The Hollywood Economist 2.0

by Edward Jay Epstein

  To be sure, NRG’s services to the studios go well beyond helping studios avert unpleasant fender benders. It also analyzes much larger issues for the studios, essentially helping them to rethink their entire business models by examining the movies’ declining share of the public’s “wallet” and “clock” as they compete with music, DVDs, cable TV, downloading, and other forms of home entertainment. But without its Competitive Positioning reports studios would have a much harder time avoiding box office collisions.

  AN EXPERT WITNESS IN WONDERLAND

  In 2005, I became an expert witness in a Hollywood lawsuit that in nearly five years managed to consume over $20 million in legal fees. The heart of this Dickensian litigation was a contract between an author and producer for the making of Sahara, a $130 million action movie released in 2005 that starred Penelope Cruz and Matthew McConaughey, and was directed by Breck Eisner (the son of ex-Disney chairman Michael Eisner). The plaintiff was the author Clive Cussler, who had sold the film rights to his 1992 bestselling book Sahara for $10 million, and charged in his suit that his right to approve the final script had not been honored. He was represented in this suit by Hollywood lawyer Bertram Fields, who, according to his legend, had never lost a case (which is less impressive than it sounds because most Hollywood cases are settled out of court and the results are sealed). The defendant was Crusader Entertainment, a production company owned by oil tycoon Philip Anschutz, who, aside from his media properties, owned the majority stake in Regal Entertainment, America’s largest movie theater chain. Anschutz, who was listed by Forbes as the thirty-sixth richest man in America with $8 billion in assets, was represented by O’Melveny & Myers, a legal powerhouse, which according to American Lawyer, had the top-rated litigation department in the country. The two law firms were located almost directly across the street from one another on the Avenue of the Stars in Century City, which once was the back lot of 20th Century Fox.

  O’Melveny & Myers star litigator Alan Rader, who co-managed the Sahara case, retained me as an expert witness in 2005. He said that he had read my writings on the logic of Hollywood and wanted me to objectively lay out for the jury, possibly in a PowerPoint presentation, the economic reality behind the movie business. To prepare, I had to review a vast array of contracts, distribution deals, financial analyses, and other paperwork that might help me explain the requisites of the movie business. I also had to provide a lengthy deposition in Bert Fields’ offices. Then, after years of convoluted maneuvering, the case actually went to trial, a rarity in Hollywood law. Six weeks later, the jury provided a surprise ending to the drama: Bert Fields, the man who putatively never lost a case, lost big for his client. Clive Cussler was ordered not only to pay Anschutz’s company $5 million for undermining the success of the movie, but he had to pay him a staggering $13.9 million to cover his legal costs. In addition to this $18.9 million, Cussler also had to pay his own legal bill to Bert Fields, which presumably was also sizable.

  But there was yet another twist: an appeal led to a judge nullifying the verdict in 2010 so that, in the end, the only winners were the lawyers who earned big fees.

  Leaving aside the brilliant lawyering on both sides, the material I reviewed provided me with a key insight into how Hollywood works: the movie-business is a fee-driven business. When viewed from the outside, movies, which are almost always set up as separate off-the-books entities, rarely, if ever, show a profit. Nevertheless, when viewed from the inside, they serve as vessels for collecting and dispensing billions of dollars in fees. In 2008, the fees from studio movies alone exceeded $8 billion. And these fees support a large part of the Hollywood community, including directors, stars, producers, and screenwriters, as well as the talent agents, business managers, and lawyers who represent them. But most of these fees are paid only if the production is approved, or green-lit, by a studio willing to finance it. So the big players in Hollywood, and their representatives, have a powerful incentive to use whatever means at their disposal to pressure studio executives into green-lighting their projects. For their part, studios also get a rich fee, the distribution fee, which allows them to take a percentage off the top from every dollar that comes from every source including theaters, in-flight entertainment, DVDs, and television licensing. This percentage can be as high as 33 percent or as low as 10 percent depending on the relative negotiating strength of each party. Before giving the green-light, studios run the numbers to make sure that their distribution fee has a good chance of covering their outlay, even if the film itself is unprofitable for others. Once a studio provides a green-light, the studio deposits money in its account, and the production can pay all the fees and salaries necessary to make the movie.

  How do studios get the money to finance this fee-driven economy? To begin with, they raise a substantial part this sum by wheeling and dealing with outside parties. This includes negotiating tax credit deals around the world with financial groups needing tax relief, lease-back deals on copyright of the titles, pre-sales agreements to sell rights to foreign markers, product placement deals with corporations to insert their product or brands in their films, and hedge fund investments. This deal-making employs a large part of the entertainment law establishment who churn out the necessary paperwork. It also often provides, depending on the film, between 20 and 60 percent of the budget. For the balance of the money, studios either use their cash flow from previous films or borrow from banks through their revolving lines of credit at banks, called “revolvers,” assuming, based on their financial analysis, that they will earn back this portion of the outlay from their own distribution fee.

  Of course, sometimes studios miscalculate and lose money. So do independent production companies, which lack the fee rake-off. And Sahara famously lost money—at least for its production company and its owner, billionaire Philip Anschutz. But not for everyone who worked on it. The actors, extras, make-up artists, hair stylists, costumers, assistant directors, set designers, animal wranglers, carpenters, cameramen, grips, editors, musicians, dialogue coaches, sound engineers, caterers, drivers, and publicists all got paid. The stars, director, and writers also got their fixed compensation (though they may never see any part of their contingent compensation, or profit participation). Paramount, which distributed the movie, got its fee. Clive Cussler even got his $10 million. And of course the lawyers on both sides got their fee, as did this expert witness.

  PART V

  UNORIGINAL SIN

  AUDIENCE CREATION

  In Hollywood, originality is anything but a virtue. Paramount rejected a recent project that had attached stars, an approved script, and a bankable director by telling the producer: “It’s a terrific idea, too bad it has not been made into a movie already or we could have done the remake.” This response, alas, is not untypical. Studios today, as a former executive explained, tend to green-light four types of movies for wide openings: remakes (such as King Kong), sequels (such as Star Wars: Episode III), television spin-offs (such as Mission: Impossible), or video game extensions (such as Lara Croft: Tomb Raider).

  If Hollywood is originality-challenged, it is not because studio executives find particular joy in mindlessly imitating bygone successes, or lack imagination. It is because they must take into account the underlying reality of today’s entertainment economy. In the prior system (1928–1950), each studio was identified with a particular genre of movie: MGM (musicals and romantic comedies); Paramount (historical epics); Warner Bros. (gangster stories); 20th Century Fox (social dramas); Universal (horror movies); Disney (cartoons), and just the mention of a studio star like Clark Gable or Carole Lombard on a marquee was enough to guarantee a full house. To this end, a studio could rely on a vast habitual herd of moviegoers to go to the movies in an average week. Most of these people went to see not just a new movie—the main attraction—but also a program of weekly entertainment that included newsreels, a slapstick short, a cliffhanger serial, a “B” feature, such as a Western, and needed no national advertising to prod it. That was befo
re TV provided an alternative source of entertainment.

  Today there is a different story. The studio names mean little, if anything at all, to audiences. Nor can the weekly audience, which has shrunk to less than 10 percent of the population, be relied on to show up for any particular movie. Studios must therefore create audiences from scratch for each and every film. For the studios, “audience creation” has become just as important a creative product as the film itself.

  Multiplex owners know that the six major studios can supply not only a movie, but the publicity campaign capable of driving a herd of moviegoers from their homes to the theater on an opening weekend. The studios have this capacity because, unlike independent film producers, they control when, where, and how the movie will be released, starting from the day it goes into production. With this control, the studios can shape the movie to fit the requisites of the marketing campaign, fusing both product and publicity, like Siamese twins, into a single entity. This carefully calibrated movie product can then be used to recruit multimillion-dollar merchandising tie-ins, such as with McDonald’s. The studios can also insert “teasers” in the coming-attraction reels (which they control) to build audience awareness. Finally, the studios have the resources to commit up to $50 million in prerelease advertising on a single movie.

  The marketing campaign has become crucial for theater owners because the names of big stars can no longer be relied on to draw a large audience unless it is incorporated into a studio-sized marketing campaign. Consider two consecutive romantic comedies with Julia Roberts, one of the highest-paid actresses; one an independent release, the other a studio release. The first, Everyone Says I Love You, released by Miramax, brought in $132,000 on its opening weekend. The second, My Best Friend’s Wedding, released by Sony, brought in $21.7 million in its opening weekend. Both films had the same star actress, same genre, same romantic twist, but one film drew 150 times as many people to theaters as the other. Next, consider two consecutive movies starring Mel Gibson. The first, What Women Want, was released by Paramount and brought in $33.6 million in its opening weekend, while the second, Million Dollar Hotel, released three months later by Lion’s Gate, brought in $29,483. A thousand times as many people went to see the opening of the studio product, although both starred Gibson. Even if Roberts’ Everyone Says I Love You and Gibson’s Million Dollar Hotel had been vastly superior movies to their studio counterparts (and I believe they were), the results would have been the same. These films played in only a handful of theaters, while My Best Friend’s Wedding opened on 2,134 screens and What Women Want opened on 3,013 screens. For the independent films to have opened “wide” as their studio counterparts did, the distributors would have had to convince the theater chains that they had the wherewithal to provide the kind of massive marketing campaign that it takes to fill 2,000 theaters with popcorn-eating audiences—a next-to-impossible undertaking.

  But, unlike Hollywood’s movies, the ending is not a happy one for originality. Since the publicity campaigns for these blockbusters have proven effective in the popcorn economy, studios recycle their elements into endless sequels, such as those for Spider-Man, Pirates of the Caribbean, Shrek, and Mission Impossible, which then become the studios’ franchises on which they earn almost all their profits. That is their unoriginal sin and, alas, salvation in the new system.

  TEENS AND CAR CRASHES GO TOGETHER

  After Hollywood lost its audience to television in the 1950s, it had to reinvent itself. If it could no longer count on habitual moviegoers to fill theaters routinely, it would go into the business of audience-creation. The means studios found to recruit audiences for each and every movie they released was national TV advertising. The tactic that evolved by the 1990s was bombarding a target audience with very expensive thirty-second ads. For this to work, studios had to find a demographic group that was both relatively cheap to reach and who could be induced by this blitz to leave the comfort of their home to see a movie. The audience that satisfied these conditions was teenagers.

  Teens have three great advantages over adults for movie studios. First, they tend to predictably cluster around the same TV programs on cable networks, such as MTV, which make them much less costly to reach than moviegoing adults who, if they watch TV at all, tend to be scattered among the most expensive programming in prime time. Second, once in multiplexes, teens tend to consume prodigious quantities of popcorn and soda, which is a powerful attraction to the theater chains that book movies for a wide opening. Third, teens buy electronic games, sports equipment, fast food, and other licensable items, which make them an appealing audience to merchandising partners with the capability of providing the multimillion dollar “tie-in” that help publicize studio movies.

  By 2009, studios had become so proficient at finding, activating, and driving the teen herd into multiplexes that over 70 percent of the audience that went to their wide-release movies was under twenty-one years old. Even though the expansion of teen programming on cable and television networks allowed the studios to zero in on their target audience, they needed, as one marketing executive at Sony told me, visuals in a thirty second ad spot that would hook male teens. The movies that filled that bill were action films laden with special effects, explosions, crashes, and mayhem. Sony learned this lesson in June 2003 when it released its action movie Hollywood Homicide, with Harrison Ford, a $20 million star, against Universal’s action movie 2 Fast 2 Furious, a lower-budget film without any stars. Hollywood Homicide featured images of Harrison Ford in its thirty second ads, whereas 2 Fast 2 Furious featured flaming car crashes. Even though Hollywood Homicide had done much better than 2 Fast 2 Furious in the pre-openings awareness polls, 2 Fast 2 Furious had a $50 million opening while Hollywood Homicide took in only $11.1 million. The Sony marketing executives could only conclude: Teens are more excited by car crashes than by big name stars, even one who gets a $20 million dollar paycheck. It thus became as important to cast car crashes and other violent stunts as stars in the teen-oriented remake of Hollywood.

  THE MIDAS FORMULA

  The studios’ Midas formula may have been perfected by Steven Spielberg and George Lucas in the 1980s but the innovator was Walt Disney. He put all the elements together back in 1937, when he made Snow White and the Seven Dwarfs. The picture was labeled a folly by the moguls who ruled old Hollywood because it was aimed at only a small part of the American audience, children. They were wrong. Snow White and the Seven Dwarfs, which was re-released every seven years to a new crop of children, became the first film in history to gross $100 million. It also demonstrated to the studios, among other things, the propensity of children to see the same cartoon over and over again. The movie was also the first to have an official soundtrack, including such songs as “Some Day My Prince Will Come,” that became a hit record. More important, Snow White had multiple licensable characters (the dwarfs, the wicked witch) who took on long lives of their own, first as toys and later as theme-park exhibits. So, here was Hollywood’s future: Its profits would come not from squeezing down the costs of producing films but from creating films with licensable properties that could generate profits in other media over long periods of time.

  The advent of computer-based technology has simply provided new ways of mining this vein. The franchises that have raked in over a billion dollars from all markets (including world DVD, television, and toy licensing), The Lord of the Rings, Harry Potter, Spider-Man, Finding Nemo, Star Wars, Shrek, The Lion King, Toy Story, and Pirates of the Caribbean share most, if not all, of the nine common elements of the Midas formula:

  1. They are based on children’s fare stories, comic books, serials, cartoons, or, as in the case of Pirates of the Caribbean, a theme-park ride.

  2. They feature a child or adolescent protagonist (at least in the establishing episode of the franchise).

  3. They have a fairy-tale-like plot in which a weak or ineffectual youth is transformed into a powerful and purposeful hero.

  4. They contain only chaste, if not str
ictly platonic, relationships between the sexes, with no suggestive nudity, sexual foreplay, provocative language, or even hints of consummated passion. (This ensures the movie gets the PG-13 or better rating necessary for merchandising tie-ins and for placing ads on children’s TV programming.)

  5. They include characters for toy and game licensing.

  6. They depict only stylized conflict—though it may be dazzling, large-scale, and noisy, in ways that are sufficiently nonrealistic and bloodless (again allowing for a rating no more restrictive than PG-13).

  7. They end happily, with the hero prevailing over powerful villains and supernatural forces (and thus lend themselves to sequels).

  8. They use conventional or digital animation to artificially create action sequences, supernatural forces, and elaborate settings.

  9. They cast actors who are not ranking stars—at least in the sense that they do not command dollar-one gross-revenue shares.

  The success of the DVD propelled the Midas-formula sequels to dazzlingly high earnings. At the height of the DVD market, a studio with a successful franchise could sell over 30 million units per sequel, harvesting for itself between $450 million and $600 million dollars. (When Shrek 2 sold a mere 30 million copies in 2005 and had 7 million in returns—it wiped out a good portion of DreamWorks Animation’s quarterly earnings.)