The Streaming Royalty Puzzle: Who Gets Paid and Why

Today, most of us get our entertainment through streaming services, ranging from Netflix to Spotify to Pandora.  When we enjoy movies, TV, or music, we rarely think about how those artists are compensated, especially after the initial release.  Many people may be surprised to discover that artists are compensated years later for their entertainment material thanks to royalties.  The use of royalties allows entertainment companies, from websites to radio stations, to use artists’ materials to attract customers for either subscriptions or in order to sell advertising space.  Subscribers pay directly, generating revenue, or advertisers pay directly for rights to use the space or time to promote goods and services.  

Royalties Explained

To use someone’s intellectual property, or artistic creation, one must pay for the right.  Without intellectual property (IP) protections, artistic creations could simply be copied endlessly for free, depriving artists of the necessary revenue to survive.  Many artists allow their works to be used by companies in exchange for royalties, or payments based on usage.  This allows the artist to be paid a small amount each time his or her work is used to generate revenue for the company.  Of some controversy, however, is how much various artists are paid per use of their creations.  Many people think today’s artists, at least those who are not considered superstars in their respective fields, are proportionally underpaid when it comes to royalties.

Splitting Royalties Among Parties

Artists, ranging from actors to writers, often rely on third parties to handle their revenue.  This typically means an agent and a company, be it a publisher, recording label, or production company.  Many artists begin their career making little revenue, and thus enter deals with agents and management companies to allow them to take a cut (percentage) of the artists’ revenue.  This incentivizes the agent to work hard to make sure the artist is well-compensated.  Both up-front pay and back-end royalties are typically divided among the artist and his or her agent, manager, production company, etc.

Splitting royalties can be even more complex when there are multiple artists involved, such as actors or musicians.  TV shows and movies, and even songs, can feature multiple artists in prominent roles.  Musicians and singers use split sheets to detail this breakdown, while actors use individual agreements and adhere to guidelines set by unions, such as the Screen Actors Guild - American Federation of Television and Radio Artists (SAG-AFTRA).  Typically, actors get residuals rather than royalties, as actors do not own the intellectual property of the films in which they act, though the principles are similar.

Bargaining Power in Royalty Splits

There can be several parties vying for royalties or residuals, with bargaining power differing by party.  Artists can command a higher percent of royalties if their work is more popular and can be utilized more widely.  Often, artists get a higher percent of royalties if their work sells more copies.  Rarely, however, do artists get more than 25 percent of total royalties - record labels and production companies get the majority.  This is because the companies do the work to create and distribute the music, video, or printed media.  Larger media companies tend to take greater percentages of total royalties, as their size and reputation allow them greater access to buyers (i.e., consumers, radio stations, TV stations, etc.).

Inelasticity of Demand

Artists have a better chance of negotiating greater royalties if they can demonstrate that their work has more inelastic demand.  This means that quantity demanded is relatively stable and is unlikely to decrease suddenly.  A key factor that helps make demand more inelastic is lack of suitable substitutes.  An artist’s work may not be extremely popular with a broad audience, but can command higher royalties if it develops a cult following among a smaller group of fans that considers it unique.  Essentially, a producer or label is often willing to sacrifice higher per-unit revenue in exchange for more guaranteed units sold, similar to buying or selling in bulk.  

Work that is popular but very similar to rivals can suddenly lose popularity, and thus revenue.  Therefore, even a viral hit or two may not give an artist high royalties; demand could collapse at any time.  Companies would argue that they could spend lots of time and effort to publicize the work, only to have a close substitute suddenly seize consumers’ attention.  Genres with many similar artists may also see producers and labels playing artists against each other to create competition and reduce payments, arguing that they can easily switch to a new artist if their current artists becomes “too demanding” in terms of payment.

Two Models of Royalties:  Pro-Rata or User-Centric

Pro-Rata Model: Traditional

The traditional model of royalty distribution is the pro-rata system, where artists receive royalty payments based on the number of listens or views received by their works across the entire network or platform.  It uses simple math to break down payment to each artist based on a percentage of total customer interactions.  For example, if a radio station pays $1,000 per month to play a record label’s catalog and 5% of those songs are by Taylor Swift, then Taylor Swift receives $50 per month.  Critics argue that this model disadvantages new artists by causing labels and production companies to mostly push the most popular content only.

User-Centric Model: New

A newer model of royalty distribution called the user-centric model would more closely pay artists based on subscribers’ actual listens.  Proponents argue that this is more fair to artists because the pro-rata model may include skewed data from “background plays” like radio stations at night.  Of course, there is a lot of context regarding what counts as a true view or a play.  Arguably, proponents of the user-centric model of royalty distribution want more weight to be given to customers’ direct efforts to enjoy the work of a specific artist.  They argue that the current pro-rata models unfairly allocate greater weight to the mass-streamed or mass-played work of mainstream artists, whom actual subscribers are no longer seeking out.