The information contained in this article is not intended as a substitute for legal advice. Your contract and circumstances may be different. Always get legal advice before entering a binding agreement.
Music producers make a big impact the you album - they can also make a big impact on your budget. Like most things in the music business, it's important to remember that people deserve to be fairly compensated for the work that they do for you - but the key word is fairly. Most producers are wonderful, fair, music loving folks who want to help you make your songs the best that they can be. Some aren't, and a bad deal with a producer can haunt you for the entire length of your career. The best way to prevent that nightmarish scenario is to understand how producers are compensated for their work so you can evaluate any deal on the table.
First and foremost, it is important to remember that music producer contracts can vary GREATLY. Everything from the genre of music to the bargaining power of the producer will determine what kind of money they can demand, so unfortunately, there isn't a cookie cutter answer about producer compensation that will suit every situation. There are some generals you can keep in mind, however. Producers have two main streams of income (there's a third way - we'll get to that in a bit):
Let's take advances first. Some producers get no advance and some get upwards of $200,000 up front for their work. As a general rule of thumb, hip hop producers get more money because they tend to be much more integral in the final product than their other-genred counterparts - after all, they supply the beats, usually. Hip hop producers are often used as a selling point for releases as well, so their involvement in a project can really add a lot of value. In fact, matching an unknown hip hop artist with a well known producer can be a way of breaking that artist. That format is not 100% exclusive to hip hop, but it happens in that genre (and dancehall reggae) more than any other.
For other genres, the size of the advance is determined by the experience of the music producer. In other words, they can charge what people are willing to pay them, and people will pay them more if they have a distinguished track record of top selling releases. A brand new producer may receive no advance at all and do the work for the purpose of building up their portfolios. If the producer owns their own studio, the advance may be wrapped up with the actual recording cost in what is sometimes called a fund deal. With a fund deal, an artist is quoted a set price that includes both fees. It is important to for the producer to make clear in the contract how much of the fund goes to an advance and how much is considered a recording fee. Recording fees are not recoupable against producer royalties, so the higher the recording cost, the higher the non-recoupable expense the artist faces. Note that advances should be recoupable from the royalties paid to the producer.
Which brings us to royalties. Many producers get a percentage of an artist's royalties on an album. These percentages are also called "points" - one point equals one percent. It is common to see producers get between 3% and 5% for their work, though again, these numbers can vary.
One very important note about producer royalties - producers are paid what are called "record one" royalties, meaning they get paid on EVERY album sold, unlike artists, who only get royalties after recording costs have been recouped. To help make that easier to pay for the artists, most producer contracts specify something called "retroactive to record one," meaning the artist does not owe the producer any royalties until they (or often, their label) recoup their recording costs. However, once the costs are recouped, the producer is owed royalties on everything sold going back to the first record.
To illustrate that point, consider some (very small) round numbers. Pretend that in some alternative universe where recording is very cheap it takes 20 sales for recording costs to be recouped. Neither the producer or artist sees any royalties while they are waiting for those 20 records to sell. However, once record 21 sells, the artist gets paid a royalty on that one sale, while the producer is now owed a royalty for sales number 1 - 21.
Remember that third way I mentioned above? Some producer forgo advances and such and simply charge an artist a flat fee and then get out of the way. This is a great way for new producers and new artists to work together in a cost efficient way that will help both of their careers.
There are plenty of little extra goodies that can be attached to producer contracts, from secondary fees upon master delivery to a label to demands for points on subsequent releases. Although how these demands apply to you depends on the producer and where you are in your music career, it is in your best interest to limit the producer's involvement in your finances exclusively to projects in which they are directly involved.
As you can see, your accounts with your producer can get pretty complex. The bottom line is this - YOU are paying for the producer. Even if a label fronts the money, eventually, all costs associated with the production of your album will be charged back to you. Never sign a deal you don't understand, and don't sign a deal you don't think you're going to be able to realistically satisfy. Don't shy away from negotiating with a producer or getting a lawyer to do it for you. if you can't come to an agreement on advances, fees and royalties, then it is worth moving on to find a producer who is a better fit for your career right now.