The
Hollywood Economist
The numbers behind the industry.
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.
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