Internet piracy to blame, with Napster forever changing the way we find and consume music, and BitTorrent bringing about the record industry’s worst nightmare? What about Internet radio stations? Are the rock-bottom royalty payments the result of corporate greed or government meddling? Do we blame Spotify and other music streaming services for striking opaque, unsustainable deals with record labels? And what about the unchecked proliferation of copyrighted material on YouTube and other platforms?

For this explainer, we looked to identify and unravel the complex network of industry stakeholders -- the rightsholders, including performers, songwriters, record labels, publishers, and licensing agencies, all of whom play a part in the process of making music, and all of whom expect a cut of the proceeds. There are the digital music sellers like iTunes and Amazon, which have supplanted brick-and-mortar stores and play by a different set of rules. And finally, the webcasters and streaming services, which struggle to achieve profitability even though they only pay artists fractions of pennies per song per play.

During his most profitable year as frontman for the Dismemberment Plan, Travis Morrison made a whopping $23,000. He was 30 years old. Despite critical success and sold out clubs, the frenzied Washington DC-based post-punk-emo-dance band didn’t enjoy the financial success of so many other indie musicians of his era, whose music was palatable enough to sell cars in TV commercials.

“I was broke,” he says. “I was mad broke when we broke up.”

The year? 2003: iTunes had barely come out of the gate. YouTube didn’t exist. Neither did Spotify or Pandora Radio. Napster had shut down and it would be a year before BitTorrent would take off. In other words, even before technology turned everything upside down, it wasn’t easy for successful rock bands to turn a profit. Last year, in a New York Magazine piece about the economic realities facing musicians, Nitsuh Abebe asked,

“What does indie rock royalty buy you in 2012?” The answer? About the same thing it bought you in 2003.

Not that Morrison is complaining. “I get this memo that there are some bands who maybe did make a lot of dough from manufacturing CDs,” Morrison says, questioning whether these artists are rewriting history. Are they nostalgic for the money they once made or did they simply miss out on a cultural moment? “You always remember fun more than you remember payout,” he adds.

Now, after a decade spent working various day jobs including a stint at the Huffington Post and singing in his church choir, Morrison and the Dismemberment Plan are releasing their first studio album since 2001, entering an industry that’s been further upended by iTunes, streaming, and piracy. But before getting into how the current system works, it’s instructive to look back on how the music industry operated in the pre-digital days.

 

How do royalties work?                                                                             

There are three situations in which a rights holder can receive royalties (OK, four if you count sheet music, but let’s not): Royalties are generated when music is purchased (mechanical royalties), when music is heard in a TV show or movie (synchronization royalties), and when music is performed (performance royalties).

Who gets paid?

There are five different parties that can claim royalty payments for a song: First, there are the performers and the songwriter(s). Then there is the record label, which records, distributes, and promotes the album, and thepublisher that owns part or all of a song’s copyright, and licenses it for commercial purposes. (Most major publishers are owned by or closely affiliated with major labels). Next, mechanical rights agencies like the Harry Fox Agency collect the royalties on purchased music and distribute them to songwriters. And finally, groups called performance rights organizations like ASCAP and BMI collect the performance royalties. That’s a lot of mouths to feed.

 

How much money does each party get?    

                     

That depends on the individual contract negotiated between the artist and the record label/publisher (it can also depend on the contract between the record label and streaming services like Spotify, but we’ll get to that). Despite the variability of contracts, there are a few trends and data points that paint a picture of how sales revenue was dispersed.

In 1995, on average 35 percent of the retail price of a CD went to the store, 27 percent to the record company, 16 percent to the artist, 13 percent to the manufacturer (even though it only costs $0.10 to $0.15 to make a CD) and 9

percent to the distributor. At the time it wasn’t uncommon for a CD to cost upwards of 17 bucks. In that case, the artist would receive $2.72 per CD.

But the musicians didn’t get to keep all that cash. There were “recoupable expenses” paid out of their share to cover recording, touring, and music video expenses. The lead singer of Hole, Courtney Love, wrote the definitive takedown of this model all the way back in 2000. She estimated that if a band made an album, sold a million copies, went on tour, and made two music videos, the band might break even, but the record label would take home $6.6 million:

“Worst of all, after all this, the band owns none of its work. . . they can pay the mortgage forever but they’ll never own the house. . .  The system’s set up so almost nobody gets paid.”Musicians can complain all they want about piddling Spotify and Pandora payments, but look at some of the piss-poor payouts artists from the pre-digital days received. R&B star Toni Braxton told ABC News that despite generating $170 million dollars in worldwide sales, she only saw $1,972 of that over her entire career. That’s 0.00116 percent. She declared bankruptcy in 1998. And while Braxton, a big seller in the 1990s, admits that her spending habits were a factor in going bankrupt, her record label didn’t do her any favors.

Big companies bleeding artists dry is by no means a new phenomenon.

Tech companies take over the music industry

It's not easy being a musician in these wild and crazy Internet times. Twitter, Kickstarter, YouTube... Enjoy a musical interlude starring an out-of-touch songwriter navigating New York's music scene, both on and offline:

Why did the industry tank?                

As noted above, the whole music industry is shrinking:

But before we get into the recent shrinkage, we can’t talk about the music industry without talking aboutNapster. In 2002, then-president of the RIAA Hilary Rosen said, without equivocation, that “Napster hurt record sales.” On the surface, she might be right. Between 1999 and 2001, when Napster was operating, the revenue generated by the music industry dipped from $14.6 billion to $13.7 billion:

But let’s look more closely at the data. During that interval, revenue from non-single CD sales actually rose slightly, from $12.8 billion to $12.9 billion. It was the singles (and cassette tapes) that took the biggest hits. Before high-speed Internet became the standard in American households, it might take your average Napster user hours (or days!) to download one song. Twitter investor Chris Sacca, who used to work at a record store, told us at a recent PandoMonthly event that the Napster days were actually pretty good for CD sales. A person would download one song, fall in love with it, and then head to the record store to buy the CD rather than spend the better part of a week downloading it.Napster wasn’t the only factor at play. According to Business Week, labels put out 20 percent fewer new releases in 2001 than in 1999, and 14 percent fewer releases in 2002. Meanwhile, as the industry’s inventory shrank, its prices increased faster than the rate of inflation. Cultural forces were also at work. By 2003, the “boy band bubble,” which drove the massive successes of the Backstreet Boys and ‘N Sync, popped.

Did Napster hurt the music industry? Yes, but only indirectly, despite the recording industry’s claims, and in a far more disruptive way. It inspired Steve Jobs to create iTunes.

iTunes and the shift to singles:In a Rolling Stone article celebrating iTunes’ 10th anniversary, Steve Knopper writes, “Steve Jobs, Apple's founder and chief executive, saw Napster, MP3s and the Internet a different way. By late 2002, he believed music fans clearly wanted to download songs they liked in an affordable and easy way rather than driving to Tower or Best Buy or some indie record store to buy them on $15-to-$18 CDs. But during this period, the record industry had no affordable, easy and legal option allowing this to happen. Jobs saw opportunity.”

Jobs fought music executives hard on pricing. But in the end, the industry caved, desperate to convince a new generation raised on Napster to start paying for music, even if it was on Apple’s terms. But by ceding pricing, the record companies lost control of their product. Now albums were back down to an affordable $9.99. Singles were $0.99. On top of that, virtually any song was available as a “single,” not just the tracks chosen by the record label. Gone were the days of dropping $15 on one album for only a couple songs you liked. Just as newspapers became unbundled around the same time, with the expensive foreign bureaus no longer subsidized by the cheap, popular gossip pages, the album was similarly disrupted. An artist’s 8-minute instrumental Krautrock song was no longer subsidized by the bubblegum pop hit on Side A.

The data supports this consumer shift: Since 2004, when the RIAA began calculating digital sales, digitally-downloaded singles have outsold albums in terms of both revenue and units sold.

How do artists get paid from iTunes? With iTunes, Apple implemented its own revenue-sharing model: Apple would get 30 percent upfront, which is actually a smaller cut than the 42 percent that went to retail stores and distributors under the compact disc model. Meanwhile, the songwriter gets $0.09 per song, while the payment to the performing artist is negotiated between the label and artist (15-to-20 percent is still an industry standard).How come label execs hate iTunes so much?

Because after iTunes, no one would pay $17 for an album ever again. Not only that, the emphasis on singles over albums hurt record labels’ bottom line. While the impact of Napster on CD sales was negligible, each year since iTunes premiered the industry has been stuck in a freefall, with sales revenue from albums and singles, both digital and non-digital, dropping from $11.2 billion in 2003 to $5.4 billion in 2012.

But iTunes isn’t the only thing causing record sales to plummet. What about other types of piracy?

We all know there are still pirates in the post-Napster world: a whopping 250 million of them who reportedly use BitTorrent clients each month. That said, it’s difficult to calculate how much piracy has affected music sales. Not surprisingly, the International Federation of the Phonographic Industry (IFPI) and the RIAA say it’s had an enormous effect. For example, the IFPI says that after cracking down on peer-to-peer piracy in France,the country’s iTunes sales rose 22.5% for singles and 25% for digital albums. But Europe’s Institute for Prospective Technological Studies isn’t convinced. The group researched the behavior of 16,000 listeners across five countries and concluded that “digital music piracy does not displace legal music purchases in digital format," and “there is unlikely to be much harm done on digital music revenues." By and large, the respondents said the music they pirated would have gone unpurchased had they not stole it. Others argue that piracy leads to legitimate purchases like concert tickets.

There’s a high probability that the respondents underreported their bad behavior: No one likes to fess up to perceived wrongdoing. And with the huge number of people using torrent clients, it’s hard to imagine modern-day piracy having no impact. But to say it’s the only, or even the primary factor causing the music industry’s woes, is disingenuous.

(Note: I’m talking exclusively about music piracy. Movie and software piracy are completely different beasts.)

...What about Pandora?

Despite record labels’ long history of shortchanging artists, and despite monumental cultural shifts in the way we purchase and consume music, two companies receive the lion’s share of blame for the industry’s woes: Spotify and Pandora.

(Before going any further, we should note that while people like to lump Spotify and Pandora together, they are completely different types of services with different legal responsibilities when it comes to royalties. Spotify,MOG, Deezer, and Rhapsody are “streaming music services.” Users search for a song and listen to it on-demand. They negotiate licensing deals with record labels and pay royalties accordingly. Pandora, on the other hand, is a “webcaster.” Although users have some control over what bands or genres they hear, users cannot listen to specific songs on-demand. Because of this distinction, Pandora is treated more like a radio station, and therefore the royalty rates it pays are set by the government.)

The artist diatribes against Spotify and Pandora are legion, but one of the most recent high-profile examples came from David Lowery, the lead singer of Cracker and Camper Van Beethoven. Lowery posted a royalties statement showing he was paid $16.89 in songwriter royalties from Pandora after Cracker’s hit 90s song “Low” was streamed 1 million times on Pandora (the actual royalty payment was around $42, but Lowery shared it with his bandmates).

 

What? This is an outrage! How did Pandora get away with this?

First off, remember that there are two kinds of royalties: songwriter royalties and performance royalties, a point that often gets lost when comparing royalty rates across different services and formats. The $42 was Pandora’s cut for songwriters.

But Pandora also pays performance royalties: As mandated by the 1998 Digital Millennium Copyright Act, Pandora must pay $0.0011 per play for non-subscription customers, and $0.0022 per play for paying subscription customers in performance royalties. This arrangement is overseen by SoundExchange, a performance rights organization that distributes the royalties to rights holders. The performing artist receives 45 percent of this total. That means Cracker as performers probably received a check for a little under half of $1100 for a million plays (writer Michael Degusta breaks down the math here). You might think $500 for a million plays is also unfair. But Pandora streamed 13 billion hours of music in 2012 and paid 60 percent of its 2012 revenue in royalty payments. That’s why it’s lobbying for the Internet Radio Fairness Act which would lower royalties for digital streaming radio services.

Meanwhile, terrestrial radio stations pay no performance royalties because it’s considered “publicity” to the artist and the label. In fact, labels often pay the radio station, not vice-versa (how do you think Limp Bizkit became big?) As Pandora CEO Tim Westergren wrote in a blogpost, “If major market FM stations paid the same rates as Pandora, based on audience, some would be paying thousands of dollars for every song they played.”

On the other hand, radio stations do pay songwriter royalties. Lowery says he received around $1,300 from radiolast year for “Low.” In other words, comparing royalties from terrestrial radio to Pandora is like comparing apples to oranges, or Kurt Cobain to the Jonas Brothers. Terrestrial radio pays songwriters more and its rates are not mandated by the government. Pandora pays performers more and its rates are mandated by the government. One play on Pandora counts as one person listening. One terrestrial radio play could reach millions at a time. It’s a shame that the new models prioritize the performer over the songwriter (that’s why Adam Lambert left RCA. His label wanted him to make an all-covers album.) But it’s a lot easier to get on Pandora than to get on FM radio without major label assistance. Even 2013’s out-of-nowhere success story Macklemore needed a leg up. “You really cannot get a radio hit at this point without major label backing,” Billboard’s Gary Trust told NPR.

...and Spotify?

Unlike Pandora, Spotify’s performance royalty rates are not mandated by the government because it isn’t a radio station -- users listen to what they want, when they want it. Instead they pay out royalties and licensing fees based on pre-arranged agreements with record labels (Spotify would not comment on the details of these). To make matters more confusing, Spotify pays artists in proportion to their popularity on the service, claiming “We will pay out approximately 2 percent of our gross royalties for an artist whose music represents approximately 2 percent of what our users stream.” Therefore it’s difficult to say exactly how much an artist makes off Spotify, although we do have some anecdotal evidence. Lowery says Spotify pays about .6 of a penny per play, andestimates from a recent New York Times article came out to be about the same. But that’s only for paid-tier customers. Streams from non-paid customers, the article notes, pay out 90 percent less. And as always, the record companies take a cut.To recap:

Here’s where we stand with iTunes, Pandora and Spotify royalties (because the numbers are dependent on individual contracts and licensing deals, these are estimations):

Per track, iTunes pays $0.105 in performance royalties (15 percent of what the record label keeps) and $0.09 in songwriter royalties, totalling $0.19 per download.

Pandora pays $0.0011 per play in performance royalties, of which approximately 45 percent goes to the artist, resulting in $0.000495 per play. The songwriter royalties are harder to estimate, but if we go by Lowery’s statement, it’s $42.25 for 1 million plays, or $0.000042 per play, resulting in a total of $0.000537 per play. A song would have to be streamed about 350 times to catch up to iTunes 19 cent per download rate.

Spotify’s negotiations are more opaque and variable so we’ll have to go with the best estimates we have. For paid listeners, the average is about $0.006 per stream. Let’s say half of that goes to the artist (that’s how Lowery says his contract works), which would amount to $0.003 per play. But only 6 million of its 24 million users pay for the service. For streams from non-paying users, the rate is estimated to be only one-tenth of that, or $0.0003 per play, which is actually worse than Pandora’s rate. That’d be over 600 plays to catch up to iTunes.

That’s why artists like Thom Yorke have removed their music from the platform. Yorke tweeted, "Make no mistake new artists you discover on #Spotify will no[t] get paid. Meanwhile shareholders will shortly [be] rolling in it. Simples."

Naturally, Graham James, Head of US Communications for Spotify, sees things differently. Spotify doesn’t displace sales, he says. It helps drive them: “If you look at the biggest albums of the past ten months: Mumford and Sons, Justin Timberlake, Daft Punk, Kanye... The first weeks when those albums come out they have monster sales weeks, great digital downloads, and record-setting weeks on Spotify,” emphasizing that all three revenue sources lead to an artist’s ultimate financial success. James also claims the company is working more on discovery tools to give unsigned bands a chance they might not have without Spotify.  The company previewed these features last week.

The tension between artists and streaming services like Spotify and Rhapsody will not be easy to reconcile. On one hand, the services provide artists and record labels with a valuable tool to deliver their music to listeners. And to anyone who thinks Spotify is greedily withholding royalties for the sake of profits, know that in 2012, Spotify doubled its revenue, and yet, due to licensing fees it pays record labels, the company still failed to turn a profit.

But on the other hand, it isn’t a musician’s responsibility or a record company’s responsibility to help Spotify make money. Even Spotify says it could be profitable if it focused less on growth. Maybe $9.99 a month is too low a fee for unlimited ad-free streaming on desktop and mobile. Maybe Spotify or one of its competitors can find more novel ways to monetize, like charging more for better sound quality, or offering advertising on branded radio shows. Or maybe it will take someone like Steve Jobs to invent a completely new model. Of course none of this helps artists right now.

What if more artists went independent?

That’s one way artists could potentially take home more in royalties, or at least have more leverage in negotiating royalty deals. Josh Antonuccio, a music business lecturer at Ohio University and co-owner/operator of 3 Elliott Studio in Athens, OH, says that’s where he sees the market trending. “Artists want to have more control,” citing acts like Macklemore who stayed independent even after he had become popular enough through touring and hustle to be signed to a major label. That’s not to say Macklemore didn’t get help from the majors. But instead of going all in on a record deal that covered all aspects of publishing, recording, marketing, and distribution, Macklemore hired Warner Music Group to help get his song on the radio and his album in stores. Taylor Swift has a similar arrangement. Although Universal handles her distribution, her songs and albums are released under her independent label, Big Machine. Even bands like Stone Temple Pilots that have been on a giant record label for two decades are going indie.

How has touring changed? Can’t bands make money that way?

Yes! Ticket sales and merchandise sold on tour can create a decent chunk of revenue for bands, at least when compared to receipts earned from album sales and song streams. Morrison says that touring was always his band’s biggest source of cash, even if they struggled to break even. That said, touring is expensive, and to make matters worse, artists may have to dip into touring revenues to pay back advances and other production costs to their label.

Lance Dashoff, who used to work for Ari Emanuel’s talent agency William Morris and now runs the concert startup Loudie, says the digital age has brought some unique challenges to live performers. “It's a bit over saturated,” he says. “There's just a significant amount of more people touring all of time.”As a result, promoters are putting more of the risk on the shoulders of the bands, Dashoff says. “A lot of deals, even for mid-level artists, are going the way of the promoter or venue saying, ‘Let's see how many tickets you sell and you'll get a percentage of the gross.’” That’s a far cry, he says, from the days when a band could be guaranteed a $10,000 payout regardless of whether 500 people showed up or 10 people showed up.

Of course, there’s at least one aspect of touring that’s improved with technology: “I want you to think about running, looking, maintaining a tour without email or a cell phone,” Morrison says. “It makes me think of Christopher Columbus or Vasco da Gama. You disappear for months at a time.”

New revenue streams

If you’ve ever seen the show Friday Night Lights, you’ve heard the band Explosions in the Sky. Their dreamy jams are the backdrop for the show’s most inspiring moments of athletic glory. Consequently, they’ve become the go-to soundtrack for sports videos all over YouTube. Whether it’s a look back on a college wrestling team’s season or a homemade highlight reel of Brazilian soccer star Ronaldinho, nothing adds drama to a sporting event like Explosions in the Sky’s reverb-y instrumental epics.But as these videos rack up millions of views, it’s only fair for the band to share some of that success, right? Enter Brandon Martinez.

Martinez runs INDMUSIC, a company that helps bands promote themselves and monetize on the Web. Remember a few months back when you couldn’t visit YouTube without coming across a basketball team or atech blog dancing to “Harlem Shake?” Mad Decent, the label behind Baauer’s “Harlem Shake,” enlisted INDMUSIC’s help on that campaign. It didn’t want to take the videos down; on the contrary, the thousands of fan videos generated millions of views and helped propel the song to the top of the Billboard’s charts (which began including YouTube views as a metric around that time).

Martinez’s crew did one better: It found a way to monetize them. At the time I wrote that it might be tough for INDMUSIC to have similar success with other artists. After all, nobody plans for a song to become a record-shattering meme. But by following the same model on a somewhat smaller scale with artists like Explosions in the Sky, INDMUSIC is pioneering a new revenue path for musicians: the user-generated royalty. And while Martinez isn’t ready to talk about how much revenue he’s created, he said that INDMUSIC is currently collecting ad dollars on more than 246,000 YouTube videos, and counting.

Is YouTube a “Spotify-killer”?

“YouTube is the biggest jukebox online,” says 3 Elliott Studio’s Josh Antonuccio. “If Radiohead takes their records off Spotify, people aren’t going to necessarily steal them. They’re going to YouTube to listen to them.”Indeed, where do listeners consume more free music than anywhere else on the web? YouTube. Accustream estimates that 38.4% of YouTube views are music videos. With more than 4 billion views a day, that’s 1.5 billion daily music streams. Meanwhile, Pandora has 70 million active users meaning every last one of them would have to listen to 20 songs every single day to catch up.On YouTube, payments to rights holders come from pre-roll ads. The rates vary wildly from $0.0025 to $0.01 per view, putting it in line with Spotify’s for paid subscriber streams. But only about half of these videos are generating any revenue at all, and then who’s to say the revenue is being funnelled to the proper rights holders?“As huge as that giant corporation is, it's still just not enough people to handle the world's video uploads,” Martinez says. “So that's where we come in to provide a specialized service. Even in dealing with all the MCNs (multi-channel networks) now, YouTube is overwhelmed.”

Martinez hopes that in the future YouTube will collect proper metadata about copyrighted material as soon as a video is uploaded. That way, rights holders won’t have to play catch-up tracking down all the videos that feature their work. Meanwhile, his company has struck deals with artists like Heems, late of Das Racist, who releases much of his work free as online mixtapes then monetizes through YouTube, touring, and merchandise. It’s a way to circumvent the complex quagmire of royalties and licensing on Spotify and Pandora without requiring millions of TED-happy Twitter followers like Amanda Palmer.

Unfortunately, as more and more content creators jockey for this ad revenue, there’s less money to go around. No one platform will save the music industry but every little bit helps.