Review – The Big Picture: Money And Power In Hollywood

The Big Picture: Money and Power in Hollywood

by Edward Jay Epstein, published 2005

What the movie business was like in 1947

The central theme of “The Big Picture” is that the economics of the film industry and the profitability of Hollywood (both mechanistically and proportionally) have changed significantly from 1947 to the present day. By way of comparison, consider a few of the following starting statistics:

• In 1947, the major film studios produced 500 films; in 2003, the six major studios produced 80 films
• In 1947, 90M people out of a total population of 151M went to a theater each week in America at a cost of about $.40/ticket; in 2003, less than 12% of the population saw a movie in a given week
• In 1947, 4.7B movie tickets were sold in America; in 2003, 1.57B were sold
• In 1947, “feature films could be shot in less than a month, and some B films were shot in a week”; today, the average live action film takes over a year to produce and the average animated film takes 2-3 years to produce
• In 1947, “virtually all [studio] films” made money, with the average cost of making a film at $732,000, and average net receipts of around $1.6M; in 2003, “a relatively good year, the six studios lost money on the worldwide theatrical release of most of their titles”

By 2003, the cost of producing the average film had risen to $63.8M. Although the dollar fell 7x from 1947-2003, the cost of producing a film rose 16x! Clearly, when the trend in film production is studied over time it is obvious that film production has become a substantially more capital-intensive business, it is a higher risk business (in terms of the chance and cost of failure) and it is substantially less profitable, at least in terms of theatrical release.

How and why did the economics of the film industry change, and how have film studios managed to stay in business today if their main product (theatrical film releases) are money losers on average? The answer consists of two elements: changing government regulations, and changing strategic dynamics.

Government intervention

The new studio system is the product of three government interventions. (The old one was a product of one– patents and intellectual property laws that caused movie studios to flee the Edison Trust on the East Coast, where the ET’s lawyers had a harder time pursuing patent infringement claims.)

1. In 1948, the Justice Department issued a consent decree to the major film studios, “give up control over major retail outlets [the theater distribution system] or face the consequences of a criminal antitrust investigation”
2. In 1970, the FCC passed the fin-syn rule on studios’ behalf, giving Hollywood an advantage over the networks in the syndication business, laying the seeds for and eventual studio takeover of the television network industry and the rise of the international, corporate media conglomerate business model
3. In the 1990s, fin-syn was weakened and in 1995, abolished altogether by the FCC, allowing studios and networks to become part of vertically integrated conglomerates controlling production, distribution, stations, networks, cables, satellites and other means of TV transmission

A few other intervention-related items of note: the Nixon administration asked studios to portray drug users as menaces to society rather than victims of addiction, resulting in the start of perpetrators of crime frequently being depicted as drug users in film and television productions. Additionally, in 1997 Congress passed a law allowing studios to be paid through a formula for integrating antidrug messages into the plots of television series that were approved by White House Office of National Drug Control Policy.

Your tax dollars at work!

Disney changes the game

The second major change to the old studio production and profitability model was Walt Disney’s decision to focus on young children and families as the primary audience for his film and television productions. This strategy began with development of Snow White and the Seven Dwarfs, which began in 1934. Between 1937 and 1948, 400 million children’s tickets at an average cost of $.25 had been sold. The film was the first to gross over $100 million. It was also the first film to have a commercial soundtrack, the first film to have merchandising tie-ins and the first film with multiple licensable characters.

Disney’s strategic decision was brilliant– he created a niche market (children’s entertainment) that the other studios refused to enter. He had this new and growing market all to himself for a long period of time, during which he established his brand as essential and synonymous with family entertainment. He  and his successors pioneered the idea of film releases as simply the starting point in establishing a long-lived exploitable IP asset which could generate additional cash flows outside the box office through merchandising and licensing arrangements.

The way Hollywood works today

Today, the major movie studios have either been subsumed into massive, international corporate conglomerates, or else they’ve become one (like Disney). Movies are just one of their many businesses, and the role of the box office has dwindled. Many movies lose money at the box office. But this is okay because the corporate studios issue their content and IP across their other media (TV, merchandising, music, home entertainment products, etc.) to make back their money, and then some.

As one example of new studio economics, consider the film Gone in 60 Seconds— worldwide box office gross of $242M, $103.3M paid by Disney to produce the film, $23.2 for physical distribution into theaters (prints and insurance), $67.4M on worldwide advertising, $12.6M in residual fees, all in costs of $206.5M to get the film into the theater and to generate an audience to see the film. The theaters then kept $139.8M of the box office gross. Disney’s distribution arm (Buena Vista) collected $102.2M. Disney’s overhead of $17.2M for employee salaries in production, distribution and marketing and interest payments of $41.8M mean the film lost over $160M by 2003.

But that isn’t the end of the story for a film like Gone in 60 Seconds, as the film IP takes on a new life once it leaves the theatrical market and enters the world of home entertainment, where it is sold as a personal home library title, rented and licensed for syndication through major domestic and foreign TV and other media networks. For animated films (and some live action titles), there is also the opportunity to merchandise relevant IP and license the film’s IP as a movie tie-in for the products of other companies.

As can be seen from the numbers above, the two primary drivers of increased film production costs are related to the competitive aspects of film advertising and distribution and the end of the “chattel talent” system whereby studios essentially owned their stars and laborers (producers, directors and film crews), compared with the “star power” arrangements of today. According to the author,

In this new era, stars, not studios, reap the profit their brand names bring to a film.

One reason that advertising costs have risen is due to the fact that in the previous era, one admission got you in for multiple screenings and every moviegoer essentially watched every screening shown during their admission. Today, movie audiences are highly segmented. This means that studios have to “create” a new audience for each and every film, they can not count on a moviegoer purchasing a general admission ticket which will result in them watching all of their films. As one Sony marketing executive put it:

If we release twenty-eight films, we need to create twenty-eight different audiences which necessitates twenty-eight different marketing campaigns.

Additionally, the transformation of the film industry into a global market with simultaneous releases means higher advertising costs (no way to reuse promotional prints and media as films no longer have “rolling releases” across the country) and higher physical film production and distribution costs (every theater needs its own copy of the film which must be shipped there and back). And because the studios no longer “control” their talent and labor, they must be willing to pay top dollar for the name-brand stars that draw the biggest crowds.

However, the studios have also gotten savvier at advertising and cross-marketing in the age of ownership by global, corporate media conglomerates. Major Hollywood studios cross-promotionalize across their various media. A studio can get actors, directors, etc. to be interviewed on the corporate parent’s TV networks to promote an upcoming film. Corporate sponsors with TV rights for certain sports and national events can get additional advertising and exposure for the corp parents film studios as well.

Film studios have also learned how to leverage their promotional efforts through tie-in marketing and merchandising partnerships. In these relationships, a leveraged marketing and advertising budget results because your partners pay to promote your characters and content for you. For example,

[McDonald’s] invested more than $100M — four times Disney’s own advertising budget– in just one film, Monsters, Inc.

The clearinghouse system

Another essential element of the modern film business that must be understood is the “clearinghouse system.”

Studios now outsource the making and financing of most of their movies and television series to off-the-book corporations

Movies used to return almost all of their money in a year; now, revenue flows in over the lifetime of licensable rights, often lasting many decades.

When revenue flows in, it is the studio that decides (initially at least) who is entitled to what part of it, and when, and under what conditions

which works to the studios advantage because

the studios usually control the information on which the payments are based

Theaters, distribution and merchandising

Today’s theaters have three primary businesses: concessions vending, movie-exhibition, and corporate advertising. However, contrary to popular belief and news headlines, the box office is not the primary source of profits for theaters– the selling of refreshments is.

Theaters want a film with broad appeal so there are more people attending who will buy more refreshments. Additionally, they want films no longer than 128 minutes in length because every film which exceeds that limit causes them to lose a potential evening showing.

Film studios, meanwhile, simply want their films to succeed at the box office because there has historically been a connection between success at the box office and later success in the home entertainment market, which is much more profitable for them as studios end up with only 45-60% of the box office revenues on average.

Non-domestic box office and non-theatrical release have long been critical to the Hollywood model. As early as 1926, Hollywood studios represented 3/4 of European box office and 1/3 of Hollywood revenues came from Europe. In the 1950s, Hollywood film studios had a 30% share of European and Japanese box office which grew to 80% by 1990. American film studios seem to flagrantly violate the Greenwaldian strategic mantra of “compete locally”!

Paramount and Universal jointly control the largest overseas distributor, United International Pictures (UIP). Pay-per-view TV earned the six major studies $367M in 2003, a relatively modest sum of money despite the hype of the model. Other major sources of revenues in nontheatrical release are airline in-flight entertainment, hotel pay-per-view and US military theaters overseas. One of the benefits of television syndication of studio content is that almost all marketing expenses are paid by the broadcaster and the network.

Merchandising is another critical element of film studio profitability. For example, merchandising alone adds an estimated $500M profit to Disney’s bottom line each year.And The Lion King produced $1B in retail sales by itself. Streams of licensing revenues can enrich a studio’s clearinghouse for many decades.

Critical competitive dynamics of the film industry

It’s a well-known fact within the industry that “the date on which a film will open can make or break a movie.” Traditionally, the 9 months between September and May when school is in session promises only a fraction of the audience possible during the three months in the summer season. Studios must compete for a limited number of big-release slots and face a distinct “prisoner’s dilemma” strategic framework in which the refusal to cooperate in selecting movie release dates can result in massively diminished box office performance for each studio.

The studio whose film has the weaker appeal to the target audience has a strong incentive to change its slot, since if the NRG numbers prove correct, it stands to get a smaller share of a confused and cross-pressured audience and will probably fail.

A key competitive strategy for film studios is the creation of franchise films. Franchise films are more stable sources of revenue, because they’re more consistent performers at the box office and in the sell-through of the home entertainment market. Additionally, they ostensibly help to lower the costs of advertising and marketing because there is already a fan-base/audience in place which does not need convincing anew to see a franchise sequel film or buy related merchandise. Additionally, television and other syndication networks are willing to bid higher for franchise films because of their consistency and predictability.

One key to creating franchise films is close adherence to the “Midas formula.”

The Midas formula

Only a very few films account for the lion’s share of a studio’s earnings. The film’s that succeed most often and most extremely typically follow the “Midas formula”. Films which follow this lucrative formula have the following features:

1. based on children’s stories, comic books, serials, cartoons or a theme-park ride
2. child or adolescent protagonist
3. fairy-tale like plot
4. strictly platonic relationships
5. appropriate for toy and game licensing
6. a rating no more restrictive than PG-13
7. end happily
8. use digital animation
9. cast actors who are not ranking stars (do not command gross-revenue shares)

The Disney empire is largely the result of Disney’s successors closely hewing to this formula. R-rated and live action films have far less chance to reach their break-even compared to films adhering to the Midas formula. In act, non-formula films have little, if any, possibility of becoming billion-dollar-club members.

Other facts and figures and final comments

First, a few stray facts and figures:

• the average cost of American distribution in 2003 was $4.2M per film for the major studios, while independent films averaged $1.87M per film
• the six major studios spent more than $1B in 2003 on film prints
• in 2003, the average advertising expense per film was $34.8M, compared to 1947 when $60M was spent on distribution and advertising by ALL major film studios combined
• in 1947, movies were America’s third largest retail business and the six major studios collectively earned $1.1B, or 95%, of all film “rentals” at the domestic box office
• in 1947, there were 18,000 neighborhood theaters
• in 1947, Clark Gable made less than $100,000 per film

Studios are moving away from physical film in favor of digital projections. This could save millions in distribution costs as there will be no more cost of producing, shipping, storing and retrieving prints from film exchanges all over the world.

A critical summary of the film studio business model from Richard Fox, a vice president at Warner Bros.:

The studios are basically distributors, banks and owners of intellectual copyrights.