The numbers behind the industry.
Hollywood's Death Spiral
The secret numbers tell the story.
screenwriter William Goldman famously explained Hollywood
this way: "Nobody knows anything." He is right—up
to a point. The six giants that dominate the industry (Fox,
Time Warner, Sony, NBC-Universal, Paramount, and Disney)
do not break down the sources of their revenues—even
in their annual reports—into clear-cut categories
such as theatrical release or DVD sales. Instead, they lump
their revenues into vague, larger categories such as "entertainment."
In the case of Paramount, this category includes earnings
not only from a movie's theatrical run and DVDs, but also
from theme parks, foreign movie theaters, music publishing,
and library sales to television.
though the studios do not provide a road map for outsiders
to the precise sources of their wealth, the real numbers
are available in Hollywood. Indeed, every 90 days, each
major studio sends a precise breakdown of all its revenue
from all its worldwide sources, including movie theaters,
video distributors, and television stations, to a secretive
unit of the Motion Picture Association called Worldwide
Market Research, located in Encino, Calif. The unit combines
the data into an All Media Revenue Report and sends it to
a limited number of top executives. As the studios' trade
organization, the MPA presumably can circulate such secret
data without running afoul of antitrust laws. With this
report, the studio executives have a benchmark with which
they can compare their performance to that of other studios
in the various markets. For example, Fox executives can
see how Fox DVD sales in Finland stack up against their
competitors. Studios go to some lengths to keep this data
discrete—each page is stamped "Strictly Confidential—Not
For Further Distribution"—and, in the best Hollywood
tradition of keeping audiences in the dark, the report is
not made available to newspapers, industry newsletters,
or Wall Street analysts.
such information, however, it is impossible to render an
accurate picture of Hollywood. Consider how earlier this
year entertainment journalists rattled on for months about
a slump in the American box office—"Box Office
Slump In Its 19th Week"—as if it were a sporting
event in which the Hollywood studios couldn't get winning
hits. The story would have been different if they had seen
the data on Page 16 in the 2005 Three Month Revenue Report.
(Click here)for that page.) Instead
of a box-office decline, the studios actually took in more
from the U.S. box office in the first quarter of 2005 ($870.2
million) than they did in the similar period of 2004 ($797.1
million). So even though the total audience at movie theaters
declined during this period, this came mainly at the expense
of independent, foreign, and documentary movies. For the
Hollywood studios (and their subsidaries), in fact, there
was no slump at all.
access to the studios' revenue numbers, prognostications
about Hollywood become little more than the blind leading
the blind. While the media would be very cautious about
projecting automobile sales trends without industrywide
data (which Detroit provides), it is a different story when
it comes to Hollywood. For example, following a DreamWorks
Animation announcement that Shrek 2 DVD returns wiped out
much of its first-quarter earnings in 2005, the Wall
Street Journal ran the headline: "In DreamWorks
Earnings Woes, A Bigger Problem: Sales of 'Shrek 2' DVD
Suggest Format Is Peaking As Hollywood Profit Center."
The story speculated that the Shrek 2 DVD returns (as well
of those of The Incredibles DVD) "may be the
front-end of an even bigger problem: a general slowdown
in DVD sales growth."
problem with that theory is that returns are not necessarily
a measure of the public's appetite for DVDs. Even many of
the biggest-selling DVDs have substantial returns. Indeed,
it is built into the business model. Since the manufacturing
cost of a DVD is relatively low ($1.85), studios often "channel-stuff"
by shipping as many DVDs to retailers as they can while
setting up reserves in their accounting—usually between
20 percent and 30 percent of sales—for returns. As
it turns out, even with some 7 million returns (which was
20 percent of the total sale), Shrek 2 actually
outsold the original Shrek in similar time periods.
The Incredibles was also one of the biggest titles in history,
selling (after returns) 17.7 million DVDs. In any case,
the attempt to divine an overall "slowdown" in
DVDs from the sales of any particular title is dubious:
No one knows whether consumers who elected not to buy the
title in question bought another title instead (in which
case overall sales would be unaffected). To assess a "slowdown"
or "peaking," one would need the results of all
the studios' sales over a comparable time period. Fortunately,
this information is available in the 2005 Three Month Revenue
numbers tell the story. In the first three months of 2005,
the studios earned $5.67 billion dollars from DVD sales,
compared to $4.375 billion in the same period in 2004. DVD
sales were up $1.29 billion, an incredible rise of 28 percent,
which exceeded last year's increase. So there was hardly
a slowdown in DVD sales. (Click here
for the numbers behind the rise of the DVD.) Indeed, DVDs
alone now provide 59 percent of the feature film revenues
of the studios, as opposed to 48 percent in 2004.
The real issue that emerges in these secret industry numbers
is not the rise of a new format. Just as the DVD replaced
VHS, a more efficient digital format will eventually replace
the DVD. (A high-definition digital recorder with massive
storage is already available in the United States and Japan.)
What has inexorably changed is the location of the studios'
crucial audience. In 1948, with studios earning all their
revenues from the box office, that audience was moviegoers.
Even as late as 1980, when the audience had television sets
and video players, studios still earned 55 percent of their
money from people who actually went to movie theaters. In
2005, however, those moviegoers provided the studios with
less than 15 percent of their worldwide revenues, while
couch potatoes provided it with 85.8 percent.
change in audience location altered the balance of power
inside the studios. It reduced the once-almighty movie distribution
arms to minor players while awarding star status to the
home entertainment divisions that produced well over three
times as much revenue. Through this reversal of fortunes,
the stage has been set for what a top studio executive warned
could be "Hollywood's death spiral."
The spiral begins with a shortening of the delay, or "window,"
that separates a movie's theatrical release from its video
release. In the early 1980s, in order to avoid having new
movies in theaters compete against themselves in video,
pay-per-view, pay TV, or free television, the studios set
up a series of insulated windows for each format. The video
window opened six months after the theatrical release and
four months before the pay-per-view window. With Warner
Bros. leading the charge, DVD cracked the video window.
Since Warner Bros.' strategy involved selling massive amounts
of DVDs on the first day of its release, by 2001 they had
effectively shortened the window to five months so they
could market the DVDs of summer blockbusters at Christmas
studios followed suit with a vengeance, shortening the window
to four months—or, in a few cases, three months—in
order to sell Thanksgiving-released children's movies at
Christmas. Even worse, the home entertainment divisions
began to announce an upcoming DVD while the movie was still
playing in theaters. For example, this July, only four weeks
after opening The Adventures of Sharkboy and Lavagirl
in 3-D, Buena Vista trumpeted the coming release of
the extras-loaded DVD. Even if only a small percentage of
moviegoers decide to wait for the announced DVD, it leads
multiplex chains, which need to maximize their popcorn sales
to stay in business, to cut the run of the movie in their
premium theaters. The shorter the run, the less money the
title takes in at the box office. As this spiral accelerates
and studios earn a larger and larger share of their money
from home entertainment, it adds to the pressure on studios
to further reduce the video window. How far can this cycle
go? After Hong Kong collapsed its video window in 2002,
there was a 70 percent reduction in theater attendance.
And, as a top studio executive pointed out after studying
the problem, "A 6% reduction in attendance in 2000-2001
led to half the movie theaters in the world going bankrupt."
How will Hollywood get out of the death spiral? "That
is the $64 billion dollar question," he replied. (Stay
tuned for the answer next week.)
[back to archive]