Tuesday, September 27, 2005

Deal Memo: Korn

By Dave Marsh

EMI's new contract with Korn provides the band with $15 million in upfront money. In return, according to the Los Angeles Times, for the next five years EMI gets "more than 25%" of the band's income from touring, song publishing and merchandise.

A lot of silliness has already been spouted regarding the deal. Hollywood attorney Jeff Light opined, "Sometimes labels have a history of forcing new bands into tough deals." Wouldn't you like to depose him as to the exceptions he's aware of? Los Angeles Times writer Charles Duhigg claims, "Many musicians rely on concerts and licensing contracts for as much as 70% of their income." Which, for most, can't be off by more than 28 percent or so.

It's tough to evaluate exactly what's going on here, since we don't know precisely what Korn is selling for that $15 million. For a group that consistently sells in excess of a million records, and has had hits that sold several times as many, that's a reasonable advance for three or four albums; it's a little light for five years of recording AND touring, though. Let's figure that Korn's getting a 15% royalty--on paper, 20 points, minus the standard deductions (some of which haven't had a basis in reality for about half a century). At that rate, a $20 list-price CD that sells 1.5 million copies yields the band $4.5 million. That's a reasonable assumption about the royalty (Michael Jackson gets a very hypothetical 50% of all Sony's profits, other superstars around 20%). But then the upfront $15 million might represent only half of what the band is guaranteed from the deal. (That is, on a five album deal, they get--in effect--$3 million per album in advance and then $3 million on delivery.)

Let's suppose that is true (because it maximizes the band's income): EMI then needs to earn back $30 million. Also, let's imagine that Korn has one big hit record--3 million sales--and one flop (800,000) along with three records that sell its 1.5 million base. That would yield 8.3 million sales, which means $25 million in royalties. That leaves EMI short $5 million ($15 million up front plus $15 million in those pesky on-delivery payments). Right?

Not quite. For one thing, the music publishing on those records (Korn writes its own material) is a statutory 8 cents per track. Figuring that EMI will whittle that down a bit (the statutory rate is a ceiling, not a floor), let's call it 75 cents an album. That's more than $6 million more--of which EMI gets "more than" $1.5 million. EMI is still $3.5 million short of break even.

Sort of. Remember that EMI gets to do all the counting on how many units sold. Because of "favored nations" agreements in other artist contracts, Korn won't have a better agreement than usual when it comes to auditing--which means it can only audit using an EMI-approved auditor and only on units shipped and returned, not on the total number of manufactured units. (How one audits download sales is a very interesting question.) So EMI's "loss" is pretty hypothetical.

Anyway, we're leaving out the part that must have EMI rubbing its hands in glee. Bands have much longer lives on tour than on record. Korn's recent live grosses have ranged from $16 million for its 2002 tour to $3.3 million for 2004 solo shows. Split the difference and say that over the next five years, ticket sales plus merchandising represent about $3 million in profit. EMI would receive more (we don't know how much more) than $750,000 there. Leaving it booking a loss of a two million bucks.


A triple-platinum album that earned the band $9 million would represent much more to the company: If the cost of manufacturing and marketing plus royalties is $6 and EMI sends it out the door for $10, that's $12 million profit, just for that one record. None of that goes to the band. So in our example EMI isn't really down $1 million--it's up $10 million.

Our example ignores a few other things,too.

Fact 1: Record companies cheat artists. They cheat as much as they can, in every way they can. This is not an aspect of the record business. This is the essence of the record business.

Fact 2: Record companies who make these kind of deals are NOT going to allow
the artist to pay them from the artist's accounting of concert and merchandise revenues. The recording corporations are going to count the dough and dole it out, and in doing so, they will use their royalty accounting techniques as best they are able. (Industry attorney Fred Wilhelms says that in his entire career, he has found one error in favor of the artist, as opposed to literally thousands in favor of the companies.) Presuming that EMI owns a merchandising company and requires Korn to use it, the company in fact double-dips: All the merch company profit plus "more than
25%" of Korn's royalties.

Suppose that Korn looks over its royalty statements and feels cheated, but EMI won't do anything about it. What has usually happened (examples range from Tom Petty to the Dixie Chicks) is that the band refuses to record and lives off gig money 'til the dispute is settled. But the money from concerts and merchandise now passes through the record company, under the terms of a contract that undoubtedly provides for "suspension" when the act won't behave. What leverage does the group retain?

Korn not only loses economic independence, its revenue streams are further compromised by the specter of what's known as cross-collateralization--the lumping together of all an artist's royalty income on a statement. Imagine that Korn's last album on the deal sells so few copies that the band is now $3 million in the red on its record royalties. But its worldwide concert tour associated with the record has a profit of $6 million. Of that, the record company is entitled to something more than 25%, that is, at least $1.5 million. Doesn't the $3 million in record royalties come out of the $6 million too? (Why else would the label make this deal?) $3 million plus $1.5 million is $4.5 million, plus a little bit more--that is, the company keeps almost all the money from the tour plus all the money from the record sales.

By the way, a group's manager receives its commission on the gross, not revenues. So even presuming all this is true--we can't be sure it is, but it would *truly* bollix industry practice if much of it wasn't--this is still a good deal for somebody. Besides EMI, I mean.

It's even a good deal for Korn, presuming they break up quickly enough.