In an unprecedented deal, Clear Channel, the largest owner of U.S. radio stations, has agreed to pay sound-recording performance royalties to Scott Borchetta’s Big Machine Label Group and its artists.

The sound recording performance royalty — which is also known as the artist performance royalty and is not to be confused with the songwriter performance royalty — is something that record labels and artists have been fighting to obtain from U.S. radio for decades. Currently, in the U.S., they have only been successful in winning such a royalty in the digital radio space.

As part of its deal with Big Machine, Clear Channel will pay an undisclosed percentage of music advertising revenue for broadcasts whether they are heard digitally or terrestrially, instead of the legislatively mandated sound-recording royalty for only digital, which currently is in the form of a pay-per-play royalty set at $0.002 for 2012.

While none of the terms of the deal struck between Big Machine and Clear Channel were disclosed, since the deal is a negotiated rate, payments will bypass SoundExchange and be made directly to the label, which in turn will split those payments 50/50 and pay the artists.

 

The reason why only one participating label has been announced thus far apparently is related to the fact that it was Big Machine Label Group president and CEO Borchetta who brainstormed the business model and brought it to Clear Channel, which wants to start small with the process and see how it goes.

Clear Channel CEO Bob Pittman told Billboard.biz he was attracted to making the deal because it treats the radio business “holistically,” meaning that it sets a percentage rate based on advertising revenue brought in against music airplay, regardless of whether the broadcast is transmitted via radio, mobile phone or through a computer.

In turn, Borchetta said he was motivated to strike a deal because currently he is only collecting artist performance royalty payments for digital radio, which comprises 2% of U.S. radio’s music-advertising revenue.

“We found a way to create the terrestrial artist performance right,” Borchetta told Billboard.biz. “We found a ground in the middle to move forward into the future as a partner with radio.”

As a result, Big Machine and its artists — which include Taylor Swift, Reba McEntire, Jewel, the Mavericks, and the recently signed Tim McGraw — “are now earning royalty payments from the 98% of ad revenue that comes from broadcast radio,” Borchetta said. “Now, we can align our interest with radio in a predictable model based on ad revenue so that we can drive digital growth.”

 

Even though radio has historically opposed a sound-recording performance royalty, Pittman said he was motivated to make the deal to help establish the digital radio space, where the performance-royalty rate is based on a per-play royalty, which he said is not a healthy business model.

“I can’t build a business space based on paying money for every time I play a song, but I can build a business by saying I will give a percentage of revenue that I bring in,” Pittman said. “What we are really trying to do is come up with a predictable model.”

Without predictability, radio has to try to play Nostrodamus, he said. “I don’t want to try and guess how much advertising I can sell — and if it’s not coming in fast enough, can I slow down the song plays? Or should I do an interview show, or do more talk radio and news and sports, or maybe do more pre-1972 music programming? That’s just a bad way to run — and even more importantly, try and build — a business. It encourages us to try and play as little music as possible.”

 

Pittman and Borchetta say that the radio-songwriter performance royalty model made to U.S. collection societies like ASCAP and BMI inspired the deal they put together. Currently, U.S. radio pays about $400 million a year to the collection societies. Meanwhile, SoundExchange paid out $292 million in sound recording performance royalties in 2011 to artists and labels.

While sound-recording performance royalties are commonplace in most countries, the closest U.S. labels and artists have come to getting such a royalty from radio airplay happened when legislators in both the Senate and House of Representatives introduced legislation in 2009 and 2010 to create a similar royalty and told the record labels and radio to negotiate a solution.

 

Although the National Association of Broadcasters waged a fierce public campaign against the sound-recording performance royalty, the organization actually engaged in negotiations with record labels and artists. The two sides hammered out an agreement, which sources say began at 1% annually of a station’s ad revenue for music, while labels agreed to support efforts to get a radio chip installed in cell phones.

But in the end, the compromise fell apart and the legislation was not enacted before the 2010 U.S. elections, label executives said.

How the deal broke down is a he said/she said situation. Label executives say the NAB rejected the compromise and came back with a counter proposal. Radio executives say, hogwash, the RIAA rejected an NAB Board-approved offer. Label executives insist that it was the NAB board that voted down the deal.

Meanwhile, some point out that the timing of the Clear Channel/Big Machine deal seems to align nicely with a Congressional hearing tomorrow on how audio is delivered to the consumers being conducted by the Subcommittee on Communications and Technology, which is expected to include, among other topics, the radio chip and why it should be installed in cell phones, according to press reports.

 

Despite that failure, certain members of Congress say they will still fight for artist performance royalties going forward. At the end of April during a Grammys On The Hill event,  in a keynote address to artists, Congressman Jerrold Nadler (D-NY) said: “I have news for… the National Association of Broadcasters: this issue of performance rights is not over,” according to a press release put out by the musicFIRST organization. “This issue isn’t over, and it won’t be over until we have a performance right enshrined in law. If the parties can’t solve the problem, Congress will.”

Pittman acknowledged that he is going against the grain by agreeing to pay sound-performance royalties for terrestrial radio.

“There are plenty of people in radio who think we already give the record labels so much by giving them free promotion to break their artists, and they say that ought to be enough,” he said. “But clearly that is not enough, or there wouldn’t be a decades-long battle over it.”

There might also be resistance from record labels, which may not like the terms of the deal — or from artists, who may not like getting their royalty payment from a label instead of SoundExchange.

“I think the problem here is nobody wants to be first; nobody wants to take a chance,” Pittman said. “But Scott is an innovator and a risk-taker and he is taking a chance — and we are [too] because somebody’s got to take the first step looking to the future instead of trying to protect the past.”

But in taking that first step, Clear Channel has more at risk, since it will pay out more money in sound-performance royalties than Big Machine, which actually will collect more revenue. Even though it will cost Clear Channel more this year, “It’s a chance and risk we are taking in order to get a more predictable business model,” Pittman said. “Shareholders pay us to take the right chances and to make the right bets.”

Although Clear Channel is starting small by agreeing to work with one label, Borchetta and his Big Machine label have considerable clout in both the indie and major label sectors.

Pittman says that while Clear Channel may cut more deals this year, the company economically can’t strike deals with all record labels until he sees how the payment scheme is working and whether it is helping digital radio to grow.

“Starting small is the way to do it because it will have less of an impact,” he said, presumably referring to the company’s expense structure. That approach should placate Wall Street analysts and Clear Channel shareholders who watch the company’s performance closely due to its highly leveraged balance sheet, which carries a whopping $20 billion in debt and last year paid a $1.47 billion in debt service. Fortunately for Clear Channel, the company’s earnings before interest, taxes depreciation and amortization were $1.82 billion, giving it a $352 million cushion after paying interest, although overall the company lost nearly $303 million on $6.16 billion in revenue for the year ended Dec. 31.

But that revenue includes its billboard outdoor advertising business. The Clear Channel Media and Entertainment division itself produced $1.16 billion in EBITDA on revenues of almost $3 billion. While the company breaks out profit and loss for different sectors of the company, it’s 10-K only presents a consolidated balance sheet, and it doesn’t break out how debt is related to specific divisions, except for some $2.5 billion in senior notes that were issued by the billboard outdoor advertising division.

If Clear Channel turns to other indie labels and offers the same deal, it could be setting a market rate precedent for the day, should it ever come, when such a sound-performance rate is legislatively enacted. But the “industry can’t wait on Congress, especially in an election year,” Borchetta said.

Also, if Clear Channel sticks to dealing with indies, the company could set a rate precedent without dealing with the major labels, which tend to ask for big advances and aggressive rates.

When the terms of the deal are eventually disclosed, Borchetta acknowledges that “we will take some criticism; that is expected. The first one through the door takes the arrow.” But he stressed that this is a “starting point,” and as others enter into the negotiations, rates will be massaged and adjusted to be fair for both the record and radio industries.

“When stations tell me that they can’t afford to broadcast digitally, what good does that do me?,” Borchetta  asked. “Now, we have a starting point to move forward.”