THE HOLLYWOOD ECONOMIST

Hollywood's Pirates of the Internet

2012-01-19T06:56:00.000-08:00

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

2012-01-15T08:01:00.000-08:00

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

My New Ebook Experiment

2011-07-29T07:13:00.000-07:00

E-BOOKS on Kindle, Nook, Ipad, Smashword

http://www.edwardjayepstein.com/cyberbooktable.htm

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

2011-04-08T12:16:00.000-07:00

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

2011-04-07T07:58:00.000-07:00

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

2011-01-17T06:29:00.000-08:00

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

2011-01-07T15:16:00.000-08:00

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.

***

Is Netflix Streaming Towards Disaster

2010-12-02T14:24:00.000-08:00

Netflix, through the simple device of using the post office to bypass video stores, has become one of the great success stories of the new entertainment economy. It now claims 16 million subscribers who pay a monthly flat fee for an unlimited number of rentals. For this mail-in business, Netflix did not need the approval of the studios. It simply buys DVDs, as does anyone else, from retailers such as Wal-Mart then mails them out to subscribers. What makes this form of rental legal is the “first sale doctrine,” which holds that once a person buys a DVD, he can rent it out to others without the permission of the copyright holder. Through that court-approved doctrine , Netflix created its mail-in empire. For a monthly charge of as little as $9 a month, subscribers get any movie they choose on the Netfix website. Whenever a subscriber mails back his DVD in a stamped address envelope provided by Netflix he receives the next DVD he has ordered. There are no late fees. Rather than backing its trucks up to Wal-Marts, Netflix buys most of its DVDs from wholesalers. Its average price of about $15 per copy. (Some studios also supply lower priced DVDs in return for Netflix delaying its mailing them until a month after they are in video stores.)
Last year, Netflix took in $1.67 billion in subscription fees. For its mailing business, its major expense, other than purchasing the DVDs, is postage and handling. It sends out about 2 million discs a day, which requires maintaining 50 distribution centers and buying over a half billion dollars worth of postage. Because of these expenses, its operating profit was only about 12 percent.
Netflix is now attempting to reduce its vulnerability to postage rate hikes by streaming movies over the Internet. Reed Hastings, the chief executive and co-founder of Netflix, explained that this new strategy is part of his concept that Netflix is not just as a mail-order house but a full-service home entertainment distributor since streaming provides movies in digital form on everything from Ipad, and Iphones, to game console and TV sets. Over the last three years, this streaming experiment has garnered a growing number of subscribers partially because it has been absolutely free to the subscribers of its mail-in service. Next year, however, it plans to charge for its streaming service. If it succeeds in converting its mail subscribers to streaming, it will in effect create a virtual channel that directly competes with the three major Pay-TV channels, HBO, Showtime, and Starz.
The problem here is that while streaming movies is a more efficient way of delivering movies than the mail, it requires a radically different business model. Unlike with mail-in DVDs, the first sales doctrine does not apply to streaming. So Netflix needs to license the electronic rights from the studios, and that is extremely expensive. In the case of new movies, studios license slates of 20 or so titles in so-called output deals for hundreds of millions of dollars. The average cost for a single title in such a deal is about $16 million for a two year license. Where Netflix can buy 10,000 copies of a major title for $150,000 to mail out, it will need to spend about $16 million to license it for streaming. Such a 100 fold increase in price can obviously be deleterious to profits especially since Netflix still has to maintain its mailing centers, and buy DVDs, for the subscribers who elect to continuing using the mail-in service either because they prefer DVDs’ higher quality and features or they don’t have the apparatus to receive digital streaming.
For the past 3 years, while building up its streaming service, Netflix found a temporary way around the licensing issue by making a sub-licensing deal with Starz Entertainment, a subsidiary of John Malone’s Liberty Media, which has its own output deal with Disney and Sony. paying Starz only $25 million a year for electronic sub-rights. Disney sued Starz claiming that such a deal violated the output agreement, but Starz held that it could sub-license these rights because Netflix was merely a “content aggregator.” No matter what happens in the litigation, the loophole will certainly be plugged in 2012 when Starz’ output deal expires. Not only will Disney likely demand on a payment for sub-licensing, but Starz itself has recently informed its other licensees that it will no longer discriminate in pricing, which means that Netflix will have to pay what everyone else pays for content.
And Netflix’s renewal problem is not merely with Starz. It also managed to license in 2008 the electronic transmission rights until 2012 for television programs, such as “The Office,” from networks. At that time, syndicators were only interested in the broadcast rights for re-runs of these series, and, as the streaming rights had little value, they licensed them at bargain prices. But the networks now have streaming, and video-on-demand of these programs on their own website, making it highly unlikely they will renew the expiring agreements.
The brutal reality is Netflix’s bargain days for streaming movies and television are coming to an end. As everyone else in the licensing game, Netflix will have to pay real world prices for content. Just the output deal it announced with three of the weakest studios, Paramount, LionsGate and MGM will cost it $200 million a year, a sum that exceeds its operating income last year. And if it wants the kind of output deals the other pay channels have, it will have to pay a great deal more than that.
Netflix, to be sure has brilliantly dominated the DVD mail order business. But, even aside from the immense cost of content, it must overcome three daunting challenges to succeed in the brave new world of cyber space.
First, it will have to compete directly with Pay-TV channels. HBO, which has nearly 40 million subscribers and a yearly cash flow of $1.8 billion, is not about to cede cyberspace to Netflix. It has just launched HBO GO which will stream to HBO subscribers “anything they want to see, anytime, anywhere, over their laptop, Iphone, tablet, Playstation”, according to Jeffrey Bewkes, the Chairman of HBO’s parent, Time Warner Communication. This includes not only the new titles, it acquires through its $500 billion output deals with Warner Bros, Fox, and Dreamworks but its prize-winning original series.
Second, since there are few barriers to entry to cyberspace, Netflix will also have to compete in pricing Internet savvy companies, including Apple, Amazon, Hulu and Youtube, all of whom can offer similar streaming services.
Third, as Netflix’s streaming consumes more and more of the capacity of broadband carriers such as Comcast, it will have to contend with either restrictions or usage charges that will increase the cost of streaming.
If Netflix fails to meet these challenges, its bold move into streaming might be nothing short of a prescription for financial disaster.

Role Reversal: Why TV Is Replacing Movies As Elite Entertainment

2010-10-13T06:40:00.000-07:00

Once upon a time, over a generation ago, The television set was commonly called the “boob tube” and looked down on by elites as a purveyors of mind-numbing entertainment. Movie theaters, on the other hand, were considered a venue for, if not art, more sophisticated dramas and comedies. Not any more. The multiplexes are now primarily a venue for comic-book inspired action and fantasy movies, whereas television, especially the pay and cable channels, is increasingly becoming a venue for character-driven adult programs, such as The Wire, Mad Men, and Boardwalk Empire. This role reversal, rather than a momentary fluke, proceeds directly from the new economic realities of the entertainment business.

Consider what happened to Pay-TV. Back in the 1970s, HBO provided something home viewers could not get elsewhere: movies uninterrupted by commercials. It was, as a HBO executive put it, “the only game in town,” so its subscribers paid a monthly fee, no matter how little or often they watch it, to their local cable provider who in turn forked over a share to HBO. As the cable systems grew, so did HBO. By 2010, it had (including its Cinemax unit) over 40 million subscribers, and just the monthly fees produced cash flow of over $1.5 billion a year. Getting new movies was no problem. HBO simply licensed them from a few major studios for an exclusive period (which began a few months after they were released on video and DVD) in so-called “output deals.” To continue to harvest this immense bounty, HBO had merely to stop subscribers from ending their service.

But that feat became far more difficult as alternatives became readily available, including video stores, Netflix, and the Internet. Why should anyone pay a monthly fee to see movies on pay TV when it could get it else where cheaper and faster? The answer HBO executives found was to create its own original programming designed to appeal to the head of the house. Here it had several advantages over Hollywood. It did not need to produce a huge audience since it carries no advertising and gets paid the same fee whether or not subscribers tune in. Nor did it have to restrict edgier content to get films approved by a ratings board (there is no censorship of Pay-TV). And it did not have to structure the movie to maximize foreign sales since, unlike Hollywood, its earnings come mainly from America. As a result, HBO and the two other pay-channels, Showtime and Starz, were able to create sophisticated character-driven series such as The Wire, Sex and the City, The L Word, and The Sopranos. As this only succeeded in retaining subscribers and also achieved critical acclaim, advertising-supported cable and over-the-air network had little choice but to follow suit to avoid losing market share. The result of this competitive race to the top is the elevation of television.

Meanwhile, Hollywood went in the other direction. In the era of the studio system, the Hollywood studios opened their movies in a few dozen select first-run theaters, most of which they owned, and then, with the help of critical acclaim and favorable word-of-mouth, gradually moved them into local theaters. To accomplish this, they did not need huge advertising or print budgets. Nowadays, confronting a very different economic landscape, they open most of their major movies on 3,500 to 5,000 screens which are owned not by them but by a handful of multiplex chains. Multiplexes are in the “people-moving business,” as on multiplex owner put it, which means moving herds of movie-goers past the concession stands In return for providing their screens, these chains expect the studios to provide them with two things: first, lavishly-produced movies; second, and even more important, a national marketing campaign for each movie that will fill their multiplexes with consumers on opening weekend. Since such campaigns cost about $30 millions of dollars per movie, studios require that their marketing arm sign off on each project before it is greenlit for production. For the marketing executives, the deal-breaker is not the intrinsic merits of the film itself but the absence of the elements needed to build a marketing campaign both in America and abroad (where up to 65 percent of the revenue comes from.) Such campaigns typically require buying time on TV programs around which clusters an audience predisposed to going to the movies every weekend and then hitting it with 7 ads in the week leading up to its opening weekend. The target audience that fits this bill is tweens and teens, which are also the groups with the greatest propensity to consume popcorn and soda.

The least risky way to find movies that lend themselves to campaigns around which a global marketing can be built is to copy the movies for which marketing campaigns have succeeded in driving the requisite audience into the multiplexes; hence, the profusion of comic book-based movies and their sequels. In addition, studios must take into account that their movies must play in overseas markets, such as Korea, Japan, China, Russia, and Brazil, where visual action takes precedence over sophisticated dialogue. So the dumbing-down of movies is no accident.
Its after all show business.

Blockbuster Busted

2010-09-24T06:09:00.000-07:00

Blockbuster, one the world's largest renter of Hollywood movies, filed for bankruptcy on September 23, 2010. To understand why its collapse was inevitable in a digital world, see my January 2006 article in Slate (below)
http://www.edwardjayepstein.com/zombie.htm

Hollywood Accounting Demystified

2010-07-18T14:53:00.001-07:00

"STUDIO SHAME!," shouts the headline on Nikki Fink’s Deadline" website, "Even Harry Potter Pic Loses Money Because of Warner Bros’ Phony Baloney Net Profit Accounting." To prove its contention, it posted Warner Bros; September 2009 distribution report for Harry Potter and The Order Of The Phoenix, and reported, as if it revealed some shameful scandal, that while the 2007 film "grossed $938.2 million worldwide," it still remains "over $167 million in the red."
The outpouring of indignation over movie studio "phony" accounting clearly resonated with a public concerned over corporate predatory practices, with comments from readers calling for RICO prosecution of Warner Bros. But what is called Hollywood accounting is in reality a form of self-deception in an industry driven by ego considerations.

Every Hollywood production is a temporary collaboration between a studio and hundreds of independent contractors, which includes actors, directors, producers, writers, and technicians. The rules governing how each of them will be paid is set forth in their contracts which negotiated and vetted by their lawyers, agents, and financial advisers. In almost all cases, they get fixed compensation for their work, which is unaffected by the profitability of the movie or whatever accounting ploys are used to determine it. They may also get contingent compensation in the form of either "gross points" or "net points" that is dependent on the accounting definitions in their contract. "Gross points," if they begin at "dollar one," are payments based on a percent of the total revenues that flow after out-of-pocket expenses are repaid. Or "Gross points" may begin after certain conditions specified in the contracts are satisfied. In either case, "gross points" do not depend on the profitability of the film. "Net points" are another story. The payments here depend on a movie achieving a net profit after the studio back its investment, interest, overhead, distribution fee and pays all the gross players. In most cases, as David Mamet has said famously, "there is no net." And everyone in the film industry knows that with a standard studio contract, there is little, if any, chance they will see a penny from "net points" So why do they sign a contract with net points? The answer, in a word, is money. They want to be paid the fixed part of the fee and have an opportunity to be in the movie to further their career.
Yes, it is true that Harry Potter and The Order Of The Phoenix lost money on its theatrical run, but so do almost all Hollywood movies. Here is why. The reported box-office "gross" that so fascinates the media is what the theaters take in , not what the studios get. Of the $938.2 million worth of tickets sold for this Harry Potter sequel, Warner Bros.' distribution arm got only $459.3 million. Out of that sum, it reimbursed itself the out-of-pocket costs. These cash expenses came to a staggering $182.6 million, including $29.2 million paid to labs for the prints, $131.1 million paid to TV stations, newspapers and other media for ads, $8 million paid in taxes to foreign governments, $5.6 million paid to dubbing studios, and $3.5 million paid to UPS and others for shipping films abroad. This is a huge amount of money but it is what it needed these days to get a film into 7000 theaters around the world and drum up an opening night audience in 50 countries. What remained after these expenses was just $276.7 million.
Since the negative cost for this Harry Potter film was $315.9 million (which included the payments to the author and other gross players ), the film was in the red after its theatrical run. But so what? Theaters are only initial harvest of money. The real profits in Hollywood come from harvesting the back-end, which includes the DVD market, Pay-TV (HBO), and TV network and cable licensing.
In any case, Harry Potter and The Order Of The Phoenix made money for everyone involved in it. Even if does not have a "net profit, Warner Bros. has a 30 distribution fee. So it rakes its cut off the top. In September 2009, which is before most of the lucrative TV licensing revenue comes in, it had already earned $211.8 million from this fee. And DVDs are even a richer deal for it. After paying a 20 percent royalty into the account of the film, its video distribution arm gets the other 80 percent. So, on the $440 million of DVD revenues to date, it got $352 million. From this sum, it has to pay most of the cost of manufacturing, warehousing, and marketing the DVDs, as well as a percent to the author of Harry Potter, J.K. Rowling, who has a "100 percent" accounting clause in her contract, but, even so, it has a bonanza of about $200 million.
The guilds and unions also got paid. Their residuals on television licensing and DVD sales amounted to $10.2 million in 2009 ( a sum that will rise substantially as the film is released in TV markets over the next 30 years.)
The gross players also did not lose. They got a percent of the revenues, either from " first dollar," as was the case of J.K. Rowling, or when the film reached the "cash break-even" point defined in their contract. These payments, which reportedly amount to over $50 million, have been added to the negative cost of the film (which is why it is now over $300 million.)
And of course everyone else gets paid their fixed compensation, including writers, actors, and producers. True, they may never receive any money from their "net points," but, given the contracts they willingly signed, they had no reason that they would pay off. What they got from them were bragging rights, and in Hollywood, where ego satisfaction is the coin of the realm, that is not small change.
***

Eyes Wide Shut: Why Journalists Don't Understand Hollywood

2010-06-01T07:31:00.000-07:00

There was a time when the box office numbers that were reported in newspapers were relevant to the fortunes of Hollywood. Up until the 1950s, the major studios owned most of the large theater chains and made virtually all their profits from their theater ticket sales. This was before television sets, VCRs, and DVD players became ubiquitous in American homes, and before movies could be downloaded and streamed into computers, smart phones and Ipads.
Today, Hollywood is in a very different business: creating rights that can be licensed, sold, and leveraged over all many different global platforms, including movie theaters, Pay Per View, DVDs, pay television channels, cable television, free television, and toy licensing. And while the box office at American theaters continue to be a part of this stream, they account for less than 15 percent of the total revenue. Yet, media continue to breathlessly report the American box office numbers every week, as if they still represented the profits and losses business of Hollywood.
Such reporting leaves their audience, much like a movie audience, in the dark about the true business of Hollywood. Even the numbers themselves are grossly misleading when used to describe what a film or studio earns because they represent what theater chains get from ticket sales, and the studios no longer own or control these chains. The distributor of a movie gets a portion of these ticket sales, usually about 50 percent and then immediately deducts from these proceeds its outlay for prints and advertising, which is called "P&A". In 2007, the most recent year for which the studios have released these expenses, P&A averaged about $40 million per title, which was more than they typically received from their share of American ticket sales In addition, the distributor deducts a hefty distribution fee, usually between 15 and 33 percent of the total theater receipts. Therefore, no matter how well a movie appears to fare in the box office race reported by the media, it is usually in the red at that point. Indeed, studio executives correctly assess, that as a rule, they lose money on "current production," their term for the American box-office. Their profit comes on most from the so-called "back end", including DVD, television and foreign receipts. In 2007, according to the secret numbers of their trade association, the MPAA, almost 90 percent of the revenue of the major studios came from world DVD sales, multi-picture output deals with foreign distributors, pay TV, and network television licensing.
There are of course notable exceptions, such as "Avatar" in 2009 and 2010, which broke all records for tickets sales, and, unlike the average movie, made a fortune at the American box-office (even though 72.5% of its revenues were abroad). Such successes, which often siphon off audience from other movies, do not change the reality of Hollywood. They are the exceptions that prove the rule. For the vast majority of movies that do not make a penny at the American box-office, the only useful thing that the newspaper box office story really provides is bragging rights: Each week, the studio with the top movie can promote it as "Number 1 at the box office." Newspapers themselves are not uninterested parties in this hype: in 2008, studios spent an average of $3.7 million per title placing ads in newspapers. But the real problem with the numbers ritual isn’t that it is misleading, but that it distracts attention from the realities that are reshaping and transforming the movie business. Consider, for example, studio output deals. These arrangements, in which pay-TV, cable networks, and foreign distributors contractually agree to buy an entire slate of future movies from a studio, form a crucial part of Hollywood’s cash flow. these unsung deals allow studios to stay in business. The loss of an output deal, uch as the termination of New Line Cinema's deal with HBO, doomed the studio, even though it had produced such immense box office successes as the Lord of the Rings trilogy. Yet, even the existence of output deals is seldom mentioned in the mainstream media. As result, a large part of Hollywood’s amazing money making machine remains nearly invisible to the public. The problem here does not lie in a lack of diligence or intelligence on the part of journalists. It proceeds from the entertainment news cycle, which generally requires a story about Hollywood to be linked to an interesting current event within a brief time frame. For such a story, the only readily available data are the weekly box office estimates; these are conveniently reported on websites such as Hollywood.com and Box Office Mojo. If an intrepid reporter decided to pursue a story about the actual profitability of a movie, he or she would need to learn how much the movie cost to make, how much was spent on P&A, the details of its distribution deal and its pre-sales deals abroad, and its real revenues from worldwide theatrical, DVD, television, and licensing income. Such information is far less easily accessible, but it can be found in a film’s distribution report. But this report is not sent out to participants until a year after the movie is released, so even if a reporter could obtain it, the newspaper’s deadline would be long past. Hence the media’s continued fixation on box office numbers.

Angelina's Bottom Line For Planet Money

2010-05-29T17:31:00.000-07:00

Hollywood studios' invisible financing, including government subsidies and tax-credit deals, is no where better illustrated than in the way Paramount put together the deal for Lara Croft: Tomb Raider. The budget, including Angelina Jolie's $9 million fee, was a staggering $94 million on paper. But after Paramount applied the arcane art of studio financing, of which the deal is a minor masterpiece, the studio's outlay was only $8.7 million.
First, it got $65 million from Intermedia Films in Germany in exchange for distribution rights for six countries: Britain, France, Germany, Italy, Spain, and Japan. These "pre-sales" left Paramount with the rights to market its film to the rest of the world.
Second, it arranged to have part of the film shot in Britain so that it would qualify for Section 48 tax relief. This allowed it to make a sale-leaseback transaction with the British Lombard bank through which (on paper only) Lara Croft was sold to British investors, who collected a multimillion subsidy from the British government, and then sold it back to Paramount via a lease and option for less than Paramount paid (in effect, giving it a share of the tax-relief subsidy.) Through this financial alchemy in Britain, Paramount netted, up front, a cool $12 million.

I recently explained how this worked on NPR's Planet Money.

Wall Street 2

2010-03-30T07:14:00.000-07:00

In November 2009, Oliver Stone literally put me in the picture. I was seated at an oval table
under an eerie light in what purported to be the office of the Chairman of New York Federal
Reserve Bank. As the meeting continued throughout the night, people around screamed about
the “moral hazard” of saving a failing investment bank. At one point, there was even a call from the White House dooming the bank in question. The frenetic scene is no more than a consensual hallucination directed by Oliver Stone for the movie Wall Street 2: Money Never Sleeps. (A sequel to his 1987 Wall Street.) The magnificently wood-paneled room is actually the executive conference room of an insurance company, Metlife, which is serving as a location for this part of the filming. The eerie glow comes from powerful lamps lights ingeniously suspended from helium balloons above us. The shouting is coming from actors Frank Langella, Eli Wallach, and Josh Brolin. Although I had only a bit part in this drama, it provided me with an opportunity to see how a Hollywood is made from the vantage point of the set.
The project was initiated in 2005 by Edward R. Pressman , the producer of the original Wall Street, after he saw the fictional villain of Wall Street Gordon Gekko (portrayed by Michael Douglas) on the cover Fortune accompanied by a headline about the return of greed to Wall Street. Pressman reasoned that if 18 years after the movie, Gekko was still the media’s icon for greed on Wall Street, Pressman, a sequel was in order. He owned the rights for the sequel but sought to interest Twentieth Century Fox, which had distributed the original Wall Street. Getting a movie made in Hollywood when the hero is not a comic book character was not an easy task. Just getting a script that was acceptable to Fox took four years– and 3 different (and very expensive) writers. Even then Fox’s approval was conditional on the stars and director, as are almost all movie deals. Pressman persuaded Michael Douglas to again play Gekko, a role for which he had won the Oscar in 1988, and Oliver Stone (who had dropped out of the project earlier), to again direct Wall Street 2. Fox then agreed to finance it.
Part of this $67 million budget could be retrieved from New York State and New York City’s tax credits (which effectively reimburses 35% of the production budget spent in New York.)
The Federal Reserve meeting scenes were filmed over a long weekend about midway in the
11 week shooting schedule. Through the seemingly endless retakes in which actors repeats
virtually the same lines while extras behind them– each of whom is called by a number rather
than a name– moves to the exact same “mark” ,or position, Stone gradually perfects the illusion.
Between each take, the time on the grandfather clock in the office is reset to the exact time at the start of the previous scene. The process is not unlike the never-ending day in the movie
Groundhog Day. But surrounding the illusion-in-the-making is an envelope of reality. It is
peopled by a small army of technicians, including make-up artists, hair stylists, script
supervisors, technical advisers, continuity girls, stand-by carpenters, wranglers, costumers,
sound boom men, camera operators, film loaders, set decorators, and electricians. They work
ceaselessly, rushing onto the set between takes, to maintain and repair the illusion. One of the
advantages of a top director such as Stone, is that he can get the best of the below-the-line talent, in this case such Oscar nominees as Rodrigo Prieto, the Mexican-born Director of Photography whose credits include Frida, Brokenback Mountain, and Babel, Kristi Zea, the production designer, whose credits include Revolutionary Road, Goodfellas, and The Silence of The Lamb,and Tod Maitland, the versatile sound technician who won the Oscar for Sea Biscuit.
Stone him self is constantly moving around the set, viewing scenes from different angles and talking to the actors and extras, often in whispers. At other times, he confers with technical advisers, including Brian Cartwright and Alex Cohen, two former SEC lawyers who had actually attended the Fed meetings, asking them about such details as how
coffee cups would be placed on the table or how precisely a phone call from the White House would be answered. When any unexpected difficulties arise, such as the camera dolly creaks audibly on its tracks, he jokes with the cast, having a gift for putting actors at their ease. But even with the amicable atmosphere, he has to keep the movie running on a tight schedule. Just the below-the-line expenditures for Wall Street 2, which does not include the compensation for the stars, writers, producers, or the director, is running about $220,000 a day for interior scenes (exterior and crowd scenes can be much m ore expensive.) So unless he shoots the planned number of script pages a day, he will run over budget. While Hollywood players are often depicted in the media as profligate spenders, the opposite is true when it comes to studio executives supervising a movie that they are financing. Before
Wall Street 2 went into production, Fox went through the budget line by line, squeezing every penny it could out of the budget., even attempting to reduce the fees of major actors (all of whom have a “quote”, or established price per movie.. If the shooting ran over budget, Fox could ask that plans scenes be cut out of the script to get it back on track or use money from the post-production budget, which includes putting in visual effects (which are crucial in Wall Street 2 since some scenes are shot with blank backgrounds), adding sound, and editing. So Stone manages to adhere to the schedule, even when it requires him– and his assistant directors-- working grueling 14 hour days (as in the Federal Reserve
Bank scenes). And, as it turns, out he completes the movie within a day of the targeted end of shooting.
When I arrive at the wrap party at the club Spin, the cast, crew, and friends are huddled around
plasma TV screens, watching clips from the movie. For most of them, it is their first opportunity to see how Stone actually realized the scenes they had worked in or on. As they watch, visibly impressed, they often cheer with the sort of gusto one might expect at a Superbowl party when a touchdown is scored.
Everyone embraces Stone, the hero of the evening, as he passes through the room. Spin is owned by Susan Sarandon (who had acted in the movie) and features ping pong tables (where Josh Brolin and Mel Gibson(who was not in the movie) engaged in wild game. ,The calibration continued into the early hours of the morning.
Unlike independent movies, which usually take years to reach the theaters, studio movies have a built-in release date from the moment they are green-lighted. Wall Street 2 was scheduled to open at the multiplexes across America on April 23, 2010. However, in March, after getting the competition report showing what other movies would draw the adult audience away from Wall street 2, Fox pushed the opening back to September 12, 2010. Even so, Fox's marketing department is already working on the advertising and marketing
campaign, which will require a huge investment in spots ads on cable and network TV in mid-April. The worldwide P&A budget will probably exceed $40 million, which will bring Fox’s total outlay to about $100 million.
The original Wall Street did far better in earning critical acclaim and buss than
money. Fox’s share of the American box office was only $20.2 million– and it fared far worse in foreign markets. The problem Fox had then, and faces again now, is that movies that involve complex issues, such as a financial crises on W all Street, did not necessarily draw the teen-age audience conditioned to expect the action heroes and fast tempo of the studios’ comic book sequels. The $100 million gamble for Fox is that it will be able to find an
adult audience for the multiplexes.
***

Hollywood's Real Money Machine

2010-03-04T07:12:00.000-08:00

This Sunday a global audience, second in size only to the Super Bowl, will watch television's most lucrative infomercial—the 82nd Annual Academy Awards. For some three and a half hours, interspersed with clips from currently-available movies, Hollywood's most publicized stars will ecstatically award the winners 13-inch-high gold-dipped statuettes known the world over as the Oscars.
The initial purpose of this gala event, which the studios created along with the Academy of Motion Picture Arts and Sciences in 1927, was, in the words of its main architect Louis B. Mayer, "to establish the industry in the public's mind as a respectable institution." But it was also designed to market and create "stars." Mayer was cofounder of Metro-Goldwyn-Mayer, one of Hollywood's most successful studios during its Golden Age (1930s-1950s), and is known as the father of Hollywood's "star system" of marketing.
Yes, the stars will be out Sunday night, but to further enhance its global audience this year, the Academy has doubled the number of Best Picture nominees. Even with this expansion, attention remains focused on two polar-opposite films: Kathryn Bigelow's "The Hurt Locker," and James Cameron's "Avatar," both of which have garnered eight other Oscar nominations
The Hurt Locker" is a reality-based film about a squad of courageous American soldiers who defuse bombs under horrendous conditions in Iraq. By Hollywood standards, it is a very small movie, costing only $15 million to produce and another $15 million to publicize and distribute. And although critically acclaimed, it sold only $18.5 million in tickets worldwide. With theaters keeping roughly half of these box-office sales and the distributor deducting its expenses off the top, it is deeply in the red. Nevertheless, for many among the Academy's nearly 6,000 voting members, it represents the kind of intelligent realism that Hollywood is capable of making for an adult audience.
"Avatar," on the other hand, is a fantasy-based movie about alien life forms who need to be rescued from neocolonialist corporate exploitation on a planet called Pandora. The film, enhanced by brilliant visual effects, may be the most expensive ever made. According to a top executive at Fox, it cost over $225 million to produce and another $150 million to publicize and distribute—a number that has been hyped to as much as a half-billion dollars.
Whatever the cost, "Avatar" has been an immense success, selling a record-breaking $709 million of tickets in the U.S., where it is shown in 3D as well as the traditional 2D format, and more than twice that amount overseas, where it's shown mainly in 2D. For Rupert Murdoch's 20th Century Fox, which gets its distribution fee off the top (as well Dune Entertainment and Ingenious Partners, the private equity funds that provided 60% of the financing, and James Cameron's production company, Lightstorm Entertainment) it is a veritable El Dorado.
The film's success at the box office has also excited hopes that its 3D visual effects will restore the Golden Age of movie attendance, a time before television when two-thirds of Americans went to the movies in an average week. Nowadays less than 10% go to a movie theater in an average week.
The overall box-office numbers, however, provide little grounds for such optimism. "Avatar" no doubt has enriched many theaters charging a premium for the 3D experience, but it did so largely at the expense of theaters showing other movies. In the eight weeks that "Avatar" dominated U.S. box-office receipts (Dec. 18 to Feb. 11), total movie attendance increased by about 6%.
But even if the audience resurgence is no more than a pipe dream, "Avatar" represents for many in the Academy the idea that Hollywood's ultimate salvation lies not in superior story-telling and acting but in eye-popping visual effects, stunning animation and state-of-the-art 3D projection that immerse the audience in the illusion.
Regardless of box office receipts, Hollywood's major studios have a sure-fire engine for making money from viewers who don't regularly go to the movies. It's what the studio calls its "library," which contains the rights to all the movies and television series that it has ever produced or acquired. By relentlessly licensing and selling the rights to these titles, studios harvest money from home audiences decades after a film plays in theaters.
Consider, for example, the Time Warner library. It has more than 45,000 hours of feature movies, cartoons and TV episodes, dubbed or subtitled in more than 40 languages, that it licenses to pay-TV, cable TV, satellite telecasters and television stations in more than 175 countries. These titles are often bundled in take-it-or-leave-it packages (a practice that is prohibited by U.S. anti-trust laws in distributing movies to theaters), which helps optimize profits. In 2009, just the television distribution part of this operation brought in more than $2 billion, according to one source at Warner Brothers. A revenue stream this lucrative, even after paying residuals to guilds, labor and other participants, would be enough to pay for most, if not all, the costs of Warner Brothers's new movies.
Libraries, of course, also pull in huge revenues from the global sale and rental of DVDs. (Technically, newly released titles are not included in the library for two years.) Even though DVD sales of movie titles and TV series are now waning, on the horizon is another promising revenue stream: digital rights for Internet delivery. While at present these rights provide little more than pocket change for studios, future revenues are due to explode with the proliferation of smart phones, netbooks, tablets, game consoles and other such gadgets. In any case, as one Viacom executive recently told me, "No studio could stay solvent for long without a library."
If the studios' libraries, the reality-based money machines that boost the bottom line, do not receive accolades or even a mention at Sunday's Academy Awards, it isn't that their value is unappreciated. It's because Hollywood's real genius is understanding that its audience prefers illusion to reality. The stars shine brightest on Oscar night. And that's show business.

Bad News For MGM

2010-02-25T07:29:00.001-08:00

The bad news came in a non-public conference call this Monday (February 22nd) to the 140 banks and hedge funds holding nearly $4 billion in MGM debt. MGM CEO, Stephen F, Cooper, the turn-about specialist brought in to save the one-proud studio, revealed in the call that the secret numbers memo circulated to potential buyers in the confidential deal had been seriously inflated by MGM’s own over-optimistic estimate of its 201o television revenue. The memo, which had been sent out by Moelis & Company to solicit offers from potential buyers, stated that "Television distribution has generated over $500 million of Library cash receipts in each of the last four fiscal years ," estimating it would produce "$529 million" for fiscal 2010 (which ends March 31, 2010). A library is made of two components: DVD sales and the licensing of movies and TV series to pay channels, cable networks and broadcast television. So, with the DVD market collapsing in 2009, the stability of television revenue, as represented in the memo, was (at least until Monday) a key selling point to the remaining potential buyers– Time Warner, Lionsgate, John C. Malone’s Liberty Media, Rupert Murdoch’s News Corporation, Ryan Kavanaugh’s Relativity Media, Anil Ambini’s Reliance ADA Group, and Leonard Blavatnik's Access Industries.lain . Now, Cooper had stunning news. He told the 140 creditors that the library sales had been anything but stable, and plunged in the fourth quarter (so far) to the extent that the estimate had to be reduced by almost $30 million for that quarter. If annualized, that would amount to a decrease of about $120 million in revenue. Even worse, this severely reduces the value of the library since, as those in the business know, when MGM renews its multi-year contracts, the money it will get for aging product will drop precipitously.In MGM’s case, as I pointed out previously , a large part of these revenues must be split with "third parties." This includes producers, stars, directors, writers and Hollywood guilds, and, in 2009, amounted to over 40 percent of the total take.
The forbearance that MGM’s creditors extended to MGM in October runs out in 10 weeks so Cooper can sell it. Now all the remaining bidders will have to drastically recalculate, if not, reconsider. the amount they are willing to gamble. The Wall Street investors who put up most of the equity for the 2004 takeover have already seen their investment effectively wiped out. The suspense that remains in this Hollywood thriller is the degree to which the bond-holders will suffer the same fate. The bond holders cannot put the company in bankruptcy without jeopardizing the valuable remake rights to James Bond movie. So if the bidders pull out, or offer only pennies on the dollar, the only alternative open to the bond holders is to themselves take-over MGM by swapping their debt for equity– but this is not the Hollywood ending they want.

The Secret Numbers Behind The MGM Fiasco

2010-02-19T14:08:00.000-08:00

MGM, once the shiniest studio in the Hollywood galaxy, has fallen on hard times. Last October it failed to make the interest payment due on its $3.7 billion debt, and even with the six month forbearance granted by its creditors, it is hovering the threshold of bankruptcy. Its equity investors — including three big hedge funds — have been all but wiped out. The 140 banks that financed the leveraged part of the leveraged buyout deal are in danger of losing over $3 billion. With the creditors demanding their money, and the clock running on its forbearance, MGM had put itself up for sale, retaining investment bankers Moelis & Company to solicit offers from potential buyers that were due in mid January 2010. For a movie studio that was bought for $4.85 billion in 2004 (which is over $5 billion in 2010 dollars), the bids that have come in so far are shockingly low. Time Warner, for example, is offering under $2 billion and the bid from Lionsgate, once the leading contender, is worth even less.

The secret numbers in the confidential information memorandum sent out by Moelis explain the problem, which goes to the root of what is happening to the movie business today. MGM's main asset, as is true in the case of all Hollywood studios, is its library comprised of 4,100 film titles, including all the James Bond movies, and 10,600 television episodes. The money that comes in through this library comes from DVD sales — mainly older titles sold in discount bins at Wal-Mart and other retailers -– and television licensing packages to Pay TV, cable networks, and television stations around the world.

The bet that the hedge funds made when they put up most of the equity for the $4.85 billion LBO in 2004 was that DVD revenue from the library would hugely increase when people replaced their standard DVDs with the Blu-Ray high-definition format that was just being introduced. But their projections proved to be pipe dreams. Instead of expanding, MGM's DVD revenue plummeted, according to the confidential memo. MGM's DVD revenues fell from $394.7 million in 2008 to just $69.8 million in the 2010 fiscal year (which ends March 31).This huge drop was attributed to a host of factors, ranging from the worldwide downturn in DVD sales to fewer new MGM releases. What turned out to be the real killer for MGM's library was what the memo termed "significant price erosion." Wal-Mart, pressured by competition from Netflix, Red Box, and video downloading, drastically reduced the "price point" that it would buy older (or so-called "catalogue") DVDs, driving prices down to less than $5 a copy. So studios' saw the stream of profits from older DVDs wither away.As with other studios, the larger part of MGM's library's money comes from television licensing. At first glance, these revenues appear remarkably stable, declining a mere one percent from $535.1 million in 2008 to $529 million in 2010. But like other phenomena in Hollywood, appearances can be deceptive. MGM had structured its long-term licensing contracts so the cable networks wind up underpaying for the early years and overpaying for the later ones, which is a common practice at studio libraries. As a result, even as properties lose value over the course of the contract (old films are worth less than newer ones), the illusion of stability is maintained . Of course, when MGM renews these multi-year contracts, the money it gets will drop precipitously.And as impressive as $529 million in revenues may seem, it is not the amount MGM actually gets to keep since it must split these proceeds with various "third parties," including producers, stars, directors, writers and Hollywood guilds. For example, the revenues from the 24 James Bond movies — which are the library's most valuable asset generating nearly 30% of its revenue — have to be split 50-50 with Danjaq LLC, the holding company for the Broccoli family that originally created the franchise. These participations and residuals (which is what the guilds get for their pension funds) totaled $235.2 million in 2010. In addition, there were $33.2 million in other expenses, such as calculating and issuing more than 15,000 different checks per quarter to participants.MGM also had to pay Fox a fee of $22.2 million for distributing its DVDs. What MGM kept turned out to be not enough to pay its overhead — $135.9 million in 2010 — and other costs, leaving it with a negative operating cash flow of $52.4 million. The bottom line here is that MGM cannot pay off its $3.7 billion in debt. And even if a white knight gallops in to carry off the library, the investors and creditors will take a bath.

Is Netflix The Next HBO?

2010-02-12T14:58:00.000-08:00

Netflix, through the simple device using the post office to bypass video stores, has become one of the great success stories of the new entertainment economy. It now has 11.8 million subscribers who pay a monthly flat fee for an unlimited number of rentals. It gets its DVDS from wholesalers and even retail stores. It can then rent them because of a court-approved "First Sale doctrine," which says that once a person buys a DVD, he can re-sell it or rent it out. Last year Netflix took in $1.67 billion in subscription fees, but because of the high cost of mailing some 2 million discs a day from 50 distribution centers, it only eked out a profit of $115 million.
So it is moving onto the Internet, substituting digital streamed movies for ones that are delivered by the postman. Subscribers get them on their TV via a set top box or game console without any additional charge. This "Watch Instantly" service effectively creates a virtual channel that directly compete with Pay-TV for the wallet and clock of viewers. Such a challenge by Netflix could also result, as Frank Biondi the former head of HBO, terms it, "a terminal career decision if you get it wrong."
The problem is that the First Sale doctrine does not apply to streaming or downloading DVDS so Netflix must buy digital rights, which is exceedingly expensive for new titles. In late 2008, Netflix found a temporary way around this stumbling block by making a deal with Starz Entertainment, a subsidiary of John Malone's Liberty Media, to sub-license the streaming rights of the titles it had obtained from Disney, Sony and smaller studios in output deals. Starz held it could sub-license these rights because Netflix was merely a "content aggregator," but the studios took a dimmer view of this loophole. Disney, according to a top executive involved in the dispute, has warned Starz that it will not renew its output deal (which expires in 2012) unless it either cuts Netflix out or pays Disney a rich premium.
Netflix chief content officer Ted Sarandos portrays the issue as merely a communication glitch, saying, "We have to fight against their fear that we~ll destroy the ecosystem." Despite this well-meaning new-age talk, what is really at stake here is old-fashioned money. The most profitable part of Hollywood's "ecosystem" is the output deals through which studios license movies to Pay TV channels, cable networks and broadcast stations. According to the studios's internal all-source revenue numbers, the six major studio took in $16.2 billion from pay-TV and television licensing of their movies in 2007, which was almost all profit. So the threat of sub-licensing for Internet circulation involves a good more than studio paranoia.
As for HBO, a subsidiary of Time Warner, it is the undisputed leviathan of Pay-TV. It has over 40 million subscribers, $4 billion in revenues, and a cash flow of $1.3 billion. And, unlike Netflix, it owns the digital rights to a large amount of exclusive material, much of which it produced. Over the past decade it invested heavily in original programming, creating such series as The Sopranos (which cost $2 million an episode) to retain subscribers. This made economic sense because cable systems paid it about $6 a month for each subscriber. As a top Time Warner executive who had authorized much of this original production explained to me, the name of the game is subscriber retention.
So HBO is not about to cede cyberspace to Netflix. It's in the process of rolling out an Internet service called HBO Go which will allow all HBO subscribers to get, as the executive puts it, "anything they want to see, anytime, anywhere, over their laptop, Iphone, tablet, Playstation." Bolstered by its exclusive content, HBO will initially offer some 800 hours a month of programming a month. Its 40 million subscribers can get at no additional charge over the Internet the linenew titles HBO acquires through its output deals with Warner Bros, Fox, and Dreamworks, past and present original series, HBO boxing, and even so-called "late night" fare such as Alien Sex Files.
Netflix, on the other hand, has almost no exclusive content with which to compete with HBO. Back in 2006, it attempted to produce its own original content through a subsidiary called Red Envelope Entertainment, but closed it down in 2008. The brutal reality is that Netflix, with only one-eighth the cash flow of HBO, does not have the scale to produce its own material. Of course, whether or not the Starz deal is renewed, Netflix can exclusively license programming through output deals. But competing in this game, in which the licenses for a slate of two dozen movies can cost in excess of a quarter of a billion dollars, could prove prohibitively expensive. Last year Netflix reportedly spent $100 million on licensing just non-exclusive rights to movies for streaming from Starz and studio libraries. Although this saved postage, Netflix still has to pay the overhead for its distribution centers. Adding hundreds of millions of dollars in output deals to this equation could wipe out much, if not all, of its profits.
Netflix has brilliantly carved out for itself a niche audience who largely enjoy the convenience of receiving older movies, which accounts for about two-thirds of its revenue. It will no doubt continue to satisfy and expand this audience via mailing and streaming. But what it lacks is the wherewithal to do is to replace HBO.
Edward Jay Epstein is the author of 14 books, including two examining the movie business: The Hollywood Economist: The Reality Behind The Movie Business will be published by Melville House later this month, which follows his 2005 book The Big Picture: Money and Power in Hollywood.

2010-02-05T14:58:00.001-08:00

If you are a producer of indie movies, the great sucking sound you may be hearing is Avatar draining money from your future projects. While this brilliant Pocahantas-meets-Jurassic Park mashup may be a bonanza for Rupert Murdoch's 20th Century Fox studio, which gets a distribution fee on every dollar it brings in from theaters, video stores, and TV, and its producer-director James Cameron, who gets a cut of the gross after it reached its Hollywood-defined $500 million cash break even point, it will further convince the heads of the major studios that their salvation lies in putting their money in "high value" movies laden with mesmerizing visual effects that can be simultaneously opened on more than 5,000 screens around the world and lend themselves to sequels, merchandise tie-ins, toy licensing, and theme parks rides.
To be sure, even before the phenomenal success of Avatar, the Big Six studios were shying away from smaller movies despite their potential profits. Consider, for example. the sad story told to me by one of the most successful indie producers in New York. In 2009, he brought a major studio a $20 million project packaged with a hot director and two stars. After running the numbers, the studio estimated that its potential box-office in America at $100 million, which would yield it, just from its 30% distribution fee and a locked-in output deal with HBO, a 100% profit on its investment. But it turned down the project. One of the studio's top executives told the producer, "We don't do films that do not have a projected box-office of at least $150 million."
The reason for this rule is that a studio has only a limited number of slots for its releases at multiplexes and it has to fill them with projects, whether profitable or not, that generate maximum revenue, since the slice it takes off the top in the form of distribution fee pays the studio's overhead (which includes the executive's six-figure paycheck). This means worldwide grosses — almost 75 percent of Avatar ticket sales is from foreign audience — and indie films even if they are profitable, cannot be counted on to do that job.
Unlike a studio producer, an indie producer rarely, if ever, has a U.S. distribution deal in advance of shooting. To raise the money to shoot a film, he or she must either find an outside investor, an equity partner, or get a bank loan. What made loans possible, at least up until recently, were the availability of pre-sales agreements. These odd devices, which had been the backbone of indie financing since Dino de Laurentiis invented them in the 1970s, worked as follows: an indie produced would sell the distribution rights in foreign territories and then use the contracts as collateral to borrow from banks. Foreign buyers were willing to sign pre-sales deals because they assumed the film would get U.S. distribution since up until 2008 there was no shortage of smaller distributors specializing in indie films, including Miramax, Fox Searchlight, Fox Atomic Films, Paramount Vantage, Warner Independent Pictures, Picturehouse, New Line, Fine Line Features, Focus Features, Sony Pictures Classics, Lionsgate, the Weinstein Company, and Summit Entertainment.
Since the cash flows from indie films tends to be erratic, these smaller distributors had come to rely on advance output deals with three pay TV channels — HBO, Showtime, and Starz — to pay their overhead. In return, the pay channels got the exclusive rights to show their new movies. In 2008, for example, the $80 million that New Line Cinema received from HBO paid its annual overhead and development costs. Bob Weinstein, the co-chairman of the Weinstein Company, not only described output deals as "the bedrock of thebusiness," but said in 2008 "not one company in this business could survive and succeed without one."
His words soon proved prophetic. When the pay-channels found they needed fewer movie titles to retain subscribers, and began cutting back on their output deals in 2008, the "bedrock" crumbled within a matter of months. By 2010, most of these indie distributors and mini-majors were effectively out of business including New Line Cinema, Fine Line Features, Picturehouse, Warner Independent, Fox Atomic, and Paramount Vantage. Miramax, the linchpin of indie distribution for nearly two decades, closed down its main office in New York, and its owner, Walt Disney, is currently trying to sell its name and library Harvey and Bob Weinstein, who founded Miramax and named it after their parents Miriam and Max reportedly want to buy back the name but, under pressure from their banks, no longer have the money to do so. Almost all remaining players have drastically changed their acquisition strategy. Sony Pictures Classics does not buy any film that costs over $2 million, Focus Features is putting its resources mainly in co-production deals in Asia, and Lionsgate is investing in horror sequels like Saw VII. With the prospect of American distribution rapidly fading, indie producers are now finding pre-sale financing almost impossible. "It's a dead business model," a former Miramax executive said.
If so how can Indie producers continue to make movies? They might be able to find wealthy individuals entranced enough with a movie fantasy to put up the money, but they still need to devise a new way in this digital age to distribute them to an audience willing to see something more than the movie versions of amusement park rides.

The MGM Follies: How Hedge Funds Lost A Billion In Hollywood

2010-01-21T07:52:00.000-08:00

Back in 2003, after Kirk Kerkorian 1et it by know that he was (yet again) prepared to sell MGM, Viacom, which owns Paramount, considered buying it. Although MGM no longer had sound stages, backlots or other physical facilities, and now produced only a handful of movies, it owned an incredibly valuable asset: a film libraries with 4,100 motion pictures and 10,600 television episodes. The crown jewels of this collection was its James Bond movies, which was possibly the most valuable entertainment franchise ever created. By licensing these titles over and over again to Pay-TV, cable networks, and television stations around the world, and selling DVDs from it,, this library brought in roughly $600 million a year. But that gross was an elusive number as it had to be split with others who had rights in the titles. Each title had its own contractual terms governing payments to partners, talent, guilds, and third parties.. Just making these payments entailed issuing more than 15,000 checks per quarter. Not only did titles have different pay-out requisites, but their future revenue stream depended on factors specific to each movie, such as the age of its stars, its topicality, and its genre. To figure it out, Viacom assigned a team of 50 of its most experienced specialists to estimate the how much each and every title would bring in over a decade. The Herculean job took the team two months. From this analysis, as well as considering other benefits of merging MGM with Paramount, Viacom’s executives agreed MGM was worth between $3.5 and $4 billion. But before they could arrive at a bid price, Viacom’s President, Mel Karmazin, asked them whether the value of the MGM vast library go the way of the music industry, which had been decimated by Internet down-loading. When none of the executives could rule out that possibility, Karmazin said "In that case, we are not bidding on MGM." Disney, after a similar deconstruction of MGM’s complex library, valued it at $3 billion, and also opted not to bid on the company.
Sony had a very different agenda for MGM. Since it had staked much of its corporate future on Blu-Ray as a high-definition format, it needed to get other major studios to choose it over a competing format, backed by Toshiba and Microsoft, called HD-DVD. Sony had learned from bitter past experience that format wars are often decided not by superior technology but by side payments made to studios. Toshiba and Microsoft (which had X-Box) were already offering huge cash inducements– one studio would get $136 million– to put their titles exclusively on the HD-DVD format. Such a pay-off competition could prove extremely expensive given the deep pockets of Toshiba and Microsoft, so Sony, which needed to establish Blu-Ray for its Play Station 3 as well as its movies, sought another route to victory. If it could put the huge library of MGM titles exclusively on Blu-Ray, together with its own library and the Columbia Tristar library (which it also owned), Toshiba and Microsoft, no matter how many side payments they made, would not be able to establish their rival format. To this end, Sony did not need to itself spend billions to acquire MGM, it only had get effective control of MGM’s library for a few years. So it put together a consortium that would be financed mainly by Wall Street private equity funds. And it would lead the consortium.
Even though the LBO would wind up costing $4.85 billion, Sony invested only $300 million of its own funds (and for that it got the profitable right to distribute MGM movies). Another $300 million came from the Comcast Corporation in return for the rights to put the MGM’s library on Pay Per View on its vast cable system. The rest of the equity money came from renowned Wall Street investors Providence Equity Partners, Texas Pacific Group, DLJ Merchant Banking Partners, and Steve Rattner’s Quadrangle Group. These savvy funds put in a cool billion dollars. The leverage part of the deal was organized by JP Morgan Chase, which very profitably arranged, since it also got a fee, for the consortium to borrow $3.7 billion (or up to $4.2 billion, if needed) from some 200 banks. The deal closed in September 2004.
For Sony, the gambit succeeded brilliantly. Putting some 1,400 MGM titles exclusively on Blu-ray, helped established Blu-Ray as the industry standard for high-definition, and it won the format war. It also made back a large share of its $300 million investment just on the distribution fee it earned on two new Bond movies (Casino Royale(2006) and Quantum of Solace (2008). But for the Wall Street players, it was nothing short of a disaster. To cut to the chase, they lost almost all their entire billion dollar investment. They had relied, perhaps naively, on impressive-looking projections showing that the net cash flow from the MGM movie and television library would be sufficient to pay the interest on the nearly $3.7 billion of debt over s decade. What they had not counted on was a sea change in DVD sales. In the US alone, MGM’s net receipts from DVDs fell from $140 million in its 2007 fiscal year (which ends March 31st 2008) to just $30.4 million by 2010. As a result of collapsing sales, higher pay-out for participants, increased distribution costs and other distribution problems, MGM’s crucial operating cash flow catastrophically fell from $418.4 million in 2007 to minus $54.2 million by 2010. In addition, it owed Fox Home Video $60 million for an "adjustment" in the DVD distribution contract it had taken over from Sony. By October 31, 2009 MGM, sinking in a sea of red ink, found itself unable to make its mandated interest payments on the $3.7 billion it owed banks.
Ordinarily when a company fails to make such payments, its bank creditors can seek to recover their money by forcing the company into bankruptcy. With MGM, however, the bankruptcy option presented a real problem since many of its intellectual property rights, including those to make sequels in the James Bond franchise, stipulate that in the event of bankruptcy they would automatically revert to another party. In the case of the James Bond franchise, for example. the sequel rights would revert to Danjaq, LLC. (These bankruptcy clauses are not mentioned, even in a footnote, in the 38-page "Confidential Information Memorandum" that MGM sent out to prospective buyers in the winter of 2009.) So the creditors learning that bankruptcy would destroy a significant part of the remaining value of MGM, gave it a three month "forbearance," which meant it had until January 31, 2010 to come up with the money. The idea was that MGM would sell itself to a white knight and use the proceeds to repay the banks. The deal book was sent out to a dozen or so prospective buyers calling for bids by January 15th. The replies, according to a source close to Moelis & Company, which is MGM’s financial advisor, have, as of January 22nd, have been "disappointing," with none of the serious bids coming within $1.6 billion of what MGM owes its creditors. As for the hedge funds, they have already written down 85 percent of their billion dollar investment in preparation for what may be a near total wipe-out. The lesson here for Wall Street that when a Hollywood deal seems to good to be true– it may not be.
***.
(My new book, The Hollywood Economist, will be published next month by Melville House)

Flirting With Disaster: Can Indie Movies Be Saved

2010-01-15T13:35:00.000-08:00

The Achilles’ heel of the independent movie business is American distribution. No matter how brilliant an indie movie may be, and no matter how many awards its wins at film festivals, it needs to get into theaters to be seen. That feat is no longer easy for an indie movie.
The Big Six 6 studios– Disney, Paramount, Universal, Warner Bros. Fox, and Sony– are also distribution juggernauts. They dominate both American and foreign distribution . Each of them employs a small army of salesmen, publicists, media buyers, theater-relations liaisons, merchandising specialists, and lawyers to get its movies and coming attractions on the best screens in theaters, its stars on the top TV shows, and its DVDs in the prime space at video stores. Because of their enormous clout with theater chains, the Big 6 can open their movies on 4,000 screens in the US and thousands of additional screens overseas. They also have long-standing merchandising deals with fast-food chains, toy companies, and other mass retailers to assist these global openings. Since their distribution machines have enormous overhead, the Big 6 studios need to confine their releases to potentially huge grossing movies. The size of the gross is crucial– even if there is no net profit– because studios, take a hefty cut of it off the top in the form of a distribution fee– typically, on movies that studios finance, it is 30 percent– which helps offset the overhead. The requisite, however, often leaves producers of smaller films out in the cold. Consider, for example. the sad story told to me by one of the most successful indie producer. In 2009, he brought to a major studio a project that had a budget of a mere $20 million with a well-regarded director and stars. After running the numbers, the studio estimated that its potential box-office was $100 million, which would yield it, just from the distribution fee and the output deal with HBO, a 100% profit on its investment. Yet, it flatly turned down the project because, as its executive told the producer, "We don’t do films that do not have a projected box-office of at least $150 million." The reason is that each studio has only a limited number of slots for their releases, and they have to fill them with so-called "high value" films with a potential to generating hundreds of millions of dollars in revenue to pay their overhead. Indie film, even if they return a profitable on a relatively small investment, cannot be counted on to do that job.
So how does an indie producer get an American distributor? Unlike studio producers, indie producers rarely, if ever, have a US distribution deal in advance of shooting. To raise the money to shoot a film, they must either find an outside investor or borrow it. As for the latter course, since the 1970s indie financing has used pre-sales agreements in foreign territories as collateral to borrow from banks. After the film is shot and edited, they then seek distribution either through screenings or by taking it to film festivals– a process that can take years. What made the gamble on finding distribution feasible was that, at least up until 2008, there were over a dozen so-called specialty distributors handling indie films, including both studio-owned "indie" companies, such as Miramax, Fox Searchlight, Fox Atomic Films, Paramount Vantage, Warner Independent Film, Picturehouse, New Line, Fine Line Features, Focus Features, and Sony Pictures Classics, and truly independent companies, such as Lionsgate Releasing, the Weinstein Company, and Summit Entertainment. Even those these specialty distributors have an order-of-magnitude less overhead than the majors, they still have to fund it. Since cash flows from indie films is erratic , they depended for a steady stream of revenue from "output deals" with the three pay TV channels. HBO, Showtime, and (later) Starz originally entered into these deals, offering to buy the entire output of a studio/distributor, to get new titles to attract subscribers to their pay channel. But as these payments were pure profit, since they entailed no expenses, they proved to vital for the smaller distributors. In 2008, for example, New Line Cinema, received slightly over $80 million for 8 titles from HBO, which paid its annual overhead. Bob Weinstein, the co-chairman of the Weinstein Company, not only described them in 2008 as "the bedrock of the business," but said "not one company in this business could survive and succeed without one." His words proved prophetic. When the pay-channels found they needed fewer titles, and began cutting back on their output deals, the bedrock crumbled into clay within a matter of months. In May 2008, as top tier indie producers gathered at the Cannes festival to seek distribution for their movies, they witnessed to their horror, as one put it in an email, "the landscape change before our eyes." In short order no fewer than six specialty distributors– New Line Cinema, Fine Line Features, Picturehouse, Warner Independent Films, Fox Atomic, and Paramount Vantage– closed while a seventh, the Weinstein Company, announced it was sharply cutting back on acquiring new titles because of cash-flow problems. A few months later another domino fell, when Miramax, which had been the lynch pin of indie distribution for two decades, announced it was closing its main office in New York. Even the few players who remained moved to change their acquisition strategy, with Lionsgate, investing more heavily in exploitation films, such as Saw I, II, and III, and Focus Features, seeking co-production deals with Asian studios.
As indie distribution shrunk, financing through pre-sales became vastly more difficult. In the past, foreign buyers had been willing to make advance commitments for indie films because they assumed that they would get the sort of distribution in America that would provide publicity and credibility for their own release. Without such a prospect, European buyers were loathe to commit themselves to a pre-sales. As the executive of a major French distributor wrote me " except for auteur directors, such as Woody Allen, Wong Kar Wai, and Pedro Almodovar, we no longer make any pre-sales deals."
Even suffering such blows, the indie business is not dead, at least not yet. Indie producers have always demonstrated incredible resourcefulness in piecing together financing, even if it comes in the form of exotic tax credits, government subsidies, or indulgences from American egomaniacs, Arab oil sheiks, or Asian tycoons entranced with a movie fantasy. So even if the pre-sales game is moribund, they will likely find other ways of raising money to make movies. But unless they also devise a new model to distribute them in America, no one will see them.
***
(My new book, The Hollywood Economist, will be published next month by Melville House)

Quivering On The Edge Of The Digital Abyss

2010-01-10T07:29:00.000-08:00

The video pirates of Shanghai have developed an amazingly successful business model for exploiting the home market. In the back rooms of video stores, shoppers fill their baskets while choosing from an almost endless inventory of DVDs that includes all of the studios’ new movies as well as a full compliment of Oscar screeners. You can also buy current television series—even the latest episodes of House, Lost, and 24. In addition, in a non-Internet form of video on demand, if a title is not on the shelves, the store gets it bicycled over from some other location in a matter of minutes.
In this business model, unlike Hollywood’s, there are no "windows" or artificial delays before a new movie is released on DVD, no ratings restricting audiences, and no zone restrictions that can prevent DVDs from being playable. Most are professionally burned from digital masters made from copies of the studios’ own DVDS. While their quality may not always be up to Hollywood’s standards they are priced to sell. Even at high-end stores I visited in Shanghai, a DVD cost less than $1.25. Other retailers—including street hawkers— charge much less. As a result of this aggressive pricing, people in China rarely go to movie theaters. Instead, they buy shopping baskets full of pirated DVDs. According to the most recent estimates, Chinese manufacturers sold well over 1.5 billion pirated DVDs in 2009, which, if true, exceeded the major studios’ sales of legal copies in America in 2009. Not surprisingly, China is by far the world's largest manufacturer of blank discs and DVD packaging (which they provide to the American studios as well). Since they do not pay any licensing fee, their main enterprise cost, aside from blank discs and boxes, are the pay-offs involved in stealing advanced copies of DVDs (which is greatly facilitated by studios’ practice of storing their DVDs for months in warehouses around the world while they wait for the DVD window to open at video stores.) The economic principle that the pirates have amply demonstrated in China is that the demand for entertainment is exquisitely elastic: DVDs priced at $15—the studios’ retail price—hardly sell in China; pirated DVDs priced $1.25 a copy (or lower on the street) sell like hot won-tons.
This economic lesson has not always played well in Hollywood. Up until the late 1990s, the studios placed a wholesale price of $55-$60 on most videos because video stores wanted a high price to protect their rental business. Even after the DVD was launched in the late 1990s, some of the studios still wanted to price them high to protect the video rental business. Sumner Redstone, who then controlled both Paramount and Blockbuster, famously argued: "The studios can't live without a video rental business—we [Blockbuster] are your profit." Despite such warnings, Warner Bros. and Sony, decided to move DVDs in another direction. They offered Wal-Mart new titles on DVDs priced as low as $15.50 as traffic builders. With two years, Wal-Mart was selling 8 million DVDs a month, making it a major player in Hollywood. Under relentless pressure from Wal-Mart, which by 2005 accounted for 40 percent of the studios' DVD sales– and nearly 50 percent of their "bin sales"– the price for older DVDs was cut to as low as $6 a copy. Wal-Mart cut its own price under the $15 wholesale price on traffic-building new DVDs, losing money on each sale to draw more people into their stores. Other stores followed suit, leading one Warner Bros DVD executive to quip, "We have the only business in which the wholesale price is more than the retail price." These reduced prices, which turned DVDs into a retail juggernaut, only increased the studios' DVD revenue, which reached an all time high of $21 billion in 2005.
As DVD sales began to slide in 2006, and became less attractive as magnets to draw customers into its stores, Wal-Mart, briefly considered a plan to burn its own copies of DVDs in kiosks in its stores. Like the Shanghai pirates, the retail giant would stamp out copies for customers from blanks discs and cheap boxes (which would probably come from China). But, unlike the Shanghai pirates, they would pay a licensing fee to the studios for each copy it sold. The advantage to the customer would be that he could choose a title from among the tens of thousands of movies in the studios' libraries, and also possibly have it in the language and rated-version (G, PG, R, or NC-17) he prefers, while the studios would save the cost of manufacturing, packaging warehousing, and returns. When Wal-Mart's scheme was proposed to an executive from Warner Brothers, he pointed out that the delay for the customer might be as long as a half-hour before he could pick up the DVD. "Great. Could you make it an hour?," the Wal-Mart executive shot back. From the point of view of Wal-Mart, the DVD need not make money itself, as long as it serves to draw—and keep—potential customers in its stores. The plan never got off the ground. The DVD was the cash cow and studios were unwilling to accept a licensing fee that could gradually reduce until it became, as one studio executive put it, "pocket change."
Fast-forward to 2010
Rapid increases in the availability of high-speed broadband threatens Hollywood with the same fate as the music industry, which saw much of its lucrative CD business replaced by downloads of MP3 files (which are much smaller than the digital files of movies). By 2010, the security codes protecting the DVD (and even the Blu-Ray) from digital copying had been irreparably broken so that virtually anyone, anywhere in the world, could download a movie. In addition, new forms of online storage, such as so-called "cyber-lockers," which are web sites capable of storing movie-sized files that can be downloaded by anyone who has been given a password, had become almost impossible to police for pirated content. So almost any new title can be downloaded free from the Internet before it is released in video stores (or, for that matter, on Pay-Per-View TV.) The studios could see the hand writing on the wall in South Korea, which, because of its online gaming culture, is ahead of America in broadband speed. In 2006, the studios had a rich $1.3 billion DVD market in South Korea. But after an increase in the bit-rate of its broadband in 2007 its DVD sales fell to $80 million with two years. What happened was that Koreans found it more convenient to download movies from cyber-lockers than to buy or rent DVDs. After all, a DVD is nothing more than a way of storing a movie’s digital formula, and if the same formula, can be as easily retrieved from the Internet, there is little reason to buy a DVD.
So the light Hollywood sees at the end of the tunnel is on a locomotive heading directly for it. The concept of licensing their titles for downloading, or as one executives put it, " "trading digital pennies for analog dollars," is anything but appealing to the studios. When Apple’s Itunes Music Store, Amazon’s Unbox Movies, and other Internet stores offered to sell (and rent) downloads of their titles at their on-line stores, the studios decided to price them at the same price as DVDs, even though they entail no manufacturing, packaging, warehousing, or other costs. The reason that the studios insisted on such a high price was, in a word, Wal-Mart, which in 2009 still accounted for 38 percent of their DVD sales. Wal-Mart executives had made it crystal clear that they would not pay a penny more for its DVDs than any competitor, including Apple or Amazon, paid. So the studios charge Internet stores the same $16-17 per copy to download as they charged Wal-Mart for DVDs. (Some stores, such as Apple’s Itune store, decided to sell studio movies at a loss to help sell other products, such as the Ipods.) By pricing downloads high, the studios in effect were replaying their losing battle against the Shanghai pirates. This time around, however, the pirates, were operating cyber-lockers in places such as Moldavia. Latvia, and Pacific islands that are unlikely to enforce US copyright law, and, As a Warner Bros. technical operations chief explained in 2008, a large number of cyber-lockers now serve as "facilitators to access pirated content." Unlike the Shanghai pirates, these pirates do not even need to buy blank discs or packaging. So they could provide free downloads of Hollywood movies and make their profit from ads on or memberships to their site.
Even with declining sales, DVDs, still provided the 6 major studios with slightly over $16 billion in 2009, and constituted their main source of revenue. But what of Hollywood’s imminent future? South Korea demonstrates that a DVD market can be wiped out within a year or so of broadband improvements that make it possible for anyone to download a free movies in 15 minutes from the Internet. So quivering on the edge of this digital abyss, the studios remain paralyzed by their fear of losing their once almighty Wal-Mart accounts.

Why Journalists Don't Understand The Business of Hollywood

2010-01-06T15:16:00.000-08:00

There was a time, around the middle of the twentieth century, when the box office numbers that were reported in newspapers were relevant to the fortunes of Hollywood: studios owned the major theater chains and made virtually all their profits from their theater ticket sales. This was a time before television sets became ubiquitous in American homes, and before movies could be made digital for DVDs and downloads. Today, Hollywood studios are in a very different business: creating rights that can be licensed, sold, and leveraged over different platforms, including television, DVD, and video games. Box office sales no longer play nearly as important a role. And yet newspapers, as if unable to comprehend the change, continue to breathlessly report these numbers every week, often on their front pages. With few exceptions, this anachronistic ritual is what passes for reporting on the business of Hollywood.To begin with, these numbers are misleading when used to describe what a film or studio earns. At best, they represent gross income from theater chains’ ticket sales. These chains eventually rebate about 50 percent of the sales to the distributor, which also deducts its outlay for prints and advertising(P&A). In 2007, the most recent year for which the studios have released their budget figures, P&A averaged about $40 million per title— more than was typically received from American theaters for a film in that year. The distributor also deducts a distribution fee, usually between 15 and 33 percent of the total theater receipts. Therefore, no matter how well a movie appears to fare in the box office race reported by the media, it is usually in the red at that point.So where does the money that sustains Hollywood come from? In 2007, the major studioshad combined revenues of $42.3 billion, of which about one-tenth came from American theaters; the rest came from the so-called back end, which includes DVD sales, multi-picture output deals with foreign distributors, pay TV, and network television licensing.
The only useful thing that the newspaper box office story really provides is bragging rights: Each week, the studio with the top movie can promote it as "Number 1 at the box office." Newspapers themselves are not uninterested parties in this hype: in 2008, studios spent an average of $3.7 million per title placing ads in newspapers. But the real problem with the numbers ritual isn’t that it is misleading, but that the focus on it distracts attention from the realities that are reshaping and transforming the movie business. Consider, for example, studio output deals. These arrangements, in which pay-TV, cable networks, and foreign distributors contractually agree to buy an entire slate of future movies from a studio, form a crucial part of Hollywood’s cash flow. Indeed, they pay the overhead that allows studios to stay in business. The much more frequently in about 2004, can doom an entire studio, as happened in 2008 to New Line Cinema, even though it had produced such immense box office successes as the Lord of the Rings trilogy. Yet, despite their importance, output deals are seldom mentioned in the mainstream media.As result, a large part of Hollywood’s amazing money making machine remains nearly invisible to the public. The problem here does not lie in a lack of diligence or intelligence on the part of journalists. It proceeds from the entertainment news cycle, which generally requires a story about Hollywood to be linked to an interesting current event within a finite time frame. The ideal example of such an event is the release of a new movie. For such a story, the only readily available data are the weekly box office estimates; these are conveniently reported on websites such as Hollywood.com and Box Office Mojo. If an intrepid reporter decided to pursue a story about the actual profitability of a movie, he or she would need to learn how much the movie cost to make, how much was spent on P&A, the details of its distribution deal and its pre-sales deals abroad, and its real revenues fromworldwide theatrical, DVD, television, and licensing income. Such information is far less easily accessible, but it can be found in a film’s distribution report. But this report is not sent out to participants until a year after the movie is released, so even if a reporter could obtain it, the newspaper’s deadline would be long past. Hence the media’s continued fixation on box office numbers, even if reporters themselves are aware of their irrelevance in the digital age.The purpose of my forthcoming book The Hollywood Economist is to close gaps like thesein the understanding of the economic realities behind the new

The Secret Numbers

2010-01-06T14:43:00.000-08:00

Up until 2008, the six major studios supplied their revenue numbers to their trade association, the MPAA. They included a detailed breakdown of the money they received from all sources– movie theaters, DVDs, television licensing, and pay television, and from every market in the world. The MPAA aggregated the data and then published it its privately-circulated "All Media Revenue Reports." Although secret from the public, these reports were provided to the top executives at the six major studios, who used them to gauge how their studio was performing vis-a-vis the other studios. Unlike retail sales reports, which at best are measures how much consumers spent buying tickets and DVDs, the MPAA numbers report much the studios actually received in revenue.
The story these numbers tell is how Hollywood's business moved from movie theaters to homes. As Table 1 shows, ticket sales from theaters provided 100 percent of the studios' revenues in 1948. In 2007, the last full year reported by the studios, theaters accounted for less than 21 percent of the studios’ revenue and home entertainment– a category that did not exist in 1948– accounted for 79 percent of their revenues. What made home entertainment even more important to their earnings is the profits margins are much higher on DVDs and television licensing than theaters. The couch potato is now king.