Movie Economics Essay

Movie Economics Essay

The film industry as it stands today spans the globe. It has evolved over the time and being a complex phenomenon and a highly specialised trade consists of the technological and commercial institutions of filmmaking – the film production companies, film studios, cinematography, film festivals, actors, directors and other film personnel. Also, different aspects of the motion picture industry have had advances and expansion of opportunities and scope at various stages like development, pre-production, production, post-production and film distribution and marketing. The history of a film is usually related through the achievements of producers, directors, writers and performers.

Making films – production, has always been perceived as a glamorous pursuit. Alternatively, our personal understanding and appreciation of film is shaped by our experiences at the cinema. The exhibition of film is a commonplace, shared cultural activity highly visible in every city and town, constantly feeding the popular memory. By contrast, distribution, the third part of the film supply chain, is often referred to as ‘The Invisible Art’, a process known only to those within the industry, barely written about and almost imperceptible to everyone else. So what is involved in this invisible process? Arguably, distribution is the most important part of the film industry, where completed films are brought to life and connected with an audience.

Completing a movie with various groups is half the task when distribution and marketing is not included. The power of the industry is very much dominated in the distribution companies, for the product, the film, can not be completely produced without the finances and influence of the distribution company. What happens to a motion picture once it is finished? How does the movie get into the hands of a distributor? How does the distributor get the movie into the hands of the exhibitor or in the case of video tape/disks, into the hands of retail stores? And how does the distributor/theatre owner convince the public to attend your movie and to buy the tape/disk? All of this business is called “Marketing and Distribution”.

Film Distribution & Marketing

Distribution is also about releasing and sustaining films in the market place. A film distributor is an independent company, a subsidiary company or occasionally an individual, which acts as the agent between a film production company or some intermediary agent, and a film exhibitor, till the end of securing placement of the producer’s film on the exhibitor’s screen. When the film is completed and sent to the studio, the studio makes a licensing agreement with a distribution company. Producers with worthy projects approach distributors with their screenplay and ask them to provide a letter-of-intent-to-distribute to at least a minimum release of their film. The producer then uses these distributor endorsement letters to attract investment capital, above-the-line cast members, and key production crew. The primary agenda of the distributor is to convince the exhibitor to rent, or book, each film. To ensure that the distributor usually arranges industry screenings for exhibitors, and uses other marketing techniques that will make the exhibitor believe they will profit financially by showing the film.

Also Depending on the different levels of film budgets there can be different scenarios for distribution of a motion picture:
In-House Production/Distribution – The selected studio /distributor to which the project has been pitched or submitted, provides the acquisition/development financing, develops the project at the studio under some level of supervision of studio creative executives, gives a “greenlight” to studio production funding and distributes the completed film with the studio affiliated distributor using the distributor’s funds to cover P&A expenses. An independent producer (or screenwriter, director, actor or actress) may have originally submitted the idea, concept, underlying property, outline, synopsis, treatment or screenplay to the studio, but rights to produce as a motion picture were then acquired by the studio. If the producer or others remain attached, they do so as employees of the studio or project.

Production Financing/Distribution Agreement – The independent producer provides the acquisition/development financing (or raises such funds from investors) and takes the deal to a studio/distributor with a fairly complete package (i.e., significant elements are attached). The studio/distributor’s money is then used to produce and distribute the picture. The distribution agreement is entered into (theoretically) prior to the start of production, or at least before the end of production. The distributor will deduct its fee, recoup distributor expenses, collect interest on the production money loan and then reduce the negative cost with remaining gross receipts, if any.

Negative Pickups (and other forms of lender production money financing) –The independent producer provides acquisition/development financing (or raises such funds from investors) and obtains one or more distributor commitments and guarantees to purchase the completed picture (for the worldwide, domestic or international markets, or individual territories) if the finished film meets specified delivery requirements (as set forth in detail in the distribution agreement). The producer takes this or these distributor commitment(s) to an entertainment lender to secure production funds using the distributor’s contract(s) as effective collateral. In this instance, the only part of the financing provided by the distributor relates to distribution expenses (i.e., the so called P&A monies). The negative pickup and other forms of these distribution/finance agreements associated with lender financing are typically entered into prior to the production of the film. Other variations on lender production financing include foreign presales, gap financing, so called “super gap” financing and partly or wholly insured sales estimates.

Acquisition Deal –The independent producer raises acquisition/development as well as production monies, often from investors outside the film industry, but distributor funds are used to distribute the movie. The distribution agreement is entered into after the film is produced). Some in the industry still erroneously use the term “negative pickup” to describe this transaction which is clearly different from the true lender financed “negative pickup” described above. This “pure acquisition” approach to film finance and distribution generally provides the producer and creative team with the most creative control (over scenarios 1 3), but involves greater financial risk for the producer and/or the producer’s investors.

Rent-A-Distributor – The independent producer raises acquisition/development, production and some or all of the money needed to distribute the film. This type of distribution agreement is generally entered into after the film is produced. Distributor fees are generally at their lowest with this transaction, (e.g., 15%).

In any given year, these five film finance/distribution scenarios will typically be represented on the film slates of each of the so called major studio/distributors, although in terms of numbers, the PF/D, negative pickup and acquisition deal combinations probably generate most of the films appearing on such slates. On the other hand, almost all of the majors will have one or more in house productions each year and the rent a distributor scenario is probably the least commonly used. Most of the independent films produced each year tend to rely on some variation of lender financing or investor financing combined with an acquisition deal. The major studio/distributor sales representatives tend to use their coming blockbusters as leverage to gain favoured treatment from exhibitors for the mediocre to poor films on their annual slates, thus partially explaining why many independent features of equal or superior quality get squeezed off theatre screens in favour of major studio product.

In the practice of Hollywood and other forms of industrial cinema, the phases of production, distribution and exhibition operate most effectively when ‘vertically integrated’, where the three stages are seen as part of the same larger process, under the control of one company.

Financial models involved with Distribution Company and producer:

Once a distributor is interested in a film, the two parties arrive at a distribution agreement based on one of two financial models:

  • Leasing

  • Profit sharing

In the leasing model, the distributor agrees to pay a fixed amount for the rights to distribute the film. If the distributor and the studio have a profit-sharing relationship, on the other hand, the distributor gets a percentage (typically anywhere from 10 to 50 percent) of the net profits made from the movie. Both models can be good or bad, depending on how well a movie does at the box office. The goal of both the studio and the distribution company is to predict which model will benefit them the most.

Most of the major studios have their own distribution companies. For example, Disney owns Buena Vista, a major distributor. The obvious advantages of this are that it is very simple to set up a distribution deal and the parent company doesn’t have to share the profits with another company. The big problem is when an expensive movie is a flop — there’s no one else to share the costs. That’s the main reason several studios have partnered on major movies in recent years. For example, Star-wars episode one was produced entirely by Lucas-film but distributed by Fox.

The next big step occurs once the distribution company has rights to the film. Most distributors not only provide the movie to theatres, but obtain ancillary rights to distribute the movie on VHS, DVD Cable and network TV. Other rights can include soundtrack CDs, posters, games, toys and other merchandising.

Exhibition

The distribution company shows the movie (screening) to prospective buyers representing the theatres. The buyers negotiate with the distribution company on which movies they wish to lease and the terms of the lease agreement. Once this is accomplished, the distributor then secures a written contract with the Exhibitors stipulating the amount of the gross ticket sales to be paid to the distributor (usually a percentage of the gross after first deducting a “floor”, which is called a “house allowance” (also known as the “nut”).

Ordinarily there are standard contracts between a distributor and an exhibitor that apply to all films subsequently booked, although on occasion some of the terms, such as the percentage of the gross to be paid by the exhibitor, may be varied with regard to a particular film.

There are two ways for such an agreement:

  • Bidding

  • Percentage

Bidding requires that the theatre agree to pay a fixed amount for the right to show the movie. For example, a theatre might bid $100,000 for a four-week engagement of a new movie. During that time, it could make $125,000 for a profit of $25,000. Or it might take in only $75,000, which means the theatre has a loss of $25,000. Few distribution companies use bidding anymore. Most agreements are for a percentage of the box office (ticket sales).

In this sort of deal, the distributor and the theatre agree to several terms:

  • The theatre negotiates the amount of the house allowance, or nut, with the distributor. This is a set figure to cover basic expenses each week.

  • The percentage split for the net box office is set. This is the amount of box office left after the deduction of the house allowance.

  • The percentage split for the gross box office is set.

  • The length of engagement is set (typically four weeks).

The distributor will get the vast majority of the money made by the movie. The agreement gives the distributor the agreed-upon percentage of the net box office or gross box office, whichever is greater.

Consider this example. Theatre A is negotiating with Distributor B over a new movie. The theatre has figured that expenses, the nut, are about $4,500 per week. The net percentage to go to the distributor is set at 95 percent for the first two weeks, 90 percent for week three and 85 percent for the final week. The gross percentage to go to the distributor is set at 70 percent for the first two weeks, 60 percent for week three and 50 percent for the final week.

One can see that during weeks one, two and three, the gross percentage is higher. The net percentage is higher for week four. So the distributor would take gross percentage on one through three then net for week four. The theatre breaks even the first week, loses money the second and makes a profit on weeks three and four.

The distribution company determines how many copies (prints) of the film to make. The distributor must also ensure that enough film prints are struck to service all contracted exhibitors on the contract-based opening day, ensure their physical delivery to the theatre by the opening day, monitor exhibitors to make sure the film is in fact shown in the particular theatre with the minimum number of seats and show times, and ensure the prints return to the distributor’s office or other storage resource also on the contract-based return date. Then the prints are sent to the theatres a few days before the opening day. In practical terms, this includes the physical production of film prints and their shipping around the world (a process that is beginning to be replaced by digital distribution) as well as the creation of posters, newspaper and magazine advertisements, television commercials, trailers, and other types of ads. Furthermore, the distributor is responsible for ensuring a full line of film advertising material is available on each film which it believes will help the exhibitor attract the largest possible audience, create such advertising if it is not provided by the production company, and arrange for the physical delivery of the advertising items selected by the exhibitor at intervals prior to the opening day.

The theatre shows the movie for a specified number of weeks (engagement). One buys a ticket and watches the movie. At the end of the engagement, the theatre sends the print back to the distribution company and makes payment on the lease agreement. The distribution company collects the amount due, audits the exhibitor’s ticket sales as necessary to ensure the gross reported by the exhibitor is accurate, secures the distributor’s share of these proceeds, and transmits the remainder to the production company (or to any other intermediary, such as a film release agent).

At the end of the negotiated engagement, the theatre pays the distributor its share of the box office earnings and returns the print. If a movie is very popular and can continue to draw a steady crowd, the theatre may renegotiate to extend the lease agreement.

While first run movies that have just been released are loss leaders, movies that have been out for a while can be profitable for the theatres that show them. Second run theatres often get very attractive leasing terms from the distributor. These theatres are facing increasing competition though, as first run theatres continue to show more movies past the traditional four to six week time frame.

If the distributor is handling an imported or foreign language film, it may also be responsible for securing dubbing or subtitling for the film, and securing censorship or other legal or organizational “approval” for the exhibition of the film in the country/territory in which it does business, prior to approaching the exhibitors for booking.

This summarises the Logistics of Distribution which represents the phase of distribution at its most basic – supplying and circulating copies of the film to theatres, of tapes and DVDs to shops and video rental stores, and managing the effectiveness of the supply. The showing of films in cinemas is a time-pressured activity. Cinemas spend their money publicising film play-dates and times in local papers or through published programmes. There’s an imperative for the distributor to deliver the film on time.

After supplying ,circulating and exhibition of the movie and thereafter achieving targeted sales the distributor then accounts for the sales of the movie against costs for prints, advertising campaigns, and other distribution expenses, such as local financing costs, taxes, customs duties, and tariffs. Per the distribution license agreement, the distributor can then return any actual positive net revenue from the distribution license to the production company directly, or to a legal trust entity created to receive net revenue for the production company and for its beneficiaries, such as equity investors, creditors, sales agencies, and talent guilds. Distribution companies generally return positive net revenue to encourage producers to provide early exclusive access to their next motion picture. Whereas, in the early years of a multi-year distribution license negative net revenue accounting reports are very common, and reflect the start-up costs for marketing a new motion picture. The first picture bears the brunt of the market introduction costs – and the subsequent pictures will benefit from brand familiarity and mass media awareness with the story characters and its elements.

Marketing

Since advertising is a major instrument of competition in the movie industry, it follows that companies often spend hefty sums on advertising for new products prior to their launch. The overall process starts with marketing research and goes through market segmentation, business planning and execution, ending with pre and post-sales promotional activities. It is also related to many of the creative arts. When a distributor has leased a movie, they will try to determine the best strategy for opening the movie. Opening refers to the official debut of a movie. There are several factors to consider which can be described through the ‘Marketing Mix Theory’

Marketing mix theory – Elements of the marketing mix are often referred to as ‘the four Ps’:

  • Product: Obviously, a movie that has everything – major studio backing, big stars and a great story is probably going to open big and do very well. If it has big stars but doesn’t appear to have legs (meaning that it will not stay popular for long), the distributor may opt to put the movie in as many theatres as possible during its first engagement. Fewer theatres will be interested in a movie with an unknown cast or poor buzz.

  • Place– Place is often referred to as the distribution channel. It can include any physical exhibition like theatres or film festivals, home theatres or domestic display or virtual display like internet streaming etc.

  • Promotion – Promotion represents all of the communications that a marketer may use in the marketplace. Promotion has four distinct elements -advertising, public relations, word of mouth and point of sale. A certain amount of crossover occurs when promotion uses the four principal elements together, which is common in film promotion. Advertising covers any communication that is paid for, from and cinema commercials, radio and Internet adverts through print media and billboards. Public relations are where the communication is not directly paid for and includes press releases, sponsorship deals, exhibitions, conferences, seminars or fairs and events. Word of mouth is any apparently informal communication about the product by ordinary individuals, viewers or people specifically engaged to create word of mouth momentum like movie critics or journalists reporting the box office appraisal. Sales staff often plays an important role in word of mouth and Public Relations.

  • Price: The right price is determined by the location and means of the distribution channel like the theatres or multiplexes charge more while the smaller exhibition channels charge less. Also, in competitive areas the maintenance of the exhibition place is high so higher charges are evident.

Extended marketing mix

  • People/Target Audience – all people who directly or indirectly influence the perceived value of the movie, including knowledge workers in the motion picture industry, the creative arts group and viewers. Sometimes a movie has gotten good buzz, but isn’t likely to have mass appeal because of the audience it is directed at.

  • Public Opinion – The people’s opinion counts in this industry where the target of processing a product is its appeal to the audience. It can attract crowds repeatedly if it has the ability to hold the audience.

  • Process – The procedures, mechanisms and flow of activities which lead to a complete package of the movie can make a difference for example a graphics based movie like Spiderman series or Ice age needs a good marketing based on the entwining mechanics and processes of computer animated graphics and in real life stills.

  • Presence – The presence on timeline makes a difference for some motion pictures too. For example it might be the wrong time of year for a particular type of movie. For example, a heart warming Christmas story is not likely to do well opening on Memorial Day weekend.

No.

Title

Gross Earnings

Release Date

Theatres

1 week before

Release day

1 week Later

1

Harry Potter and the Half Blood Prince

275,19

286,44

281,27

Jul 15, 2009

4325

2

Ice Age

169,2

170,46

134,72

Jul 01,2009

3300

3

Bruno

119,56

108,22

64,65

Jul 10,2009

1895

4

Angels and Demons

152,66

151,7

109,44

May 15,2009

327

Utility characteristics of goods – The motion picture industry is an industry with the product/goods that are usually modeled as having diminishing marginal utility. The first individual purchase has high utility; the second has less. Thus, in these goods, as the quantity consumed increases the price of the units approaches zero, assuming that one cannot re-sell it, there is a point at which a consumer would decline to purchase an additional product, even at a price very near zero. This margin of utility is the consumer’s satiation point. In other words, the shelf life of movie is very short and with time the shelf life of movies in theatrical releases seems to be getting shorter and shorter.

Courtesy – Hollywood Stock exchange

Through the analysis of a small sample of motion pictures it is concluded to be an evolving rank tournament of survival and death. The results of a survival analysis indicate that the failure rate of motion pictures is time-dependent, and that survival time is strongly related to the number of initial bookings. Long runs do not guarantee success. A specialty film may play on only a few screens and it may run a long time if its audience develops slowly and its revenue is not diluted over many screens. A mass appeal film usually will be licensed to many theatres. Because there are many screens, it may play of rapidly because demand is saturated quickly. Its revenue per screen will fall rapidly and exhibitors drop it. But this short theatrical shelf life is extended by several afterlives, first as videos to rent or buy (VCR or now DVD), and then as TV programs first narrowcast (on pay-per-view, on airplanes, on cable) then broadcast then on other networks and to a growing extent, as downloadables on the Web. This is called as Domestic Marketing.

Domestic Marketing: Depending on the licensed home entertainment format, the distributor may create the local DVD versions of the motion picture from the deliverables. Sometimes, this requires developing a separate local home entertainment marketing campaign from the deliverables, which can result in an enhanced or extended version of the motion picture, replete with Internet hyperlinks to contracted local product and service promotions. Then, the distributor ships the DVD-video to retail outlets within his territory.

While these after-markets were once incidental to the fiscal health of a movie studio, they now have become a central part of the finance plans of every film. Because of these after-markets, all films have now, in theory, an indefinite shelf life. This factor is changing the way movies are made, distributed, and sold.

To further increase the shelf life the movies are marketed and distributed in various regions over the timeline i.e. in different countries. This stimulated release enhances the shelf life of a motion picture thereby producing revenues over the timeline spaced on physical coordinates over the various geographical regions. Thus international release is another way of extending shelf life .Many marketing and distribution companies hope to make the real money in the international distribution rights. Global distribution is getting stronger rapidly – with the enormous Asian markets just starting to open up. Over the past decade, more and more cineplexes are being built in more and more countries. The international factor, once just icing on the financial cake is now a fundamental to the planning and making of most Hollywood movies.

International Marketing: Depending on the licensed territory, the distributor may create local language versions of the motion picture from the deliverables under the license. Local language versions appear as subtitled motion pictures or as voice-dubbed motion pictures – depending on the sophistication of the distributor. The dialog transcript and music cue sheet both support this function. When the local licensing rights expire, the local language edition of the film should revert back for future distribution and archiving. International markets are as important as domestic.

Digital advertising /distribution – As the Internet bandwidth bottleneck disappears, and watching films and videos online and via mobile has gained substantial ground, a whole new realm has emerged for enterprising filmmakers to generate earn-income from their media content. Branded blogs, video streaming, and social networking sites are becoming a valuable landscape for savvy media-makers. This has enabled further increase of shelf life in the motion picture industry. As, is evident from the data and charts the movie looses its oomph over a period of few weeks in the theatrical arena thus, the digital advertising increases its reach to a larger audience which is unable to access the theatres or don’t have time to catch up with the fast pace world of motion pictures with enormous content available. This allows the viewers more discretion to view the products of their choice by increasing their availability over a larger span of time.

Also, through digital marketing it can reach out and appeal to a larger audience and not just the group of people who keep a pace with the fast pace motion pictures industry. Making the movies available in theatres is a more expensive endeavour and its access is limited to the people who can reach out to these theatres physically. Digital distribution makes the product available to a larger range of people.

Rank

Title

Box office($)

1

Titanic

600,779,824

2

Star Wars

460,935,665

3

Shrek 2

436,471,036

4

Star Wars: Episode I

431,065,444

5

Spider man (2002)

403,706,375

6

Star wars episode III

380,262,555

7

Lord of the Rings: Return of the King

$377,019,25

8

Spider man 2

373,377,893

9

Lord of the Rings: Two Towers

340,478,898

10

Spider Man 3

336,530,303

B

Fig. 2 Established series as a formula for successful marketing

rand marketing – Some companies having copyrights to any popular characters or brand names may seriously affect the success distribution or marketing companies market on the basis of a brand or so called brand advertising. Thus it is easier to make a mark on the box office if the motion picture is marketed on the power of certain characters like Spiderman Also, once established as a success many distribution and marketing companies cash on the audience appeal of such characters, story lines or certain special effects or themes and build series for them such as Spiderman series , Lord of the Rings, Harry potter and of course Walt Disney characters. 

All of these factors help the distributor determine the number of prints to make. Each print typically costs about $1,500 to $2,000 to make, so the distributor must consider the number of theatres a movie can successfully open in. Many of the 37,000 screens in the United States are concentrated in urban areas. A popular movie might fill the seats in several theatres in the same city while another movie would have a much smaller audience. Since opening a movie on 3,000 screens could cost $6 million for the prints alone, the distributor must be sure that the movie can draw enough people to make the costs worthwhile.

Major distribution companies of the industry

The motion picture industry is very much dominated by large and very diversified conglomerates, such as The Walt Disney Co., News Corp., Sony Corp., Time Warner Inc., and Viacom Inc. which finance the development of new products, in this case motion pictures, own vast libraries of older products, and often own distribution channels for bringing these new products to the public. The vast entertainment conglomerates i.e. the distribution companies very much dominate the industry because they do have more clout with theatre owners and TV networks, if they do not own their own subset within the very conglomerate. They can offer brand name recognition to the viewer, and have more connections to the creative talent and experience with effective management. Sometimes the distributor finances the movie from beginning to end and other times, provides a portion of the finances and subsequently receives a cut of the profits.

Hence this invisible art is practiced in so many ways and is expanding with every passing day. According to the Motion Picture Association of America (MPAA), films financed by major distributors cost $53 million in 1998; almost triple the price tag of 10 years ago.

List of References

  • Kotler, Philip, Keller, Lane (2005) “Marketing Management”, Prentice Hall.

  • Cones J. W. (2007) ‘Film Finance/ Distribution Scenarios’

  • De Vany, A. and Eckert, R. (1991). Motion picture antitrust: The Paramount cases revisited. Research in Law and Economics.

  • Consolidated Management Group, LLC versus the California Department of Corporations, 2008 (as reported in the California Business Law Reporter in its July 2008 issue).

  • Cones .J.W., 2008 ‘Forty-Three Ways to Finance Your Feature Film’, third Edition, Southern Illinois University Press.

  • Church.A.R. ,Godley .A. (2003) ‘The emergence of modern marketing’.

  • Chisholm, D. C. ‘‘Asset Specificity and Long-term Contracts: The Case of the Motion Pictures Industry.’’ Eastern Economic Journal, 1993.

  • ‘‘Uncertainty in the Movies: Does Star Power Reduce the Terror of the Box Office?’’ Journal of Cultural Economics, 1999.

  • Filson, D., D. Switzer, and P. Besocke. ‘‘At the Movies: The Economics o f Exhibition Contracts.’’ Economic Inquiry, 2005.

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