Big musicians flex their muscle with record labels
Talent agency The Firm encourages its musicians to cut out the middle man, make more money for themselves, writes Fortune's Devin Leonard.
By Devin Leonard, Fortune Magazine senior writer

(Fortune Magazine) -- Jeff Kwatinetz, CEO of the Beverly Hills management company known as the Firm, made the rounds to several major record companies with a proposition earlier this year. His client, the rapper-actor Ice Cube, was preparing to record his first album in six years. Did they want to put it out? How could any record company resist?

Ice Cube is a founding father of West Coast gangsta rap. His profanity-laden classics like Lethal Injection and Death Certificate sold millions in the early '90s. Sure, gangsta rap is old school. These days so-called crunk acts like Dem Franchize Boyz are the rage with hip-hop fans.

But Cube hasn't been lounging by the pool reading The Source. He's been producing and starring in movies like "Are We There Yet?" and "Barbershop 2: Back In Business." In short, Ice Cube has become a mass-market brand like Snoop Dogg, another Firm client.

There was a catch. Typically, music companies own the records their artists make. After all, they underwrite the costs of production, marketing, and distribution. But Kwatinetz explained that Ice Cube didn't want a traditional record label deal.

The OG (original gangsta) just wanted a music company to distribute his record. The rapper would personally write the check for his production and marketing costs. Since he was taking all the risk, Ice Cube felt it only fair that he own the music and reap all the profit from its sale in the U.S. Kwatinetz says Universal nearly did the deal, but backed out at the last minute. "They feared Ice Cube's success would show that superstar artists with big management firms wouldn't need record labels," he says. (A Universal spokesman says the discussions never got that far.)

In the end, Kwatinetz got EMI's (Charts) Virgin label to distribute Ice Cube's "Laugh Now, Cry Later." It was a big financial gamble for the rapper, but it paid off. "Laugh Now, Cry Later" debuted at No. 4 on the Billboard 200 in June, and it has sold nearly 500,000 copies worldwide. No, those aren't Lethal Injection numbers. But Ice Cube keeps all the U.S. profits. (EMI gets distribution fees and overseas licensing rights.)

Says Kwatinetz: "We have ring-tone checks coming in. We've licensed music to TV shows. We've licensed music to films. It all goes into his pocket."

The rules of the music business are changing fast in the Internet Age, and no manager is trying harder to exploit this than Kwatinetz. Record companies don't like deals like the one he cut for Ice Cube, and until recently they rarely needed to do them.

Direct-to-consumer distribution

The companies were the gatekeepers between the artists and the audience. If you wanted your video played on MTV, you needed a major label. If you wanted your CD displayed at Tower Records, you had to have a big record company. Sure, the company paid you a big advance. Then it would bill you for production, distribution, and marketing costs using accounting methods that would give people in Hollywood pause.

The record companies are no longer so powerful, because artists have more ways to get their music to fans. Garth Brooks sells his albums exclusively in Wal-Mart (Charts) stores and on the retailer's website.

Radiohead's contract with EMI's Capitol label has expired, and the band is in no rush to sign a new one. In July, Thom Yorke, Radiohead's lead singer, released a solo album, "The Eraser," on an independent label. It was promoted on the homepage of Apple's (Charts) iTunes Music Store and became the No. 2 record on the Billboard 200. Who needs a major label when you can do that?

The success of "Laugh Now, Cry Later" raises the same question. Ice Cube didn't need a record company to get radio play. He's Ice Cube, dammit! He personally courted DJs around the country. The rapper also expanded his fan base on the web.

Rob Stone, founder of Cornerstone Promotion, which Ice Cube and the Firm hired to push the album, says he got DJs to urge listeners to check out the rapper's singles on his MySpace page, and the number of Ice Cube's "friends" climbed from 2,000 to 150,000.

Kwatinetz, 41, is cutting other innovative deals for the Firm's music clients, who include American Idol veterans Kelly Clarkson and Taylor Hicks, Jennifer Lopez, and angst-ridden nu-metalists Korn and Linkin Park.

He was the driving force behind a deal in which EMI and Live Nation--the country's biggest concert promoter - paid Korn $27 million to create a separate corporation that oversees and shares in the profits from sales of the band's records, concert tickets, and merchandise.

Jonathan Davis, the band's dreadlocked lead singer, gets to sit at the table with his record company and his tour promoter and make decisions that increase the value of brand Korn. "It's pretty cool how Jeff rigged it all up," he says.

In July, Kwatinetz announced that the Firm was starting an "artist-friendly music company" that would release albums by clients such as actress-singer Mandy Moore and Army of Anyone, a group comprising the remnants of star '90s grunge acts Stone Temple Pilots and Filter.

The terms are similar to the Ice Cube deal. EMI is financing the venture and will distribute the records. The Firm will handle A&R, marketing, and promotion, and split profits evenly with the artists.

David Munns, vice chairman of EMI Music Worldwide, praises Kwatinetz: "He has a burning desire to reshape our industry." But other music-industry people dismiss Kwatinetz's talk about new business models. They say Ice Cube's record sales are nothing to brag about, and, yes, you still need a major label if you want to get anywhere in this business.

Kwatinetz also has a tendency to speak in grandiose terms about plans that don't always pan out. He says the Firm will be the successor to what he describes as "artist-friendly companies" like MCA, the legendary Hollywood talent agency.

He moved the Firm into the television and film businesses with the purchase in 2002 of Michael Ovitz's Artists Management Group for $12.7 million. That won him clients like Leonardo DiCaprio and Cameron Diaz. But the Firm had some tough financial times after the merger. It has also lost some high-profile acts like the Dixie Chicks. Kwatinetz says the Firm will soon be debt-free and is in "amazing" financial shape. But it's a long way from Lew Wasserman's fabled organization.

Kwatinetz, a Harvard-educated lawyer, says he is trying to diversify the Firm into a company that not only manages music clients but can produce and promote their records and oversee publishing, touring, and merchandising. He says this is what record companies did in the 1960s and '70s.

"The most enduring brands were created in that time," he explains. "Those are the brands that still sell concert tickets, that are still out there selling records, whether it is the Eagles, Pink Floyd, or even Chicago. The last time I saw them they had only two original members, and they were horn players."

Record sales became so profitable that the labels were willing to give up their revenue streams from ticket and T-shirt sales. That was great until Napster came along and CD sales plummeted. Kwatinetz argues that now these same companies are so focused on making their quarterly results from album sales that they can no longer build long-term careers for their artists.

"They are in a death spiral," he says. "The record business will shortly be extinct. But the music business, the business of creating music, will not be - because people love music."

All this raises an interesting question: Why is EMI acting as Kwatinetz's enabler, when he is out to show that big acts don't necessarily need big labels?

To get an answer, I visit David Munns at his office in the Capitol Records building on Hollywood Boulevard. The circular tower is a monument to the industry's glory days: Its hallways are decorated with iconic black-and-white photos of Capitol artists like Frank Sinatra, Duke Ellington, and Nat King Cole, many of whom recorded classic albums in the building. If you love music, this record factory is a wondrous place.

Munns tells me that EMI is making a minimal investment in Kwatinetz's record company. (A source familiar with the deal says EMI has committed up to $10 million, and that's only if the Firm meets certain "performance triggers.") "I believe in portfolio management, and that's what I'm doing here," he says. "I'm not going to start a third frontline label like Capitol or Virgin. It's a bet on Jeff Kwatinetz."

It's a risky bet. If Kwatinetz succeeds, who needs Capitol? Then again, the economy has not been kind to record companies. Could it hurt to be out front for once?

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.