Download The Cost Disease is Alive and Well and Living in the Theatre

Is Making Movies All That Different Than Making Plays?
Analysis of Cost Structure in Film and Live Theatre
Dr. Anna P. Della Valle*
Presented at
The 14th Biennial Conference of the Association for Cultural Economics International
Vienna, Austria
July 6-9, 2006
* School of International and Public Affairs, Columbia University; Telephone: (917) 864-4430
Email: [email protected]; Mailing address: 20 West 77th Street, 7th floor, New York, N.Y. 10024
Introduction
This paper focuses on the similarities and differences in the cost structures of film and
live theatre. The line of inquiry of the paper is as follows: there are certain categories of
costs that are very similar in both industries. These are: (1) the production costs
associated with making a film (excluding photography, editing and post-production costs)
or mounting a play; and (2) the costs associated with marketing and advertising the
venue. In both industries, these categories of costs involve similar properties, issues and
risks (prevalence of the cost disease, super star phenomenon, high demand uncertainty.)
Beyond these costs, the film1 industry is characterized by three other categories of costs:
(3) the costs associated with actually filming and editing the movie, i.e. producing the
“negative”; (4) prints, i.e. the costs of making prints of the movie; and (5) distribution,
i.e. the cost of distributing the movie through movie theatres, television, home video and
the internet. Negative and print costs do not pertain to live theatre because of the largely
irreproducible nature of the medium2. Distribution costs in the film business are the costs
associated with reaching audiences. As such, I suggest that they are comparable (in terms
of the function they serve) to operating costs in live theatrical productions.
The paper analyzes on how similarities and differences in these cost categories affect the
film and theatre markets, particularly with regard to: contractual terms, audience reach,
profitability, risk, demand uncertainty and the ability to capitalize on “hits.”
I. Yet Another Look at the Dismal “Economics” of the Theatre
To illustrate the dismal economics of the performing arts, one need only take a look at the
most successful of the performing arts venues: Broadway theatre.
During the 2003-2004 season, Broadway ticket sales totaled 11.6 million, generating
revenues of $771 million (www.LiveBroadway.com, 2005.)3 Broadway shows on the
road accounted for an additional 12.4 million tickets, generating additional revenues in
excess of $700 million (League of American Theatres and Producers, April 2005, p. 2).
But the overall economics of Broadway is not very rosy. As shown in the attached chart,
over the last 10 years, annual revenues from all Broadway plays barely covered expenses4
(League of American Theatres and Producers, March 2004, p. 20 and www.Live
Broadway.com, 2005).
In this paper, I use the terms “film” and “movie” interchangeably.
I confine myself here to “live” performing arts venues, putting aside for the moment the filming or
recording of performing arts venues (e.g. musical or opera on DVD or television and musical recordings.)
3
Musicals accounted for 10 million of the tickets sold and $683 million of the gross revenues in 20032004.
4
Notwithstanding the overall sad economics of theatrical productions, occasionally there are shows that are
phenomenally successful (“hits”). For example, the musicals Cats, Les Miserables, the Producers and
Phantom of the Opera each ran for over 10 years on Broadway and were extremely profitable (Vogel
2004, p. 440.)
1
2
Broadway Costs and Revenues
800
700
$ millions
600
500
Total Costs
400
300
Revenues
200
100
0
1996-97
2000-01
2002-03
Year
This is all the more true for off Broadway productions. In 2001, total box office revenues
for Off Broadway totaled $554 million against total costs estimated at $923 million
(TheatreCommunications Group, 2001—as reported in Vogel, 2004, p. 427). Thus,
earned income covered barely 60% of total expenses. The difference was made up by
contributions (public and private). Indeed, a 1993 study by Rosenberg and Harberg,
which analyzed theatre data over a period of 50 years, found that 76% of musical
comedies and 80% of stage plays did not earn back their investment (Caves, 2000,
p.120.)
A. Production vs. Operating Costs in Theatre
To better understand the underlying economics of these art forms, it is instructive to take
a closer look at the cost breakdown between production costs and operating costs
associated with Broadway plays (League of American Theatres and Producers, March
2004, p. 20.)
Broadway Costs
800
700
600
500
S millions 400
300
200
100
0
Operating Costs
Production Costs
1996-97
2000-01
2002-03
Year
This cost breakdown suggests the following observations:
(1) Operating costs dwarf production costs. This is due to the labor-intensive
requirements of live theatre, the presence of unions, and the cost of theatre space.
(2) Depending on the nature of the performance, theatre size and ticket prices, operating
cost breakeven average in the range of 60-80% of seating capacity (Farber 2005, p. 46
and Appendix H, I and Vogel 2004, pp. 434-435.)
(3) Recovery of any portion of fixed costs is secondary to recovery of operating costs and
therefore is highly dependent on filling the theatre over breakeven capacity.
(4) Operating costs have to be incurred whether the theatre is full or not.
A useful way of interpreting operating costs in the theatre is that they are the costs
associated with reaching audiences. I wish to distinguish here between the costs of
reaching audiences and attracting audiences. One may argue that: (a) production costs,
including a great script, advances to secure top actors and directors, costumes, sets and
the like contribute to attracting larger audiences and (b) targeted marketing of the venue
can influence audience size significantly. However, whether or not these costs contribute
to a flop or a runaway hit, the point still remains that reaching audiences requires
incurring weekly operating costs. Furthermore, reaching larger audiences requires
moving to a larger theatre (if the nature of the performance permits it), extending the run,
or taking the show on the road. In all three cases, this involves incurring additional
operating costs. The nature and size of those costs, and the extent to which they are
characterized by economies of scale or scope, differ depending on which of these options
is chosen (Taalas, 1997, pp. 346-347 and Gapinski, 1980, pp. 583-584).
B. Cost Structure in Theatre
Producing and distributing a play involves a series of interconnected arrangements or
contracts between the various parties involved, including investors, producers, actors,
writers, directors, stage hands, theatre owners, and the like. From the point of view of the
investors in a play, the costs associated with producing a play and the nature of the
contractual arrangements are approximately as follows (Farber 2005, pp. 7-11 and
Appendix I; Caves 2000, pp. 116-117):
Option cost: the investor/producer secures an option on a script, book, score or idea and
usually pays a small upfront fee to the holder of the rights to the work in question for the
right to produce the play for a given period of time.
Royalties: In acquiring the option to produce the play (or use the optioned property in the
play), the investors agree in addition to pay a royalty to the holder of the theatrical
property. Royalties are paid either (a) as a fixed percentage of gross box office receipts,
in the range of 2.5 to12.5% in total5, or (b) on a so-called royalty pool formula which
involves a fixed percentage (usually 40%) of net box office receipts after the deduction of
weekly operating costs. The proceeds of the royalty pool are shared among the holders of
the theatrical property (e.g., authors, composers, lyricists). The royalty pool formula was
developed as a way to reduce risk to investors who complained that they rarely recovered
their investment, even when all of the other participants were made whole.
Payment to theatre owners: Up until the late 1970s, theatre owners retained 25-30%
share of gross box office revenue for providing the theatre space, ushers, box-office staff
etc. This changed in the late 1970s, when theatre owners decided to “separate their
landlord and risk-bearing roles” (Caves, 2000, p. 117), shifting to a two-part fee structure
5
Depending on the fame/reputation of author/originator of the theatrical property.
involving a fixed fee to cover variable and fixed theatre costs (rent, insurance, mortgage
and personnel) plus a 5-10% share of gross box office revenues (theatre owner rate).
Weekly operating expenses: These include expenses associated with performing the
play, including salaries, rentals, insurance and costs associated with the theatrical space.
Marketing and advertising: Baring special arrangements, these costs (which can be
substantial) are borne by the play’s investors.
Let:
Q = quantity of tickets sold
T = average price of ticket
OE = operating expenses
Theatre owner rate: 5%
Royalty rate: 6%
Royalty pool rate: 40%
Then, from the point of view of investors, net revenues after payment of weekly
operating expenses and royalties is given by:
(a) If royalties are calculated as a % of gross box office receipts:
QT – OE - .05QT - .06QT =
.89QT - OE
(b) If royalties are calculated using the royalty pool formula:
QT – OE – 0.05QT – 0.4(QT – OE - .05QT) =
0.57QT – 0.6OE
These are the net revenue from box office sales from which investors must fund
marketing and advertising, recover production costs, rehearsal costs, any advances paid to
secure top actors and directors and, if there is anything left over, make a profit. I have
presented the cost structure in this way to emphasize that cost recovery in the theatre
business is highly dependent on operating costs. As is evident from comparing the net
revenue formulas in (a) and (b) above, the royalty pool formula effectively shifts some of
the risk/reward associated with operating expenses from investors to the other
participants (theatre owners and royalty recipients.) Nonetheless, in both cases, the
ability to recover fixed costs and/or make a profit depends on: the number of tickets sold
(Q), the ticket price (T) and the size of the operating expenses (OE).
At this point, we may be tempted to argue that:
(1) THIS is the problem with the economics of live theatre: the operating costs associated
with delivering this type of creative output are so high that it is extremely difficult to
recover production costs (let alone make a profit) unless the performance is close to sold
out over relatively long periods of time;
(2) The problem is exacerbated by the realization that there are serious limitations to
increasing audience size and thus ticket sales (Q).
(3) This problem is exclusive to the live performing arts and is not shared by the media
arts and, in particular, by the film business where operating costs are much lower and
audience size is significantly larger.
The purpose of this paper is to address these issues by taking a closer look at the cost
structure of the film business.
II. Cost Structure in the Film Business
The process of making a movie is characterized by the following sequence of activities
and their corresponding costs:
(1) Production--This includes: (a) story rights acquisition: concepts, books, screenplays;
(b) pre-production: script, set design, casting, crew selection, costume design, location
scouting; (c) above the line inputs: creative elements without which the film could not be
made: actors, directors, writers, producers; and (d) below the line inputs: other elements
necessary to make the film: sound, wardrobe, set design, special effects.
(2) Post production--editing, dubbing, titling, additional special effects, sound track,
scoring
(3) Prints--printing and copying the negative itself
(4) Marketing and Advertising
(5) Distribution
Production, marketing and advertising activities in the film business are very similar in
nature to those associated with the live theatre business. Post production and prints are
costs that pertain exclusively to making films and have no direct equivalent in live
theatre. Distribution costs are costs associated with reaching audiences and, as such, are
analogous (within the cost structure) to operating costs in the theatre. In the following
sections, I analyze each of these cost categories in the film business and compare them to
the corresponding cost categories in the live theatre business.
A. Production Costs
A substantial portion of the production process in film is very similar to the production
process in live theatre. It involves scripts, actors, directors, sets, costumes, lighting and
sound.
“The production side of the industry is quite similar, in an economic way, to stage
production.”(Johnston, 1926, p.22)
“The production of movies and plays follows similar time lines, with successive
creative decisions and economic costs sunk.” (Caves, 2000, p.103).
Furthermore, the evolution of the contractual terms between the various participants
involved in the production process is also very similar:
“Contracting processes for cinema films and Broadway plays thread their way
through this minefield of problems, including the participation of humdrum
lenders and highly risky projects.” (Caves, 2000, p. 103).
Indeed, according to Caves, these inherent similarities in the production processes are due
to the fact that all creative industries are characterized by the same seven basic properties:
1. The “nobody knows” property: creative goods are characterized by highly uncertain
demand and “symmetric ignorance” on behalf of both the creators and the consumers of
the creative output.
2. The “art for art’s sake” property: creative workers care passionately about their
product and this affects their creative effort.
3. The “motley crew” property: creative products require combining diverse types of
creative and humdrum skills and inputs.
4. The “infinite variety” property: creative products span a very wide range of possible
varieties.
5. The “A-list/B-list” property: creative inputs are subject to vertically differentiation
with respect to their quality.
6. The “time flies” property: due to the presence of high fixed costs, delays that postpone
the generation of revenue are very costly.
7. The “ars longa” property: creative products are durable and command durable rents
for their future use or representation.
In discussing these properties, Caves reiterates how they apply equally to the performing
arts and the media arts:
“Note that the preceding seven properties make no distinction
between…’popular culture’ and ’high culture’”…[S]tage plays require a motley
crew of creative and humdrum inputs similar to the cinema film.” …“Many
creative products are durable: not the symphony or play or ballet performance
itself, which dies with the last reverberation in the hall, but the symphony’s
published score, the play’s script, the ballet’s choreography which are all
durable goods in that they can command royalties in the future for the rights to
use them again and again” (Caves, p. 9).
B. Marketing and Advertising Costs
Marketing and advertising costs (ads) can account for well over 50% of a film’s
production budget6. Recent data on ads costs indicate that, increasingly so, they tend to
be tied not to the production cost but to the expected gross receipts collected by movie
distributors (i.e. how widely the film will be distributed), amounting to up to 40 percent
of such costs. In live theatre, marketing and advertising can be sizeable, amounting to
almost 30% of production costs. (Vogel, 2004, p. 434 and Farber, 2005, Appendix H, I).
C. Post Production and Prints
Specific to film only and tied to the reproducible nature of the technology itself.
D. Distribution Costs
Distribution costs are the costs associated with reaching movie audiences via movie
theatres, television, home video and the internet. In this part of the paper I confine
myself to distribution via movie theatres. Distribution costs in the movie business are
similar to operating costs in live theatre in two important respects:
(1) With regard to distributing movies in movie theatres, they include the costs
associated with owning/renting and operating the movie theatres themselves;
(2) Because of the contractual nature of the production/distribution/exhibition
functions, distribution costs are directly tied to and increase with the increase in
audience size.7
But they differ from operating costs in live theatre in three important respects:
(1) They do not include the (substantial) costs associated with repeating the live
performance night after night
6
Average ads spending per major film releases in 2002 amounted to $27.3 million per film on an average
production cost of $58.8 million—i.e. right around 50%. (Vogel 2004, p.90)
7
Thus, although it is likely that there are substantial economies of scale and scope associated with
distribution, this type of analysis does not capture those economies. They are instead captured as profits for
the various participants who are able to take advantage of them at various stages in the distribution process.
(2) Distribution costs are incurred only if additional viewers actually see the movie,
i.e. they are incurred for each additional movie viewer.
(3) The presence of significant non-theatrical distribution outlets (other than movie
theatres) such as video, DVD, television and the internet.
I suggest that distribution costs are the major cost element that distinguishes the film
business from the live theatre business (and, more generally, the media arts from the
performing arts):
“The production side of the industry is quite similar, in an economic way, to
stage production…But, as soon as positive prints of the motion picture show
(the negative) are made and the films go in the cans, the business enters a
regular industrial phase. This phase is characterized by distribution…”
(Johnston, 1926, p. 22).
To better understand the nature of the distribution function in the film business, it is
necessary to analyze the contractual terms that underlie it.
E. Contractual Arrangements Underlying Distribution of Films To Movie Theatres
Distribution of films to movie theatre audiences8 involves a series of contracts between
the producer, the distributor and the exhibitor of the film. The contract terms are
approximately as follows9:
- The distributor arranges for and organizes the printing of the film for distribution.
The cost of prints is pretty much fixed and usually in the range of $3-4 million per
film.
- The distributor organizes and incurs the costs associated with marketing and
advertising the movie (known as “ads” in the film business) so as to distribute the
film as widely as possible10. Recent data on ads spending indicate that they are
tied to expected film revenues, amounting to approximately 40% of distributors’
gross receipts (Vogel 2004, p. 159 and Baumgarten 2004, p. 61).
- The distributor identifies key target markets in which to preview and exhibit the
movie. It then contracts with domestic and foreign movie theatres for release and
exhibition of the movie.
- The exhibitor (owner of the movie theatre) normally retains up to 50% of the box
office revenues on a sliding scale basis11, after recovery of fixed costs such as
location rent, electricity, insurance and mortgage payments—also known as the
exhibitor’s “nut” (Vogel, 2004 p. 95).
- On the remaining 50% or so of box office revenues (known as gross receipts or
rentals) the distributor retains distribution fees of approximately 30% for domestic
8
I will consider other distributions outlets (television and home video) later in the paper.
In describing the contractual arrangements, I separate out the individual roles and contract terms
associated with production, distribution and exhibition, putting aside for the moment the fact that these
functions may be performed by the same entity or by different subsidiaries of the same holding company.
Indeed, as I will address later in the paper, consolidation in the industry has led to many examples of media
conglomerates involved in one or more aspects of production, distribution and exhibition. (Baumgarten,
2004, p. 75, 84-87.)
10
The decision to spend more or less on ads is a risky one which sometimes pays off and at other times eats
away at profits or increases losses.
11
That is, the percentage retained by the exhibitor may start lower (10-20%) in the first few weeks of the
movie’s release, eventually reaching 50% in later weeks, depending on the film’s success and the nature of
the contract between the exhibitor and the distributor.
9
distribution and 40% for foreign distribution, after recovery of prints and
marketing and advertising expenses (Baumgarten, 2004, p. 58-59.)
This structure is in part similar to the contractual structure in stage productions, with the
theatre owner in lieu of the distributor + exhibitor. Like the distributor, the theatre owner
retains a portion of the box office receipts for “distributing” the play. Beyond this role
played by the theatre owner, the contractual nature of the distribution function in live
theatre differs from that in the film business in three important respects:
(1) Marketing and advertising costs are the responsibility of the investors/producers
of the play (rather than the distributors);
(2) The distribution function involves incurring weekly operating expenses associated
with repeating the live performance; and
(3) The only way to distribute the play more widely is to extend the run, move to a
larger theatre or take the play on the road.
F. Simplified Algebraic Model of Cost Structure in the Film Business
Total costs in the film business are the costs associated with production + distribution of
the movie. In what follows, I develop a simplified algebraic model of this cost structure.
Production Costs
Production costs include all of the direct costs associated with literally producing a
negative of the movie. Over and above the direct cost of producing the negative, movie
studios normally add to production costs an allowance for costs associated with studio
overhead and interest. Overhead costs usually range between 12.5 and 15% of direct
negative costs as a means of recovering costs not associated with making the movie but
nonetheless necessary to running a movie studio. Interest is usually calculated at 200
basis points above prime rate over the period of time necessary to film and edit the movie
(which can be years) as a measure of the opportunity cost of capital used up in the
making of the movie. (Baumgarten 2004, pp. 61-62.)
Let:
N = direct costs of producing the film negative
r = prime rate
y = number of years to produce the negative
Thus, production costs = N + 0.15N + 1.15N (r +.02)y
Distribution Costs
The costs associated with distributing the movie to movie theatres12 are given by the costs
associated with making prints, marketing and advertising the film, and distributing it for
exhibition in domestic and foreign movie theatres.
Let:
Qd = quantity of domestic tickets sold
Qf = quantity of foreign tickets sold
Td = average price of domestic movie ticket
Tf = average price of foreign ticket price
P = cost of making prints of the film for distribution
Ads = marketing and advertising costs incurred by the distributors.
12
Ignoring discounting
Using the above notation and incorporating the contractual arrangements described in
section E, yields:
Distribution Costs = P + ads + 0.5 (QdTd + QfTf) + 0.3 (0.5 QdTd) + 0.4 (0.5QfTf)
Prints and ads
Exhibition13
Domestic Distr.
Foreign Distr.
As explained above, recent data on ads suggests that on average they amount to
approximately 40% of gross receipts. Thus, we can rewrite the above as:
Distribution Costs = P + 0.4 (0.5QdTd + 0.5QfTf)+ 0.5 (QdTd + QfTf)+ 0.3 (0.5 QdTd)
+ 0.4 (0.5QfTf)
Thus, the total cost associated with producing, marketing and distributing a movie (in
movie theatres) is given by14:
TC = N + 0.15N + 1.15N (r +.02)y + P + 0.4(0.5QdTd + 0.5QfTf)+ 0.5(QdTd + QfTf) +
+ 0.3 (0.5 QdTd) + 0.4 (0.5QfTf)
To simplify the analysis, let:
Qw = the number of tickets sold worldwide
Tw = average price of a ticket worldwide
0.35 = average worldwide distribution cost percentage
Then, total cost can be rewritten as:
TC = N + 0.15N + 1.15N (r +.02)y + P + 0.4(0.5QwTw)+ 0.5(QwTw) + 0.35 (0.5
QwTw); or
TC = 1.15N(1+r + .02)y + P + 0.2(QwTw) + 0.5 (QwTw) + 0.175(QwTw)
TC = 1.15N(1+r + .02)y + P + 0.875(QwTw)
And:
Marginal Cost MC(Qw) = 0.875Tw
Average Cost AC(Qw) = [1.15N(1+r+.02)y + P]/Qw + 0.875Tw
That is:
(1) The MC of reaching an additional viewer is equal to approximately .875 of the
additional revenue (ticket price) associated with reaching that additional viewer.
(2) AC(Qw) consists of a fixed cost and a variable cost component. The fixed cost
component reflects the cost of producing the negative and prints. The variable cost
component reflects the cost of marketing and distributing the movie to movie audiences
in theatres. As the number of tickets sold worldwide Qw increases, the fixed cost
component declines (towards 0) while the variable cost component stays constant. Thus,
13
For simplicity, I assume that the exhibitor retains on average 50% of gross box office receipts including
recovery of fixed expenses (the “nut”).
14
In modeling the cost structure in this way, I have assumed that audience size (Qd + Qf) is exogenously
determined. One could argue that the nature of the investments made in production (superstars, director,
script, special effects, etc.) will affect audience appeal and audience size. However, the film business, like
the theatre business is characterized by high level of demand uncertainty (the “nobody knows” property)
which can justify treating demand as exogenously determined and not directly associated either with
negative or ads costs: “[T]he movie industry is complex and often operates on the edge of chaos in the
midst of uncertainty…Seemingly sure-bet, big budget films with “bankable” stars flop, low-budget titles
with no stars sometimes inexplicably catapult to fame…” (Vogel 2004, p. 108)
AC(Qw) does not approach 0 as Qw. The lower limit of AC(Qw) is 0.875 of the ticket
price Tw. Given an average ticket price in the US of $5.81 in 2002 (Vogel, p. 60), this
means that as Qw , AC(Qw) approaches but does not fall below $5.08.
These results are viewed from the perspective of the film producer under the assumption
that the film producer has no participation in exhibition or distribution. Note that,
viewed in this way, exhibition and distribution are costs to the producer, whereas they are
revenues to the movie distributors and movie theatre owners. The ways in which costs
(and revenues) are divided up is dependent on the contractual arrangements among the
various participants to the film production, exhibition and distribution process.
G. Profitability Analysis in the Film Business
From the producer’s point of view, profitability is given by the difference between total
revenue and total cost or between average revenue and average cost per ticket sold times
the number of tickets sold. The average revenue per ticket is the ticket price Tw. Thus,
the producer’s profit per ticket is given by:
AR(Qw) – AC(Qw) =
Tw – {[1.15N(1+r + 0.2)y + P]/Qw + 0.875Tw} =
0.125Tw – [1.15 N(1+r)y + P]/Qw
As Qw increases, profitability per ticket increases, reaching a maximum of .125Tw or
12.5% per ticket sold.
This simplified profitability analysis provides the following interesting insights:
(1) Contrary to popular belief, the average cost of a film does not approach $0/viewer as
the number of viewers reached increases because, although fixed production costs do
indeed decline towards $0/viewer, reaching additional viewers involves incurring
additional exhibition and distribution costs.
(2) Profitability is directly tied to the percentages taken by exhibitors, distributors and the
size of marketing and advertising expenses. This suggests the following incentives and
strategies for increasing profit potential in the movie business (see Table 1 and Graph 1):
(a) Since costs as well as revenues are based on ticket prices, increasing the ticket
price will increase the $ profit per ticket but will not increase the rate of profit
per ticket sold.
(b) A reduction in the percentage of box office receipts retained by exhibitors will
increase profitability. For example, decreasing the average exhibition
percentage from 50% to 40% of box office receipts significantly increases
profitability potential from 12.5 to 30%.
(c) A reduction in the percentage of gross receipts paid to distributors will further
increase profitability. For example, decreasing the average distribution
percentage from 35% to 30% further increases potential profit to 32%.
(d) Reduction in ads costs, particularly once it is clear that the film is a success,
significantly increases profitability15. For example, reducing ads costs from
40 to 30% of distributors’ gross receipts further increases potential profit to
36%.
15
If the movie is a success and the number of tickets sold worldwide increases, it is likely that the %
increase in ads expenditures do not remain constant relative to gross receipts but rather decline significantly
(“the movie sells itself.”)
Table 1: Calculation of Profit Potential in Movie Business
Ticket price
Base
Case
$5.81
Increase
Ticket
Price 10%
$6.39
Decrease
Exhibition
10% pts.
$5.81
Decrease
Distribution
10% pts.
$5.81
Decrease
Ads
10% pts.
$5.81
Distributor % of gross receipts
35.0%
35.0%
35.0%
30.0%
30.0%
Exhibitor % of box office
50.0%
50.0%
40.0%
40.0%
40.0%
Ads as % of gross receipts
40.0%
40.0%
40.0%
40.0%
30.0%
Contribution to Average Cost per ticket (%)
Exhibition costs
Distribution costs
Ads
Total
50.0%
17.5%
20.0%
87.5%
50.0%
17.5%
20.0%
87.5%
40.0%
14.0%
16.0%
70.0%
40.0%
12.0%
16.0%
68.0%
40.0%
12.0%
12.0%
64.0%
Contribution to Average Cost per ticket ($)
Exhibition Costs
Distribution costs
Ads
Total
$2.91
$1.02
$1.16
$5.08
$3.20
$1.12
$1.28
$5.59
$2.32
$0.81
$0.93
$4.07
$2.32
$0.70
$0.93
$3.95
$2.32
$0.70
$0.70
$3.72
Maximum profit potential per ticket (%)
Maximum profit potential per ticket ($)
12.5%
$0.73
12.5%
$0.80
30.0%
$1.74
32.0%
$1.86
36.0%
$2.09
Graph 1
$/viewer
Average Cost
$5.81
average ticket price
PROFIT
$5.08
$4.07
$3.95
$3.72
Number of viewers/t
(3) This profitability analysis is performed from the point of view of the movie producer,
assuming that the producer must contract with separate distributors (and they with
separate exhibitors) to market the movie domestically and internationally. Considering
the significant risks associated with movie production (particularly in a “nobody knows”
world) and the higher percentages retained by distributors and exhibitors, there is a
powerful incentive for the industry to spread risk and returns by consolidating both
horizontally as well as vertically into production + distribution + exhibition. In fact, the
industry has been characterized by a significant amount of consolidation, particularly
since the easing of antitrust restrictions16. In the United States, seven major theatre
chains (some owned or partly owned by media conglomerates also involved in production
and distribution) own or control approximately 65% of the movie screens and account for
at least 80% of movie exhibition revenues. On the production-distribution side, the
industry is dominated by six major producers-distributors that produce, finance and
distribute their own films but also finance and/or distribute films produced by
independent filmmakers (Vogel 2004, pp. 48-49.)
H. Film Distribution to Television, Home Video and Internet
The above analysis was confined to movie distribution to domestic and foreign movie
theatres. Adding in television, home video (VCR and DVD) and merchandising revenues
adds significantly to the revenue stream associated with a successful movie. The major
area of distribution growth has been from home video rentals and sales, which for almost
two decades has surpassed theatrical sales as a percent of total revenues. Home video
accounted for 38.2 % of total revenue sources in 2000 (versus 7% in 1980) while
domestic and foreign theatrical accounted for 29.4% of total revenue (versus 52.4% in
1980) (Vogel 2004, p. 68.) The availability of these additional distribution sources for
reaching audiences significantly improves the economics of the film industry, particularly
for films that are initially successful at the box office (“hits”.) Again, however, the extent
to which this affects the profitability of the various participants involved depends on the
nature of the contractual arrangements between them and the degree of vertical
integration in the industry. Needless to say, most major film studios and/or distributors
either own their own video distribution company…or have a very favorable output deal
with a video distribution company (Baumgarten 2004, 151.)
The availability of these additional distribution options can also benefit the not-sosuccessful films, which can thus rely on television and home video to enhance their lessthan-stellar performance at the box office. As a result, even “losers” at the box office
may be able to recover their costs or even make a profit thanks to these alternative means
of reaching audiences. Finally, the increase in the scale of movie distribution options has
enhanced the so-called “superstar phenomenon.” As the market expands, so do the
potential gains for the most talented (or well-known) screen actors, thereby increasing the
rents that they are able to command (Rosen, 1981, p. 856.)
III. Implications of Distribution Options On Uncertainty and Risk in the Film
Business Versus the Live Theatre Business
The availability of these extensive distribution options has important implications not
only for the profitability potential of film and other media arts but also for the degree of
uncertainty and risk associated with them. Film, like live theatre, suffers from the
16
In 1948, the US film industry was subject to antitrust laws that restricted major film studios from owning
and operating movie theatres and governed how distributors placed movies in theatres (United States v.
Paramount Pictures, Inc. 334 U.S. 131, 1948). Over the past 60 years, these rules have been eased in the
light of significant changes in the film and television markets. However, aspects of the rulings still apply.
See and Conant, 1981 and Orwall and Lippman, 1999.
“nobody knows” property, i.e. extreme uncertainty as to the extent to which the movie
will appeal to audiences. However, once it becomes clear that a movie is a “hit” (which
occurs very soon after its release), then, in fact “everybody knows” and the extensive
distribution options allow the movie producers/owners to capitalize on the movie in a
very significant way:
“it is the combination of two properties that make movies so exciting: First
movies are experience goods—you know their quality only after you have
experienced them…Second, at the time the movie is released almost all costs
have been sunk and quantity can be adjusted practically without bounds. Thus,
uncertainty is extreme; everything can happen...” (Schulze 2005, JCE
introduction)
One may argue that size and longevity of audience appeal for “hits” in the performing
arts may even be greater. Consider the longevity of Tennessee Williams’ plays,
Balanchine’s ballets and Andrew Lloyd Weber’s musicals and, even more so for
performing arts masterpieces, such as Beethoven symphonies, Mozart operas, and
Shakespearean plays. They are characterized by extreme “ars longa” property, which
lasts across decades or, even, centuries. However, the ability to capitalize on the
audience appeal of these “hits” in the performing arts differs from that in the media arts
in several important ways:
(1) With the exception of performing arts that are amenable to reproduction via
technology (musical recordings, opera and some theatre and ballet on video, DVD or
television) the magnitude of the distribution options for the performing arts are much
more limited.
(2) The success of performing arts venues is often closely tied to the presence of “stars”
which requires those stars to continue to perform in the “hit” roles. Substitution of the
stars with other actors/singers/dancers is not always a guarantee of continued audience
appeal. For example, the popularity of hit musical “The Producers” in New York
declined significantly after the departure of stars Nathan Lane and Matthew Broderick.)
(3) A large proportion of the revenues and profitability associated with a hit movie are
reaped fairly quickly (e.g. over the first 24 months) after a film’s release. By contrast,
revenues and profitability associated with performing arts hits are spread out over a much
longer period of time. For example, Les Miserables’ impressive box office revenues of
$1.8 billion were spread out over a period of 15 years, from 1987 to 2003 (Vogel, 2004,
p. 440.)
(4) The spread-out nature of the revenue stream in the performing arts makes them more
susceptible to changes in tastes, which may undermine the performing arts venue’s
continued audience appeal. Films are equally susceptible to changing tastes but, from a
profitability perspective, this is less of a problem because such a large proportion of the
revenues are generated up front.
(5) Like some movies (Casablanca, the Godfather), some performing arts masterpieces
(Shakespeare, Pirandello) seem never to lose audience appeal. The movie studios that
hold the rights to these classic hits can continue to enjoy the revenues associated with
rerelease, television and home video viewing. This is more difficult for the originators of
the performing arts masterpieces, particularly if the royalty rights associated with them
have long expired. They continue to generate revenues but these are spread among new
participants (actors, directors, producers, distributors, etc.)
Conclusion
Closely analyzing the cost structures of live theatre and film and the contractual terms
that underlie them provides important insights with regard to similarities and differences
between the film business and the business of live theatre. Notably among these are:
1. Both industries are characterized by costs associated with production, distribution
and exhibition.
2. The production process is quite similar in both industries. This is in large
measure due to the fact that both industries share the fundamental characteristics
of creative industries.
3. The distribution process is the process by which the movie or play reaches
audiences and is fundamentally different in the two industries. In theatre,
distribution requires incurring weekly operating costs associated with performing
the play. In film, it is characterized by a distribution network via movie theatres,
television and home video. The ways in which the costs and revenues associated
with the distribution function are shared between the various participants (i.e. how
the pie is divided up) depend on the contractual terms between them. It is
important to note that distribution costs (or revenues, depending on whose
perspective is taken) are (a) directly tied to the size of the audience reached and
(b) represent a large part of the pie. As such, distribution has become the most
lucrative part of the business and explains in large measure the motivation for
consolidation and vertical integration in the film business.
4. The cost disease lingers both in the media and performing arts and is tied to the
labor-intensive nature of the production process in both industries. Indeed, in the
film business, the cost disease has been exacerbated by the ability of “superstars”
to extract formidable rents as film distribution options have expanded. On the
other hand, in the theatre business, contributions to the cost disease are present
not only in the production side of the business but also in the distribution side of
the business because “distributing” live theatre involves incurring ongoing
operating costs associated with doing the show over and over again.
5. The extent to which the distribution options of live theatre (as well as ballet,
symphony and opera) can be improved via larger live venues (e.g. La Traviata
performed in Rome’s soccer stadium) or via television, home video and
recordings17 can contribute significantly to improving its underlying economics.
6. We must recognize, however, that there are serious limitations to the expansion of
these alternative distribution options for live theatre (and the performing arts
generally—with the possible exception of opera18) due to: the nature of the
medium itself which does not lend itself well to large spaces or to be filmed,
televised, watched on video or DVD. Furthermore, unlike film, successful live
performances involving language (as opposed to music or dance) cannot easily be
“dubbed” and exported to other countries. All of these factors make it difficult to
capitalize on “hits” in ways that are available in film and, therefore, compensate
for the risks associated with a “nobody knows” world.
17
In a recent attempt to attract new and younger audiences, some Broadway producers have struck deals
with movie theatre companies (Loews and AMC) to market their hit tunes in movie theatres (Blankenship,
2005.)
18
DVD sales of live opera performances (as opposed studio recordings) have risen significantly in recent
years. Due to the substantially higher cost of studio recordings and the public’s taste for opera DVDs
(“People are listening with their eyes”), some industry experts expect DVD sales to soon replace studio
recordings (Gennusa, 2005, p.5.)
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