| The
Hollywood Economist
The numbers behind the industry.
The
real El Dorado is TV.
Multiple-Choice Quiz
1. Is Hollywood's biggest money-maker:
a) Movies?
b) DVDs?
c) Television?
The best-kept secret in Hollywood,
especially from Wall Street, is that the movie studios'
biggest profit center is not theatrical movies, or even
DVD sales; it is TV licensing. If the details of the profits
remain clouded to outsiders, it is no accident. The studios
purposely blur together their three principal revenue sources—the
box office, video sales, and television licensing—into
a single portmanteau category called "studio entertainment"
in their quarterly and annual reports. Keeping audiences
in the dark may be a time-honored Hollywood tradition, but
this breakdown can be demystified by consulting the studios'
internal numbers, which they furnish to the Motion Picture
Association on a confidential basis.
Last
year, the six major studios—Disney, Fox, Warner Bros.,
Paramount, Universal, Sony, and their subsidiaries—had
total revenues of $7.4 billion from world box-office sales,
$20.9 billion from world video sales, and $17.7 billion
from world television licensing. Revenues, however, are
what companies record, not what they earn. And, in the case
of Hollywood, the revenues from movies, DVDs, and TV yield
very different earnings.
Once
upon a time—before the TV and VCR—studios earned
virtually all their profits from a single source: the theater's
box office. Nowadays, in the new Hollywood, the world box
office is a money loser: In 2004, the studios lost an estimated
$2.22 billion on the $7.4 billion they took in from the
box office. (Click here to see Table
1.) This sad reality is not a result of the high cost
of making movies, inefficiencies, or of any sort of studio
accounting legerdemain. The simple fact is that the studios
pay more to alert potential audiences via advertising and
to get movie prints into theaters than they get back from
those who buy tickets. Consider, for example, Warner Bros.'
movie The Negotiator, with Samuel L. Jackson and
Kevin Spacey. It was efficiently produced for $43.5 million,
scored a world box office of $88 million, and appeared to
be a modest success. In fact, Warner Bros. collected only
$36.74 million from its theatrical release after it had
paid check-conversion and other collection costs, the theaters
had taken their cut, and the MPA had deducted its fee. Meanwhile,
to corral that audience, Warner Bros.' advertising bill
was $40.28 million, and its bill for prints, trailers, dubbing,
customs, and shipping was another $12.32 million. So, after
the movie finished its theater run, without even considering
the cost of making the movie, Warner Bros. had lost $13
million. Why? For every dollar Warner Bros. got back from
the box office, it shelled out about $1.40 in expenses,
which was about average, if not slightly above par, for
studio movies.
This
might seem equivalent to the joke about a manufacturer who
says, "We lose on every item but make it up on volume,"
except that Hollywood has another way of making up the loss—the
so-called back end, which includes home video (now mainly
DVD) and TV licensing.
Home
video is both more complex and more profitable. With the
advent of the DVD, home video has become a vast retail business,
with studios selling both new and past titles, as well as
television programming such as The Sopranos, Friends, or
Chappelle's Show, at wholesale prices that can go as low
as $5 a DVD. Studios, which have meticulously analyzed these
costs, estimate that manufacturing, shipping, and returns
costs average 12.4 percent; marketing, advertising, and
returns costs average 18.5 percent; and residuals paid to
guilds and unions for their members and pension plans come
to 2.65 percent. So, about two-thirds of video revenues
are gross profits (which participants, such as stars, producers,
and directors, may share in once the movie breaks even).
In 2004, the studios' estimated video gross profit was $13.95
billion.
But
the studios' real El Dorado is television. What makes television
licensing, both at home and abroad, especially profitable
for the studios is that virtually all the expenses required
to market a television program, including tapes and advertising,
are borne by the licensee. The studios only have to pay
the residuals to the guilds and unions, which varies between
movies and TV and average roughly 10 percent. The studios
get to keep the other 90 percent. In 2004, this amounted
to slightly more than $15.9 billion, making it the studios'
single-richest source of profits.
This
El Dorado comes from many tiers of the television industry.
(Click here to see Table 2.)
In 2004, studios made $3.9 billion from licensing their
films, shorts, and TV series to the American broadcast networks—all
of which are now owned by the corporate parents of the studios,
creating a cozy, not to say incestuous, relationship. Another
$4 billion came from licensing studio films to pay-per-view
TV. All the studios have an "output" arrangement
with pay-per-view TV channels to sell them an entire slate
of films at fixed prices. Warner Bros., for example, sells
all its films to its corporate sibling HBO, and Paramount
sells all its films to its corporate sibling Showtime. Overseas,
almost all the main pay-per-view TV outlets are owned or
controlled by the studios' corporate parents. Finally, $9.8
billion comes from so-called library sales, through which
the studios license their movies and TV programs over and
over again to cable networks, local stations, and foreign
broadcasters. Fifty-nine percent of this immense $17.7 billion
of revenue from television licensing comes from America,
which is not surprising, considering that on an average
day fewer than 2 percent of Americans go to movie theaters,
while more than 90 percent watch something at home on TV.
And without these profits from TV, no Hollywood studio could
survive.
Even
though the television profit center is often overshadowed
by the public's fascination with box-office results, it
accounts for the direction Hollywood is taking in three
significant ways. First, it explains the relentless marriages
between the principal outlets for profitable entertainment—TV
networks—and the Hollywood studios, which have been
television's primary content-providers since
1970.
In
1970, the FCC passed the Financial-Syndication rule, which
effectively took the television networks out of the business
of producing their own television series. This rule prohibited
television networks, but not movie studios, from having
a financial interest in television programs broadcast by
networks and then sold in syndication to local stations.
By effectively removing the three networks from the syndication
business, the FCC radically changed the economic landscape
of television. Since it was not profitable to produce television
series for their original run without owning the rights
to sell them in syndication, the networks simply withdrew
from television production. The movie studios were then
able to dominate the business of making and owning television
programs, which they then licensed to the networks for their
original runs and afterwards sold in syndication to local
stations as well as foreign stations. When the FCC lifted
its Fin-Syn rule in 1995, the studios' corporate parents
moved in to take control of major networks.
After
Rupert Murdoch was unable to buy a network and boldly created
his own Fox network, Michael Eisner bought both ABC and
ESPN for Disney in 1995—a coup that changed not only
Disney but the landscape of the entire entertainment economy.
The other entertainment giants quickly followed suit. Today,
the studios' corporate parents own or control all six over-the-air
networks, as well as 64 cable networks, accounting for almost
all the prime-time television audience. (Viacom, even after
it is divided into two separate units, will be controlled
by a single corporate parent—Sumner Redstone's National
Amusement Inc.)
Second,
it explains why so many of Hollywood's new leaders hail
from TV. Robert Iger, Eisner's replacement as CEO at Disney,
was president of ABC television; Sir Howard Stringer, the
first non-Japanese chairman of Sony, was president of CBS
television; Jeff Bewkes, the head of Time Warner's new Entertainment
& Networks Group (which includes Warner Bros. and New
Line), was president of HBO; Tom Freston, the new co-president
of Viacom, was president of MTV; Peter Chernin, the president
of the Fox Entertainment Group, was head of Fox Broadcasting;
and Brad Grey, the new head of Paramount, was a television
producer. Their ascensions simply confirmed that what used
to be a business centered in movie houses has been transformed
into a business centered around the TV in the home.
Finally,
it explains why so-called studioless studios find it difficult
to survive in Hollywood. The big six studios, with vast
libraries of movies and TV programs, can count on this income
flow no matter what happens at the box office or video stores.
For example, even though Sony has a batch of movies this
summer, its profitability is assured by the licensing fees
flowing in from its library of more than 40,000 hours of
movies and TV episodes. No such luck for the independent
studios. With no comparable libraries, or, for that matter,
corporate sibling alliances to ease their access, they need
a constant quota of hits to keep their heads above water.
Consider Dreamworks SKG, run by three of the most successful
and creative executives in Hollywood's history—Steven
Spielberg, Jeffrey Katzenberg, and David Geffen. Even though
it still is in the black, Dreamworks was not able to produce
anywhere near enough hits to prevent it from burning through
a large part of of its capital, and is currently trying
to sell itself to NBC Universal. The problem for these wannabe
studios is that without a juicy slice of the $17.7 billion
television pie, they cannot compete with the studios that
have this rich cushion to fall back on.
The
union between Hollywood and TV has paid off handsomely.
The 2004 MPA Consolidated Sales Report—another confidential
document—shows that the six studios' revenues from
television licensing went from $6.8 billion in 1994 to $17.7
billion in 2004—a nearly $11 billion increase. And
this does not include the fortunes that studios now earn
from selling TV series on DVD. Unfortunately, Hollywood's
movies are coming to play an ever-smaller part in the big
picture.
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