The Hollywood Economist (2 page)

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 backend, 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
unwinding of output deals, which started to occur 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 moneymaking machine remains nearly invisible to the public.

The problem here does not lie in a lack of diligence on the part of the 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
Hollywood.com
and Box Office Mojo, which also attach authoritative-sounding demographics to the numbers. 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. (See, for example, the report on
Midnight in the Garden of Good and Evil
.) 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 are aware of their irrelevance in the digital age.

This book’s purpose is to close gaps like these in the understanding of the economic realities behind the new Hollywood. In this pursuit, I benefited enormously from the help I received from people inside the industry. I was greatly aided by distribution reports, budgets, and other documents given to me by producers, directors, and other participants in the making and marketing of movies, and I am deeply indebted to several top studio executives who furnished me with the secret MPA
All Media Revenue Report
for 1998 through 2007 and with studio PowerPoint presentations concerning marketing costs. These documents revealed the global revenue streams of Hollywood films, including the money that flows in from theaters, DVDs, television licensing, and digital downloads.

I am also grateful for the help I received from the Motion Picture Association, which is the major studios’ trade and research organization, and particularly from Robert Bauer, its director of strategic planning; Julia Jenks, its director of worldwide research and information analysis; and Dean Garfield, its former executive vice president.

I further thank everyone who answered my often-pesky e-mails (and my sometimes off-the-wall questions), including John Berendt, Jeffrey Bewkes, Laura Bickford, Robert Bookman, Anthony Bregman, Michael Eisner, Bruce Feirstein, Tara Grace, Billy Kimball, Thomas McGrath, Richard Myerson, Edward Pressman, Couper Samuelson, Stephen Schiff, Rob Stone, and Dean Valentine.

I am especially grateful to the very talented director Oliver Stone for casting me in a small part in his
Wall Street 2: Money Never Sleeps
in November 2009. This bit role allowed me to view the art of moviemaking—and it is an art as well as a business—from a perspective that I would not otherwise have had.

I also received an invaluable education in Hollywood law from Alan Rader and Kevin Vick at O’Melveny & Myers, which retained me as an expert witness in the
Sahara
lawsuit, and from Claude
Serra of Weil, Gotshal, and Manges. These lawyers helped me understand the art of the deal.

I also am indebted to those editors who helped shape this material, including Tina Brown and Jeff Frank at
The New Yorker;
Jacob Weisberg and Michael Agger at
Slate;
Howard Dickman, Erich Eichman, and Ray Sokolov at
The Wall Street Journal;
Mario Platero at
Il Sole 24 Ore;
and Gwen Robinson at
The Financial Times
. Finally, I owe a great debt of gratitude to Kelly Burdick at Melville House, who suggested the idea for
The Hollywood Economist
—and brilliantly edited the book.

Once upon a time, attending the local movie theater was an experience that most Americans shared on a regular basis. For example, in 1929, the year of the first Academy Awards, an average of ninety-five million people—about four-fifths of the ambulatory population—went to movies every week. There were more than twenty-three thousand
theaters, many of palatial size, like the six-thousand-two-hundred-seat Roxy in New York. In those days, the major studios made virtually all the movies that people saw (over seven hundred feature films in 1929). The stars, directors, writers, and other talent were under exclusive contract, and, in addition, the studios owned the theatrical circuits where first-run movies played. This regime, which allowed the major studios to exert total control over movies, from script to screen, came to be known, and feared, as “the studio system”; it more or less ended in 1950, when the United States Supreme Court upheld antitrust decrees ordering several of the major Hollywood studios to divest themselves of their theater chains.

Today, in a world with television, video, the Internet, and other home diversions, weekly average movie attendance is about thirty million, or less than 10 percent of the population. As a result of this diminishment, many larger theaters either closed or divided themselves into smaller auditoriums under one roof. (There are only a third as many theater sites today as there were in 1929, but there are more screens—over thirty thousand.) These multiplexes afforded theater owners significant economies of scale. They could also show a greater variety of films, tailored to different, if
smaller, audiences. And as smaller theaters closed the chains expanded; today, the fifteen largest North American chains own approximately two-thirds of all the screens. These large chains, and their centralized film bookers, are the principal gatekeepers for the American film industry. They are responsible for determining what movies most Americans see.

Today a handful of nation-wide multiplex chains account for more than 80 percent of Hollywood’s share of the American box office, and a large share of these bookings are done at ShoWest, the annual event in Las Vegas in which movie distribution and exhibition executives meet over four days to discuss plans for releasing and marketing upcoming films. In 1998, I contacted Thomas W. Stephenson, Jr., who then headed one of these major chains, Hollywood Theaters, and arranged to accompany him to ShoWest. Stephenson was willing to let me tag along to meetings in Las Vegas on the condition that I not directly quote or identify those with whom he met. As part of the deal, he agreed to a Don’t Ask, Don’t Tell protocol in which, unless they specifically asked, he would not identify me as a journalist to the other participants at these meetings with bankers and studio executives.

On the way to Las Vegas, Stephenson, an energetic, peppery-haired man in his early forties, gave me a quick course in the economics of his business. Of the $50 million customers that paid for tickets in 1997, he said his 450-screen chain, Hollywood Theaters, kept only $23 million; most of the rest went to the distributors. But, he continued, since it cost $31.2 million to pay the operating costs of the theaters, his company would have lost $8.2 million if it were limited to the movie-exhibition business. Like all theater owners, though, he has a second business: snack foods, in which the profit margin is well over 80 percent. And with the snack foods, Hollywood Theaters made a profit of $22.4 million on the sale of $26.7 million from its concession stands. “Every element in the lobby,” Stephenson told me, “is designed to focus the attention of the customer on its menu boards.”

When we arrived, he decided to skip the reception hosted by independent distributors. “I personally enjoy watching many of the low-budget films that come from independents,” he said, “but they are not a significant part of our business.” In fact, according to Stephenson, 98 percent of the admission revenues of his theater in 1997 came from the principal Hollywood studios—Sony, Disney, Fox, Universal, Paramount, and Warner Bros.
These companies supplied his multiplexes not only with films but with the essential marketing campaigns that accompany them. (Occasionally, to be sure, independent films do succeed in winning a mass audience, as, for example,
The Full Monty
and
Slumdog Millionaire
did; but, as Stephenson put it, “We don’t count on them.”)

Marketing campaigns begin months before the release date, use the most sophisticated methods available to target demographic groups, and intensify their activity in the final week, often with saturation television advertising, in order to capture “impulse” moviegoers. Stephenson and other theater owners rely on them to muster, if not to create, the audience for a film’s crucial opening weekend. The campaigns require massive resources. The major studios spent, on average, $19.2 million in 1997 to advertise each of their films, a sum that would be considerably higher if it included the advertising provided by fast-food restaurants, toy companies, and other retailers in promotional tie-in arrangements that can amount to many times what the studio itself budgets. Rather than attend the large reception, therefore, on our first night we dined with the representative of Coca-Cola, a company that exclusively “pours” the soft drinks in over 70 percent of American movie theaters, including
Stephenson’s. Soft drinks are an important part of the movie business. All the seats in Stephenson’s new theater, and most other multiplexes, are now equipped with their own cup holders, a feature that theater executives consider one of the most groundbreaking innovations in movie-theater history. With cup holders, customers can not only handle drinks more easily in combination with other snacks but can store their drinks while returning to the concession stand for more food. Hollywood Theaters, which now offers an oversized plastic cup with unlimited refills, sold slightly in excess of $11 million dollars-worth of Coca-Cola products in 1997, of which well over $8 million was profit.

Although most of ShoWest’s official functions take place in convention halls and hospitality suites at Bally’s Hotel, much unofficial business was done in its sprawling coffee shop. It was there early the next morning that I joined Stephenson for a breakfast meeting with an analyst from J. C. Bradford & Co., an investment firm. Acquisitions were in the air; Kohlberg Kravis Roberts had just bought and consolidated two of the largest theater chains. Stephenson, as he made clear at the outset, planned to partake in this industry consolidation by acquiring state-of-the-art multiplexes. Since he planned to finance this aggressive expansion by
selling part of his company to public or private investors, he needed the services of investment bankers who, in turn, needed a story or convincing rationale, to raise the money.

Stephenson’s story centered on stadium seating, in which every row of seats is elevated about fourteen inches above the row preceding it, allowing all customers to have an unimpeded view of the screen. While the seats take up more space, Stephenson said, “Our focus groups show that people now seek out theaters with stadium seating and will drive as far as twenty miles to find one that has it.” Attendance increased between 30 and 52 percent where he had installed such seating. Stephenson would repeat this story to four other investment bankers at similar kaffeeklatsches over the next two days.

A little later, Stephenson moved to a different table to meet with two of the top executives of another major chain. He had told me beforehand that he wanted to buy five of their multiplexes and sell them an equivalent number in different locations, or “zones.” In the movie business, the country is divided into zones that contain anywhere from a few thousand to a few hundred thousand people; the major distributors license their films to only one theater owner in each zone. Just over two-thirds of Stephenson’s theaters are in such exclusive zones, and he wanted to increase this
number. These talks ended inconclusively, and in the late morning I accompanied Stephenson to the convention hall, where we took assigned seats in the grandstands. Stephenson, along with 3,600 other attendees, was there to see the first major studio presentation, Sony’s product reel. Sony’s top executives sat on a dais, as if addressing a shareholders’ meeting. Jeff Blake, the president of Sony’s distribution arm, said that last year Sony films had brought a new record gross into American theaters: $1.2 billion. Indeed, Sony accounted for nearly one out of every four dollars spent on movie tickets in 1997.