The Interview

The movie industry today faces a genuine threat to its existence. Thanks to a decade of willful blindness, the studios have failed to create a coordinated response to the transformation of almost every aspect of its century-old way of doing business imposed by digital technology. Distribution fiefdoms are a relic of the past. Copyright protection is under assault, increasingly from legitimate, not just illegitimate, sources. Most crucially, an industry that has sold its products on an à la carte basis through a series of carefully spaced windows that—in theory—maximized its profits is now facing the reality of all-you-can-eat subscription pricing in the form of Netflix and others.

All of this might be manageable were the studios not run by people who have been permitted to combine, to a shocking degree, shortsightedness, cupidity, and often downright venality. Why do I say “permitted”? Because every major studio apart from Lions Gate is a subsidiary of a diversified media company with shareholders. I believe it is the studios’ overseers who have, for a variety of reasons, essentially abandoned their normal governance roles. (From personal experience, I know that all of the many attempts by parent companies to rein in studio excesses have foundered on the rocks of the studios proclaiming “this is how it is done in Hollywood.” More to the point, the only real method of control corporate HQ enjoys over the operating companies is allocation of new capital. While the amounts may be paltry, the studios, by managing in most years to generate some positive net cash, leave their overseers with little means of direct control.)

How did Hollywood dig itself into this hole? By the mid-Nineties, just as the run of profits from VHS was running out of gas, along came DVDs. It was one person, Warren Lieberfarb, the head of Warner Home Video, who did the near-impossible: he got all the other studios to look—momentarily—beyond their narrow self-interest and work for the industry’s collective greater good. As a result, DVD replaced VHS, and at its peak became more than twice as big and roughly three times as profitable.

Snowpiercer

Based on Motion Picture Association of America data, not all of which is public, DVD sales deposited roughly $150 billion of total gross revenue into the studio coffers from inception in 1997 through this past year, of which nearly $100 billion was “profit,” or what the industry calls home video’s “contribution margin”—meaning that a significant portion of this profit, the part from each year’s new releases, went toward the production and marketing of next year’s upcoming slate. But a large part (the release of older, fully-paid-for library titles on DVD) was almost pure profit. In line with classic studio management practice, Lieberfarb’s reward for making the biggest single contribution to industry profits ever was to be fired in 2002, at the height of DVD’s success.

The dirty little secret of film industry financial reporting is that the studios, to differing degrees (a large degree for Warner and Disney, less for the others), start each year with an assured flow of profit from their libraries, carried on their books at valuations that average $1.5 billion. Thus what each media company reports as its “Filmed Entertainment” profits is, by and large, library profits, less what it blows on that year’s production slate. Astronomical DVD profits allowed Hollywood to go on the equivalent of a binge of pure crack cocaine. What happened to that $100 billion of incremental profit? It simply got built into the cost structure of new productions, with $100 million budgets becoming the norm and $200 million pictures ever more frequent.

There was one problem: around 2007, the home-video market started cratering. Again based on non-public MPAA figures, the major studios hauled in about $17 billion from worldwide home-video in 2007, and by 2014 that figure had fallen to around $10 billion. Meanwhile studio spending—in pursuit of gross but not net—has continued on its merry way, with the studios dialing back on low- and medium-budget films and maintaining a steady stream of releases with ever-increasing average budgets and a needless P&A spend that inflates the gross but does nothing for net profits—from the publicly disclosed $35 million per film in 2007 to a reliably estimated $50 million average today. (A top marketing expert has told me that, today, spending $80 million just to open a picture in North America is no longer unheard of.)

A Most Violent Year

While the studios’ sins are mostly ones of omission, they have one giant mea culpa to answer for: Blu-ray. By 2005, digital delivery of movies via iTunes and other services was clearly going to make the leap from being a computer-tethered medium to encompassing a growing variety of mobile devices and, very soon, the TV set. What was the studios’ response? Blu-ray, a moderately enhanced format but, critically in the consumer’s eye, more expensive than the DVD. Sony and Disney, with Fox close behind, saw Blu-ray as a chance to feather their nests and did so in the face of advice from a raft of experts who said this simply wouldn’t fly with a public who knew streaming was on the horizon. And so, eight years after its introduction, Blu-ray constitutes only about one-third of the tired DVD format, while the entire revenue for packaged goods (DVD plus Blu-ray) is down over 40 percent from its pure-DVD peak in 2006.

That said, the industry did not entirely ignore the need for a joint digital strategy. As early as 2002, three years before iTunes began offering videos, five of the then-majors—Sony, Warner, MGM, Paramount, and Universal—cobbled together a plan to offer streaming content under the name Movielink. But after $100 million-plus of investment and a crucial approval of the joint venture from the Justice Department in 2004, the entire enterprise was stillborn for a variety of technological and business reasons, with inter-studio squabbling chief among them. In a final bit of delicious irony, Movielink was sold to Blockbuster (!) for $7 million, a few years before its final bankruptcy.

Ten years on, as the industry watches the remains of the DVD/Blu-ray business disappear, it is imperative that the studios come up with a collective strategy for digital delivery. Jeff Zucker, when he was CEO of NBC, famously referred to “trading digital dimes for analog dollars.” It’s not quite so bad as that, but here’s the real point: selling someone a movie for $10-15 brought in real bucks, but renting them entire libraries in the form of streamed files is a two-bit business. And what makes the industry’s failures far less forgivable is the advantage it enjoyed having watched the cautionary example of the music industry’s decimation at the hands of iTunes and others unfold some four years before.

Boyhood

Given this sea change, some say that bringing in the very modest—but more or less consistent—profits that most of the studios have generated is a praiseworthy accomplishment. I disagree. They have eaten their seed corn, during what I fear will be seen as a period of relative prosperity in the near future, when practically everyone will be able to select from a vast choice of on-demand movies for a flat—and reasonable—monthly fee. The studios’ dream of everyone paying $14.95 to buy and store a digital copy of a post-theatrical release has proved to be just that—a dream.

But enough macro talk. In ascending order of culpability, let’s rate the individual studios on their financial performance over the last decade.

Disney: The one shining star among the majors. Bob Iger made three gutsy acquisitions, all of which Wall Street questioned: between 2006 and 2012, he shelled out $15.4 billion in stock and cash to buy Pixar, Marvel, and Lucasfilm. The first two purchases have already been vindicated beyond measure, with Pixar revitalizing a moribund Disney animation unit thanks to Tangled, Wreck-It Ralph, and Frozen. And the Lucasfilm buy is another smart bet on the value of unique content. This year’s profits may have zoomed in part thanks to last year’s Frozen, but the future looks bright.

Lions Gate: Doing the remarkable, it has joined the ranks of the majors following its cash purchase of Summit Entertainment for $412.5 million in 2012. Summit had achieved mini-major status with four Twilight films in just four years; when combined with longtime mini-major Lions Gate and its Hunger Games franchise, together they became the first new true major since Disney became self-distributed in 1953. While we saw Twilight’s last gleaming in 2012 and the presumed last of The Hunger Games debuts in November, Lions Gate’s no-nonsense approach, on the New Line model, and its strong home-video (particularly digital) exploitation of a solid library should carry them well past the expiration of these franchises. While their profitability is nothing special at the moment, they show every sign of improving it to achieve stability and remain in the club.

Universal Pictures: Since its acquisition by NBC/Comcast in 2011, nearly all of the old guard is out with TV veteran Jeff Shell put in charge two years later. While the history of television operators running movie companies is decidedly mixed, there can be no quarreling with the results at Universal. In 2014 they released 14 pictures without a single franchise tent-pole and had a very creditable year: at an average budget of $33 million, nine of their top 10 grossers brought in just under $200 million each in worldwide box office. Comcast is clearly determined to run the studio as if it were a business—a goal that many have pursued only to be shipwrecked on the intractable mores of Hollywood. I sincerely wish them good luck.

21st Century Fox: This is the name by which the public company is now known, but the studio is still, tellingly, stuck in the 20th Century. Fox is every Wall Street analyst’s poster child of the well-run studio. Not mine—I’d call it a well-spun studio. Its ostensibly superior operating profit margins (14.9 percent last year compared to an average of 9.1 percent for its six competitors) are, I am reasonably certain, due to its TV production arm, whose numbers are firmly embedded in their Filmed Entertainment totals. Fox has the virtues of a certain consistency until you dig a little deeper. In fiscal 2010, it had $7.6 billion in revenue and $1.35 billion in EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). Four years later, revenue is up by an impressive $2.1 billion but profits have only risen by $9 million, or about one-third of the CEO’s annual total compensation. That’s good management?

Warner Bros.: Proudly claims that it has been the number one or number two studio in worldwide grosses in nine out of the last 10 years, but their P&L (Profit and Loss) Statement shows the hollowness of the brag. Their marketing is a juggernaut and their spending legendary, ensuring that the top line is rosy. The bottom line? Not so much. In the fall of 2014, WB’s new-ish CEO Kevin Tsujihara, in a rare moment of unguarded candor, revealed to the financial community that motion pictures represent only about 40 percent of their total reported Filmed Entertainment operating profits. As revenue from films (new releases plus their vast library with its built-in profits) accounts for an estimated 60 percent of that total, the world learned for the first time just how puny their movie margins are—about eight percent, with WB’s TV production/distribution activities probably earning double that rate. Since their grosses are first-rate, Warner is emblematic of the industry’s biggest problem: box office “winners” that don’t particularly win.

Sony Pictures Entertainment: What does the departure of Amy Pascal and her 25-year career at Sony—10-plus as head of the Motion Picture division—tells us about the state of the industry? Reading the encomia that accompanied her exit, I thought: “Am I the only person who has looked at the actual financial record of SPE under her (and Michael Lynton’s) leadership?” SEC documents reveal that in 2007 Sony showed revenue of $8.6 billion and operating income of just $580 million. Six years later, those figures have never been bested and, for the latest fiscal year, had slipped to $8.3 billion and $516 million, respectively. One needn’t be a moralist of the first rank to carp at the levels of compensation that the studios routinely provide, irrespective of actual performance. But the near-automatic awarding of absurdly lucrative “independent producer deals” upon departure has made getting fired the holy grail of every senior executive in Hollywood. The gold standard for such deals is Peter Chernin’s when he left Fox, or News Corp. as it was then known, in 2009. He was widely lauded for a successful 20-year run, much of it as Rupert Murdoch’s number two; sadly, it wasn’t a great run for News Corp. shareholders, whose stock fell 70 percent over that period, while the overall stock market more than doubled.

Paramount Pictures: Parent company Viacom breaks out its numbers for Paramount’s moviemaking operations, shorn of any confusing TV production, offering a gift to students of the quirks of the film business. They aren’t pretty. Since 2008, per public filings, revenues have fallen every year but one, decreasing from $6.0 to $3.7 billion, and during the same period, almost inexplicably, home-video revenues have plummeted from $2.7 billion to just under $900 million. The overall DVD market decline of some 30 to 40 percent since 2008 accounts for only about half of this drop. For “managing” this calamity, Brad Grey is—per a number of sources of widely varying reliability—paid a reputed $15-20 million a year in total comp.

The Imitation Game

Okay, all these play-money figures are fun to toss around, but here’s why anyone with a serious interest in film should give a damn. Surprisingly, the big-picture units of the majors contributed five titles to FILM COMMENT’s Best Films of 2014 list. Most studios still make the occasional film with appeal to what the late, great Warner production chief John Calley called “the three-digit crowd” (referring to IQ points). But this is not why we need to care about whether the studios succeed in their primary mission, i.e. getting a decent return on the average $15 billion each of them carries on its balance sheet as the total assets of its Filmed Entertainment division. If they continue to earn such incredibly subpar returns on their purely commercial titles, the willingness of their notoriously unsentimental but strangely lackadaisical parent companies to allow them to keep their specialty film divisions alive, or to make the occasional venture into Paul Thomas Anderson Land, will be in jeopardy. In 2008, nine different studio specialty affiliates released a total of 79 films; by 2014, only three such smaller picture affiliates remained, releasing just 34 films.

Two of them, Fox Searchlight and Sony Pictures Classics, accounted for eight out of Film Comment’s top 50 titles. Fox Searchlight will have no difficulty justifying its existence to its overlords with no costly flops and the massive profitability of The Grand Budapest Hotel ($175 million worldwide), Birdman ($69 million and counting), and last year’s 12 Years a Slave ($188 million). Co-Presidents Nancy Utley and Steve Gilula should have the safest jobs in town. Sony Pictures Classics presents a more complex situation: lots of small, modestly budgeted pictures aimed at the cinematically literate minority of the audience, with the hope of the occasional breakout. Making critical faves is nice, but they have to pull in more than awards. SPC has released 84 films over the past five years, averaging $3.6 million at the North American box office. As someone who has greatly enjoyed many of these pictures, I sure hope that the Culver City and Tokyo bosses continue to answer in the affirmative the question I am left wondering: is this a business?

The massive scale of waste at the studios, the various negative trends afoot in the business, and the seeming paralysis at the top of both the studios and their corporate parents in counteracting those trends will all, I believe, come together in the relatively near future to work serious visible hardship on these companies. When this happens, I am certain that the first victims will be not the tent poles, but the “little” pictures. Moreover, I suspect that this current generation of studio executives will find themselves viewed, a decade or so hence, the way the aging moguls in the Fifties and Sixties were seen by the Seventies generation of filmmakers and executives—dinosaurs who couldn’t imagine that their way of life was about to be swept away. They thought that spectacle and theatrical innovation would get people away from their television sets—and spent lavishly to prove it. By 1969, every major studio had either changed hands at paltry prices or was in receivership. This will not be their exact fate today, but I sure would like to know how to short Malibu real estate and Lamborghini stock.