Thursday, January 21, 2010

Flirting With Disaster: Can Indie Movies Survive?

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 linchpin 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)

Wednesday, January 20, 2010

Quivering On The Edge Of The Digital Abyss

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 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.

Saturday, January 16, 2010

Why Journalists Don't Understand Hollywood

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 studios had 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 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, 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 these
in the understanding of the economic realities behind the new Hollywood.