Furthermore, studios have to pay the entire bill for the advertising and other inducements required to lure the ticket-buyers to the theatres. Last year, studios spent an average of $39 million per film on advertising and prints in America, but only recovered $20.6 million per film from the theatres. So, on average, they paid more to get people to buy tickets than they got back from the theatres (and this dismal calculation does not include the cost of making the film). And advertising bills are becoming even higher: according to the New York Times, Warner Bros committed $60 million to marketing Alexander in the US. If so, Warner Bros share of even a $100 million ‘box-office gross’ would not pay the advertising bill.
When Hollywood movies fail to find audiences in America, it is often claimed that these movies redeem their losses overseas. The assumption here is that the box-office receipts abroad are pure gravy for the movie studios. For example, the usually financially-savvy Wall Street Journal reported on 19 November 2004 that three notable ‘duds’ in America – Troy, The Terminal and King Arthur – “ended up turning handsome profits” because “in each case, box-office receipts from outside the US far outweighed domestic returns.” It then cited impressive sounding numbers: Troy “made” $363 million internationally; The Terminal, $96.3 million, and King Arthur, $149.8 million – as if these receipts represented their salvation. In reality, however, these impressive-sounding receipts represented the foreign theatres’ revenue, not the studios’ share of it. In fact, the studios get an even smaller share of the foreign than of the American box-office. Last year, the studios’ share averaged about 40 per cent of ticket sales. And from those revenues studios have to pay for foreign advertising, prints, taxes, insurance, translations, etc. Once those expenses are deducted, the studios are lucky to wind up with 15 per cent of what is reported as the foreign gross.
Consider a typical movie – Disney’s Gone In 60 Seconds. Its reported ‘foreign gross’ was $129,477,395. Of that sum, Disney got $55,979.966 and paid out $37,986,053 in expenses. They included:
| Foreign advertising | $25,197,723 |
| Foreign prints | $ 5,660.837 |
| Foreign taxes | $ 5,077,286 |
| Foreign versions | $ 822,997 |
| Foreign shipping | $ 454,973 |
| Currency conversion | $ 266,900 |
| Foreign trade dues | $ 122,275 |
After paying these expenses, Disney was left with just $17,993,913 – a far cry from the reported $129,477,395 ‘gross’. And the film is still over $153 million in the red. So while the foreign box-office helps out, it does not necessarily make a movie profitable.
As late as 1948, Hollywood studios made virtually all of their money from a single source: the box-office. But with the emergence of television, studios had to find new ways of making money. They therefore moved to home entertainment. By 2003 the studios were taking in almost five times as much revenue from home entertainment – television, videos, and DVDs – as from movie theatres (see Table 1).
Table 1. Studio revenues worldwide 1948-2003 inflation-adjusted in 2003 (billions of dollars)
| Year | Theatre | Video/DVD | Pay-TV | Free TV | Total | Theatre % |
| 1948 | 6.9 | 0 | 0 | 0 | 6.9 | 100% |
| 1980 | 4.4 | 0.2 | 0.38 | 3.26 | 8.31 | 55% |
| 1985 | 2.96 | 2.34 | 1.04 | 5.59 | 11.9 | 25% |
| 1990 | 4.9 | 5.87 | 1.62 | 7.41 | 19.79 | 22% |
| 1995 | 5.57 | 10.6 | 2.34 | 7.92 | 26.53 | 20% |
| 2000 | 5.87 | 11.67 | 3.12 | 10.75 | 31.41 | 19.5% |
| 2003 | 7.48 | 18.9 | 5.56 | 11.4 | 41.2 | 17.9% |
Not only did movies in theatres provide a smaller share of the revenue in the new entertainment economy, but, because of the ever-increasing cost of marketing them, they yielded little, if any, profit. Video, DVDs, Pay-TV and broadcast, which have much lower marketing costs, now yielded almost all the profits for the corporate owners of the studios.
The TV dimension
So what is Hollywood’s biggest money-maker: a) movies; b) DVDs; or c) TV?
The best-kept secret in Hollywood, especially from Wall Street, is that the movie studios’ biggest profit centre 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-honoured 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.
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. (see Table 2).
Table 2. 2004 worldwide gross profits for six studios* inflation-adjusted in 2003 (billions of dollars)
| Segment | Gross revenue (MPA) | Est. cost of sales & residuals | Margins (cost as % of sales) | Gross profits** |
| Theatrical | $7.4 | $9.62 | 130% | ($2.22) |
| Video/DVD | $20.9 | $6.95 | 33.3% | $13.95 |
| Television | $17.7*** | $1.77 | 10% | $15.93 |
* Includes all studio subsidiaries (eg, New Line, Miramax and Focus)
** Before administrative, overhead, and organizational charges
*** Includes $1.34 billion in barter sales
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 theatres 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 theatres 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 theatre 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 the 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 analysed these costs, estimate that manufacturing, shipping, and returns costs average 12.4 per cent; marketing, advertising and returns costs average 18.5 per cent, and residuals paid to guilds and unions for their members and pension plans come to 2.65 per cent. So, about two-thirds of video revenues are gross profits (which participants, such as stars, producers, and directors, may share 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 in the US and abroad, especially profitable for the studios is that virtually all the expenses required to market a television programme, 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 per cent. The studios get to keep the other 90 per cent. 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 (see Table 3).
Table 3. 2004 worldwide TV licensing revenue for studios* (millions of dollars)
| Breakdown | 2003 | 2004 | Change |
| WorldPay TV (inc PPV) | $5,600 | $4,000 | -$1,600 |
| US Network (features/shorts) | $801.3 | $680 | -$121.3 |
| US Network (TV programs) | $2,748 | $3,222 | $474 |
| US cable/local syndication** | $2,980 | $4,622** | $1642 |
| Foreign TV (movies) | $1,956 | $2,401 | $445 |
| Foreign TV (TV programs) | $2,052 | $2,514 | $462 |
| World TV | $16,138 | $17,700 | $1,562 |
* Includes all studio subsidiaries.
**Includes $1.34 billion in barter sales for feature films, shorts and TV programmes).
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 programmes 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 two per cent of Americans go to movie theatres, whereas more than 90 per cent watch something at home on TV. And without these profits from TV, no Hollywood studio could survive.
TV’s influence on movies
Even though the television profit centre 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 programmes 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 programmes, 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 US 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 still 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 centred in movie houses has been transformed into a business centred 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 programmes, 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.
Tax shelters
Although it may be difficult to achieve profits from theatrical release alone, the studios still have some impressive accounting tricks up their sleeves to help cushion the blow. Hollywood’s most consistently profitable illusions are not the movies it makes but the movielike shams it puts together with its German ‘partners’. In 2003, German tax shelters, with the aid of German corporate shells and the happy cooperation of American studios, invested some $3 billion in the total fiction that they were owners, producers, and profit-sharers in Hollywood movies.
It works like this: a provision of German tax law allows investors in a German company to take an immediate tax deduction on their film investments, even if the film they’re investing in has not gone into production. In practice, this means that Germans in high tax brackets can borrow a large sum for their ‘investment’ and defer their entire tax bill to a more convenient time.
The American studios, for their part, net between 8 and 12 per cent from these tax-shelter deals – a sum that amounts to several hundred million dollars each year. Since the movie studios do not give up any actual rights or control over their movies, it is ‘money for nothing’, as one Paramount executive explained, adding that his studio made between $70 and $90 million from these tax shelters in 2003 (more than it made on all its movie releases combined).
The beauty of the German tax code, as far as Hollywood is concerned, is that, unlike tax laws in other countries, it does not require films to be shot locally or to employ local actors or personnel. It simply requires that the film be produced by a German company that owns its copyright and shares in its future profits. These requirements have proved child’s play for the savvy legal minds of Hollywood. First, a German tax-shelter fund invests in a German corporate shell. The shell, in turn, buys the copyright for a movie and the right to produce it. Simultaneously, the shell leases the copyright back to the studio and enters into a Production Service Agreement and a Distribution Service Agreement to authorise the studio to produce and distribute the movie. Next, completing the fiction, the studio pays the corporate shell a ‘minimum advance’ in lieu of any actual participation in the movie’s earnings or ancillary rights. In the eyes of German tax authorities, this satisfies the requirement that the German corporation enjoy a share of profits. Finally, at some point, the studio exercises its option to buy back the copyright – and, presto, the German connection with the film, which only ever existed on paper, is nullified. And, of course, since the German corporation paid more for the initial copyright than it ever makes back for it, the studio is guaranteed a profit.
Consider the case of The Lord of the Rings: The Return of the King. A Munich-based tax-shelter fund, Hannover Leasing, had a corporate shell pay $150 million to New Line Cinemas for the movie’s copyright, which it simultaneously leased back to a New Line affiliate. It also entered into agreements for New Line to produce and distribute the movie. At the end of filming, New Line Cinemas paid the German company the agreed-upon minimum advance (which approximately equalled the interest on the initial investment) to honour the pretense that the Germans had participated in the profits. For engaging in these strictly paper transactions, New Line ‘earned’ $16 million, a tidy ‘money-for-nothing’ sum.
The studios have good reason not to talk about the skim they take from German tax shelters. If anyone were to look behind the curtain and see that the wizard is really just a bunch of American studios taking money from German tax shelters, the German treasury, which is the only real loser in this game, might well change the rules and take back the very real German money that makes the American illusion possible.
The indie strategy
In the face of studio ownership of TV outlets and corporate lawyers’ familiarity with every tax loophole going, how can independent features ever hope to compete? Well, the genius of the indie film business lies in its use of Hollywood stars. The same actors and actresses who quote Hollywood studios $20 million per movie will work on indie films for a small fraction of that fee.
Often they accept ‘scale’, as the Screen Actors Guild’s minimum wage of $788 a day is called, or ‘near scale’ of about $10,000 a week plus overtime. Instead of requiring private jets, luxury suites, and multimillion dollar perk packages as they do in studio films, the stars will fly on commercial flights, stay in inexpensive condos and get the same per diem as the rest of the cast. Instead of receiving a sizable chunk of the gross receipts as they are accustomed to on studio films, for indie films stars will accept ‘net points’ (even though they – or their agents – are no doubt familiar with David Mamet’s famous observation that in Hollywood, “there is no net.”).
“The total cost of a star can be less than that of running the office Xerox,” explained one knowledgeable producer. The willingness of top stars – including Keanu Reeves, Mel Gibson, Jim Carrey, Will Ferrell, Drew Barrymore, Al Pacino, Angelina Jolie, Pierce Brosnan, Leonardo DiCaprio, Charlize Theron, Tobey Maguire, Demi Moore, Sean Penn, and Julia Roberts – to work for near scale in the parallel universe of indie films allows indie producers to take advantage of a star’s cachet to finance the movies.
Ironically, in the era of the moguls, the Hollywood studios gained a similar advantage over stars by locking all their actors and actresses into long-term contracts in which they were paid a specified weekly salary regardless of the success of their movies. Since the stars could not work for any other studio, the studios who employed them could create PR images and reap all the benefits of a star’s cachet for themselves. After the studio system collapsed in the late 1940s, the stars, represented by powerful talent agencies, quickly turned the tables on the studios. Now, no longer under studio contract, the stars auctioned off their services to the highest bidder from film to film. The studios still paid for their films’ publicity, but the stars now reaped the benefits of their cachet via product endorsement, licensing their images for games and toys, and a raft of other celebritized enterprises. So, for example, while Warner Bros, Sony, Fox, and Universal collectively invested over a half billion dollars to hammer the super-hero image of Arnold Schwarzenegger into the public’s mind in a dozen different action movies, Schwarzenegger himself got the rewards of his cachet, which included a record-breaking $29.25 million fee for Terminator 3, a personal licensing empire and the Governorship of California.
Commerce and art
Despite the lure of enormous compensation from studios – which now include perk packages and cuts of the gross receipts that can easily exceed $30 million a film – stars find occasional satisfaction in working for coolie wages in indie productions, making a distinction between, as one top CAA agent put it, “commerce and art”. Some stars may find that roles in studio amusement-park movies (that they share with live stuntmen and digital doubles) do not provide the acting opportunities, award possibilities, prestige, camaraderie, or even aura of coolness of indie productions. Others may want to work with a particular director, such as Woody Allen, Robert Altman or David Mamet, or burnish their fading image as an actor. They might also need to fill a hole in their schedule – since, PR hype aside, there is not an endless cornucopia of $20 million parts in Hollywood. Also, when stars do “artistic” films practically pro bono they do not lower their $20 million quote.
Whatever the star’s motives, the indie producers get, if not a free ride, a means of financing their movies through a three-step process called ‘presales’. Here is how it works: Step One. Since indie producers, unlike studio producers, typically cannot get a distribution deal in America before they finish the movie, they raise money by making ‘presales’ abroad. In such an arrangement, the indie producer turns over all rights to exhibit the movie – as well as sell it on DVD and to TV – in a particular country in return for a minimum guarantee of money once the film is completed and delivered. The catch-22 here is that a foreign distributor often will not commit to a presale contract if there is no American distributor or unless the film has a recognisable star (with a star they have at least a chance of selling the DVD and TV rights). So indie producers must persuade or seduce a star into joining the movie – and here is where the genius comes in – for practically no money. With a star in tow, they can often make enough presales to cover most, if not all, of the budget.
Step 2. Since presales are no more than promissory notes, the indie producer must borrow against them from banks to pay for the movie. Before they can do that, they need to guarantee the banks that the movie, once begun, will get finished and delivered to foreign distributors. So they need a completion bond, which guarantees the banks that it will pay all cost overruns necessary to finish the movie and, if the production is abandoned, it will pay all the money lost on the venture, which means that one way or another the bank will get back its money. Two companies, Film Finance Inc and International Film Guarantors, provide almost all the completion bonds for independent productions (studios that internally finance their own movies do not need completion bonds). Before either company will sell a producer a completion bond, they have to meet its requisites, which include buying full insurance for the star (so if they are injured or quit, the completion bond coverer gets all the money back from the insurer) and turning over to the completion bond company the ultimate control of the budget (including the right, if anything goes wrong, to take over the production and bring in its own director to complete it). They also have to pay the company about two per cent of the budget.
Step 3. With the completion bond in hand, and the presales contracts as collateral, the producer then borrows the money from a bank or other financier. Since the completion bond companies are themselves backed by giant insurers, such as Lloyds of London and Fireman’s Fund, the banks take only a very limited risk in making such loans. John W Miller, the head of JP Morgan Securities’ movie financing unit, which last year had $7.5 billion in movie loans outstanding, told me that he does not even “reads the scripts” of the indie films he finances. “My bet is on the solvency of the distributors.” When these presales contracts are with established international distributors, such as Sony Pictures, United International Pictures, Canal Plus, Tojo Films or Buena Vista International, that risk is, he said “negligible”.
Even after scaling all these hurdles, securing the money and making the movie, the indie producer faces one further challenge: getting the movie into American multiplexes. Unlike the studios, which have their own distribution arms and often set a tentative opening date even before filming is complete, indie producers typically cannot arrange American distribution until after they have shot and edited the movie. For many indie producers, finding a distributor requires going from film festival to film festival, an odyssey that often proves unfruitful. More than 2,000 indie films were submitted to the Sundance Film Festival last year, for example, of which about one per cent were accepted. But if an indie movie has a Hollywood star it can improve its chances, especially in those festivals, such as Cannes, Berlin, Venice, and Toronto, that depend on celebrity stars for publicity. The presence of a star not only often fasttracks the film into these festivals, but even more importantly, as one highly-successful indie producer explains, “it gives the acquisition executives there more of an incentive to give the film a chance with distribution, because they figure that even if the film is a hard sell, they can always promote the star. Selling the film ultimately is what it’s all about.” So the Hollywood star as homo ludens, or at least seeking some kind of non-monetary gratification, winds up as the crucial element in a business model that now sustains a large part of independent films – and, for that, we can all be grateful.
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Edward Jay EpsteinEdward Jay Epstein is author of The Big Picture, an account of how the six big Hollywood studios make money. His other books include Inquest: The Warren Commission; News from Nowhere: Television and the News; Establishment of Truth; Legend: Lee Harvey Oswald, and Dossier: The Secret History of Armand Hammer. He lives in New York City. You can buy The Big Picture at www.amazon.com |