Record Label Chorus: High Risk, Low Margin

Music: With stars questioning their deals, the big companies make their case with numbers.

By CHUCK PHILIPS, Times Staff Writer

     You're a 19-year-old dropout without a nickel to your name.
     No car, no job, no credit.
     Who in their right mind would hand you $750,000?
     Welcome to the record business, where giant corporations risk more than $1 billion each year on young, untested musicians whose careers typically crash and burn.
     The few who do succeed contribute truckloads of cash to industry coffers. Profits from blockbuster releases by such acts as 'N Sync and Hootie & the Blowfish help companies offset losses from thousands of failures each year.
     For every successful act such as the Spice Girls, there are nine bands like the rock group Radish--signed for a ton of money and touted as the next big thing--that never make it.
     There are the millions in marketing and promotion lost on pop acts such as Take Five, which disappeared in a blink, and a seemingly endless list of promising hopefuls such as rock band Gwen Mars, hip-hop act Major Figgas and R&B singer Sammy.
     This is the record industry's defense in a controversy now winding its way through the courts and in a debate with activist artists who are challenging the economics of the record business.
     Company practices have come under scrutiny by lawmakers after some stars complained recently to Congress that the industry uses unconscionable contracts and corrupt accounting tactics to rob artists of their share of earnings.
     But the record companies say that just isn't so. According to the major labels, it's the artists who are making out like bandits.
     Major label executives decided to come forward after articles in the Los Angeles Times detailed efforts by rock star Courtney Love and others to break their contracts and organize an artists trade group to fight the Big Five music conglomerates.
     Pop music, executives say, is a high-risk, low-margin business in which more than 90% of the CDs released each year flop--at great expense to the companies, not the artists.
     It's an industry, the executives say, in which even unknown acts are treated like royalty, receiving millions of dollars in advances per project as their labels struggle to transform them into global stars.
     To bolster their point, executives from Vivendi Universal, AOL Time Warner, Sony, Bertelsmann and EMI Group provided The Times access to internal budgets and cost-analysis data for dozens of recording projects, from marquee stars to failed unknowns.
     The information was disclosed on condition that no specific artist would be named in this article.
     Executives for the companies agreed to be interviewed on the condition that they would not be identified.
     The documents disclose the following:
     * Only one of 10 acts ever turns a profit.
     * It costs about $2 to manufacture and distribute a CD, but marketing costs can run from $3 per hit CD to more than $10 for failed projects.
     * Successful acts thwart the existing contract system by refusing to deliver follow-up albums until they extract additional advances.
     "You might want to ask yourself why it is that most recording stars who have the opportunity to exit the major label system typically re-sign with a major label," said Hilary Rosen, president of the Recording Industry Assn. of America, the Washington trade group that represents the nation's largest music companies.
     "There is a very simple reason: Record companies know how to market and promote records to mass audiences. And they take huge financial risks that help advance artists' careers--risks that few artists are willing to take on their own."
     But rock stars such as Love and Don Henley say the execs can do a better job and treat artists more fairly in the process.
     They and 100 other acts in the Recording Artists Coalition have pledged to launch a trade group or a union to challenge the industry tradition of long-term contracts that keep acts tied up for years longer than is legal in other industries, including film and sports.
     Under the standard contract, artists are prevented from owning their original music and, after attaining success, must repay companies for financing their recordings, videos, retail placement and tour support.
     The standard contracts also allow companies to deduct fees for a variety of promotional expenses and to pay artists reduced royalty rates for albums sold overseas and through record clubs.
     "Record companies get away with their sloppy and obsolete system of accounting," said Love. "They are terrified of having their practices exposed.
     "The state of California and the stockholders need to know that they're missing out on billions in revenues and thousands of jobs because of this unwillingness to stop the excess and stupidity of the old-fashioned system," the singer said.
     But to hear the corporations tell it, contemporary artists have little to complain about. Even those whose contracts are severed, executives contend, earn the opportunity to pursue their creative dreams on the company's dime. Failed unknowns walk away debt-free, no matter how many millions of dollars in losses they leave behind.
     And the artists who produce hits, executives say, typically renegotiate for even larger advances and frequently parlay their musical fame into other financial opportunities. Superstars can earn millions of dollars from concerts, commercial endorsements, merchandising, music publishing and acting deals--none of which they share with their labels.
     Nonetheless, record company executives are reluctant to publicly challenge the artists. And for good reason, Rosen said.
     "It's their job to promote artists, not attack them," she said. "They see no upside in alienating their own artists, even when they're feeling abused. No act wants to work with a company that bad-mouths artists."
     It's true, companies acknowledge, that years ago artists were not always compensated fairly. The industry's history is rife with tales of great musicians who signed away their rights for a pittance and died broke.
     It wasn't uncommon during the 1950s and '60s for artists such as Motown singer Mary Wells and blues act Jimmy Reed to suffer at the hands of unscrupulous managers, lawyers, concert promoters and independent labels who once dominated pop music.
     But these days, executives say, the $40-billion industry, which throws off an estimated $3.5 billion in annual operating profit, is run by public corporations that pay artists fair royalties commensurate with the risk each party takes. Even the most obscure acts, they say, now enter the business represented by competent attorneys who negotiate fair deals. And artists who do not want to sign a major label contract always have the option of putting out their own recordings.
     The five music conglomerates spend billions of dollars each year to keep their global star-making machines intact. The industry employs about 50,000 people, and the price of signing talent, producing videos and promoting records continues to skyrocket, squeezing margins in a business already threatened by Internet piracy.
     "If this was an industry showing Microsoft-like profits, the artists might have an easier battle ahead of them," said Michael Nathanson, a media analyst at investment firm Sanford C. Bernstein & Co. "But music margins are under serious pressure, growth is nearly negative and everybody's already scrambling to cut jobs. The business is a mess."
     Statistics tabulated by SoundScan, an independent research firm that monitors U.S. record sales, confirm the industry's predicament.
     Of the 6,188 albums released last year, only 50 sold more than a million copies. Sixty-five sold 500,000 units and 356 sold 100,000 or more.
     In other words, more than 90% of last year's releases flopped.
     Generally, a major-label album needs to sell about 400,000 copies to reach profitability.
     "People who don't understand the business just look at what makes it to the top of the chart," said SoundScan CEO Mike Shalett. "They fail to appreciate what it takes cost-wise to get there.
     "Companies invest enormous amounts of capital trying to make hit records. It's like searching for a needle in a haystack."
     Few artists concern themselves with the financial intricacies of record-making. Indeed, most musicians enter the business with nothing more than a demo and a desire to become famous. Once an act begins to exhibit commercial potential, however, it usually doesn't take long to rustle up a deal.
     The drill, executives say, goes like this: After the artist solicits an offer from one label, his or her attorney usually contacts competitors in an effort to drive up the signing price. A bidding war can ensue and, by the time it's over, the act normally walks away with a check for about $750,000 to cover recording costs and living expenses. (That's for pop and urban acts. Rock and country acts are often paid less.)
     All five major labels provided The Times with lists of their latest failed acts to support their contention that artists are often the only ones making money on these projects.
     In the case of one unknown act that received a $750,000 advance, the money was allocated to cover the cost of recording its first album and to provide the group with about $250,000 to live on--after deducting legal and management fees.
     The contract required the singers to repay the $750,000 and all other advances from future sales, assuming the album did well, before receiving any royalties.
     After the artists turned in the finished studio recording, the company invested an additional $2.8 million to roll out a marketing campaign to reach retail stores, radio, musical networks MTV and Black Entertainment Television, which play crucial roles in stimulating music sales.
     A big chunk of that money, approximately $800,000, went to produce two videos, neither of which ended up getting much airplay on cable music shows.
     Another $800,000 was set aside for independent promoters to pitch the first two singles to radio programmers. Neither single got much play before being axed from broadcast playlists.
     Over the course of a six-month campaign, the company spent an additional $1.2 million for retail product placement, tour support, photo shoots, advertising and radio and TV show appearances to boost the CD.
     Despite the effort, the album sold only about 100,000 copies and the label decided to drop the act. The company lost more than $2.7 million on the project. The artists walked away debt-free.
     If a company decides to risk a follow-up on a failed act, the meter starts running again. Either way, the corporation eats the loss.
     But the music companies get no sympathy from attorney Jay Cooper, whose clients include Recording Artist Coalition co-founder Sheryl Crow.
     "These companies are run by intelligent, well-paid executives who have no one to blame but themselves that the industry's failure rate is so high," Cooper said.
     Cooper and other critics contend that the record labels should be more discriminating when signing artists and stop wasting so much money on videos, retail positioning and independent promotion.
     If executives ran their labels more efficiently, critics say, they could afford to pay better royalties to the artists who succeed, instead of forcing them to offset the losses of so many failures.
     Why, critics ask, does Wall Street bother with a business that doles out millions of dollars each year in salaries and bonuses to executives who fail so frequently?
     The record companies respond that music is not a commodity and that public taste is not easy to discern. Executives who deliver the hits, companies say, are entitled to the big bucks they earn.
     And to hear them tell it, artists aren't always so altruistic either. Each of the major labels privately shared horror stories involving a number of successful newcomers who dominated the pop charts last year.
     Two of those acts racked up more than $18 million each in marketing expenses on their first albums.
     One singer charged the company $2 million just to make a video. Another billed the label $250,000 to film a 15-second video sequence.
     Several entertainers billed their labels more than $20,000 each for hair and makeup "glam squad" fees every time they appeared on TV.
     Overnight sensations aren't shy either about using their newfound leverage to strong-arm labels for additional money not covered under their contracts.
     "About six seconds before they go back into the studio to record the follow-up, you get the gun to your head," said one label chief. "We call it the second-album hold-up. They want bigger advances. They want better royalties. The risk escalates exponentially."
     One pop act, whose debut album sold 7 million copies, demanded a $13-million advance before returning to the studio.
     Another act, whose debut album sold 4 million units, refused to deliver a follow-up until it received a $4-million advance and a beefed-up royalty. The band pocketed the money and the album bombed.
     Executives say the success rate for follow-up albums by blockbuster bands is no better than for debut acts.
     "The problem is almost nobody has more than a three-album shelf life in this fickle market," said one executive.
     To make matters worse, superstars are having a tough time delivering hits. Companies say they are still smarting from a spate of expensive deals negotiated during the middle and late 1990s.
     The concept behind such deals is that career acts create a body of work that will sell for a long time.
     Indeed, the value of a record company hinges primarily on the size and quality of its catalog. That's why labels are so adamant about owning the master recordings of the acts they sign to long-term deals.
     But in a business threatened by encroaching Internet piracy, companies have watched catalog sales slip from about 50% to 38% over the last decade.
     In one recent case, a label signed a $25-million, three-album pact with a superstar act that broke up shortly after delivering one CD. That CD sold fewer than 300,000 copies.
     Another label signed a $30-million, three-album deal with a star who took four years to deliver his first recording, which ended up selling fewer than 500,000 copies.
     Four of the five music conglomerates are saddled with similar money-losing propositions.
     "You know, sometimes running a record company feels like working in the emergency room of a hospital or a cancer ward," said one executive.
     "The odds are so severely stacked against you. No matter how hard you try, in the end you know from experience that the vast majority won't make it.
     "Every now and then you get lucky. It's not as easy as it looks."