The Hollywood Economist 2.0

by Edward Jay Epstein

  If a movie contains less explicit nudity, it earns an R rating, which merely prohibits youth unaccompanied by an adult. Even though this option means that some number of multiplex employees—who might otherwise be selling popcorn—are required to check the identity documents of the teenage audience, theaters accept R-rated films, as was the case with Troy, if the R is for graphic violence because movie violence is a huge attraction for the teen audience. An R rating for nudity has a further problem in the popcorn economy: it greatly complicates the movie’s all-important marketing drive. When a film receives an R rating for nudity, many television stations and cable networks, particularly teenage-oriented ones, will not accept TV ads for the movie. In addition, an R rating for nudity will preclude any of the fast-food chains, beverage companies, or toy manufacturers that act as the studios’ merchandise tie-in partners from backing the movie with tens of millions of dollars in free advertising. As a result, it becomes much more expensive to alert and herd audiences to theaters for R-rated films.

  Second, there is the Wal-Mart consideration. In 2007, the six studios took in $17.9 billion from DVD sales, according to the studios’ own internal numbers. Wal-Mart, including its Sam’s Club stores, accounted for nearly one-quarter of those sales, which means that Wal-Mart wrote more than $4 billion in checks to the studios in 2007. Such enormous buying power comes dangerously close to constituting what the Justice Department calls a monopsony—control of a market by a single buyer—and it allows the giant retailer to effectively dictate the terms of trade. While Wal-Mart may not use its clout to advance any political agenda or social engineering objective, Wal-Mart does use DVDs to lure in customers who, while they pass through the store, may buy more profitable items, such as toys, clothing, or electronics. For this task, Wal-Mart’s concern with the content of DVDs is that they not offend important customers—especially mothers—by containing material that may be inappropriate for children. Hence its “decency policy” that consigns DVDs containing sexually related nudity to “adult sections” of the store, which greatly reduces their sales. (Wal-Mart is less concerned with vulgar behavior and language.) These guidelines, in turn, put studios under tremendous pressure to sanitize their films of nudity.

  Finally, movies with nudity are a problem for the studios’ other main moneymaker: television. As became abundantly clear in the controversy surrounding Janet Jackson’s wardrobe malfunction at Super Bowl XXXVIII, broadcast television is a government-regulated enterprise. When the government grants a free license to a station to broadcast over the public airwaves, it does so under the condition that it conform to the rules enforced by the Federal Communications Commission. Among those rules is the standard of “public decency,” which among other things specifically prohibits salacious nudity, which is why CBS had to pay a fine for Ms. Jackson’s brief exposure. Because the FCC regulates broadcast television (though not cable television), television stations run similar risks and embarrassments—if they show movies that include even partially nudity.

  So, before a studio can license such a movie to a broadcast network, it first has to cut out all the nudity and other scenes that run afoul of the decency standard. Aside from the expense involved, it requires the hassle of obtaining the director’s permission, which is contractually required by the Directors Guild of America. The same is true in studio sales to foreign television companies, which have their own government censorship.

  Since graphic sex in movies is a triple liability, the studios can be expected to increasingly find that the artistic gain that comes from including it does not compensate for the financial pain and green-light fewer and fewer movies that present this problem. We may live in an anything-goes age, but if a studio wants to make money, it has to limit how much of “anything”—at least anything sexually explicit—it shows on the big screen. As one studio executive with an MBA lamented, “We may have to leave sex to the independents.” In the New Hollywood, as far as studios are concerned, no nudes is good news.

  THE VANISHING BOX OFFICE

  The regular movie audience has been so decimated over the past six decades that the habitual weekly adult moviegoer will soon qualify, if not as an endangered species, as a niche group. In 1948, 65 percent of the population went to a movie house in an average week; in 2008, under 6 percent of the population went to see a movie in an average week. What changed in the interval was that virtually every American family bought a TV set. In 1948, when home TV was still a rarity, theaters sold 4.6 billion tickets. By 1958, TV had penetrated most American homes, and theaters sold only 2 billion tickets. The Hollywood studios tried to counter television with technology dazzle, including wider screens (CinemaScope), noisier speakers (surround sound), and more visually exciting special effects, but technology did nothing to stem the mass defections. They also tried epic, three-hour movies, such as Ben Hur, Lawrence of Arabia, and Dr. Zhivago, that, although they succeeded individually, had little effect on the weekly movie audience. Even the much-heralded fantasy bonanzas of Spielberg and Lucas could not halt the decline. By 1988, ticket sales hovered at 1 billion. The studios, realizing that they could no longer count on habitual moviegoers to fill theaters, devised a new strategy: creating audiences de novo for each movie via paid advertising.

  Audience-creation is a very expensive enterprise—in 2007 the studios’ average cost for advertising a film was $35.9 million. Studios justified this expenditure on the grounds that huge opening-weekend audiences would help turn a movie into an “event,” generating word-of-mouth and other free advertising that would continue to bring moviegoers into theaters, and, later, into video stores. Titanic, for example, took in only a modest $28 million over its opening weekend. Two weeks later, after it had become a word-of-mouth event, the movie had earned $149 million. It wound up grossing a phenomenal $600 million at American theaters. Such “event” films are what studios depend upon to pay the bills.

  What terrifies top studio executives now is the dearth of word-of-mouth event movies. “Word of mouth is no longer a factor,” Thomas McGrath, a former Paramount vice president explained. Instead, studio marketing chiefs try for big opening numbers by driving with a drumbeat of TV ads the one audience they can rely on: male teens. While with $36 million of ads they can still manufacture weekend teen audiences, they can no longer create the event movies that the studios need. Meanwhile, a quantum leap in quality in high-definition DVDs, television sets, and digital recorders threatens to further erode the edge movie theaters have over home entertainment. Studio executives are coming to grip with the reality that they have as much chance of reversing the secular shift of audiences from the theater to the home as King Canute had in commanding the tide to recede.

  But what alternative do they have? The skill that movie executives have honed over the years is audience-creation. Even if it takes $30 to 50 million to herd teens to the multiplexes, and the movie fails to earn back that outlay, they hope it will lead to a future franchise. To abandon that hope means the end of Hollywood as they know it.

  THE REEL SILVER LINING

  The public most often sees Hollywood through the lens of paparazzi cameras and the PR wires of publicists as a wildly extravagant, if not recklessly wasteful, place from which stars, accompanied by personal entourages, fly to lavish parties in private jets. But there is a less profligate side to Hollywood: the culture of the suits, in which the tight-fisted executives who run the studios pride themselves on their ability to pinch pennies out of movie budgets and wring profits out of unlikely places. Consider, for example, the profits studios found in their graveyards of dead prints. Up until the mid-1980s the initial opening of a movie required only several hundred prints—Star Wars, for example, opened in 1977 on only thirty-two screens. Nowadays, with simultaneous global openings, it takes 5,000 to 10,000 prints to open major movies. The 2009 sequel in Warner Bros.’ Batman franchise, The Dark Knight, for example, which played on over 9,000 screens in the US alone, required 12,000 prints for its worldwide distribution, each costi
ng about $1,500. Studios order the prints for these immense runs from film labs and then deduct their cost from the first revenues that flow in from the theaters. So the film production company, which is almost always set up as a separate business entity, absorbs the cost on its books. Then after a brief shelf life of a few weeks in the multiplexes, almost all the prints—except for a few hundred sent to theaters on military bases—are scrapped.

  But studios found in this mounting scrap heap a literal silver lining. Each shredded print contains a small quantity of silver, which the studios can “mine” via a recovery process and sell. Silver mining, to be sure, is not a new pursuit in Hollywood. Much of the studios’ pre-1950s libraries, including many of the irreplaceable negatives of its classics, were destroyed to recover the silver. But with rising precious metal prices—silver exceeded $30 an ounce on the commodity market in November 2011—and hundreds of thousands of dead prints to mine, it provides a rich vein of extra income for the studios (which is not returned to the film production companies charged for the prints). Of course, this mine will peter out as more and more multiplexes convert from analog to digital projection, and prints themselves are no longer necessary.

  Even though the proceeds studios recover from prints may amount to little more than “pocket money,” as a Paramount executive described it, it fulfills a vital requisite for the suit culture: finding new sources of income.

  PART II

  STAR CULTURE

  THE CONTRACT’S THE THING—IF NOT FOR HAMLET, FOR ARNOLD SCHWARZENEGGER

  The nonstop anecdotes that stars give in celebrity interviews about the stunts they supposedly performed, their favorite hobbies, and how much they enjoyed working with other stars may serve to hype their latest project—a job they are contractually required to do—but they evade a central issue: the art of the deal has come to replace the art of movies. To understand how the new Hollywood really works, one need only read stars’ contracts. Consider, for example, Governor Arnold Schwarzenegger’s agreement for Terminator 3: The Rise of the Machines. It’s a state-of-the-art exercise in deal-making.

  The contract was brilliantly put together by the Hollywood super-lawyer Jacob Bloom between June 2000 and December 2001, requiring no fewer than twenty-one drafts, and runs thirty-three pages including appendices. For starters, Schwarzenegger got a $29.25 million “pay or play” fee, meaning he would be paid whether or not the movie was made. (At the time, that figure was a record for guaranteed compensation.) The first $3 million would be delivered on signing and the balance during the course of nineteen weeks of “principal photography,” which is the part of a production during which the actors are in front of the camera. For every week the shooting ran over its nineteen-week schedule, Schwarzenegger would receive an additional $1.6 million in “overage.” Then there was the “perk package”—a lump sum of $1.5 million for private jets, a fully equipped gym trailer, three-bedroom deluxe suites on locations, round-the-clock limousines, and personal bodyguards. The producers Mario Kassar and Andrew Vajna did not agree to pay Schwarzenegger this record sum because he possessed unique acting skills—after all, the part he was to play (along with a digital double and many stuntmen) was that of a slow-speaking robot. They also did not pay Schwarzenegger on the basis of his box office track record. Indeed, his previous two films, End of Days (1999) and The Sixth Day (2000), had failed both at the world-wide box office and at video rental stores. Nevertheless, in the ten years that had elapsed since Terminator 2: Judgment Day, Schwarzenegger’s image had become so inexorably linked in video games and TV reruns to the deadly robot that he had become the crucial element of the deal and Kassar and Vajna needed him to raise money.

  To make this deal Kassar and Vajna first needed to get the rights to the moribund franchise. So, backed by the German-owned movie financier Intermedia Films, they bought the sequel rights to the Terminator franchise for $14.5 million from the bankrupt Carolco Pictures and the initial producer, Gale Anne Hurd. Next, they spent another $5.2 million developing a script. That was the easy part. Now they needed $160 million in financing, which was more than any other movie had cost in those days. They had lined up three distributors: Warner Bros. would pay $51.6 million for North American rights, the Tokyo distributor Toho-Towa would pay $20 million for Japanese rights, and Sony Pictures Entertainment would pay $77.4 million for the rest of the world. (The balance would come mainly from tax shelter deals in Germany.) But all three distributors—Warner Bros., Sony, and Toho-Towa—made their financing conditional on Schwarzenegger signing on to play the robot. So: No Schwarzenegger, no money.

  Kassar and Vajna had no real choice but to accept Schwarzenegger’s terms if they wanted to make the movie (and, aside from reviving the franchise, they themselves would earn $10 million in producer fees if the deal went through). Schwarzenegger’s demands, however, did not stop with the guarantee of $29.25 million. He also insisted on and got 20 percent of the gross receipts made by the venture from every market in the world—including movie theaters, videos, DVDs, television licensing, in-flight entertainment, game licensing, and so forth—once the movie had reached its cash breakeven point. Such “contingent compensation” is not unusual in movie contracts, but, in some cases, Hollywood accounting famously uses smoke and mirrors to make sure to define “breakeven” in such a way that a movie never reaches it. Schwarzenegger’s contract, thanks to the ingenious lawyering of Jake Bloom, allowed for no such evasion.

  Schwarzenegger also could decide who worked with him. The contract “pre-approval” clause gave him choice of not only the director (Jonathan Mostow) and the principal cast, but also his hairdresser (Peter Toothbal), his makeup man (Jeff Dawn), his driver (Howard Valesco), his stand-in (Dieter Rauter), his stunt double (Billy Lucas), the unit publicist (Sheryl Merin), his personal physician (Dr. Graham Waring), and his cook (Steve Hunter). Finally, Schwarzenegger had the contract structured to give him every possible tax advantage.

  All the money was to be paid not to Schwarzenegger but to Oak Productions Inc., a corporate front he controlled. Oak Productions, in return, “lends” Schwarzenegger’s services to the production. Since Schwarzenegger didn’t get any money personally from the movie itself, he had more flexibility managing his exposure to taxes. For example, Oak Productions entered into a complex tax-reimbursement scheme with the production to help avoid additional tax liabilities that might occur abroad. In return, Schwarzenegger agreed to make himself available for eighteen weeks of principal photography, one week (on a nonexclusive basis) for rehearsals—if any were required—and five days for re-shooting. In addition, he had to make himself available for at least ten days, seven of them abroad, for promotional activities in connection with the initial theatrical release of the movie. This media work included everything from television and radio appearances to appearances at premieres and Internet chat rooms. The negotiation of this contract did not come cheaply—the legal and accounting budget for the movie was $2 million—and, by the time all of Schwarzenegger’s demands were met, the budget of the film had risen to $187.3 million, making it then the most expensive independently produced movie in history. Another $90 million was spent advertising and marketing it.

  Terminator 3 had a world box office gross of $433 million which, together with DVD, TV, and other rights, allowed the distributors to eke out a small profit, but Arnold Schwarzenegger, who had created his own “cash breakeven,” was the big winner. In the bygone days of the studio system, the studios had exclusive contracts with their stars that allowed them to reap the profits from the images their PR machines had created. In the new Hollywood, the stars themselves reap the profit their brand names bring to a film. So it is not surprising that even after Schwarzenegger became the governor of California in 2004, his holding company protected his image rights by suing a small toy maker selling a Schwarzenegger-like bobble-head doll on the grounds that “Schwarzenegger is an instantly recognizable global celebrity whose name and likeness are worth millions of dollars and are solely his prope
rty.”

  Ironically, whereas Schwarzenegger was crucial to making the deal, once the Terminator franchise had been successfully resurrected, his acting services were no longer necessary for future sequels. In 2007, Kassar and Vajna sold the rights to the franchise to the game company Halcyon for $25 million, which produced Terminator Salvation in 2009, the first of three planned sequels. Even without Schwarzenegger, who was by now fighting his own budget battles as governor of California, it did almost as well as Terminator 3 at the domestic box office, though not as well in the Asian markets.

  MOVIE STARS COME IN TWO FLAVORS: $20 MILLION AND FREE

  The difference between studio-made movies and independent-made movies is the former have an American distributor before they are filmed, or even green-lit, and therefore investors in them are assured that they will be shown in theaters, while the latter don’t. And since it may take years of screenings, and endless trips to film festivals, before an indie film has a chance of finding an American distributor and many never do, raising money for them is a daunting challenge.