Sunday, March 24, 2013

Let's do some simple addition: aka How much did Macklemore make?

Note: Apologies if there are font jumps later in this post; am experiencing some formatting problems and will try to resolve asap.

Today we're going to look at traditional music industry economics vs new music industry economics, using Macklemore, the subject of the last string of posts, as our case study.  I won't commit to a hard and fast definition of new music industry economics just yet, because I'm not only referring to the world of digital vs physical music, or the world of independent vs major label artists, or the world in which artists can go direct-to-fan and fans can communicate directly with the artist, as well as with each other.

Things are not that black and white, as we began to see in the previous post about Seattle rapper Macklemore. An unsigned artist, Macklemore rose to #1 on the charts around the world, sold millions on iTunes, generated close to 200 million YouTube views (as of late March 2013) for a single song, and/but did so with a combination of independent and industry resourcesAs we'll see, there are still intermediaries, just different ones, and under different deal terms. Will the post-industrial music business look that different from the industrial music business?  Come along for the ride and let's decide together.

But first, a few bases for our discussion. Major labels have long been vilified. Their processes have been said to lack transparency (there's that word again), their economics are said to resemble those of sweatshops, their royalty statements have been referred to as "works of fiction". Yet, the fact of the matter is that the major labels have been operating as investors in products that fail about 97% of the time. The money for recording, manufacturing, distribution, promotion, marketing, and sometimes touring is put out up front by the label, in the hopes that there will be a hit down the road. Preferably quite soon down the road. The labels work with a model of advances, i.e. the funds are doled out by the label to cover the costs listed above and then if/when the earn back happens, it is deducted from the advance.  Most major label artists only get a few albums with which to prove themselves, and most don't recoup, or pay back the advance or the charge backs to them. While it's easy to condemn this business model, it's one in which the odds are stacked against everyone. It's the ultimate high rollers game. The only reason it works/has worked, even with ridiculously low hit to non-hit ratio, is because the 3% that do become hits have become such colossal hits that they are able to carry the other 97% of the roster. Such are the economics of hit-driven businesses; movie studios and network television work with similar ratios. Just last week I heard a former president of one of the major studios speak and during his talk he shared his opinion of the industry's wildly unpredictable economics: "The movie business is a terrible business. It shouldn't even exist."

Despite all the disintermediation, or removal of middlemen, brought about in these days networked, digital systems, there are a few things that are the same in the old and the new. I'll do a quick review of them here, before doing some guesstimates of how the actual numbers look in Macklemore's case, just because it's been the object of study for the last several blog posts. Feel free to grab a pencil and paper as we go through the basic accounting and categories.

Royalty rates: These can vary from fractions of pennies for digital streaming to tens to hundreds of thousands and up to millions for use in advertising campaigns. Back in the good old days artists were able to command  multiple millions for the use of their song in a TV ad, as was the case when Microsoft wanted to use the Rolling Stones' Start Me Up in the Windows '95 ads. But back to digital royalties, the source of much consternation among artists today. It's another one of those 'it's the good news and it's the bad news stories'. The good news is that the radio programmer gatekeepers and the MTV-type programmers have been removed from the process. As an artist you can upload your music, you can make it available to streaming and on-demand sites. As a user you can click on songs and stations and playlists with Spotify, Pandora, Slacker, Rdio, Rhapsody, and others whenever you like. You can help yourself to all the streaming music you want, and if you don't mind listening to a few ads, you can do so for free. The bad news is that this adds to audience fragmentation and demassification. Where the mass media delivered mass audiences, digital media is able to deliver niche audiences. Consequently, the royalty rates are tiny. It has been reported that 70,000 plays on Spotify net approximately $300 to the artist. And what's more, none of these services has achieved profitability. Not yet, anyway.  In fact, it has been estimated that if traditional terrestrial radio had to pay the same royalty rate as services like Pandora they (radio) they would incur an additional 2 billion dollars in annual costs, which would most likely make their business model unfeasible. Because the numbers for digital royalties of this kind are so small, we won't even include them as a line item on the revenue side for the calculations below. They'll just be thrown in when numbers are rounded up.

On to revenues from the sale of recorded music. In the traditional music business model, in which the label signed the artist, and in which the artist failed to break even about 97% of the time, the pie was generally divided as follows:


Note that not all deals have the label taking 63%, sometimes it's closer to 50%, and a lot depends on the bargaining power of the artist (new artists have less, established artists have more). But as the above pies illustrate there's a whole lot of slicing that has to go on. So what if we removed the entity taking the biggest slice, i.e. the label, from the plate? Now, pencils in hand, let's make some sort of kind of educated guesses as to how this might look in the case of an unsigned artist like Macklemore, now with a huge international hit on his hands. I've tried to make none of these figures wild guesses, and have run numbers that I'm guesstimating past some folks in the industry.  So no guarantees that the numbers are accurate, just that they're not completely ludicrous.

iTunes: The Thrift Shop single has now sold approximately 5 million copies. Not only on iTunes, but also on Google Play and Amazon and probably via other smaller vendors too. But the vast majority of sales would have happened on iTunes. In the label world, if the download was priced at $1.29 the monies would be split this way:


With no label in Macklemore's scenario the $0.60 is not taken off the top. But, as we learned in the previous post there is a distribution company involved, ADA, as well as some label services via ADA's parent company, Warner Music. According to manager Zach Quillen these services are paid for out of pocket, as opposed to with an advance, but we don't know if there's a percentage take involved as well. Just to be safe, let's say 20% to ADA and Warner. So, from that $1.29, let's say 40 cents to Apple, 20 cents to ADA/Warner, and the rest to recording artist and songwriter. In a way Apple (or whoever the digital vendor is) becomes the label in this scenario, taking 30% off the top; but in this scenario with no investment or risk in the artist. And while selling a digital product, with no incremental cost per unit, no manufacturing, shipping, or warehousing required. Meet the new boss, worse than the old boss?  (See this post for estimates of Apple's margins on iTunes and software sales.) Nonetheless, Macklemore & Ryan Lewis keep about 69 cents of every $1.29 sale. 5 million paid downloads @ $0.69 each = $3.45 million.

On to the album, The Heist, which has sold close to 500,000 copies in the U.S. and Canada as of late March 2013. I haven't been able to find a number for global sales, but let's throw in another 200,000 for a total of 700,000. The math here gets a bit conjectural as the digital album The Heist comes in two packages -- a deluxe version for $11.99 and the regular version for $9.99. Note the role of Amazon's discounting of the album to $1.99, which resulted in swift early sales figures. (This is a strategy Amazon has experimented with before, most notably with Lady Gaga's album in 2011. Demand was so high that their servers ended up freezing). To expedite the math let's just say $10 for the digital album, with a similar breakdown as for the digital single. Of the $10 we'll assume $3 goes to the digital retailer (iTunes, Google Play, Amazon, etc), and another $2 goes to the distributor ADA, which leaves $5. Therefore if we are assuming the sale of 700,000 copies worldwide = $3.5 million. So we're up to around $7 million, net to the artists, from the sale of physical and digital albums and singles.

Next up, YouTube, where the Thrift Shop video has 185 million+ views of today, and the Macklemore & Ryan Lewis channel has approximately 260 million views in total.

In other words Thrift Shop accounts for about 70% of the views on the channel. But, not all videos on the channel have been monetized. In fact Macklemore didn't start doing so for the big hit single until Thrift Shop hit 90 million views. So that brings the total of 260 million views down to 170 million views. And not all of the videos on the channel are monetized and not all views are as valuable as others. So let's take 100 million of those views as monetized and use a CPM (cost per thousand) of $5 (which seems fair, compared to the $8 CPM received by Gangnam Style). Continuing to pencil this out, we add another $500,000 of revenue from Macklemore's YouTube channel, bringing our running total up to about $7.5 million. 

Our next line item is touring. In Macklemore's case it looks like he and his crew have been doing several shows per week, often headlining at venues with a capacity of 4-5,000 as well as appearing on multiple band bills at festivals.

If we take an upcoming show at Sioux Falls, South Dakota's Elmen Center as an example, we have a venue with a capacity of 4,000, which seems to be in line with the size of venue he generally plays at, and let's assume a ticket price of $28-32. So, since the release of the album The Heist, approximately 6 months ago, let's say there have been 100 shows, with audiences that started out in the hundreds and increased to the thousands, with ticket prices starting at $12 - $15 and going up from there accordingly. 100 shows, with an average price of let's say $20, playing to an average of 1500- 2,000 people = gross revenues of $3 - 4 million for the past year. And out of this come the cuts taken by promoter, booking agent, and ticket agency, along withhotel rooms for band members and crew, flights and/or buses, meals, roadies, and per diems while on tour. Because it's difficult to estimate the below the line, or operating costs, I'm just going to assume an average to the band of $10 net per ticket x 1500 people x 100 shows, for a total of $1.5 million for touring for the past year after expenses have been paid.

One part of the Macklemore operation that is particularly profitable is the merchandise arm. This is the sale of t-shirts, hoodies, and assorted trinkets bearing the band name, that takes place at shows on the tour as well as on the website. The margins are generally high, meaning if a fan buys a CD and a t-shirt at a show, for a total of, say, $35, it's reasonable to assume that about $20 of that is profit. So while touring at this level may be modestly profitable, it's the sale of merchandise that helps offset the laundry list of costs detailed above. As a guideline, those in the merchandise industry suggest that 1-3% of concertgoers at the large arena venues purchase band merchandise, and at smaller venues not more than 7%. So let's take a conservative 3% of the average of 1500 people we assume have attended a Macklemore concert over the past year, and let's say that on average they spent $35 on merchandise. 3% of 1500 - 45 people. 45 people spending $35 each = $1350 per night. $1350 x 100 shows = $135,000 of which we'll assume close to half, or $70,000, is profit.

There are other revenues coming in, from activities such as songs licensed to ads, such as the one below, for a Miller Genuine Draft commercial in 2012, another for Microsoft's, and  a promotional ad for the NBA's All-Star Week in February 2013. Let's pencil these in at $50,000 each, for a total of $150,000 of revenue.

But remember, in the absence of a label the artists are financing everything themselves. Recording, manufacturing, design and production, distribution, marketing, promotion, producing and maintaining their website, producing and selling the merchandise, and don't forget there are also professional services required by the likes of accountants and lawyers.

After all these partially informed calculations I'm going to say that Team Macklemore -- the core group of Macklemore, Ryan Lewis, Manager Zach Quillen and Tricia Davis, has probably netted between $8 and $10 million in the past 6 or so months.  Although the numbers taken into account in this post add up to around $8 million I'm factoring in some margin for error, and to account for any overlooked revenue streams. Because we don't know exactly how they split the cash among the core team, I'm going to say that Macklemore himself has netted around $4 million since Thrift Shop has taken off.  For want of a better reality check we can use this estimate as one data point for testing our math. The author assumes $2 million net worth for Macklemore himself. This is when Thrift Shop was at 66 million views (it is now at 3x that level) and album sales were at 272,000 (it's now at 1.5x that level). Twice that level now seems reasonable.

Had Macklemore been on a major label the math would have looked something like the following:

Label advance of $500,000 to $1 million

First 50-60% of revenues go to label

Next 25% of revenues go to distributor

Charge backs for video production, marketing materials, promotional services, and miscellaneous fees such as breakage, container fee, etc.

If the deal was a 360 deal, in which the artist and label share revenues not just from the sales of physical and digital product, but also touring, merchandising, licensing, etc., the percentages would continue to be split. Much depends on the terms of the particular deals, and as this cautionary tale lays out, situations do exist where the artist sells a million albums, and still owes the label half a million dollars. This doesn't always happen, but it can happen.

So -- if we can draw some reasonable conclusions here, under a regular label contract, approximately 50%, or $4-5 million, would have gone to the label.

Under a 360 deal, which some labels now require artists to sign, the percentages would have extended to the revenues from concert ticket sales, merchandise sales, and song licensing from ads, so let's say a 50% cut of the $135,000 from merchandise, the $100,000 from licensing, and presumably a cut of the $3 million gross from touring, all of which adds up to an additional $1-1.5 million on top of the $4-5 million.

And still, some questions loom: Had Macklemore been signed to a major label from the outset would the sales have been higher? Would today's 5 million paid downloads of the single be 10 or 20 million? Rather than take four months to get to the top of the charts could Thrift Shop have hit the jackpot earlier, and enjoyed the higher chart position and higher sales for a longer period?

I guess we'll never know, but can think of it this way: the label would have needed to double the sales level for Macklemore to have benefitted at the same monetary level he has. Inversely, had Macklemore sold half as many singles, t-shirts, and concert tickets on his own, he may have fared better under a major label deal, in that the label would have put in more than he brought in, but that would probably ultimately have led to getting dropped by the label, which is how the major label model works, and I think has to work when the odds of success are so crushingly low.

As an indie (or more accurately 'indie plus', in which the artist is not signed to a label but instead buys, a la carte, major label services as s/he desires) the cash flow is as estimated above. Bear in mind, however, that the Macklemore scenario was only possible because of the leverage he possessed after close to ten years of building audience, building fan relationships, paying out of pocket for goods and services the label otherwise would have subsidized, and, of course, the wearing of many, many hats.  Is this a new model for the music industry? Perhaps.  In this pretty much ideal scenario we have the much desired win-win. A win for the artist, still able to call his own shots and guide his own career path, and a win for the label, who didn't have to risk capital up front on an unproven act.

Doing things the Team Macklemore way is a new way of operating both within and without the music industry, and requires rolls of the dice and sets of skills that not all artists currently possess, but may have to as the industry unravels, and then in time re-ravels.

Your thoughts and comments are welcome below; as are polite indictments of the assumptions or math in this post.

The next post in this series, on the new faces of the middlemen in the music industry, can be found here.