‘Free’ Records Cause Discord With Artists

Every time someone buys an album in a record store, the performer is supposed to get a royalty. It usually ranges from 30 cents a record for a newcomer to $1.25 for an established star. That’s a lot of dollars if a record sells several hundred thousand copies, or millions.

But performers don’t get paid on every record.

Some experts estimate that record companies do not pay royalties on as many as 30% of the records and tapes sold. That represents a staggering amount, considering that more than 700 million records and tapes were sold in the United States last year.

Bitter Battle

Not surprisingly, the discrepancy between the number of records sold and the number of records on which royalties are paid is the focus of an increasingly bitter battle between record companies and artists.

The most hotly disputed issue is the companies’ so-called “free-goods” policy.

It has long been common practice for companies to discount the price of recordings to wholesalers by offering a percentage of free goods with their purchases. For example, instead of a cash discount of, say 10%, the companies give the wholesalers one free record for every 10 that they buy.

By contract, the companies pay no royalties on free goods, on the theory that they are given away, not sold. As one record company attorney put it, “We don’t get paid on those records either.

However, that theory is disputed by many artist managers, attorneys and accountants contacted by The Times. They see free goods as an economic practice that “lets the record company determine how many records they are going to pay royalties on,” in the words of one lawyer.

According to Steve Tenenbaum of the New York accounting firm of Laventhol & Horwath, “There’s no such thing as a free record--it’s just a billing technique to reduce payment of royalties to artists.”

Tenenbaum, who specializes in auditing record companies on behalf of artists, offered a hypothetical example of how free goods work:

“Say that I’m a record company and you are a customer. If I sell you 1,200 records at $1 each, then you give me $1,200 and I give you 1,200 records and I’m paying artist royalties on all 1,200 records. If, instead, I sell you 1,000 records at $1.20 each and give you 200 free, then I’m still getting $1,200 and you’re still getting 1,200 records but I’m only paying artist royalties on 1,000 records.”

Artist Is Hurt

“The economic reality is that we each end up with the same thing and the artist is the only one who gets hurt,” Tenenbaum said.

The artist-producer royalty is the highest single element in the unit cost of an LP or cassette recording, averaging about 15% of the suggested retail price of $8.98 or $9.98, or between $1.35 and $1.50.

By contrast, the per-unit manufacturing cost can be less than 50 cents. The rest of the typical $5 wholesale cost is taken up by packaging, songwriting royalties and shipping. Original production costs are deducted from the artist’s share of royalties.

Record executives don’t like to discuss their companies’ specific free-goods policies, they say, because they want to protect the confidentiality of their artists’ recording contracts. In general, however, executives defend the practice as a long-time economic fact of life that benefits artists because it helps to sell more records.

They point out that artist royalty rates are predicated on a certain percentage of free goods and that artists agree to the free-goods policies when they sign recording contracts.

And most artist representatives say they don’t object to a reasonable amount of free goods--in the range of 5% to 10%. But they complain that the major companies often are excessive in the use of free goods, violating their artists’ contracts in the pursuit of competitive advantage and increased profits.

Sell Another’s Product

“As a matter of practicality, you have to do something to get the product out into the marketplace, and free goods are a means to do that,” an auditor for a top New York accounting firm said. “But if they’re using one artist’s product to sell another’s, then that’s wrong, it’s not what the free-goods clause in the recording contract intends.”

Such practices are not uncommon. Lawyers for the Beatles claim in a lawsuit that Capitol Records, the group’s longtime label, routinely gave retailers free Beatle albums in order to promote recordings by lesser-known Capitol artists. The lawsuit is still in litigation.

Last summer, Los Angeles-based MCA Records shipped at least 50,000 free recordings by some of its most popular artists--including Olivia Newton-John, Tom Petty, the Who, the Oak Ridge Boys, Barbara Mandrell, Jimmy Buffett and Neil Diamond--in order to promote an entire line of reduced-price merchandise, according to a statement issued by the company.

The recordings, which had a total retail value of about $315,000, were shipped to branches of Detroit-based Handleman Co., one of the world’s largest wholesalers of records and tapes.

According to company documents obtained by The Times, MCA paid no royalties on the recordings. MCA said in a prepared statement that the recordings were distributed to Handleman at no charge “in order effectively to reduce the price of MCA’s Platinum Plus line (priced at $3.21 wholesale and $5.98 retail) so that MCA Records could meet its competitors’ price with respect to similar product.”

Response to Discounting

According to several major wholesalers, MCA’s free-goods program apparently was a response to special discounting programs offered by RCA Records and CBS Records, which last year reduced the price of their midline recordings by 20% and 30%, respectively, through distribution of free goods. The wholesalers said MCA subsequently offered them a program of 20% free goods.

A spokesman for RCA in New York said the company has a policy of “not commenting on pricing.” CBS spokesmen did not return a reporter’s phone calls.

MCA apparently didn’t offer the deal to everyone, however. The Times interviewed several major wholesalers who said they took advantage of the CBS and RCA discounts but were unaware of MCA’s free goods program.

MCA said in a statement that the company “feels that it is inappropriate to discuss its pricing policies in general, other than to state that it considers such policies to be sound and valid.”

MCA’s meeting-competition explanation does not satisfy attorney John Mason, who represents Olivia Newton-John, the company’s biggest-selling artist.

Mason said MCA had “no right to give away Olivia’s records in order to promote the sale of other artists.” He said MCA’s actions appear to represent a breach of Newton-John’s contract, which calls for MCA to obtain written permission any time it offers free goods on her recordings. Mason said MCA neither requested nor received permission.

Mason said he has submitted a claim for royalties due on all Newton-John recordings given away by MCA in the last couple of years, but he wouldn’t say how many that was. “I’ll decide how to proceed after I receive MCA’s response to the claim.” he said.

‘Intended for Resale’

Alan Susman, MCA’s outside general counsel, responded: “In the past, MCA Records has always paid Olivia Newton-John on all records distributed as free which were intended for resale, and plans to do so in the future, except where she may have expressly waived any such right.”

Industry experts offer different versions of the history of free goods. Some say the practice began in the 1950s as the record companies’ way of giving a “baker’s dozen” on the initial shipment of a new release in order to help launch the record. Others say it was to compensate dealers for records that invariably were broken during shipment, back in days when records were breakable.

“It should have disappeared when vinyl records came along,” one former record company president said. “But somewhere along the line someone came up with the concept of using free goods as a way of discounting price and that gradually became standard practice in the industry.

One accountant explained, “The point is, for every purpose except paying artist royalties, what the companies call a free record is considered sold. Music publishers consider them sold and demand royalty payments for their songwriters. And when the Recording Industry Assn. of America certifies a record gold or platinum (signifying sales of 500,000 copies or 1 million copies, respectively), it includes the so-called free goods.”

“One of the problems today is that companies are drafting artist contracts that almost give them carte blanche to call a portion of sales free goods and not pay a royalty,” music industry attorney Don Engel said.

Nearly All Do It

According to Engel and a number of artist attorneys and managers, nearly all the major record companies--including Warner Bros., Capitol, PolyGram and MCA--have moved in recent years to label a flat 15% of records shipped as free goods. CBS accomplishes the same thing in a slightly different manner, defining “net sales” in its contracts as 85% of gross sales.

Returning to his hypothetical example, Steve Tenenbaum said, “Now they can sell 1,000 records and only pay royalties on 850 without having to go through the charade of saying 150 of them were really given away.”

The record companies often reserve the right in their contracts to offer special periodic free-goods promotions on top of the flat 15%, attorneys say.

In addition, companies pay no royalties on thousands of promotional records, sometimes called DJ copies, that are provided free to radio stations, record stores and reviewers. Promo records are marked--either by a sticker or stamp, or by having a corner cut or punched--to prevent their being sold or returned to the record company for credit as unsold goods.

Paging through a sample standard recording contract, attorney Engel ticked off clause after clause relating to recordings on which royalties were not paid. “According to this, if the artist gets paid anything at all, it’s practically an accident,” he said.

Paltry Royalties

In a recent article titled “Recording Artist Royalty Calculations,” Lionel S. Sobel, an associate professor at Loyola Law School in Los Angeles, detailed how an artist could conceivably earn royalties of $7.36, or even less, on a recording that sold 500,000 copies.

For the article, which was published in the monthly Entertainment Law Reporter, Sobel based his calculations on provisions contained in “a widely circulated record contract form.” The various free-goods clauses in the sample contract resulted in the hypothetical artist receiving no royalties on 158,000 copies, or 32% of the 500,000 copies shipped.

According to Sobel, current free-goods policies “are the end product of years of negotiations with each side seeking to gain an advantage--’We’ll give you this royalty rate, but we want this amount of free goods.’

“The problem is, many of these provisions were negotiated a long time ago by people with relatively equal bargaining power,” he said. “They might might well have been fair at the time, but over the years they got embedded in standard contract and as a result young artists are presented with this position that is not negotiable.”

Sobel cautions that when entering into a recording contract artists should “negotiate a limit to the amount of free goods that can be given away. It should not be left to the discretion of the record company,” he said.

Impossible to Determine

According to accountant Jerry Shustek, a partner in the New York CPA firm of Shustek & Stella, even in an audit--which can cost the artist between $60,000 and $80,000--it’s often impossible to determine the amount of free goods given out on a particular recording, because companies only provide documentation on what is sold, not what’s manufactured.

“The problem is that the company is making a decision on what is a sale,” he explained. “I’ve had a company say a sale wasn’t a sale, it was ‘a reimbursement of cost.’ So if they don’t post those transactions to sales accounts, and they don’t provide you with manufacturing records, you don’t know that this income is coming into the company.”

In the course of a just-completed audit of MCA’s books, Olivia Newton-John’s accountant wasn’t provided with any documents of last summer’s free-goods shipments to Handleman until he specifically asked for them, according to Mason, her attorney.

According to internal MCA documents obtained by The Times, the recordings sent to Handleman were described as “promotional,” but they were shipped as so-called “cleans.” That means they didn’t have the usual promotional markings that would prevent them from being sold at full price or returned to MCA for credit.

‘Common Industry Practice’

MCA said in a prepared statement that Handleman transaction was in accordance with “common industry practice.” However, executives of other record companies queried by The Times disagreed. Responding to hypothetical questions, the executives all said they could think of no reason why shipping documents would specify that the recordings be “cleans.”

“If the records are going to a legitimate wholesaler, there’s no reason to specify clean copies because that’s all they buy, they don’t buy promotional records,” said one executive. “And if they really are promotional records they shouldn’t be cleans, that’s a contradiction in terms.”

Accountant Tenenbaum offered a possible explanation why a company would record a free-goods transaction with the seemingly contradictory terms “promotional” and “clean.” “A lot of the bigger artists have limitations on the amount of free goods the company can give out without payment of royalties,” he said, “but there’s rarely a limit on number of promotional copies they can give away.”

Tenenbaum added that he’s always been “very confused” by the fact that there’s “no rule of thumb on promo records.”

“It seems to me that they could come up with a list of the number of legitimate promo copies they need to send to radio stations, record reviewers and retail stores. But I’ve never seen such a list at a record company, although I’ve asked about it. I suspect that it exists. I know if I were in the record business I would sure have it in my organization.”

Consumer Doesn’t Benefit

One former record company president pointed out that “the consumer doesn’t see any reduced prices from so-called free goods. It’s just something in the pockets of the middlemen, the wholesalers.”

Even some wholesalers question record companies’ use of free-goods discounts. “We’d prefer a straight cash discount because it gives us an immediate benefit, whereas with no-charge records we have to sell them first to get the benefit,” said the head buyer for one large Midwestern wholesaler. “Unfortunately, it’s the option of record company to decide.”

Said another major wholesaler, “I don’t blame the artists for not liking free goods--it comes out of their pockets.”