Gross Hysteria

January 23, 2006

by Edward Jay Epstein

The Hollywood Economist

The numbers behind the industry.


Studio executives are hardly clueless when it comes to negotiating contracts with top stars, although the popularity of The-Moguls-Must-Be-Crazy stories in the media would have you believe otherwise. Examples abound: the Wall Street Journal report that, “In order to sign actress Cameron Diaz and director Nancy Meyers, the [Sony] studio had planned to offer both women a share of the movie's gross box-office revenue from its first day of release on. It is a practice known as ‘first-dollar gross' and it's standard fare for top-tier talent,” or the Variety report that “20 percent of the gross [of King Kong ] is going to [Peter] Jackson,” or the Wired report that “A deal worth $20 million against 20 percent of the box office gross [is] the kind of contract Tom Cruise or Tom Hanks generally get.”


In fact, the Hollywood studios never give participants—not even gross players as powerful as Arnold Schwarzenegger, Tom Cruise, Tom Hanks, Jerry Bruckenheimer, Steven Spielberg, or even Pixar Animation Studios—an unadulterated percentage of the box-office gross, or the video store gross, or any other retail gross. As one top Viacom executive explained “The first truism of Hollywood is ‘Nobody gets gross—not even a top first dollar gross player.'”


What the top gross players do get are two kinds of compensation: fixed and contingent. The fixed part is the up-front money that gross players are paid whatever happens to the movie. The contingent part is the percentage of a pool—called the “distributor's adjusted gross” in Hollywood lawyer lingo—that the players get after certain conditions are met, such as the movie earning back the amount of fixed compensation or reaching a contractually-defined cash break-even point. The pool is “filled” with the money that the distribution arm collects or, in the case of DVDs, gets credited with. With movies, the pool (eventually) gets the remittance from theaters (anachronistically called “rentals” from the days when movies were rented to exhibitors) left over after the theater owners deduct their share of ticket-sales and house allowance and after the distributor deducts “off the top” expenses, such as check collection, currency transfers, stamp taxes, duties, and trade association fees.


With DVDs, the pool gets the “royalties” paid by the studio's home entertainment arm to its distribution arm. It's a remarkable exercise in self dealing, and produces an amount that represents only a small fraction of the studio's actual revenue. The standard DVD royalty is 20 percent of the wholesale price, but a few of the very top stars get a royalty as high as 40 percent. (There is also an alternative arrangement called “100% accounting” in which the pool is credited with the home entertainment arm's total proceeds minus its manufacturing and packaging costs, but this is usually reserved for only full-fledged partners, such as Pixar.) In the case of TV licensing, the pool gets the license fee minus the “residuals” paid out to actors, directors, writers, and guild pension plans.


To see how these “gross” participations work in practice, look at Arnold Schwarzenegger's 33-page contract for Terminator 3 , which is still considered the gold standard for the super-gross players. For his fixed compensation, Schwarzenegger received $29.25 million—then a record sum. He got the first $3 million on signing and the balance during the course of principal photography. His “contingent” compensation was 20 percent of the “adjusted gross receipts” of the distributors (Warner Bros in the US, Sony Pictures and Intermedia abroad). The “adjusted” part of the equation allowed the studio to deduct the items specified on page 3 of the contract: “All industry-standard and customary off-the-top exclusions and deductions– i.e. checking, collection conversion costs, quota costs trade association fees, residuals, and taxes.” Schwarzenegger's lawyer Jacob Bloom is without peer in the entertainment business but the best he could do here was to cap some of the collection charges at $250,000; he could not touch the residuals or tax deduction. Bloom did manage to get the all-important DVD royalty contribution to the pool raised to 35 percent (although only for Schwarzenegger). As good as this was, it meant that Schwarzenegger was entitled to only 7 percent of what the studios took in from their DVD sales.


Schwarzenegger's contingent compensation would not kick in until the film met the break-even point defined in the contract (Click here to see how his contract defines cash break-even.) Although the film achieved a $428 million world box-office gross, it just barely reached its cash break-even point, so, alas, Governor Schwarzenegger has earned only a pittance so far from his gross participation beyond his $29.25 million pay day. Tom Cruise got a more immediate slice of the action for Mission Impossible 2 . In return for his producing, acting, guaranteeing against cost overruns, and paying other gross players their share—including Director John Woo's 7.5 percent—Cruise's production company got 30 percent of Paramount's adjusted gross receipts. Since the DVD royalty going into the MI:2 pool was calculated at 40 percent royalty, Cruise would end up getting 12 percent of the DVD revenue. As part of his unique deal, Cruise did not take up-front fixed compensation (other than the minimum required by the Screen Actor Guild), and, in return, his 30 percent contingent compensation was not deferred until a cash break-even threshold was met.


In this light, Peter Jackson's compensation for King Kong was a relative bargain. Universal paid $20 million in fixed compensation to Jackson's production company not only for his directing services, but also for the script writing and producing services of his collaborators Fran Walsh and Philippa Boyens. (The Terminator 3 budget for script, producers, and directors exceeded $34.5 million.) And, making a sweet deal even sweeter, the New Zealand citizenship of Jackson and his team qualified Universal for a cash subsidy from the New Zealand government that could be as high as $20 million (and, by itself, could pay Jackson's entire fixed compensation). In addition, once the fixed compensation is earned back, Jackson's company also gets 20 percent of Universal's adjusted gross receipts, which means it will get at least an additional $20 million from movie rentals (which now have passed $200 million worldwide) as well as a huge pay-off from future DVDs and television rights.


Such deals are costly, but not crazy. The studios' business nowadays is entirely driven huge franchises that serve as worldwide licensing platforms. And the most predictable rain-makers for these windfalls, such as Steven Spielberg, George Lucas, Tom Cruise, Jerry Bruckenheimer, and Peter Jackson, are all gross players represented by savvy lawyers and agents who know all the ropes of the movie business. To be sure, not all of their projects turn out to be billion-dollar franchises, but they have little down-side. Look at King Kong: The upside for Universal was a Midas-touch licensing franchise that would enrich the studio with billions in revenues for years to come.  But even if that gamble fails and there are no ape sequels, the studio will lose little, if any money, on the movie itself.  So, even with Jackson's generous deal, there is little downside risk. In this big-stakes game, it makes great sense for the studios to recruit the best gross players, as long as the gross they give way is not really the gross.




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