Hollywood's Morality Play

Financial Times
August 25, 2006

by Edward Jay Epstein

The Hollywood Economist

The numbers behind the industry.
In the fantasy industry of Hollywood, where public relations is often the
dominant coin of the realm, Sumner Redstone, chairman of Viacom , moved with great dispatch to put a favourable spin in the loss of its Paramount studio's single largest rain-maker, Tom Cruise. He told the Wall Street Journal, for example, that the reason for Mr Cruise's departure was his public antics, explaining: "We don't think that someone who
effectuates creative suicide and costs the company revenue should be on the
While Mr Redstone might have temporarily succeeded in diverting the media
by his personal attack on Mr Cruise, the underlying reality of the decision
is that Paramount has not only lost its most successful producer,
Cruise-Wagner Productions “ which produced over three years crucial
tentpole films such as War of The Worlds, around which Paramount hung the
television and foreign sales of its other films but its lost its only
successful long term franchise. (Paramount's desperate attempt to revive
Indiana Jones has been blocked by its inability to get a script approved by
Harrison Ford, the film's star).  Of course, battles
between studios and stars have been part of Hollywood history ever since
the end of the studio system in 1948,  but the Cruise-Paramount conflict
which had been going for six months concerned a radical change in the
studios division of profits:the back-end DVD revenues. The decision to end Cruise's contract , despite Mr Redstone's jibes, was, to quote The Godfather, "Not
personal, Sonny; it's strictly business."

In reality, Mr Cruise did not work for Paramount. His company had a
long-term first-look deal with Paramount under which, in return for
giving Paramount first-bid option on its projects, Paramount paid for
Cruise/Wagner's office and other overhead costs and contributed to revolving fund to buy properties.. According to an ex-Paramount executive, the outlay, which came to between $5m-$8m a year,
was "small change" for Paramount. The real problem was the basic contract
that Mr Cruise applied to all his movies with Paramount.
The good news is that Mr Cruise takes no cash fee up front for either his
acting or producing role, which otherwise would be between $35million plusper
film, so the films are easy for a studio to finance. The bad news is that
Mr Cruise gets some 22 per cent of the gross revenues received by the
studio on the theatrical release and the television licensing. Even worse,
from the studio's point of view, is Mr Cruise's 12 per cent cut of
Paramount's total DVD receipts.

What most stars, directors, writers and other Hollywood participants get is
a cut not of the DVD revenue itself, but of a 20 per cent â "royalty". The
other 80 per cent goes to a wholly-owned subsidiary of the studio called
the home entertainment division. In other words, in the conventional deal
that has existed since the 1970s, one arm of the corporation collects all
the money from DVDs, and then pays a mere 20 per cent of it to the studio,
which then becomes the "gross" number that the studios reports to
participants. The justification for this system was that, unlike other
rights, such as television licenses, which require virtually no sales
expenses, DVDs have to be manufactured, packaged, distributed and marketed.
So, usually stars, directors, writers, investors, actors, guilds, pension
funds and other gross participants get their share of just the 20 per cent
royalty.  For example, if a star has a 10% participation, he gets 10% of only the 20% royalty, or 2% of the DVD revenues.   But not Mr Cruise. He insisted on and gained in his first
Mission: Impossible deal "100 per cent accounting", which means that the
studio, after deducting the out-of-pocket manufacturing and distribution
expenses, paid Mr Cruise his 22 per cent share of the total receipts.. As a result, Mr Cruise earned more than $70million on Mission: Impossible, and he opened the door for stars to become full
partners with the studio in the so-called back-end.
After DVD profits began altering Hollywood's profit landscape, and because
it was complicated to track all the expenses, Mr Cruise revised the deal
with Paramount. His cut of the gross was increased to 30 per cent and, for
purposes of calculating his share of the DVDs, he accepted a "royalty" but
it was doubled to 40 per cent. So, he would get a whooping 12 per cent of
the total DVD receipts with no expenses deducted by Paramount. From the
DVDs alone, Mr Cruise gained over $30m on Mission: Impossible II. With
Mission: Impossible III, Mr Cruise still got his huge percentage of the
gross, although both Mr Cruise and Paramount were disappointed with the
theatrical gross , even though it is Paramount's highest grossing
film in 2006. Mr Cruise blamed Paramount, whose new regime headed by Brad
Grey, had fired a number of Paramount's top marketing and distribution
executives in Europe, and Paramount blamed Mr Cruise's tiffs with the
The bottom line was that Paramount could not make much of a profit from
even a high-grossing film like Mission: Impossible 3 with Mr Cruise getting
a 40 per cent royalty of DVD sales. When Mr Cruise refused to reduce his
cut, Paramount "played hardball", as an executive put it, and lost the
Mission Impossible franchise. Faced with this disaster, Mr Redstone turned
it into a morality play, with himself in the role of Mr Morality.

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