November 6, 2016    12 minute read

The Economics Of Hollywood

Is Tinsel Town Losing Its Sparkle?    November 6, 2016    12 minute read

The Economics Of Hollywood

 

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Despite its red carpet glamour, unparalleled visual effects and seemingly large grossing box office, Hollywood is one of the least successful industries in the world. Yet many businesses, big and small, choose to operate in this unforgiving environment.

So why do wealthy New York financiers fund the creative LA movie directors when they could own a piece of the next Snapchat or Uber Unicorn startup? Both investors and producers choose to pursue their dream to be involved with the glitz and the glamour of Hollywood. They purchase the rights to a piece of intellectual property, pay an exorbitant salary for a celebrity actor and receive a continually decreasing proportion of the profits.

Any real attempt to uncover the economics of a movie takes considerable time, as studios keep details on the terms of distribution deals, financing, subsidies and compensation strictly sealed in Non-Disclosure Agreements. However, using all available industry data to piece together the lifetime of a film in money, The Economics of Hollywood can be scrutinised.

Hollywood

Industry Background 

In 1929, on average, 95 million went to the cinema once a week in the US. This was four-fifths of the population. But today, theatre attendance is declining, with only 10% visiting on a weekly basis. As such, PwC director Matthew Lieberman has predicted that industry growth is under 0.6%. The Motion Picture Association of America’s (MPAA) 2014 Theatrical Market Statistics, reported that the US and Canadian box office raked in $10.4bn, down from $10.9bn in 2013.

Once thought to be Hollywood’s saving grace, in 2014, the 3D box office only produced $1.4bn in revenue, which, at 14% of the total box office figure, was two percentage points less than the previous year. The 1% climb in global box office films from 2013’s total was only down to increased sales in the Asia-Pacific region.

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Hollywood is surprisingly stable for the biggest market players – Columbia, Disney, Paramount, Warner Brothers and 20th Century Fox, who have been on top since the 1950s. But this stability is even more puzzling if one considers that movie studios do not have many assets. Why then is Hollywood experiencing a declining influence and where are the shortfalls across its business model? To understand the answers to these questions an exploration into the timeline of a movie is required.

The Economic Timeline Of A Movie

1. Establishing The Budget

Movie budgets for the big studios often amount to $40m, while independent films are estimated at $25m on average. To make a profit after print and advertising costs, these films need to receive around $75m in ticket sales, but many fail to do so. For instance, Disney’s movie Gone In 60 Seconds (released in 2000) was hailed as one of its greatest successes grossing nearly a quarter-billion dollars. Yet as it produced $11.6m from theatres and the movie cost $103.3m to make, it actually made a loss in theatres.

This is largely a consequence of the challenges a film project faces in its marketing and distribution data collection. Before introducing a new product to the market, businesses will conduct market research to establish the likelihood that the new model will succeed. Before releasing the iPhone 7, Apple relied on analyst predictions, just as new car companies base their predictions on the direction of oil prices.

This is impossible for Hollywood. No analytical model can predict consumers ever-changing tastes. Without being able to determine the revenue the movie will generate, it is impossible to master a feasible budget prediction. The process in itself can also add a further $100m to the total investment.

Filming

Print and advertising tend to include billboards, television commercials, and subway adverts. Thanks to Hollywood’s ever-increasing global reach, print and advertising can often tremendously raise the original production budget. For example, the studio behind Transformers: Age of Extinction spent $100m in North America alone.

All of the aforementioned considerations fall under accounts payable. But what can the budget rely on as accounts receivable during the production process?

Many locations, such as Canada, Morocco and Georgia will give tax incentives to movie directors to shoot their films in a particular region. This is to provide stimulation to the local economy, encourage tourism and provide locals with an opportunity of employment on the movie set.

2. Opening Weekend

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The process of making a movie can often take up to 36 months. Timing is crucial, as playwriting, screenwriting, filming, production and visual effects must be punctual to meet the date set for the film’s opening weekend. It is decided months in advance, as Bank Holidays, Christmas, Summer weekends and Thanksgiving are all increasingly difficult to secure. A movie cannot fall short of the deadline because it needs to be able to manage its cash flow adequately, but it also cannot miss its opening weekend.

Previously, the commercial value rested on the opening weekend, as release patterns were dictated by the return on investment secured. However, the box office race is no longer able to accurately measure the popularity of a film, due to Hollywood’s global reach. Perhaps this is why Hollywood has been accustomed to revisit its blockbusters, but we will come back to this later.

3. Ticket Pricing

In more recent times, a typical film studio would hope to make 50% of the revenue generated from the ticket sales, with the other 50% going towards the movie theatre. A producer can establish contracts with the multiplexes to encourage them to show their films on more screens, but this can mean they will receive less of the original revenue.

Ticket sales are more successful during the summer than in winter, with half of the year’s earnings made in July and August.

Much of profit that cinemas make, however, is solely on the sale of popcorn and soft drinks. As such, cinemas are far more concerned with how many people enter their compound than with the ticket sales of each film. Ticket prices must be low enough to entice the public, (i.e. approximately $10-15) and the studio only receives a certain percentage of each seat sold, so the film must perform well. This percentage is affected by the location, the number of screens, and the frequency that the film is shown. This may sound like a lot, but with falling cinema attendance, most make a loss out of paying the theatre to show the movie in the first place.

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4. Foreign Sales

Foreign sales are a growing critical source of revenue, notably for independent films. Independent movies must have outstanding foreign sales agents who can sell their movie in the key overseas markets. Asia is one, which is generating an increasing amount of revenue growth.

But exporting movies to markets often requires big names in the industry. For instance, Jennifer Lopez and Tom Cruise are known to travel well in France and China.

Movie, Reel

Bollywood (Indian Hollywood) and Nollywood (Nigerian Hollywood) contrastingly do not rely on foreign sales. Their focus is far more inward looking, using local customs to appeal to the everyday nature of their audience. Just like Disney and Warner Bros, Indian studios do their own distribution, all-time Bollywood favourite “Rang De Basanti” (2006) earned $31m on a far more localised scale, having spent a mere $6m.

5. Product Placement

Product placement is one of the critical sources for replacing the movie budgeting expenses. Companies often sponsor films to showcase their products in the hope that moviegoers will see the item and go out to purchase it. A survey conducted in the US in 2009 revealed that 60% of consumers feel more positive about the brand.

BMW signed a three-film deal to have their Z3 featured in the James Bond film Golden Eye. Before the movie was released, 9000 cars were pre-ordered. Heineken paid $45m to feature their beer rather than Bond’s typical vodka martini in Skyfall. Considering the movie made $1bn worldwide, the Heineken product placement contributed to 4.5% of the revenues.

6. Merchandising

During the peak decades of Hollywood’s global influence, a movie would appear in theatres, with the majority of the revenue being made purely on the sales of seats. But now studios and filmmakers rely on increasingly diverse sources of income.

To merchandise, the film must have a built-in audience before it hits the screens. Movies that appeal to children, e.g. Star Wars and Toy Story, can bring in a significant proportion of their revenue from selling toys. The former brought in $12bn in revenue from toy licensing, compared to the $4bn it made from ticket sales. The latter established $2.4bn in revenues from retail sales.

Toy, Story

Therefore, movies with a built-in audience have a significant advantage over those that do not. Looking back at the US box office revenues chart, this becomes more apparent. A few names appear more than once, such as The Twilight Saga or Avengers, and names that had garnered fame beforehand through other means, like Harry Potter in literature.

7. DVD And Streaming Rights

Several decades ago, studios and producers fought for the ability to manufacture VCR and then DVD rights. Now the consumers have moved towards streaming and online viewing, and the market has followed. This can work out in favour of filmmakers, particularly independent ones who do not have to pay substantial printing and advertising costs. For example, once a film has been sold to Netflix, it can stay on there forever, but they have to leave a cinema theatre within a few weeks or months.

Although movies with a critical audience can still generate huge returns from investing in DVD rights. The Hunger Games sold 3.8 million copies in its first week on the shelves.

Finally, airlines in-flight entertainment can add a source of income for a movie.

Growing Competition

In 2012, the US produced 476 films, China managed 745, but Bollywood oversaw the creation of 1,602 movies. Hollywood sold 1.36 million tickets but Bollywood succeeded in selling 2.6 million. In 2009, even Nollywood passed Hollywood to become the second largest film industry, second only to Bollywood, and in 2013 it produced 1,844 movies.

Bollywood

Bollywood and Nollywood have recently been applying pressure. Despite the glamour of the major productions, populations are attracted to local content that more directly relates to them. Even innovative mediums are looking to create more local content. For example, Netflix is planning to produce shows in Polish.

But while there is a demand for localised content, it is still being dwarfed and assimilated by the giants of Hollywood whose superior Box Office revenues easily surpass the competition. Disney has increased its stake in Bollywood’s largest studio, UTV, from 14.9% to 30%. Viacom, News Corporation and Sony Pictures have all snapped up Indian film producers in the recent years. Furthermore, Netflix recently paid $12m for movie rights for the Nigerian novel Beasts of No Nation.

Returning To Its Former Glory

Unfortunately, it seems that the only comeback measures on the horizon are the use of the big actors in the industry. In today’s celebrity clad society, the only hope for Hollywood is using the same big names and storylines with a built-in audience to create them.

One only has to look towards Matt Damon’s Bourne series salary to understand that a film’s success is built more on the name recognition of its star than the quality of the movie production itself. Damon was paid $42,194 per line.

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The world is moving at a much faster pace than it was during Hollywood’s peak. Therefore the key demographic to target is surely the younger end of the population. Hollywood now predominantly targets under 21s who extend to over 70% of the key audience intake at multiplex theatres. Epstein reported that “the movies that bill are action films laden with special effects, explosions, crashes and mayhem” – think San Andreas.

But Fabrizio Perretti, a Management Professor at the University of Bocconi in Italy, argues that Hollywood is now actually beginning to destroy itself and its long-established reputation.

Conclusion

In Hollywood, famous names, repeated storylines with a built in audience and gimmicks that can attract the under 21s are the only sure fire way to make money.

Hollywood has secured some lucrative profits since its establishment. But these success stories have painted an unrealistic picture of the business. Only 5% of movies produced will be profitable, between 15% and 20% will break even, and 65-75% will make a loss.

The movie audience relative to population growth has been shrinking since 1948, and with society becoming increasingly fast-paced, with consumer products continuing to meet our immediate demands across all sectors, this looks unlikely to change.

Not to mention the intense growth of avenues such as Netflix, Amazon and Time Warner, who are already appearing the winners out of the cable vs. online streaming competition, highlighted by the recent growth of deals and acquisitions within the telecom industry (i.e. AT&T acquiring Time Warner).

With society’s attention span reducing rapidly, it seems that shorter series are set to overtake movies. Hollywood must adapt to this market, as cinemas may soon be a memory from the past.

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