30 June 2014
A REDEF ORIGINAL: Part II - How The Major Studios Can Drive Domestic Growth
By: Liam Boluk and Prashob Menon
In our last piece, we confronted the fact that the US film industry has stagnated: underlying demand continues to fall, with (nominal) revenue growth held-up only by a mix of population growth and pricing increases. In this piece, we put forward five ways the Majors can drive growth – and discuss one logical, but ultimately ineffective option.
#1 New Release Models and Capturing Lost Spend
If we accept the premise that per capita consumption of theatrical entertainment is unlikely to rebound, the question then becomes how studios can bolster film revenues that are outside the theatrical channel. A more constructive way to think about this is “how can studios take advantage of improvements in home theaters” or better still, “how can studios derive value from increased entertainment consumption in the home.” Aside from failed initiatives such as UltraViolet, studios have yet to tackle either question in a meaningful way.
Meanwhile, the trends behind each question have cost the majors more than $25B in revenues to date. The addition of newer film distribution models, such as OTT video or digital downloads, have offset only a fraction of the physical film sales they have cannibalized. Much of this has to do with the economics of services such as Netflix, which charges consumers an effective price per film watched that’s far lower than Blockbuster or Best Buy historically charged. But the studios too, hold blame, having offered no compelling alternative to Netflix’s AYCA library. Fortunately, this inaction does allow us to peer into the upside left on the table.
Despite inflation of 13% since 2007, the average household spent nearly 25% less on recorded entertainment last year – representing a decline of over $55 for each of America’s 116M homes. This leads to one of Hollywood’s most promising and controversial opportunities: “Premium Video on Demand”. PVOD would enable households to rent On Demand films that are still showing in theaters, but at a significant premium to today’s VOD prices (or theater tickets). In doing so, studios would be able to confront declining interest in theatrical entertainment, address vast improvements in home theaters and potentially reclaim lost household spending.
Yet, PVOD isn’t a new idea. In 2011, Universal planned a pilot in which Tower Heist would be available to Comcast’s Portland and Atlanta subscribers only three weeks after its theatrical release for $59.99. The plan led several theater chains, which operated a combined 25% of all screens in the United States, to threaten a boycott of the film. Universal subsequently scuttled its planned trial, but stated that it “continues to believe that the theater experience and a PVOD window are business models that can coincide and thrive and we look forward to working with our partners in exhibition to find a way to experiment in this area in the future.” National Association of Theater Owners CEO John Fithian offered an olive branch in his public reply, stating “…Many theater owners could not ultimately support (the proposal), (but) the open and collaborative nature of the dialogue is appreciated. NATO recognizes that studios need to find new models and opportunities in the home market, and looks forward to distributors and exhibitors working together for their mutual benefit.” Despite this apparent commitment, nearly 2.5 years have since passed during which there has been no mainstream PVOD release or attempt.
The business case for studios is relatively straightforward: Will PVOD revenues cover cannibalized box office receipts? With the average American watching fewer than 4 films per year, it does seem unlikely that PVOD would cause significant cannibalization. Certain films, such as Gravity or Iron Man 3, demand theatrical consumption. Other films are seen on the Big Screen simply because it’s a night out, date or simply “something to do”. PVOD’s price point (likely 4-8x the cost of an average theater ticket) will also dissuade home consumption, as would a 2-3 week release lag. The real issue is the imbalanced consequences. On an $8 admission price, film distributors collect roughly $4.40, with the theater chain retaining the balance. The studios therefore risk cannibalizing only that $4.40 per would-be viewer. Theater operators, however, miss out on both its $3.60 share and high margin confections and arcade games, which generates an additional $4.00 per ticket (a total 72% more than the studios).
This amplification means that theater operators will (understandably) treat any disintermediation with hostility, no matter how few tickets are at stake. What’s more, boycotting a mid-budget comedy such Tower Heist is far more painful for the studio/distributor than it is for a theater operator. Were AMC Theaters to boycott The Avengers, would-be customers would undoubtedly flee to the chains that didn’t – but theater operators trust that no studio would risk harming their tentpole franchises.
As a result, establishing a PVOD solution will require the scaled might of multiple studios and a more comprehensive release plan than a single pilot test, studio or film. It may also mean increasing the theater operator’s share of tickets sold for films that are offered PVOD, though the rationale will be hard for distributors to accept.
Film ownership and renting will likely continue to deteriorate as it’s substituted for lower-value OTT consumption, thereby drying up lucrative ancillary revenue and letting billions of household spend disappear. If theatrical entertainment were a growth business, studios could afford to shy away from the opportunity. Today, however, they need to get moving.
#2 “Non-Traditional” Release Dates
Our entertainment lifestyle has evolved tremendously over the past decade. We now consume more content than ever before, on an ever-expanding set of devices and can do so when and wherever we like. The proliferation of these enabling technologies (video game consoles, smartphones, digitally distributed content and content providers) is likely at the heart of declining US per capital film consumption. While the Big Screen remains the premier way to consume content, its comparative advantages have diminished as the flexibility and breadth of its substitutes waxed. Given all of this change, it’s incredible to see how the industry adheres to release strategies established more than 35 years ago:
As studios force filmmakers to abandon 35mm for digital reels, they remain fixated on another age-old idea: the “best” (or most promising) films should be released during one of only two periods: Summer (primarily May, June and July) and late November to Christmas Day. One would expect these two periods to be over-indexed given the prevalence of vacation/time-off, but the persistence of this trend is remarkable. Even as the majors, their subsidiaries and leading indie competitors have increased their collective film slate by nearly 1.5x, executives remain convinced that their properties can only achieve mass market success in 5 of 12 months. This is particularly surprising given the fact audiences don’t ‘flex’ to the quality/quantity of films available at a given time. Cramming another film to the summer or winter season – however good – rarely convinces the average American to purchase another ticket. Given per capita consumption trends, this should be obvious.
Despite the concentration of film consumption, the theater’s primary (and growing) substitutes are consistently consumed throughout the year. According to Nielsen, Q1 television time actually exceeded Q4 by an average of 1.7% over the past five years – and this was the most significant quarterly variation. Netflix even releases its marquee original series, House of Cards, in February. The major television networks are also aggressively expanding into the summer – a time once relegated to television reruns and ceded cineplex blockbusters. This begs the question as to whether 1980s industry axioms have become largely circuitous inevitabilities. Studios release their biggest films in the summer because that’s where the biggest audience is – but the audience is there to see the films the studios scheduled in the first place.
If studios want to reverse decline per capita trends, they’d be better off of getting movie-goers to attend when they usually don’t (or don’t have much of a reason to), rather than attend more films when they do. The Majors are understandably reluctant to release its hottest franchises in non-traditional periods. Yet, with Summer and Christmas so brutally competitive and increasingly-failure prone, launching an already established property weeks away from real competition could be lucrative. Distributors should take note: the final chapter of the Hunger Games (2013’s domestic box office champion), Pixar’s The Good Dinosaur, the first entry in the new Star Wars trilogy, Kung Fu Panda 3, Mission: Impossible 5 and Inferno (the second sequel in Dan Brown’s Da Vinci Code franchise) will all be released within 30 days of one another during November-December 2015.
#3 Improving the Reliability and Comfort of the Theatrical Experience
While nearly 93% of theater screens in the United States and Canada have been upgraded to digital (up from only 14% five years ago), these improvements pale in comparison to that of ‘home theaters’. Plummeting prices, soaring quality and shrinking equipment has reduced the experiential difference between enjoying a film in the theaters versus in the ‘comfort of your own home’. The Big Screen continues to be the best way to consume sweeping landscapes and frenetic action scenes, but in many instances the home experience is now good enough. In response, theaters need to do more than screen upgrades and odd seat improvements.
First, they should expand the availability and usage of advance seat selection. In doing so, theater operators will reduce consumer fears of receiving a poor seat and eliminate the need for time-wasting queues. As a result, would-be movie goers will be more confident that the theater experience will outmatch the one they’d have at home.
Second, theater operators need to invest in bigger, more comfortable and recline-able seating. Most theaters seats pale in comparison than their in-home counterparts (not to mention the inevitable basketball player sitting in the seat directly in front of you). With seat occupancy at record lows, theater chains can dismantle many of their Ryanair configurations and redeploy otherwise-unused space up to revenue-generating customers. Not all of a theater’s screens should be converted to ‘deluxe’ seating – opening night/weekends for major blockbusters routinely sell out. As such, theater operators should retain some of their configurations for blockbusters in their first one to two weeks of release, after which the film can be transitioned to ‘deluxe’ seating theaters. Those going opening weekend are the least likely to be dissuaded by cramped seating, while the added comfort may help convince on-the-fence or word-of-mouth driven viewers to watch in theater.
For each of the past three decades, movie tickets have remained largely price inelastic. While consumption has declined roughly 12.5% since 2003, prices have increased at nearly 3x that rate – a gap greater than the industry has ever experienced. This presents both a liability and opportunity for the theater business. Such inelasticity is unlikely to continue ad infinitum: theatrical substitutes continue to proliferate and challenge the medium’s value-per-dollar. At the same time, theatrical inelasticity undoubtedly varies between different film categories (an indie film versus a mega-blockbusters, for example), as well as individual films themselves. Yet, this upside has remained uncaptured for decades due to one of Hollywood’s most bizarre predilections: flat pricing.
Despite the dramatically different cost profiles, target markets and demand for motion pictures, film-to-film pricing remains largely flat nationwide. This is obviously inefficient. The average American may only attend four films per year, but it’s not unreasonable to believe that their willingness to pay for one to two of those films - such as The Hunger Games or Frozen – exceeds that of average films. IMAX and 3D have enabled some price discrimination, but the issue remains as widespread as it is significant.
Studios and theater chains have been reluctant to raise prices because of the inherent chaos involved with the shift. Not only would take time for new price points or tiers to equilibrate, executives are afraid of the implications of price on film positioning. Is a less expensive film worse or just niche? How will an extra dollar – or five – impact customer satisfaction and willingness-to-recommend? Theater operators are particularly afraid that increased ticket prices (55% of which they pay out to the distributor) will cannibalize higher margin concession revenue (of which they share nothing). Of course, almost every other consumer media segment deploys variable pricing. Moreover, consumers have not only embraced tiering, but also accepted routine re-tiering – whether that’s an app, song download or Netflix subscription. Yet, introducing a new pricing scheme is far more disruptive than modulating an existing one.
All of these concerns are valid – but the industry will need to do more than fret impossibilities if it hopes to sustain growth despite declining ticket volumes.
#5 More Bundled Experiences
As I explained in a previous piece, bundling offers studios a unique opportunity to stimulate (or sustain) theatrical attendance. It also comes in two varieties: storytelling and pricing. By integrating various multimedia products at the story, rather than promotional level, studios can make seeing a film in theater a true “must see event” for franchise fans. Marvel’s TV series Agents of S.H.I.E.L.D., for example, teed up Captain America: The Winter Soldier and was itself fundamentally affected by the film’s events. Though the show’s relatively modest ratings limited its total effect on Captain America’s box office gross (which did break the record for an April release), it nevertheless helped fans stay engaged in the Marvel Cinematic Universe over the five month’s since its last theatrical entry. Studios can also encourage theatrical consumption by offering a variety of bundled packages (e.g. a discounted 3 in 1 package contain a video game, 6 month comic subscription and movie ticket) or offering theatrical discounts with the individual purchase of those same products. This will come at the expense of margin, but it also allows studios to directly market to its most likely customers, many of whom would otherwise wait until the film was available On Demand (or The Pirate Bay).
#6 Indie Acquisitions
Acquiring independent studios is a seemingly sensible way the Majors can fight stagnation – especially given the massive increase in the number of independent studios and films. While the strategy has paid dividends in the past (Warner Bros. pre-Lord of the Rings purchase of New Line was particularly profitable), it provides only short-term improvements. This is to be expected. An indie acquisition provides the acquiring studio with two primary assets: talent and pipeline. Over time, the independent studio’s talent tends to move up into the acquiring studio or leaves the subsidiary altogether (or in the case of Bob and Harvey Weinstein, goes on to create a new independent competitor). The indie’s pipeline, too, eventually run outs or its IP is subsumed by its corporate parent. As a result, the subsidiary eventually finds itself competing against sister subsidiaries and independent competitors with no distinct raison d'être.
While these can still reflect successful acquisitions, they have not driven growth for the Majors. The Big Six control roughly the same share of the market today as they did before their subsidiary strategy took off on the 1990s/early 2000s. Given the increasing indie fragmentation, the Majors may also struggle to achieve comparable acquisition success in the future.
The Big Six studios face a difficult challenge: How do you sustain theatrical revenue growth despite persistent volume declines? Fortunately, they do have a number of opportunities, but they require fundamentally reconstructing a channel that hasn’t changed since the Supreme Court forced the major studios to sell their theaters 67 years ago. Hollywood has no trouble imagining the future. It’s time they made it.
@Liamboluk / firstname.lastname@example.org