Hollywood's Pirates of the Internet

Now we learn why Christopher Dodd, the retired Senator from Connecticut, is receiving over $1.5 million a year to head the Motion Picture Association of America.

The MPAA, the trade organization for the Hollywood studios, is financed by Warner Bros., Fox, Universal, Disney, Sony, and Paramount. Each provides about $10 million per year. Aside from efforts to suppress digital piracy, it lobbies Congress and regulatory agencies. Its crucial job here is to protect the Big Six’s crown jewels: their intellectual properties. Without their libraries of movies, animated shorts, and TV series, they couldn’t survive.

Consider Warner Bros. Its library has more than 60,000 licensable properties, including 6,500 movies and 40,000 TV episodes. Whereas its DVD sales have been on the wane, its TV licensing has skyrocketed. In 2010, according to sources at Time Warner, Warner Bros. harvested over $4 billion from worldwide licensing to TV. Nearly 80 percent came from just four cable customers—HBO, Turner, ABC Family, and NBC-Universal’s cable channels. Not only did this far exceed its share of theatrical box-office receipts, which were $2.4 billion in 2010, but this licensing is highly profitable: The studio pays none of the cost of advertising, prints, or logistics. Almost all proceeds, minus some residuals paid to third parties, go to a studio’s bottom line. Whatever the vagaries of the box office, licensing is the largest and most reliable source of profits for the studios.

But these golden geese are in danger of being strangled to death by video streaming. New age companies, notably Netflix, Amazon, Apple, and Google, now compete with cable TV by streaming movies and other video directly over the Internet. Netflix, for instance, offers unlimited streaming for $1 extra a month with its mail-in service, Amazon offers free streaming to its 10 million Amazon Prime customers, and Google offers YouTube free.

How can they afford it? Whereas the old-line cable and satellite companies have enormous building, servicing and amortizing costs, the Internet is essentially free to transmit over. Even if the new age streamers paid the same to license, buy, or produce content, they have a comparative advantage. “I don’t see how cable can compete with free transmissions,” a savvy top executive of Time Warner told me, pointing out that Netflix, after sublicensing Starz’s content, offers it for a fraction of what Starz charges its subscribers. No doubt Starz will end this bargain rate when its Netflix contract ends in October 2011, but so long as transmission remains free, streaming will chip away at the cable audience. “Cord cutting” will leave the cable systems with diminished revenue but the same overhead. “If 5 percent cut their cord, it would be a financial disaster for cable networks,” said a pay-TV executive. The result: cable nets would cut back on the amount they pay for content (which has happened in the case of pay-TV channels).

The Hollywood studios not only risk losing billions of dollars in licensing revenues, but their corporate parents own almost all the big cable networks. Since anti-trust law prevents the studios from meeting to restrain trade, they must act through the MPAA.

Enter Dodd. While technically prohibited from lobbying Congress until 2013, he can provide guidance to the MPAA’s massive D.C. lobbying operation. And as a former chairman of the Democratic Party and former head of the Senate Banking Committee, he knows how the who-gets-what system in Congress works.

Among other things, the MPAA has sidled into the battle raging at the FCC over regulation of the Internet regarding so-called net neutrality, which would guarantee anyone could send anything at no cost over the Internet. Proponents argue that free, untampered with transmission is vital to democracy (and their businesses). They have the support of FCC Chairman Julius Genachowski, a former IAC executive.On the other side are the telecom and cable companies that argue it’s their right to manage traffic that goes through their pipelines as efficiently as possible. Just as cities should be able to manage vehicle traffic by discriminating against trucks on certain streets, they say they should be allowed to segregate traffic along their routes, even if it results in slower, and possibly more expensive, video streaming. Here the interests of the telecoms, the cable networks, and studios converge.

The PR-acceptable issue that Dodd can use his considerable skills and connections to both solidify such an unwieldy alliance and lobby Congress is internet piracy. So we now have the MPAA supported Stop Online Piracy Act (SOP). The formidable roadblock to it is the powerful influence that the Internet titans have over the Obama administration. Hence the current war over SOPA.

The 69th Annual Golden Globe Infomercial

If the Golden Globes infomercial did not exist, NBC might have had to invent it to compete with ABC’s Oscar Awards. Fortunately, for NBC,the Hollywood Foreign Press Association (HFPA),  an otherwise obscure group,  had invented this award-ceremony in 1944 during a free lunch for its members in the 20th Century Fox commissary. Although its dozen or so "members" were mainly war refugees in LA. The German occupation of their homelands had made most of them correspondents without a country, but they loved movies. At this point, Twentieth-Century Fox’s ingenious studio head Darryl F. Zanuck saw that they offered a highly-valued product in Hollywood: awards for studio movies. Since the Academy of Arts & Sciences had passed over his studio's Song Of Bernadette for the "Best Picture" Oscar in 1943), why not accept the "Best Picture" award-- as well as Best Director" and Best Actress-- from the Hollywood Foreign Press Association (although the "association" had not yet put together enough money to design the "Golden Globes.") So, with a little largesse from the studios, another annual Award ceremony-- and opportunity for product placement-- was born.

In short order, the Hollywood Foreign Press Association came up with a slew of other awards that appealed to studio chiefs, such as "Best Film for Promoting International Good Will," "Best Film Promoting International Understanding," "Best Non-Professional Acting," "Hollywood Citizen Award," "Ambassador of Good Will," and a special award for "Furthering the Influence of the Screen" (which went to the Hindustani version of Disney's Bambi.) With them, it managed to promote free dinners for its members at celebrity hangouts including Ciro's, the Coconut Grove and the polo lounge of the Beverly Hills Hotel.

For a while, it was run by Swedish twin brothers; Gustav and Bertil Unger, who were tap dancers. Gustave wore his monocle in his right eye, Bertil in his left, and one consideration in picking winners was who they could get to show up.

But despite the fun, the enterprising group only began to make real money when Ted Turner elected to televise its informational in the 1980s, a gig taken over by NBC in 1996 (which paid the HFPA roughly $3 million a year for the broadcast rights.)

Nowadays it is of no matter that the 82 members who vote the awards are mostly free-lance writers and photographers with day jobs or that they have little, if any, connection with the Hollywood community. As the Hollywood Reporter observed "The studios couldn't care less whether the awards are decided by isolated Benedictine monks in the Himalayas or angels on high, at least not since the Globes have evolved into a tremendous marketing tool." As such, it offer scripted speeches by stars, promotional clips from movies, and nostalgic eulogies to some 20 million viewers. And by this time the value of public self-congratulation has become so inculcated in the Hollywood culture that one producer complained to me, "These ceremonies have taken over our social life. Almost every week we get into our formal gear, push through a gauntlet of paparazzi to get to some ballroom, give ourselves awards for everything from movies to lifetime achievements, and then applaud ourselves." Nevertheless, Hollywood’s star troopers suited up last night for yet another black-tie award ceremonies, NBC got its high ratings, the media could report, as if it was a news event that Social Network, won best movie, and Hollywood got yet another infomercial

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THE HOLLYWOOD ECONOMIST
RISE & FALL OF DIAMONDS
AGENCY OF FEAR
HAVE YOU EVEN TRIED TO SELL A DIAMOND?
THE BIG PICTURE
THE JFK ASSASSINATION THEORIES
JIM GARRISON'S GAME
ARMAND HAMMER:
ZIA'S CRASH
MYTHS OF THE MEDIA
WHO KILLED GOD'S BANKER
THE ROCKEFELLERS [August 9]
THE CRUDE CARTEL [Aug 9]

KILLING CASTRO [Aug 9]
TABLOID AMERICA:
CRIMES OF THE PRESS [Aug 9]

How Hollywood Reads The Latest Numbers

The latest market research by the MPAA carries a clear message to the marketing arms of the studio: target the young.


This is important to what we see because the six major studios rarely, if ever, green light a project unless it is certified as “marketable” in America. What makes a movie “marketable” is that the marketing arm finds that it contains the action, stars, visual effects or other elements that it needs to put in 30 second television ads to activate millions of people on a particular weekend to go to the opening of a movie at thousands of screens across the country. This operation is extremely costly. The average ad budget was $32 million for wide-released movie in 2010. But even with such huge budgets, given the cost of TV advertising, studios usually can only afford seven times coverage, which means hitting the same television audience 7 times in the weeks prior to its opening. To be effective, not only must the ads resonate with those targeted, but those targeted must be people who are frequent movie-goers. If they are not, even if the ads excite them, they are unlikely to go to that movie. So the marketability decision really comes down to a single issue: Will a proposed movie yield the kind of ads that will reach frequent movie goers at a cost the studio is willing spend?

In the pre-television era, there was no problem finding frequent movie goers. That job description indeed fit most Americans. As late as 1948, sixty percent of all Americans routinely went to the movie theaters in an average week. But, alas, that is no longer the case. According to the 2010 Theatrical Market Statistics Report, “frequent movie goers,” now defined as people who go at least once a month, constituted “only 11% of the population.” The MPAA, which published the research in February 2011, correctly pointed out, “This relatively small group is the locomotive of the industry, now responsible for more than 50% of ticket sales.” If anything, that assessment may be an understatement. Without these frequent movie goers, and their popcorn and soda purchases at concession stands, the multiplexes could not remain in business. In 2000-2001, for example. just a 5% decline in theater attendance drove almost half the movie theaters in America to file for bankruptcy. The clear mandate of studio marketing department thus is to sift out the few frequent movie-goers from the masses, and then, once isolated, to laser-beam them ads.

But who are they? According to the MPAA report, 47 percent of the total are under 25 years old. Fortunately for the marketing arms this demographic group is easily reachable because its members to concentrate their attention on the same cable television shows. Even better, they also are of prime interest to the merchandisers, such as McDonald, Dominos, and Pepsi who are willing to make merchandising tie-in deals with the studios (such as handing out toys based on the characters in the movie.) Such deals greatly amply the reach of a movie’s ad budgets to this prized frequent-goer group.

Of course, with the aging of the American population, there is also a sizable grey-haired audience of frequent movie goers, but it is much smaller and more difficult to locate. The MPAA research shows 8 percent of people 50 to 60 are frequent movie goers, but, as this more elderly audience does not cluster around MTV-style programs, attempting to bombard them with 30 second ads is a risky business. Even if they find programs watched by people 50-60, 92% of them are not frequent movie-goers. And marketing executives are not prone to taking such risks with the studio’s money. After all, they have to worry about losing their jobs if their campaign goes wrong. So while adult-oriented films can garner critical acclaim, Oscar nominations, and even make money, they are not likely to be deemed marketable.

The 2010 data merely reinforces what has become the marketing play book of Hollywood: Green-light the movies whose action, visual effects or iconic stars can be used in 30 second ads to stampede the herd of youth into the multiplexes .

Netflix's Brick Wall

In the past three years, Netflix has been merrily speeding ahead on the streaming highway.


It has induced a large portion of its 20 million mail-in subscribers to watch movies that are electronically transmitted, or “streamed,” to their television sets, computers, or mobile gadget. Perhaps 5 million or more of its monthly subscribers are now using the streaming service instead of getting their DVDs in the mail. In the process, Netflix saves hugely in its postage and handling charges.

While Netflix’s conversion of a mass audience to a geek technology in such a short time period is no doubt a phenomenal achievement, it is now heading straight toward a brick wall. Its crucial 3-year licensing contracts for the electronic transmission of both movies and TV programs will begin expiring in just 7 months. When Netflix had made these extraordinary deals in 2008-9, streaming movies was of such little monetary value to traditional media that its newly-created digital sales divisions were willing to license these rights to Netflix at a small fraction of the price that the rights for the same content was licensed to cable and pay-TV channels.

What content-providers had not reckoned on in making these digital deals in 2008 was that Netflix’s streaming would directly compete with its cash cows such as cable and telecom systems. Netflix, with its bargain-basement licensing fees, could offer an unlimited number of streamed movies and TV programs, instantaneously delivered to their TV screens, for $8 a month, while pay-TV channels were charging $14 a month.
Not surprisingly, as Netflix became an increased threat by 2010, the cash cows made it crystal clear to the content providers that this bargain had to be ended when its contracts are renewed. 
The first speed bump Netflix will hit is in October 2011 when its contract with Starz Entertainment runs out.

Starz, which has output deals with Disney and Sony, had sub-licensed in 2008 to Netflix the electronic right to stream those movies for less than $30 million. That amount was about one-twentieth of what the studios charged pay-TV for the same movies.

But there is no way that Starz can renew that deal at the expense of its cash cows. Indeed, it has already assured its cable, satellite and telecom customers that it intends to establish “pricing parity,” as its CEO Chris Albrecht made clear. So if Netflix wants to continue getting Disney and Sony new movies via Starz, it will have to pay the equivalent as Starz’s conventional licensees. In dollar terms, according to industry insiders, this will mean that Netflix will have to pay an additional $300 to $400 million a year to stream new movies.
And this is just the beginning.
As Netflix’s other contracts expire in 2012-3, its other content suppliers, including television networks, will also hike the price. To stay in the game, Netflix’s licensing cost will rise, according to the estimates of content providers, by at least a half billion dollars.
That is in addition to the $1.2 billion it is presently paying to license digital content (including its deal with EPIX).

Netflix would require 5 million or so new subscribers to offset the additional $500 million cost. Finding them will be far more difficult than when it launched its service and had no formidable competition in the streaming arena.

Now it has competition from all directions: Amazon has just launched this year a movie streaming service that is absolutely free to its 10 million users of Amazon Prime. Apple’s iTunes store and Google (YouTube et al) are also moving more deeply into the streaming business.
Then there is Facebook. Here Warner Bros broke the ice by using it to stream the Batman movie “The Dark Knight.” And by now all the major TV networks and Pay-TV platforms are streaming their programs from their websites on demand.
Through the power of its brand and computer savvy of its management, Netflix may well garner a big enough herd of streamers to plow through the brick wall of rising licensing fee. But it won't be easy.

The Golden Globe Infomercial

If the Golden Globes infomercial did not exist, NBC might have had to invent it to compete with ABC’s Oscar Awards. Fortunately, for NBC, an otherwise obscure group calling itself the Hollywood Foreign Press Association (HFPA) had invented this award-ceremony in 1944 during a free lunch in the 20th Century Fox commissary. Although its dozen or so "members" were mainly refugees in LA. The German occupation of their homelands had made most of them correspondents without a country, but they loved movies. At this point, Twentieth-Century Fox’s ingenious studio head Darryl F. Zanuck saw that they offered a highly-valued product in Hollywood: awards for studio movies. Since the Academy of Arts & Sciences had passed over his studio's Song Of Bernadette for the "Best Picture" Oscar in 1943), why not accept the "Best Picture" award-- as well as Best Director" and Best Actress-- from the Hollywood Foreign Press Association (although the "association" had not yet put together enough money to design the "Golden Globes.") So, with a little largesse from the studios, another annual Award ceremony-- and opportunity for product placement-- was born.
In short order, the Hollywood Foreign Press Association came up with a slew of other awards that appealed to studio chiefs, such as "Best Film for Promoting International Good Will," "Best Film Promoting International Understanding," "Best Non-Professional Acting," "Hollywood Citizen Award," "Ambassador of Good Will," and a special award for "Furthering the Influence of the Screen" (which went to the Hindustani version of Disney's Bambi.) With them, it managed to promote free dinners for its members at celebrity hangouts including Ciro's, the Coconut Grove and the polo lounge of the Beverly Hills Hotel.
For a while, it was run by Swedish twin brothers; Gustav and Bertil Unger, who were tap dancers. Gustave wore his monocle in his right eye, Bertil in his left, and one consideration in picking winners was who they could get to show up.
But despite the fun, the enterprising group only began to make real money when Ted Turner elected to televise its informational in the 1980s, a gig taken over by NBC in 1996 (which paid the HFPA roughly $3 million a year for the broadcast rights.)
Nowadays it is of no matter that the 82 members who vote the awards are mostly free-lance writers and photographers with day jobs or that they have little, if any, connection with the Hollywood community. As the Hollywood Reporter observed "The studios couldn't care less whether the awards are decided by isolated Benedictine monks in the Himalayas or angels on high, at least not since the Globes have evolved into a tremendous marketing tool." As such, it offer scripted speeches by stars, promotional clips from movies, and nostalgic eulogies to some 20 million viewers. And by this time the value of public self-congratulation has become so inculcated in the Hollywood culture that one producer complained to me, "These ceremonies have taken over our social life. Almost every week we get into our formal gear, push through a gauntlet of paparazzi to get to some ballroom, give ourselves awards for everything from movies to lifetime achievements, and then applaud ourselves." Nevertheless, Hollywood’s star troopers suited up last night for yet another black-tie award ceremonies, NBC got its high ratings, the media could report, as if it was a news event that Social Network, won best movie, and Hollywood got yet another infomercial.

Why Indie Movies Are An Endangered Species

Up until 2008, it was not easy to finance an independent film but, with the right script, stars, and director, the entire budget could be borrowed from banks on the strength of pre-sale agreements. What had made this business model work then was the likelihood the film had of getting meaningful distribution in the US domestic market (which includes Canada). Most of the better financed indie distributors, such as Miramax, New Line, and Paramount Vantage, were owned by the major studios that had bought these companies for, among other reasons, to expand their DVD shelf spaces at WalMart and other retailers. Their willingness to make commitments to distribute movies domestically had a great advantage overseas: it greatly increased the value of pre-sales, since foreign distributors benefitted from the buzz and publicity from an American opening. Indie producers also could rely on domestic market to get a substantial part of their financing. Prior to 1990, they could get over fifty percent of their movie financed based on the value of the domestic market. Even though the value fell as distributors cut their commitments in the 1990s, the domestic market could provide a producer with 20-30 percent of his budget as late as 2007. And with that keystone in place, a producer could get the balance from foreign pre-sales and government subsidies. This formula was not perfect but it allowed indie producers to make such award winning films as The English Patient, Traffic or Babel. In 2008, however, he value of the American market virtually disappeared for the purpose of financing a movie. As one top producer told me in late 2010 ,”it is now zero.”

What caused this sudden decline was the closing of most of the studio-backed specialty distributors. Within the space of a few months, New Line Cinema, Miramax, Fine Line Features, Picturehouse, Warner Independent Films, Fox Atomic, and Paramount Vantage shut down. Most of the remaining ones, sharply cutback on making advance commitments. The causes of this cratering ranged from faltering DVD sales in large retail chains to the ending of output deals by HBO and other Pay-TV channels.

The result was that indie producers had to base their ability to borrow money almost entirely on the foreign market. Yet, foreign distributors then greatly reduced the amount they were willing to commit because they could no longer be confident that indie films would have the publicity and hype that goes with an American release. Making matters worse, three of the top seven markets, Japan, Spain, and Italy, sharply cut back on making pre-sales deals. So it was nearly impossible for a producer to assemble enough pre-sales in the remaining major foreign territories– Germany, Britain, France and Australia– to finance the film.

Even so, in theory, it was possible to raise the additional funds through government subsidies and tax shelter (which can provide 30 percent of the budget.) In reality, however, both pre-sales and subsidy agreement are just pieces of paper. To convert them to cash, the producer must bring them to a bank willing to accept them as collateral. And no bank will make such a loan without another piece of paper, called a completion bond, which guarantees that the movie, come hell or high water, will be delivered to the foreign distributors with all the elements, such as stars, specified in the contracts. So the producer must accede to the terms of one of the companies who sell completion bonds. The problem here is that the accommodations that must be made eat up a large part of the loan.

To begin with, banks will no longer will provide 100% of the value of the contracts. The best a producer can obtain is 80 percent minus the bank fees and pre-paid interest. From what remains, the foreign sales agents will deduct their fees, which usually run about 20 percent of total foreign sales. Then the completion bond company will deduct its fee and require the producer to segregate a portion of the loan in an account under its control for unforeseen contingencies. Even though a few top producers are able to negotiate lower fees and better terms, most indie producers wind up with no more than half the money he needs for the movie.

Consider, for example, the case of a producer who needs to raise $10 million to shoot a film. Assume that he has lined up all the ingredients necessary for international sales, including three stars, that his foreign sales agent, who got the standard 20 percent commission, arranged $8 million in pre-sales contracts, and that he has received commitments for government subsidies and tax credits worth $3 million.. So, on paper, he has $11 million to make a $10 million movie. In addition, he has bought a completion bond from an insurer and found a bank willing to loan him money

In this case, the bank lent him 80 percent of the value of the $11 million collateral, or $8.8 million. From that sum, the bank deducted its 3 percent fee, or $264,000. It also required that the producer set aside in an escrow account the interest on the loan for 18 months. At a blended rate of five percent, this amounted to $660,000. So there is only $7,876.000 available from the loan.

Next, the producer was contractually obligated to pay the foreign sales agent his 20 percent fee, or $1,600,000. Now he had only $6,276,00.

Then the completion bond company takes its 2.6 percent fee, or $260,000, and requires that 10 percent of the budget, or $1 million, be set aside for “contingencies” and $200,000 be set aside for the “deliverables” (which is the material that has to be delivered to foreign distributors before they pay for the rights.). After meeting these terms, the producer has only $4,816,000 left from the loan, or less than half the money he needed to shoot the movie.

How can a producer close such a yawning gap? If he reduces the budget by cutting out any of the stars or other specified production values, he will violate the terms of the pre-sales and subsidy contracts. So unless he wants to re-negotiate with everyone, he has to stick to the budget. Nor can he borrow more money against the collateral since he has mortgaged his production to the hilt.

This leaves the producer only one feasible way to fill the gap: finding an equity investor to buy part of a movie that has not yet made. Making this even a harder task, , all the salable foreign markets have been disposed of. So the only real asset that remains is the 20 percent tier of the foreign contracts and subsidy contracts which is not covered by the bank loan. This is also the riskiest tier. But if all goes well that 20 percent will yield $2,200,000 which can be committed to repaying the equity investor after the film is delivered in all the foreign markets. But that still leaves an unsecured gap of $3 million. If the producer manages to bring the movie in on budget, the $1 million fund held for contingencies is released by the completion bond company, and this money then can be used to repay the equity investor. Even so, the investor still has $2 million at risk. To get back this money, and make a profit, he must gamble that the unsold American rights will be sold after the movie is completed. But not all indie films ever get distributed in theaters of America . Every year tens of thousands of movies are submitted to film festivals, only a few dozen get meaningful distribution in theaters. And without such distribution, a movie has little chance of being licensed for TV or getting shelf space in major retailers for its DVDs.

Despite these odds, indie producer often do succeed in finding investors to fill the gap and produce award-winning movie. But this flawed business model also exacts a price. As one of the leading indie producers told me “The new number crunching game has caused the production budgets of films to collapse, so that what we used to make for $10 million a few years ago, needs to be made for $5 million now -- if it can be made at all! And meanwhile, all the hard costs of production (union rates, equipment, locations, etc.) have gone up, which means that producers now have to figure out how to deliver the same production value for much less than 50 percent of what they used to get to get the job done.” The picture may of course brighten in the future with new specialty distributors, such as the new Miramax, Anchor Bay, Film District, and reorganized MGM, getting into the act. 
It is also possible producers may soon be able to borrow against new forms of distribution, such as Video-On-Demand.  Even so, as long as the American market lacks value for the purpose for the advance financing of movies, indie producers have a difficult, if not impossible, road to hoe.

***